Trump's Fed battle a matter of fiscal — not just political — control

President Donald Trump is once again floating the idea of firing Federal Reserve Chairman Jerome Powell, ostensibly in objection to excessively high interest rates. But this debate is not about monetary policy. It's a power play aimed at subordinating America's central bank to the fiscal needs of the executive branch and Congress. In other words, we have a textbook case of "fiscal dominance" on our hands — and that always ends poorly.

I'm no cheerleader for Powell. During the pandemic, he enthusiastically backed every stimulus package, regardless of size or purpose, as if these involved no tradeoffs. Where were the calls for "Fed independence" then? And where were the calls for fiscal restraint after the emergency was over?

Powell failed to anticipate the worst inflation in four decades and repeated for far too long the absurd claim that it was "transitory" even as mounting evidence showed otherwise. He blamed supply-side disruptions long after ports had reopened and goods were moving.

And as inflation was taking stubborn hold, Powell delayed raising interest rates — possibly to shield the Biden administration from the fiscal fallout of the debt it was piling on — well past the point when monetary tightening was needed.

If this weren't the world of government, where failure can be rewarded — and if there had been a more obvious alternative — Powell wouldn't have been invited back for another term. But he was. And so Trump's pressure campaign to prematurely end Powell's tenure is dangerous.

With budget deficits exploding and debt-service costs surging, I get why the president wants lower interest rates. That would make the cost of his own fiscal agenda appear more tolerable. Trump likely believes he's justified because he believes that his tax cuts and deregulation are about to spur huge economic growth.

To be sure, some growth will result, though the effects of deregulation will take a while to arrive. But gains could be swamped by the negative consequences of Trump's tariffs and erratic tariff threats. No matter what, the new growth won't lead to enough new tax revenue to escape the need for the government to borrow more. And the more the government borrows, the more intense the pressure on interest rates.

One thing is for sure: The pressure Trump and his people are exerting on the Fed is a push for fiscal dominance. The executive branch wants to use the central bank as a tool to accommodate the government's frenzy of reckless borrowing. Such political control of a central bank is a hallmark of failed monetary systems in weak institutional settings. History shows where that always leads: to inflation, economic stagnation and financial instability.

So far, Powell is resisting cutting rates, hence the barrage of insults and threat of firing. But now is not the right time to play with fire. Bond yields surged last year as investors reckoned with the scale of U.S. borrowing. They crossed the 5% threshold again recently. Moody's even stripped the government of its prized AAA credit rating. Lower interest rates from the Fed — especially if seen as the result of raw political pressure — could further diminish the allure of U.S. Treasuries.

While the Fed can temporally influence interest rates, especially in the short run, it cannot override long-term fears of inflation, economic sluggishness and political manipulation of monetary policy driven by unsustainable fiscal policy. That's where confidence matters, and confidence is eroding.

This is why markets are demanding a premium for funds loaned to a government that is now $36 trillion in debt and shows no intention of slowing down. But it could get worse. If the average interest rate on U.S. debt climbs from 3.3% to 5%, interest payments alone could soar from $900 billion to $2 trillion annually. That would make debt service by far the single largest item in the federal budget — more than Medicare, Social Security, the military or any other program readers care about. And because much of this debt rolls over quickly, higher rates hit fast.

At the end of the day, the bigger problem isn't Powell's monetary policy. It's the federal government's spending addiction. Trump's call to replace Powell with someone who will cut rates ignores the real math. Lower short-term interest rates will do only so much if looser monetary policy is perceived as a means of masking reckless budget deficits. That would make higher inflation a certainty, not merely a possibility. It might not arrive before the next election, but it will inevitably arrive.

There is still time to avoid this cliff. Trump is right to worry about surging debt costs, but he's targeting a symptom. The solution isn't to fire Powell — it's to cure the underlying disease, which is excessive government spending.