Transcription
President Trump has officially picked who he wants to replace Jerome Powell as chairman of the Federal Reserve. And he has picked Kevin Walsh.
President Trump has officially picked who he wants to replace Jerome Powell as the next chairman of the Federal Reserve. And he has picked this guy whose name is Kevin W. So, I'm going to tell you everything you need to know about who Kevin Walsh is and what it means for the economy and for your portfolio.
In summary, this is way less bullish of a pick than most people expected Trump would choose. And as evidence of this, the market overall sold off on Friday as a result of this news. Though it only closed less than a half a percent down from the prior day's open, recovering from those lows.
But gold as well had an absolutely terrible day on Friday, partly because of the unwind of the blowoff top and precious metals. But it closed down 9% from the prior day, largely on this news of Trump's next pick. Gold being a safe haven asset is where many dollars were rushing to protect themselves from less Federal Reserve independence and maybe the next leader of the Fed coming in and just bowing to Trump's wishes, printing money out the ears.
But it does not seem like Kevin Walsh is going to be somebody who is going to do that, basically because of his history of being very critical of every time the Fed has done this in the past.
So who is Kevin Wsh? He's actually a veteran of the Federal Reserve. He joined all the way back in 2006, left in 2011. And if you remember those years, those were when the great financial crisis happened. And he was actually instrumental in helping form all of the bailouts and the troubled asset relief program, otherwise known as TARP. This was the first time the Federal Reserve intervened directly in markets by buying assets onto their balance sheet like treasuries and mortgage back securities, which took their balance sheet from under a trillion dollars in July of 2008 to over $2 trillion by December of 2008.
However, shortly after Walsh left the Fed, he became very critical of how their policies continued, even though the emergency was now in the rearview mirror. If you take a look at the Fed's balance sheet, you can see starting in 2011, they resumed a new round of quantitative easing, bringing their balance sheet to $3 trillion. But even that wasn't the end of it because starting in 2013, they expanded the balance sheet yet again, bringing the total balance sheet level to a peak of about $4.5 trillion before letting the balance sheet move sideways for a couple of years. Ultimately, they did try and wind it down in 2018 and that failed, resulting in what we now call not QE in 2019 and then massive, massive printing in 2020 and 2021 before we get to modern day where the Fed over the last couple years has been bleeding its balance sheet off yet again. And now, zooming in on the last couple of months, you can see the Fed has started adding to its balance sheet yet again.
Kevin W has been very critical this entire time of all of the monetary policy the Fed has been engaged in that has been easing, adding liquidity to markets. In fact, he has gone on record saying that this has directly contributed to the widening wealth gap, the inequality that Americans have been experiencing over the last decade plus. He has pointed specifically to the drastic rise in asset prices which have caused asset owners obviously to become much, much richer. He specifically said that this rise in asset prices has been a lot more than the Federal Reserve initially expected it would be. In other words, the Fed knew that doing QE and keeping interest rates low would cause some asset price appreciation, but the effect on assets specifically was much, much larger than the Fed originally anticipated.
He has also called out the fact that the opposite is true for the broader economy, for wages, for jobs, pointing out that purchasing power, wages, and employment have been much, much worse over the last decade plus than the Federal Reserve initially expected. So, not only was there just the direct effect of the rich getting richer and the poor getting poorer as a result of the Fed's policies, but it also makes it harder to climb that ladder because now it takes more dollars to purchase assets like stocks than it used to. It takes more dollars to purchase assets like homes than it used to. It takes more dollars to purchase assets like gold than it used to. Meanwhile, most average workers and employees have not been getting paid more dollars enough to compensate them for the loss of that purchasing power. So, not only is life, the cost of goods, the cost of living, and also the cost of assets, not only are all those things more expensive, but the average person has been falling behind in terms of how much income they've been getting relative to the asset price appreciation. So, not only has the wealth ladder widened, so not only has the wealth ladder gotten taller, inequality been increasing, but the distance between the rungs on that wealth ladder have also increased. And Kevin W has been outspoken, explicitly critical of the Federal Reserve's role in causing that. And guess what? He's right.
A lot of people today talk about late-stage capitalism or how free markets have been running wild and causing all of this inequality, causing all these problems. Most people just have no idea how much the government is to blame, how much the Federal Reserve is to blame. People look at the rich and they look at the corporations, see them getting richer, then they look at their own budgets, see themselves getting poorer, and they think it's their fault. And I don't blame them, 'cause that's the most obvious place to look. But the Federal Reserve and the government are directly responsible for enabling this to happen.
But it's not just QE and the balance sheet part of monetary policy that WASH has been critical of. And this is the interesting part because he's also been very critical of how low interest rates have been and how much low interest rates have contributed to all the problems we just talked about. Over the last 40 years, though there have been times when interest rates have risen, over the long term, interest rates have continued to move lower and lower and lower. And ever since 2009, they've spent most recent years near zero. However, as a result of the inflation that was unleashed in 2020, the Federal Reserve has been forced to reverse that long-term trend and rates have been moving higher. Although if you zoom in on just the last year and a half, you can see the Fed has been lowering interest rates yet again.
However, this is nowhere near as low as President Trump wants interest rates to be. He's been very critical of how high interest rates are right now and doing absolutely everything he can possibly think of to try and get the Federal Reserve to lower interest rates right now, even going so far as trying to charge Powell criminally for fraud and wasteful spending in a building renovation. Now, don't get me wrong. Federal Reserve exists outside the economy. They create money, and they spent way too much money on renovating those Federal Reserve buildings, but that's not actually what this was about. This was about applying pressure to the Federal Reserve and saying, "There is nothing that will stop me from trying to get you to lower interest rates to where I want them."
However, despite the fact that short-term interest rates have been going down, you look at long-term interest rates like the yield on the 20-year Treasury or the 30-year Treasury, they've actually been heading higher, which means that if Trump gets his wish and short-term interest rates by the Fed do actually go lower, it probably won't result in a lower interest rate cost on the overall national debt. And it definitely won't result in long-term interest rates moving lower, allowing the government to roll over a lot of its short-term debt into long-term debt at really cheap rates. In other words, the more Trump gets his way and those short-term interest rates go down, the more the long end of the curve rises and the whole overall yield curve steepens.
Why is this? Well, it's because if short-term interest rates go down, that means right now the US government can borrow for cheaper. That means they can borrow more. That means they can spend more. But all that borrowing and spending prints money into existence because that's how dollars work. Dollars are loaned into existence. Which means the more the government borrows and spends, the more the money supply increases. This is why despite the money supply falling briefly in 2022 and 2023, it's actually been heading higher since then and is now sitting at an all-time high. As the government borrows and spends more money, it increases the money supply. Now, what happens when the money supply goes up? All else being equal, prices go up because you have more money chasing the same amount of goods and services. So, a rational investor and a rational lender will take a look at what the government is doing and say, "Hey, if the government can borrow and spend more money into existence easier, and that causes the money supply to rise, which causes prices to rise, I'm not going to loan the government money for 20 or 30 years at a low interest rate. I'll demand a higher interest rate so that I can get compensated for the loss of purchasing power along the way," which is one of the reasons why long-term interest rates have been heading higher.
So, how is this all going to fit together? How in the world could Trump pick somebody like Kevin Marsh who's going to go lead the Fed, maybe reduce interest rates like Trump wants, but also probably start to wind down the balance sheet? Well, it has to do with the fact that banks don't actually really care about the yield that they are getting on the loans they make, especially to the US government. You see, you and I, when we lend money to the US government, we care about the absolute rate we're getting. If we're going to go buy a 30-year Treasury at 4.8%, 8%. That means we're locking ourselves into a yield of under 5% for the next 30 years. We would need to be very confident that that would result in a real return on our investment even after accounting for any inflation that happens along that way. But banks do not have to worry about this because they're not investing their own money. They're investing our money. See, you and I put our money in the bank in a checking account. We put it in a savings account, high yield savings account even. We put it in a money market fund. We have cash in our 401k, in our IRA, in our brokerage account, and all that cash behind the scenes is being used by the banks, which means all they care about is the difference, the spread, the delta. They care about what they can get on your money. And so, if the bank can go get 4.8% from the US Treasury and they only have to pay you .1% or a half a percent or even 3%, they're fine with that 'cause it's free money for them.
So why don't they just do this all day, buy up all the US treasuries, driving yields even lower? The answer to that is because of something called the supplementary leverage ratio. Now, we could get technical, but very basically this is just a restriction on how many treasuries banks can buy because the rules right now regulating banks say that treasuries are risky. And guess what? They are, 'cause treasuries can go down in value. This is what led to the collapse of Silicon Valley Bank a couple years ago. So the supplementary leverage ratio says banks can't buy more than a certain number of treasuries. However, recently there's been a push at the Federal Reserve to deregulate the banks, especially from people like Governor Steven Moran. In other words, this would make permanent what temporarily happened during 2020 and 2021, which suspended the supplementary leverage ratio and allowed banks to buy an unlimited number of US treasuries.
Now, without getting too far into the weeds, you're probably thinking that this could be risky because they could buy a bunch of treasuries, they could go down in value, banks would collapse. In short, the Federal Reserve already has a tool to deal with that called the bank term funding program. If treasuries do go down in value, banks can temporarily sell those treasuries back to the Fed for full price as long as they buy them back within a year. Which means that functionally now treasuries can operate like reserves for banks. In other words, treasuries can be risk-free for banks, assuming the Fed is there to bail them out.
What does this all mean? Number one, Trump can get his way and short-term interest rates can go down. This is the federal funds rate. Even with WASH, we could see interest rates move somewhat lower, giving Trump what he wants. However, that could backfire, pushing long-term interest rates higher, especially considering the fact that worsh coming in to lead the Fed might mean the Federal Reserve's balance sheet continuing to move lower and them selling treasuries off their balance sheet. Which means that the third piece of this puzzle is going to be bank deregulation. means the supplementary leverage ratio will be permanently removed and banks will be able to buy an unlimited number of US treasuries and if they ever get into trouble with how many treasuries they own, the Fed will be there to temporarily bail them out. And if the Fed is there as a temporary potential implicit bailout, that means that in reality banks will never face the trouble with the treasuries. If you know your bank has the money, you're not going to go do a bank run. You're only going to do a bank run if you think they might not be able to give you your money. So knowing that implicit bailout is there makes treasuries safe for banks, which means Trump gets his lower interest rates. Worsh gets the smaller Federal Reserve balance sheet. Banks get an unlimited appetite for US treasuries, which pushes long-term interest rates lower, effectively pushing banks to do QE for the Fed, allowing the government to borrow anywhere along the yield curve, lower than the rate of inflation. banks are okay with it because they just care about the spread between what they pay you and what they get from the government and everybody wins except for the little guy again.
And if you think somebody like WS who has been as critical of these kind of policies in the past would allow something like this to happen under his watch, then you just don't know the history of the Federal Reserve. Heck, go back all the way to Alan Greenspan who was very vocal about how much he liked gold, very critical about easing monetary policy in order to bail out the economy. But guess what? That's exactly what he did. When the .com bubble began to burst, he lowered interest rates to try and smooth out the effect on the economy and he planted the seeds and paved the way for the great financial crisis. Do not underestimate the corruptive ability of the power of leading the Federal Reserve.
At the end of the day, the money supply must continue to expand, otherwise we go into a deflationary death spiral. The government borrows all of the money out of the economy that there is. That's what happened in 2019. That's what happened again at the end of 2025. If the Federal Reserve does not continue to find ways to feed the appetite for borrowing for the US government, then the entire economy enters a deflationary death spiral. There is no other way. And so, the Federal Reserve will do what the Federal Reserve always does, and that is figure out ways to provide for the unlimited appetite of new money for the government, regardless of who is in power.
As always, thank you so much for watching. Have a great day.