The DOJ Comes for Jerome Powell

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1:24Today's other number is zero. That's how many dieticians deserve employment. Money market's mad. If money is evil, then that building is hell. The show goes on! The folks in there are questions. Show! Show! Welcome to Prof G Markets. I'm Ed Elson. It is January 13th. Let's check in on yesterday's market vitals. The major indices opened the day down after the Justice Department announced it is investigating Jerome Powell. More on that in just a moment. However, they quickly erased their losses with the Dow and the S &P closing at all-time highs. Meanwhile, the yield on 10-year Treasury spiked before moderating.

2:04Capital One shares fell more than 6 % after Trump said credit card companies should cap interest rates at 10%. Google hit a$4 trillion market cap after Apple said it will use Gemini to power Siri. And finally, President Trump said he is levying a 25 % tariff on any country doing business with Iran. Effective immediately, he said, quote, this order is final and conclusive. OK, what else is happening? The Justice Department has opened a criminal investigation into Federal Reserve Chair Jerome Powell. The probe, which was launched on Friday, is examining whether Powell lied to Congress in his testimony about the Fed's building renovations.

2:47But Powell says that the testimony which took place last June is merely, quote, pretext for the Trump administration's threats to lower interest rates. In a rare video statement that was released on Sunday, Powell called the investigation, quote, unprecedented. And he argued that it is part of the administration's ongoing pressure campaign. Let's listen to what he said. The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the president. The chain of events initially rattled markets.

3:23The S &P opened Monday in the red, but then it rallied into positive territory by the end of the day. Meanwhile, the dollar slid, and investors rushed into hard assets like gold and silver, which hit record highs. So, this is a pretty incredible story that we are witnessing. And in keeping with that, we're going to do something a little bit different today. We're joined by two favorites of the Prof. G podcast. That is Liz Hoffman, Semaphore's business and finance editor, and also Justin Wolfers, professor of public policy and economics at the University of Michigan. Liz, Justin, thank you very much for being here today.

4:02Excited to get into this.

4:04Liz Hoffman:Thanks for having us. Absolutely. Liz, I'm going to start with you. I just want to start with your reactions to what we saw. We have seen a criminal investigation opened against Jerome Powell. What is your initial reaction to the news? pretty incredible. I mean, I watched the statement that Jerome Powell gave last night, and this is someone who has just tried as hard as humanly possible to stay away from this narrative, to kind of ignore the noise, ignore the criticism, and finally got to a place where he felt like he could not. And his statement is, I mean, it's really worth, you know, your listeners should go watch it in full.

4:44Liz Hoffman:I mean, it is incredible. To state the obvious, this is not about the renovations to the Fed building and what Jay did or did not say to Congress about it. This is punitive and it's retaliatory. And it's, I mean, really, you know, unprecedented is a word that's getting used quite a lot these days. But I was really floored by the whole thing. Justin, were you floored? Is this unprecedented? Absolutely not floored. I was flabbergasted. Completely different. Every day we hit that day where I think I never thought I'd see this in my life. So it is unprecedented in American history. It's not in the world.

5:28Tin pot dictators do this all the time. This is, and one of the things I admire Liz for Liz called it what it is, which is it's the president threatening to jail the bed chair. Put all the pretext aside. That's what it is. Well, so we've got a president threatening to jail the head of the central bank. That's happened before. It's happened in Russia, Venezuela, Argentina, Zimbabwe, Turkey, and now America. So it's not unprecedented, but it puts America in a club of tinpot dictatorships who've experienced hyperinflation and immense economic instability. it's bananas. Based on those examples that we've seen in other nations, so this hasn't happened in America, and when we say this, we're saying the president basically threatening the chair with some sort of criminal charge to enact whatever monetary policy he so desires.

6:32But given what we've seen in other nations, like you say this has happened, how does this usually play out when this happens, Justin? Not well. So look, here's what each of the examples has in common, which is a strongman head of state. A strongman head of state possessed of enormous self-belief who eschews experts. Again, that's common in every one of those stories. and often who finds themselves in some form of economic trouble and they think they can fiddle with interest rates to solve it, or they have an internal belief that if they were to fiddle with interest rates, it would lead to better outcomes.

7:11In many of these cases, can we introduce word for the day? Word for the day is fiscal dominance. Fiscal dominance is this idea that, and I think this is what's going on if you listen to what the president has said. Normally, we set interest rates with a view to trying to keep inflation low and unemployment low. Interest rates play another role in our economy. The interest rates determine the monthly credit card bill for the United States. We have an enormous government debt. The interest rate determines how much we devote to paying interest. And every dollar we spend on interest is a dollar of tax cuts we can't give to our mates or a dollar we can't spend on roads or defense or ice.

7:53so what you get often with cases of fiscal dominance is the head of state says well i don't like paying interest and i control the interest rate or if i take over the central bank i can control the interest rate so they could reduce the interest rate with an eye of reducing the government's interest payments and so far so good that works but what that means now is that you're setting interest rates not to control inflation and not to control unemployment if you were to do that, then you typically set interest rates far lower than current conditions warrant. And the president has already said he'd like interest rates to be 1 % right now.

8:26That would give him a whole lot more money to splash around. Now, if you set interest rates below what is required to keep inflation low and stable, you don't get low and stable inflation. You get higher and higher and higher inflation. As inflation goes up, the appropriate interest rate goes up too. But if you're pigheaded, you leave interest rates where they are and then inflation keeps going all the wait till you get a hyperinflation. And so to be clear, this is not moving from an interest rate of an inflation rate of 3 % to 4%. It's moving from 3 to 30 or from 30 to 300, or in some of these cases from 300 to 3000, or in fact, 3 million percent.

9:02We move to an economy where one of the most important things you do every day is you wake up and you think about inflation. You think about how to maintain your family's purchasing power. You might say this couldn't happen in the United States. And I hope that's true. But you might have said that wouldn't have happened in some of these other countries. Some of these other countries, take Turkey, for instance, it had fairly low and stable inflation. It had a checkered history. But it looked like it was determined to be a modern industrial country. And a populist strongman came to power. He got rid of the independence of the central bank.

9:36He had, like President Trump, an unusual attachment to low interest rates, implemented his own theory of the case, and Turkey ended up not that much later with 80 % inflation. I would like to say that's impossible here. I can no longer say that. Yeah. Liz, I mean, just looking at what we've got here, which is probably the clearest evidence we've seen that there is at least significant interest in reducing the Fed's independence to bending it to the will of the strong man in this situation, which, as Justin points out, like we've seen this before. We've seen this in other countries. It leads to hyperinflation almost every time.

10:15But the market's reaction has been quite interesting in that it's reacted, but not massively. I mean, the S &P was down and then it actually rebounded and closed in the green. Same with the Dow. We did see some big moves in gold. Gold hit a record high. silver hit a record high. But overall, I guess if I had to, you know, pass what the market is telling us, it's something along the lines of like, this is maybe important, but not that big of a deal. Would you agree with that reading? What do you make of how the market has reacted?

10:51Liz Hoffman:I would say I was disappointed, but not surprised in what the administration did. I was disappointed and surprised in the collective response of the markets today, as you said, stocks ended up higher. I mean, really what you want to be looking at here, if you're hoping that there's some check on behavior like this, is the bond market. Treasury yields, I think, were up a couple of basis points. I mean, not reflecting any kind of concern. And if you wind back to Liberation Day, it was actually the bond market throwing a temper tantrum that got the president to back off his most aggressive tariffs, not, in fact, the stock market.

11:22Liz Hoffman:there's been this talk of, is there a Trump put somewhere in the market? Is there a pain point that will reel in the policy process? And it is much more likely to be found in the bond market than in the stock market. As you said, gold and silver hit highs, but they've been doing so pretty consistently for a bunch of months now. I'm very surprised. And, you know, I think we had a column last week or saying the market's kind of acting like a teenager with noise-canceling headphones on. And I wish I had saved that column in my pocket for this week. Because, you know, one of three things is happening.

11:55Liz Hoffman:The market is kind of reading that this is going to be mostly theater, a non-event. And I should say there was some reporting today that suggested kind of that this was a bit of perhaps a rogue advisor. This came out of the district court in Washington, run by Janine Pirro, that it may have had some influence from Bill Pulte, who's the housing czar, who has, you know, a history of some more aggressive policy ideas, and that perhaps, you know, Scott Besson, Treasury Secretary, who's sort of emerging really as the economic czar of this administration, perhaps has some qualms and wish it had not happened.

12:28Liz Hoffman:So we'll see. There is an off-ramp, as there often is around Trump, where you have advisors kind of trying to see what he might want them to do in doing it, and he can turn on them too. So there is a bit of an off-ramp. But, yeah, you know, so either people think it is just theater and is going to go nowhere. They think it's real but not a problem, which is alarming. Or they have just so totally tuned out the noise, you know, a year into the Trump administration. and I think that's a real problem. I mean, you know, the one check, like we said, on the president has been severe market reactions and if that starts to go away as, you know, the so-called the bond vigilantes, if they're ceding their power here, I don't know.

13:14Liz Hoffman:I mean, you know, there was a call today from JP Morgan that, you know, they think the Fed's next move on rates is up, not down. Like, I don't know how to square those two things, especially if you assume that there will be a more compliant or White House-friendly Fed chair coming in to replace Jerome Powell. I also think this makes it more likely that he sticks around. He's entitled to stay as a member of the board after his term as chair expires. And you could see him dig in there. So I don't know. And we're coming off this political cycle where inflation was just proven, as it has so many times in history, to just be politically toxic.

13:49Liz Hoffman:And they're already flirting with that, with the tariffs, which we've not yet really seen come through on prices. but at some point probably will. Justin, you may have a point of view on this. They probably have to, if import prices are coming up, get passed on to consumers. So this all just feels very politically dangerous. And my question often is like, who is this for? Like what, even if you're trying to play kind of crass kind of campaign politics, who is this for? I don't know. Yeah, an argument that I've seen floating around is that it's an argument that I've seen in the past, which is that Trump is trolling Jerome Powell.

14:22and so it's not to be taken seriously um it's it's not to be considered like a real threat he's just having a goof it's sort of like whatever presidential equivalent of shit posting is which seems to me to be perhaps how the market is is is viewing this as well oh he's just trolling oh, it's not that big of a deal. Oh, he's just kind of kidding. I guess, Justin, is that wrong? I mean, clearly we don't want to take this stuff lightly, but maybe he is just trolling and maybe we shouldn't care. I mean, what do you think? I have a different story. So let me try mine out. So look, I think this is a grave, grave threat to the United States.

15:13Liz does too. It sounds like you did too. And every economist I spoke to today agrees. Yet the markets didn't sink. So option one is I'm a fool. Liz is a fool. Ed's a fool. The other economists are fools. Option two is let's go back and make sense of this. So the question is, what do we know right now that we didn't know 24 hours ago? What do we know about the world? Well, last night, I knew that Trump wanted leverage over the Fed. I already knew that. Last night, I already knew that Trump had no respect for the independence of the Fed. He's been undermining it for a long, long time. I already knew that he'd weaponized the Justice Department.

15:56So all of those things I already knew. So what did I learn today? Now, one thing to understand is this news cycle did not come from the administration. It was Jay Powell who'd received the subpoenas who decided he would move this into the public arena. This was meant to be a private threat. Do what I want or you go into jail, brother. Powell moved it to the public arena. He did so powerfully. He did so directly to the public. He's literally never done before what he did last night. Neither has any chair of any industrialized central bank that I'm aware of. He released a video directly to the American people.

16:32not only put it on the Fed website, but also many others as well to make sure it couldn't be taken down and spoke directly to the camera about what's going on here. What happened is we had a round of Trump trying to undermine the Fed. Powell won. Powell beat him. Look, Powell said, I'm not backing down and you don't have the goods. And here we are talking about it right now and everywhere. No one's saying that tomorrow, that this threat, which is the only news we learned about was this threat. No one's saying this threat in and of itself is doing anything to the stance of monetary policy. And in fact, what we got was he laid the whole game out so clearly that we saw Senator Tillis today come out and say, this is not okay.

17:19Tillis said, I'm not voting for a Federal Reserve chair until this is cleared up, by which he means I'm not voting for a Trump toady. Lisa Mikowski did the same thing. What that actually means is now I'm going to make the argument markets should have gone up. Because what it actually means is we were, many of us were worried that Trump was going to appoint a toady and that we would have a non-independent central bank and would have occurred through the normal process of him suggesting Kevin, Kevin, yes, sir, has it. and Kevin would have gone and been Federal Reserve Chair in name only and taken all of his marching orders from the Fed and we would have gotten all of the negative consequences.

18:00And now what he's done is he's woken up the Senate and that Senate confirmation now we have at least two Republicans now on record as saying, no, I'm not going to rub a stamp of toady. And I think what happens in that fight, that fight to replace Jay Powell is going to be vitally, vitally important. But the thing I want you to notice is when I tell the story, But we didn't actually learn much that was bad that we didn't already know. And markets respond to new knowledge. And so I think that's really the story. Now, let me say it in simpler language, right? Markets had priced in that Trump hates the Fed.

18:37Yeah. They priced in a lot of that. And then there's the yap, yap, yapping. Well, the president yap, yap, yaps all day. And some of the yaps are really offensive, but only some of them he means. And then even the ones he means, he often tacos. If I'm a trader on Wall Street, I would be sick to death of losing money because I responded to a yap only to get taco. By the way, those are technical trading terms. And so, of course, they're not going to move. Yeah. Right? So you need to discount everything by the probability that it actually happens. And for any given yap, the probability it actually becomes an untarcoed outcome is incredibly low beyond knowing that it's going to continue this campaign to undermine the Fed.

19:21We'll be right back. If you're enjoying the show, give Prof G Markets a follow.

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21:22We're back with Profity Markets. Just thinking ahead, Liz, as Justin was talking about here about what happens next for the Fed chair. I mean, his term is up in May. the concern was that we'd get some form of a yes man in his place um do you think that this changes anything looking ahead to the next few months or so i mean does this tell us anything about who will be the next fed chair what that will look like does this change things i guess

21:57Liz Hoffman:is my question i would still expect to see one of the kevins probably kevin asset as justin said or Kevin Warsh, who are both seen as, you know, fairly compliant, I would say. There was a longer list of people who would probably likely be a little bit more independent. There was a BlackRock executive, Rick Reeder, on that list at one point. A current Fed governor, Chris Waller, was on the list at one point. I don't know exactly. But the other thing to think about, and this gets kind of a little inside the way the Fed works in Fed baseball, is that it is fundamentally a consensus-driven place. People vote and no one has, you know, more power than anyone else.

22:34Liz Hoffman:And, you know, a bunch of new voting members rotate on and rotated on this year. And there's a real there's a real mix, you know, that the dot plot that everyone talks about, which is this, I think, twice a year. The Fed officials kind of say where they expect to see interest rates over the next, you know, one, two, three years. And, you know, for for in most normal times, they're in a fairly tight band. They are all over the place right now. You know, and there were dissents in both directions at the last Fed meeting in, you know, late last year. And so I don't know. But I think, you know, the one thing that Powell had tried very hard to do as Fed chair was kind of maintain consensus.

23:13Liz Hoffman:And you could see it fraying on him. And, you know, he hasn't quite lost control of it, you know, but I think you're going to end up with just people who have wildly different points of view, some for political reasons, but also because, you know, especially with the government shutdown, We were in a bit of a blackout. And it was, you know, the dual risk to the economy right now or that the labor market is weakening even faster than we think or that inflation is sort of primed to rise again and we're going to get this double dip thing. And the policy prescriptions for those are really different.