PETER NAVARRO: Powell and his Fed allies could box in Warsh and hammer growth

Kevin Warsh has now been sworn in as the new Federal Reserve Chairman. Outgoing Chairman Jerome Powell refused to leave the Fed Board, breaking the modern tradition of departing Fed chairmen leaving the Board rather than lingering as rival powerhouses.

The obvious danger: Powell will have enough Board support to act as the Fed’s Shadow Chairman and force Warsh into a series of rate hikes.

Never mind that even a single rate hike would be the worst response to an oil price shock. Never mind that Jay Powell’s two predecessors understood the difference between demand inflation and an oil shock.

When Iraq invaded Kuwait in 1990, Alan Greenspan understood that an oil shock could both increase headline inflation and hurt growth. His FOMC repeatedly cut the federal funds rate as the economy weakened.

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While oil, foodstuffs, fertilizers and industrial metals rose sharply in 2008 on rising market demand, limited supply, weak spare capacity and speculative flows, Ben Bernanke’s Fed likewise cut federal funds rates in April. It then held steady in June, refusing to launch a recessionary campaign of rate hikes at prices the Fed could not extract, refine, extract, establish or transmit.

This is the fundamental mistake that is coming. The Fed cannot produce an extra barrel of oil. Cannot reopen a shipping lane. It cannot refine gasoline. It can’t reduce diesel costs by crushing mortgage demand in Ohio or forcing a small producer in Pennsylvania to renew loans at punitive rates.

The Fed’s interest rate hike now would rein in demand in response to the supply shock, hitting the exact point where the economy is already fragile. Housing will become even weaker. Interest-sensitive production will suffer from this. Small business credit will tighten. Financial conditions will tighten as energy prices consume real incomes. The dollar may strengthen and put pressure on exporters.

Note to the Fed: The oil shock is already acting like a tax increase. It takes money from household budgets, increases transport costs, squeezes margins and slows down real activity. The Fed adding another interest rate increase will not solve the oil problem. This just adds a credit shock to the energy shock.

Why do this when the bond market vigilantes are already pushing contractionary policy? A 30-year Treasury yield north of 5% and a ten-year yield above 4.5% is not loose money. Mortgage rates, corporate borrowing costs and duration-sensitive assets are already feeling the pressure. In such weather, the central bank does not need to prove its strength or independence by firing another bullet into the hull of the ship.

April inflation reports are also not an argument for panic. Core PPI came in a little hot at 4.4%, but core CPI came in at 2.8%. Neither figure justifies treating the energy-induced commodity shock as a demand-side emergency.

The right question is whether the rise in oil will spread to the core elements and create a second round of wage-price dynamics. We have a long way to go until we find out, and the Fed shouldn’t be in the business of playing worst-case scenario games.

Instead, the Fed’s job is to keep inflation expectations steady while maintaining maximum employment, as it always should have been. As Greenspan and Bernanke understood long ago, the risk shifts increasingly toward recession as long-term bond yields rise.

This is where the specter of Powell’s Shadow President rears its ugly head: Three Biden-appointed governors — Philip Jefferson, Michael Barr and Lisa Cook — remain in place. The Powell and Biden trio now have a four-vote majority on the seven-member Board of Governors. It’s bad enough.

If Trump appointee Christopher Waller proves to be the real defector he has indicated, it would turn Powell’s Shadow Chair majority into a rout. Warsh would take the title. Powell would check the reaction function.

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And regional Fed presidents in Cleveland, Minneapolis and Dallas (Beth Hammack, Neel Kashkari and Lorie Logan) are already forming the chorus line for a possible hawkish turn.

It’s this Shadow Chair math that could keep Kevin Warsh and the American economy stuck. If Powell, his Biden-era allies and regional hawks turn the rate hike campaign into an oil shock, they won’t be able to defend the Fed’s credibility or prove its independence. They will add a credit shock to the energy shock and only prove their recklessness. The bill will come due not in the Eccles Building, but in factories, homes, small businesses and export markets across America.

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