The Breakdown - Brazilification Risk and the Fight for Fed Independence

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, August 28th. And today, we are talking about whether or not we are seeing the Brazilification of the United States. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the broader conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit. why slash breakdown pod. Well, friends, this administration was never going to be normal.

Starting point is 00:00:42 Heading into the election, there was a tacit recognition among many crypto folks that a Trump presidency was likely to be very good for the industry and its place in the U.S. For some, that was enough to get completely on board, but there were, of course, many crypto industry participants who still had lingering doubts about the rest of the policies that would come with the first crypto president. To some extent, everyone knew what we were getting ourselves in for, at least in the sense that we knew that we weren't going to have someone who played by the normal set of rules. The first Trump administration was marked by a willingness to cast aside political norms in pursuit of the broader agenda, and that impulse has certainly continued into the second term. On the economic front,

Starting point is 00:01:18 we've had on-again, off-again tariffs, alongside continual jabs at the Federal Reserve, that have made macro shocks a fairly regular occurrence. Frankly, to a certain extent, market participants just adjusted and came to expect a Trump headline bomb at any hour of the day. This week, though, there has been something of a shift. Trump is starting to double down on certain questionable policies, and market commentators are beginning to get even more uneasy. The first big shift was Trump's war against the Federal Reserve ratcheting up. Until now, the feud has been a little alarming, but mostly amusing. Basically, Trump calling Powell an idiot and squawking loudly for rate cuts is par for the course and basically what we expected would happen. Trump's visit to Fed headquarters, for example, to view

Starting point is 00:01:56 the construction site was mostly notable for the quality of the memes that it produced. However, the firing a Fed Governor Lisa Cook on Monday has caused prominent people to begin to rethink their priors about how far Trump is willing to go. In a Bloomberg op-ed on Wednesday, former New York Fed President Bill Dudley wrote, earlier this month, I wrote a column downplaying the threat that President Donald Trump poses to the Federal Reserve's independence. Now, I'm much more worried. I think markets should be, too. Now, it's beyond the scope of this show to do a full recap of Cook's firing. The basic contours are that Cook was accused of declaring two properties as her primary residents in order to obtain favorable mortgage terms. The practice is, to be clear, technically

Starting point is 00:02:33 felony mortgage fraud. At the same time, it's fairly widespread and very rarely prosecuted. The president can't fire a Fed governor without cause, so many viewed this as a trumped-up charge to justify Cook's removal. The president has never gone all the way and fired a Fed official before, but there are some lesser parallels. Many noted that this doesn't look all that different to the trading scandal that saw a trio of Republican Fed officials resign in 2022. One of the big differences is that Cook has lawyered up and will fight the allegations and attempt to remain in her seat. It's still way too early to know how this will play out. It'll take at least a week to get in front of the Supreme Court for an injunction hearing and likely months for a final ruling on whether

Starting point is 00:03:09 the president overstepped his bounds. In the interim, we have an FOMC meeting in two and a half weeks. There will be pressure on Powell to deny Cook access to the meeting and treat her seat as vacant unless the Supreme Court delivers some guidance quickly. The administration also seems like they'll put the pressure on. The Wall Street Journal reports that Trump has told advisors he wants to move quickly to announce a nominee to replace Cook. That's potentially, in addition to White House Economic Advisor Stephen Moran, who was nominated to fill Governor Adriana Coogler's seat after she resigned at the end of last month. The Washington Post reports that Moran's selection is hugely controversial among Senate Republicans, not because of his credentials, but because the

Starting point is 00:03:43 administration has floated the idea of him keeping his White House position while also joining the Fed Board of Governors. That would be another completely unprecedented move, really hammering home that Fed independence is under threat. However, there seems to be more to this plan to take over the Fed. During a televised cabinet meeting on Tuesday, Trump said, we'll have a majority very shortly, so that'll be great. Once we have a majority, housing is going to swing. People are paying too high in interest rate. That's the only problem for us. We have to get the rates down a little bit. Now, even if Moran and a yet-to-be-announced replacement for Cook are approved, Trump still doesn't have a majority on the FOMC. Assuming governors Waller and Bowman are on side, Trump would have four out of the

Starting point is 00:04:20 seven-member board of governors. However, the FOMC also includes five of the 12 regional Fed presidents serving on a rotating basis. Currently, all the voting presidents were appointed during the Biden administration save for New York Fed President John Williams. In his post coverage of Jackson Hole on Sunday, Nick Timmeros of the Wall Street Journal discussed how the threat to Fed independence was thick in the air.

Starting point is 00:04:39 He also laid out how Trump could seize control of the entire Federal Reserve system early next year. While Fed governors are confirmed by the Senate, the 12 regional Fed presidents are selected by the board. The regional presidents serve concurrent five-year terms, so they are all set for renewal at the same time next March. Timmeros wrote, If Trump has a majority on the board of governors before next March, they could decline to reappoint

Starting point is 00:04:59 regional Fed presidents, dismissing presidents who have served ably would shatter decades of precedent, and pierce a key firewall protecting the Fed's independence that dates to the central bank's founding in 1913. Bloomberg reported on Wednesday that the White House was exploring this option according to inside sources. There are a huge number of articles at this point across the financial press, warning that central bank independence is genuinely under threat. And yet, interestingly, many of them noted a strange lack of reaction in the markets. Bill Dudson's, wrote, Markets are too complacent. Even if Trump stands only a small chance of taking control of the Fed, the effort itself is disruptive and the consequences of success would be dire. The threat to the Fed's

Starting point is 00:05:34 independence, along with the risks of uncontained inflation, much higher, longer term borrowing costs, and a significantly weaker dollar isn't going away. In an op-ed in the Financial Times, former Fed Chair Janet Yellen wrote, if markets believe the Fed's hand is guided by political orders, every interest rate decision will lose credibility. Inflation expectations could become on moored. The dollar standing as the world's reserve currency would be imperiled. Investors and allies alike would conclude that the U.S. no longer has an independent central bank. Now, if this plays out as some fear it's going to, it'll be interesting to observe whether Fed independence is actually important to market pricing, or if that's all a bit of a charade. The textbook idea is that

Starting point is 00:06:10 an independent Fed has more credibility as an inflation fighter, so we'll keep long-term rates more well-anchored. That's nice in theory, but with inflation running above target for 52 months in a row, it's certainly reasonable to question how much credibility fed independence is actually worth. Financial analyst Mike Sikardi looked at global long bond spiking and wrote, You'd think Trump were trying to pack other central bank voting committees based on some of these 30-year yield jumps outside the states. The U.S. 30-year is actually one of the most mild on the board compared to other developed markets that are having their own structural issues. This week, the French finance minister said that they may need an IMF bailout as the government is on the brink of their second collapse in two years. Japan is still unwinding decades of experimental monetary policy and has the highest inflation,

Starting point is 00:06:49 among major economies. U.K. government bonds are hitting 27-year highs. Basically, it seems as though central bank independence isn't doing a darn thing to keep yields down anywhere in the world. Bed Guy commented, China doesn't have an independent central bank yet they suffer from deflation. In the U.S. are, quote-unquote, independent central bank led to a 25% increase in the price level in just a few years. CB independence can be good, but it is neither necessary nor sufficient for price stability. Now, just to reinforce the other side of the argument, the worst version of losing central bank independence looks like Turkey, where the president insisted that the interest rate should be lowered to fight inflation over the course of several years. During that time, inflation spiked to more than 80%

Starting point is 00:07:26 and the lira lost 80% of its value. Inflation is still running at 33%, and the lira just hit an all-time low against the dollar, even though President Erdogan hasn't fired a central bank governor in two years. The point is that central bank independence and the credibility that goes with it, once gone, is incredibly difficult to get back. So if it is ultimately important, then the president is running a huge risk. Today's episode of The Breakdown is brought to you exclusively by Grayscale. Grayscale is almost certainly a name you know. They've been offering exposure to crypto for over a decade now

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Starting point is 00:08:33 in your share of the future. Now, the other big narrative shift this week is best summed up by this Babylon B headline. Trump vows to nationalize as many private companies as it takes to defeat socialism. That's, of course, referring to the administration taking a 10% stake in Intel, and Trump stating, I will make deals like that for our country all day long. There are a ton of breathless takes on this topic, declaring that the country has turned socialist or fascist, and that our economic system has been replaced by state capitalism or something resembling the oligarchy of 1990s Russia. We're going to skip over those because they don't really add much to the conversation. Specifically in the case of Intel, there is certainly a very decent steelman argument to be made.

Starting point is 00:09:13 Intel has been a basket case for almost a decade and completely whiffed on the AI trend. Three years after the release of ChatGBT, BT, they have zero AI chips in production. They recently replaced their CEO, and until Trump intervened earlier this month, it seemed like the board was forcing him to sell off the company for parts. For a certain segment of free market absolutist, that would be just fine. Intel is a crummy company, exactly the kind that the capitalist system is supposed to kill off, so resources can shift to more productive firms. The problem is, of course, that this is a chipmaker, not a bakery.

Starting point is 00:09:40 These are incredibly capital-intensive companies to the point that they're there is really only around four in the world that run their own manufacturing process. And notably, that does not include Nvidia, who are dependent on Taiwanese chipmaker, TSMC. Essentially, the argument goes that this would be similar to allowing GM or Boeing to fail, fairly unique companies that are unlikely to be replaced, at least in any sort of short order. Chipmaking is also central to national defense. We saw in 2021 that when the supply of chips shut down, so did the supply of cars, TVs, and all manners of other goods. The issue has only become more important with the adoption of AI. So if you accept this,

Starting point is 00:10:13 keeping Intel is a national security imperative, then it naturally follows that the government will need to bail them out or even provide an ongoing subsidy. Then the only question is whether the American public should take an equity stake in the company they're paying to keep afloat. Notably, the government took an equity stake in GM, AIG, and major banks and Fannie and Freddie during 2008, so this is not without precedent. Of course, the other side of the argument is valid as well. The point is simply that taking an equity stake in Intel is not the obvious slippery slope that some presented as. However, as the week progressed, it seemed like the slippery slope argument was getting validated. On Monday, Kevin Hassett, the director of the National Economic Council said,

Starting point is 00:10:49 the president has made it clear all the way back to the campaign. He thinks that in the end, it would be great if the U.S. could start to build up a sovereign wealth fund. So I'm sure that at some point there will be more transactions, if not in this industry, than other industries. Now, the idea of expropriating your way to a sovereign wealth fund has a lot of people concerned, not least of all bitcoiners. Nick Carter wrote, this is why we shouldn't be cheering government Bitcoin acquisition efforts. The SBR is and remains a dangerous road. In an interview on Tuesday, Commerce Secretary Howard Lutnik remarked that top officials at the Pentagon were considered acquiring equity stakes in defense contractors like Lockheed Martin. He said that Lockheed is basically,

Starting point is 00:11:22 quote, an arm of the U.S. government. On Wednesday, Treasury Secretary Scott Bessent tried to clean things up as a third government official to speak on appropriation in three days. He explained that the government wouldn't be taking a stake in NVIDIA because they don't seem like they need financial support. Besant tried to lay out the principle, discussing industries like shipbuilding or farmer where the U.S. needs to be self-sufficient. The major quote that resonated was best in stating, 99% of the most advanced chips in the world are manufactured on the island of Taiwan. That's a national security risk we haven't seen since the Arab oil embargo. We just have to derisks several aspects of the U.S. economy. Now, that doesn't exactly sound like the administration

Starting point is 00:11:56 is planning to seize a stake in TSMC. However, even that is not completely off the table after what's happened in the past week. TSMC executives recently held preliminary discussions about handing back their government grants if the Trump administration asks for some equity. So how does this all net out? Without drawing any judgments here specifically and just presenting the discourse as it has been, this week does seem to mark a really big shift in that discussion. Heading into the administration, there was a sense that America had knowingly voted for someone who violated the norms of governance as a standard operating procedure, and so we shouldn't be at all surprised when norms get broken. Episodes like Liberation Day tariffs and the doge cuts were notable, but there was also a sense that this is what

Starting point is 00:12:34 the people voted for. It's less clear that there are people out there who really favored ending Fed independence or taking equity stakes in private companies. TXMC on Twitter wrote, It's wild that we're watching this happen and there seems to be little anyone can really do to check or mitigate it. Reelecting a chaos agent with an axe to grind is putting all our institutions and legacy norms to the test. Bucco Capital ran through his bingo card posting, fire central bankers, demand equity in private businesses, increase militarization for national defense, armed National Guard patrols, economic central planning, weaponized legal inquiries against political opponents, replaced legitimate press with sycophantic hacks. The playbook is incredibly clear and

Starting point is 00:13:10 simple. He is a tin pot dictator, an emerging market strongman, open your eyes and invest accordingly. Now, by the way, for those of you who disagree with that, which is totally fine and reasonable, I share Bucco's point because he's not some leftist firebrand political account. This is a mainstream big fin-twit poster. Paulo Macro added, pretty much this. Oh, and the thing about EMification is the market multiples go down, way down, like single-digit levels. Again, I'm not presenting these takes because I necessarily agree with them. The point is simply that serious market participants are sitting up and paying attention when they were more likely to brush things off a week ago. The op-ed pages of the financial press are filled with takes on these two issues, so they are clearly

Starting point is 00:13:46 front of mind on Wall Street. Doesn't seem to matter that much to the market so far, but everyone is on high alert for the next shoe to drop. Maybe nothing comes of it, but these moments are potential inflection points to keep an eye on. We could see Trump, go way beyond insisting on rate cuts towards a more fundamental shift in the U.S. economic order. Anyways, friends, interesting stuff as we head into this Labor Day weekend. That's going to do it. However, for today's breakdown, appreciate you listening as always, and until next time, be safe and take care of each other. Peace.

The Breakdown - Brazilification Risk and the Fight for Fed Independence

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