What’s a central bank supposed to do?

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Now, we've been talking a lot on this humble podcast recently about Donald Trump's efforts at a hostile takeover of the Federal Reserve, the central bank of the mighty US of A.

One thing that may not be obvious though, when you really, really think about it, is why this stuff actually matters.

Why is independence important at a central bank?

Is it important?

Today on the show, we're going to answer exactly that.

This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin.

I'm Katie Martin, a markets columnist at the FT in Soggy, London.

Now, it always helps when you're talking about something complicated like this to talk to an expert.

And let me tell you something, listeners, that is not Robert Armstrong off of the unhedged newsletter.

But he is here anyway.

It is, however, Brendan Greeley, formerly of this parish at the FT, who has forgotten more about the history of the Fed than Rob or I will ever know.

Brendan, I heard that you were coming on the show today fully 20 minutes ago, but it's a total delight to speak to you.

How are you?

I am so excited to be here.

I'm a frequent listener of this podcast.

I can't believe I get to be here with the great Katie and Rob.

No, flattering.

Well, sorry, I'm sorry.

I get to be here with Katie and the great Rob, or the great Katie and Rob.

So, Brendan, kindly lay out your credentials in this matter.

You know stuff about this stuff, right?

Yeah.

So

I covered the Fed for Bloomberg Business Week and then Bloomberg Television and then for the Financial Times for about 10 years.

And over that time, I began to realize that there was something that I was missing, that there was a language that I had learned from economists about how the Fed works that sort of stopped making sense to me.

And it stopped being good at predicting what was happening.

And it stopped being good at explaining why certain things were happening when the Fed acted the way it did.

So I went back to school.

I am currently getting my PhD in the history of finance and money at Princeton.

And I have passed my general exams.

which involves reading a pile of 200 books.

It's an exquisite torture that you pick out for yourself and been examined on their contents.

And I am currently writing a dissertation.

You know, most people,

when they find something doesn't make sense to them, they just change the topic, Brendan.

They don't get a PhD.

You know, it seems like a very extreme response.

I mean,

it is.

It is, Rob, but I will take that point from literally anyone else on this line.

I think you have a PhD in philosophy.

I do.

I made the same mistake that you did, but I had the excuse of being young when I did it, whereas you're doing it when you were old.

So, Brendan, let's get to it.

I am worried about

the Trump administration trying to take over the Fed.

Most

recently, they're literally going around in Fed governors' dirty laundry to find out things they can fire them for.

And I think this is an awful development.

And it makes me worry about things like inflation.

It makes me worry about a whole range of things.

Are we right to be as worried as we are?

Yes, absolutely.

And you're also right to point out that what happened with Lisa Cook is different from any kind of political pressure on the Fed that's that's gone before.

And we can talk about the long history of politics in the Fed, and the Fed is not blameless in that long history.

But what happened with Lisa Cook, I sort of feel uncomfortable talking about the specific allegations because that's clearly not the point of them.

Yeah, it's utterly irrelevant what it is that he found.

The point is to do two things.

One is to sully her and to see whether he can get her to climb down on her own.

Thankfully, she seems to have decided not to do that.

I do wish that the Fed had put out a more full-throated defense of her.

But the other thing that this accomplishes is it puts everybody else in the entire Federal Reserve System on notice.

Whatever secret you might be covering up, up, that's not even a secret, that's not even, it's anything that might make you look

awkward.

Anything, yeah.

We will find it and we will make it public.

And in the meantime, the way you prevent that from happening is doing exactly what we've made it clear we want you to do.

One thing I think is useful to kind of back up into is like for markets people, the Fed is the Fed, right?

It's just like a mountain.

It's a thing that exists on the earth like a natural phenomenon.

But actually, it's like gravity.

It's as close to gravity as we have in finance.

It's like, what is gravity in finance?

It's the Fed funds rate.

Yeah.

Right.

But it's almost like, you know, almost nobody can articulate how a toilet works.

You know, we just know that they do.

Similarly, we just know that the Fed chucks out interest rates, and that's kind of the extent to which a lot of people worry about it.

But like,

how did it come about?

When did it come about?

What kind of, where did it get its power from?

At some point, sovereigns began to realize that banks were powerful.

and the best way to control banks so that they did things you wanted them to do was to have your own big bank and to give that big bank the imprimatur of the sovereign so if we look at the original charter of the bank of england in 1694 i have it i pulled it up it says a bunch of stuff then it offers a purpose towards the carrying on the war against france

That was it.

That was the purpose of the Bank of England.

Now, we know now that the Bank of England does other things.

It does those It doesn't just troll the French.

It does other things.

It does other things now.

But those things were invented.

So let me just see if I've got this picture right.

So originally they were just banks.

Maybe they were called moneylenders at first, but eventually they were called banks.

And I guess it was the Bank of England was the first, and they said, we'd like one of those of our own, says the government.

Is that too much of a simplification?

So now

in that story, I mean, the point of your story that you just told is that at the outset, independence had nothing to do with it.

On the contrary, right?

They wanted the government of the UK and presumably other countries wanted a little bankie they could play with.

That's exactly right.

And banks were very powerful.

They existed.

There was a developed financial system in England at the end of the 17th century.

And William and Mary decided that they wanted a bank of their own.

And in particular, they wanted a bank of their own so that they could borrow money to carry on the war against France.

Which is essentially the kind of thing we don't want the government now to be doing.

Yes.

Yes.

Maybe, maybe.

Let's get there, Rob.

Okay, okay.

So then, if we move forward quickly and mercifully,

there are certain things that we've decided since then that banks are supposed to do.

So the Bank of England was not originally supposed to be the lender of last resort.

They figured out through a series of financial crises in the 19th century that if they provide liquidity, if they buy any asset that looks reasonable in a crisis to prevent fire sales, to prevent other banks' balance sheets from breaking down, then they can save the whole financial system.

Again, that's not written down.

We just figured this out over time.

So

America famously resisted having a central bank for a long time.

There was something called the Bank of North America during the Revolutionary War.

It was explicitly supposed to help Congress carry on the war against the British.

Same thing again, right?

It's like we want a bank so we can lend ourselves money so that we can make war on someone.

This seems to be an emerging theme.

Yeah, that's exactly right.

All the silver that they had borrowed from France to capitalize the bank had to be carried down from Canada on ox carts and it arrived too late.

They won the Battle of Yorktown before they even got the bank set up.

But there's resistance in America

to

a central bank.

And that's because of the peculiar way in which sort of American banking was set up, which is that all of the states under the Constitution could not issue their own bills of credit.

That means an American state cannot issue its own money.

So instead, they chartered banks to do it themselves.

And they very jealously guarded the privilege of creating their own state banks.

So when we think of a bank now, the bank is pretty mercenary.

It just wants to make money.

But at the beginning of the 19th century, every state had several banks.

And, you know, I spent a lot of time looking at the archives of banks in New Orleans.

The Canal Bank in New Orleans was chartered to produce a canal.

They also got the right to produce their own banknotes and make money, but their job was to make a canal.

How long did this American world last where we just had a jimbal jumble of different banknotes issued by different states all over the place?

That lasted until the Civil War.

But briefly before then, we had something that looked like a central bank.

Its job was basically to be the banking agent agent of the United States government.

It sort of took in payments for Western lands and then moved them back east.

It was pretty good at sort of moving money around the country.

And it was not as good at restraining state banks.

It tried to.

But Andrew Jackson decided that he was going to veto the charter of the Central Bank of the United States, Second Bank of the United States.

And Lincoln always hated that decision.

And he did two things.

He issued greenbacks.

These were, this was sort of dollar bills that were on the account on the ledger of the United States itself.

And Lincoln basically taxed state banknotes out of existence.

So, this world that Rob is describing, where in any given state, you've got five to ten different banks and they're all producing their own banknotes.

That world goes away.

State banks can no longer produce their own banknotes.

So, you get a sort of coherence in dollar bills.

There's a new bank charter, it's a national bank charter.

They create an office to regulate national banks.

That's the office of the comptroller of the currency.

It still exists today.

It sure does.

And this was created in the Civil War, and they created a national bank charter.

If you had a national bank charter, you could print banknotes.

However, that's a liability, as we know, and we can explain to everybody.

But again, these were not liabilities of any central government function.

These were liabilities of that particular bank.

That's exactly right.

The one change was that to produce those liabilities, they had to buy one asset and one asset only, which was federal debt.

So you had to help the Union fight the war against the confederacy it's turning into a real theme here isn't it yeah it's interesting isn't it yeah that's a thing so when do we fast forward to the point where we get something that looks like a modern-day fed katie am i meandering no i wouldn't say

you're being you're being too clever brendan certainly certainly for rob and a little bit too much let's get ahead to the fun part where all right so we have an independent fed so now we're at the fed yeah so the problem with that national banking system was that it was up to a nationally chartered bank.

So this is a private commercial bank.

It was up to them to decide how many banknotes they wanted to produce.

And, you know, in America,

until relatively recently, until the middle of the 20th century, money goes out to rural areas at the beginning of the planting season and then it comes back in and then it goes back out at the end of the planting season.

There's this sort of seasonal rhythm to money.

And there were...

All the time, there were banking crises

right around in the spring or in the fall as money was moving and something got disrupted in this chain.

And so national banks were not up to the job.

They didn't want the job of making sure that banknotes got out to these rural banks when they needed to.

So you had contractions of credit when you didn't need it.

So this happens again.

It's the crisis of banking panic of 1907.

J.P.

Morgan rescues the entire United States, decides he's going to be the lender of last resort.

Finally, you know, after that guy.

First thing is, first thing I ever covered as a financial journalist, the crisis of 1907, I remember it well.

Yeah, he brought it up.

This is incredibly recent, right?

You know, in historical terms.

Yeah, it is.

So the Fed was chartered to fix this problem.

And the original goal of the Fed was to create a more flexible currency.

There's nothing in there about unemployment.

There's nothing in there about

inflation.

It's just to make sure that country banks can get dollar bills when they need them.

So they give the Fed.

It's a liquidity provider, right?

Yeah, it's a liquidity provider.

That is the first job of the Fed.

That is interesting.

Right, but it's not a race, not a ratesetter, not a growth protector or employment protector, but a liquidity provider.

Everything that Rob is saying is right, but let me wrap it up in a little bow.

It's a political liquidity provider because the people who weren't getting the liquidity were farmers.

That's the problem.

You had a banking system that was centered on liquidity coming out of New York, going through regional banking centers and into country banks.

And every once in a while, your country bank would not open its doors because it can't get the bank notes to redeem its deposits.

So the Fed explicitly said farmers are getting the short end of this stick.

We have to make sure they have liquidity.

There's already a decision in the creation of the Fed to protect a certain group of people who are not being served by a very free market for money.

Well, that's that's a step up from funding wars to funding farmers.

I like that.

I think

that sounds to me like human progress.

Rob, I have such bad news.

Yes.

We go back to wars.

Oh, for heaven's sake.

1935.

Yeah.

So

there are lots of reasons for the Great Depression.

We don't have to go into any of them.

But one of the consequences of the Great Depression was that banks closed all over America.

They failed everywhere.

Banks weren't particularly stable in the 1920s.

Even the go-go 1920s, there were about 200 bank failures a year.

Currently, there are almost none.

But it was in the many thousands of banks closed in 1932 and 1933.

And when a bank closed, there was no deposit insurance.

You just didn't have your deposits.

You had to wait for the bank receiver to come in from the state and decide what were the good assets on the bank's balance sheets and sell them slowly and give you back your deposits so it's it's all a bit higgledy piggledy still at that point yeah and the fed didn't see it as its job to protect these banks when you see banks failing in 1927 1928 and you read the regional reserve bank reports they're like good harvest this year

they don't see it as their job it's not their problem And so Mariner Eccles, this kind of small-time banker from Utah with big ideas, becomes the architect of the new Fed.

And what he tells Roosevelt, and he rewrites the Federal Federal Reserve Act for 1935.

Well, there are two acts, 1933 and 1935.

Anyway, he basically says it needs more political control.

Right now, the Federal Reserve is distributed among 12 regional reserve banks.

They're all making their own decisions.

They can't help when they need to.

The Board of Governors, the institution we're talking about right now, was sort of consolidated and strengthened under Mariner Eccles with Franklin Delano Roosevelt because they said the Fed needed to be more political.

It needs to be answerable to Congress.

It needs to do things that politicians need it to do.

And the first thing that new Fed did was, Robert, what did it do?

I don't know.

It supported the war.

Yes.

It buys

treasuries.

You know, the United States starts issuing treasuries on a scale that it had never issued them before at the beginning of World War II to build stuff.

And under Mariner Eccles, the Federal Reserve says we're going to buy treasuries not to finance the war, but to keep the price of debt down.

So that's quantitative easing, friends.

We've gotten there.

That's QE, baby.

Yeah.

So already in the history of the Fed, its first job was highly political.

It was to protect farmers from seasonal bank failures.

And the second job of the Fed, we come up with a new structure of the Fed.

First thing it does is not carrying on the war against France, but carrying on the war against the fascists.

Yeah.

And does QE to do it.

Where literally the United States issues debt, the central bank buys that debt, monetizes that debt, we might say, if we were in a grouchy mood, in order to keep interest rates down.

Yeah, that's exactly right.

So that comedy between the Fed and the United States Department of the Treasury only lasts until just after the Second World War.

What you get then is a Fed that's sort of looking at the disruptions of significant inflation at the end of the 1940s and sort of wondering what its job is.

And then Truman, Fort Truman, says, we got to pay for the war in Korea.

You guys are are going to help out, right?

And the Fed says, no, we aren't.

And they went back and forth.

And Truman even sort of publicly said, look, I talked to the Fed, they're going to do it.

And the Fed had to come out and say, nope.

We talked to Truman and we told him no.

We now call that, it's hilarious.

We call that the Fed Treasury Accord.

Yeah.

As if it's a treaty between two sovereign powers.

It was just a handshake agreement.

It was just the Fed saying, we're not going to support the price of debt for you anymore.

You're going to have to borrow on your own dime.

We're not going to bring down rates on treasuries anymore.

We've got our own job to do.

We're worried about inflation.

But isn't that good?

Right.

Like,

isn't this a good innovation that came up for whatever contingent historical reasons it came up for, but that has worked as a system, not just for the United States, but for other countries too?

I mean,

yes, but it's a qualified yes.

I'm sorry to put an asterisk on my yes to you, Rob.

Yes.

Because it worked so long as the great moderation worked.

So, yes, it's true.

When you talk to economists, particularly economists at the Fed, anytime this comes up, they will go back to 1951.

They will say the Great Treasury Fed Accord 1951 said that we have to be independent.

We aren't independent.

That's what we pursue.

But that independence hasn't been perfect.

And it only works if broadly the American economy works.

So this ability that the Fed has to sort of nudge interest rates up and down works so long as there isn't a savings clutch.

It works.

So the great moderation, the great moderation you're talking about is the period of what?

I would say until 2008, I would say the early 80s until 2008,

there was a period of inflation.

Inflation is lowish

and

yeah, yeah.

And I also think that the Fed, when the Fed thinks about history, they think about what Paul Volcker did.

So Paul Volcker was the chairman of the board of governors late 70s and early 80s.

And he pushed and pushed to raise interest rates to basically caused a recession in America, but it did get inflation down.

And so I think there's also a cult among central bankers where they really believe that one of the reasons they have to be independent is they have to have the freedom to cause people pain.

So it's quite interesting actually that like Christine Lagarde from the European Central Bank and Andrew Bailey from the Bank of England have both come out in the past few days to say the independence of the Fed is really important and bad things can happen to the global economy if this is compromised.

But one point I'd just quickly like to go back to is that sitting looking at the political situation in the US from over on this side of the pond, it certainly looks like there's a lot of, you know, far too clever guys with like beards who are very online and are very good at like

torturing the historical record to find precedent for stuff that they just want to do anyway.

And are looking at the kind of history of the Fed as you describe it, Brendan, going back, you know, way back into history and saying, see,

there's nothing like written down that says that we can't monkey about with this system in a way that just happens to

satisfy what we want to achieve politically.

Why shouldn't, says someone from the administration, why shouldn't the president have his own people on the Fed board?

You know, for the last 10 years, increasingly, as a journalist and then as an academic, I've been a critic of the Fed.

You know, the Fed grades itself on homework it assigns itself.

It sort of it decides what its job is.

And its job is actually not the mandate from Congress.

The mandate from Congress says the Fed is supposed to maintain the growth of credit and monetary aggregates.

So it's supposed to make sure that sort of all the all the different kinds of credit grow and that all the different kinds of money grow, all the different kinds of deposits for different people in a way to increase the productivity of the economy.

They don't do that.

I mean, that's literally their job from Congress.

They don't do that.

They don't have any sense of what the aggregate should be.

They don't have any definition of what a productive or an unproductive loan is.

They don't want to be in that business because that is tricky political stuff that they don't want to do.

So, however,

I'm going to set that all aside for a second and just agree with the consensus both in the room and among financial journalists and among economists that if we were to reform the Fed, this is not the way we'd go about it.

Right.

And the idea that we would sort of arbitrarily shorten the terms

through blackmail of Fed governors and install people that are beholden to somebody who, you know, I'm not sure whether we're allowed to use the word autocrat yet at the FT, but that seems to be how he styles himself.

It's the direction of travel, yeah.

That's not how we would go about it.

And if we look at sort of what the Fed has done well over the last 30 years, a lot of that is going to start to fall apart.

So the Fed is a provider of data.

They're really good at it.

We rely on the Fed's data.

They're all a bank

and they're part of the complex overlapping bank regulation sort of scheme that America has that's sort of really complicated and often works poorly, but they're an important part in it.

Brendan, it sounds to me like you're saying it's the job of the Federal Reserve Bank to help the people of the United States.

And the people of the United States get to decide what form that help takes.

And it's taken a lot of different forms over the course of history.

But what a a cynic might think listening to you talk is

Greeley wants to politicize the Fed.

He just wants to politicize it in a different direction than Trump wants to politicize it.

You know what I mean?

And I put that question to you or that challenge to you because I think whatever the historical facts are, just having this organization focus on managing a balance sheet, QEQT stuff,

setting interest rates, regulating banks and doing research, and doing all of that independent of the executive branch.

That is a formula that works pretty well.

And we should keep doing that.

And that's what we're worried about when we talk about Fed independence.

Absolutely.

And if I had my choice between what's happening now and the imperfect Fed that we had a year ago, 100 times out of 100, I picked the imperfect Fed that we had a year ago.

But I want to make an important distinction.

So I take your point.

Yes.

If the Fed's supposed to be political, it's inherently political.

Who gets to decide?

Who's politics?

I would say that if we were going to change the Fed, we would start by asking it to explicitly define what its mission is.

You know, it doesn't have, it doesn't do some basic stuff that it's politically charged with doing.

So that's how I would have started.

I mean, honestly, what I wanted more than anything was a member of Congress to ask Jake Powell what's a productive loan?

and watch him stumble and then like watch him go back to the board and like come up with an answer.

If we wanted to change the structure of the Fed, what we'd do is follow the same democratic process that Franklin, Delano Roosevelt, and Mariner Eccles followed when they rewrote the Fed Act in 1933 and 1935.

You know, you need

the right majorities in Congress to say, this is the new form, this is the new job of the Fed.

You need consensus.

You need an understanding that it didn't work for as we did in the Depression, and that's going to work in a different way in the future.

And our democracy is now behind this new way of doing it.

That's not what's happening right now.

Right now, he's sniping down one Fed member after another to, outside of Congress, change what the board does.

That's incredibly dangerous.

And it shortchanges the democratic legitimacy that a central bank has to have.

Just as an American, just as an American, I really like this point in the sense that we spend a lot of time saying, Trump this, Trump that.

And we should spend a lot more time probably in this area and in others saying, where's Congress?

Yeah.

Right.

Absolutely.

I think that's that is important that this is a generalizable lesson from the Fed to larger questions about the future of the Republic.

I'm very worried now.

And the reason I'm very worried now is until this moment, it has still been Congress's bank.

And it's got flaws like everything that Congress does has, but it still had some democratic legitimacy as Congress's bank.

Trump is actively turning it into Trump's bank.

That's new, that's different, and it's a little terrifying.

Look, listeners, normally it's the academics who tell you that, well, in the grand scheme of things, I'm sure everything will be fine.

The academics are not saying that this time around when it comes to the Fed.

So, if there are any members of Congress listening, I can give you Brendan's number.

He will chat you through this whole thing anytime you like.

Guys, we've had a lot of history here, but we're going to have to get onto something more current and come back in one sec with Longshore.

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Okey-dokey, it's time for long short, that part of the show where we go long, a thing we love, or short, a thing we hate.

I am long,

maths, or math, as you Americans insist on saying.

So, guys, here's a question for you.

XTX, big trading shop, it's full, I say this affectionately, of massive nerds.

They've got an internship scheme that Louis Ashworth was writing about on FT Alphabille.

Have a guess to be an intern at XTX.

How much do you think you'll get paid a month in dollars?

Oh, lunch money?

Something like that.

Yeah, Brendan, what's your guess?

$40,000 a month.

Well, the correct answer is $35,000 a month.

You were close.

With us.

Oh my God, I just made up an arbitrarily big number that seemed unreasonable.

And there's a sign-on bonus and similar benefits to other U.S.

permanent employees.

Guys, we're doing this wrong.

$35,000 a month to be an internet.

Summer internship.

Yowshar.

Brendan, you long or short something?

Yeah, I'm short private credit.

I've been reading a lot about the size of the private credit market recently.

And I did this thing where the internet was freaking me out.

So I decided I was just going to read the newspaper instead.

And so I read the Financial Times and there was an article about private credit.

I was like, you know what?

I don't know enough about this.

And I started reading into it.

And I am, it turns out that the financial reading the newspaper terrified me more than looking at the internet.

Maybe you should be short the newspaper.

Never be short.

There will always be long news.

Well, Brendan, it's been great having you on, and I will be long

your forthcoming book.

What is that called?

The Almighty Dollar, 500 Years of the World's Most Powerful Money.

Do you think the dollar will still be the world's most powerful currency by the time the book actually comes out?

It is a...

Katie, it is a, I am writing.

I mean, I got to hand this at the copy desk in 48 hours, and I'm frantically trying to figure out how I can hedge that question.

Brendan, as Rob said, it's been a total pleasure.

Please come back on the show soon.

Listeners, that's it for today.

We are going to be back in your ears next Tuesday.

So listen up then.

Maybe I'll see you in real life at the FT Weekend Festival on Saturday.

Either way, remember everyone, try really hard at maths, at school, and then maybe you can get an internship for $35,000

a month.

Unhedged is produced by Jake Harper and edited by Brian Erstadt.

Our executive producer is Jacob Goldstein.

Topher 40 is the FT's acting co-head of audio.

Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler.

FT Premium subscribers can get the Unhedged newsletter for free.

A 30-day free trial is available to everyone else.

Just go to ft.com slash unhedged offer.

I'm Katie Martin.

Thanks for listening.

Honey,

Brendan's in the basement writing about bonds again.

Tell her to get out of bed and get a real job.