Messing With the Fed Is Playing With Fire

Americans will miss economic stability when it’s gone.

Donald Trump and Jerome Powell. (Photo by Drew Angerer/Getty Images.)

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My earliest political memory is of a currency crisis. I was eight, and Venezuela’s decades-old currency peg to the U.S. dollar had collapsed. I remember the adults in my life huddled around TV sets, whispering in worried tones as their world came apart at the seams. I didn’t understand all the details—I didn’t understand any of the details—but I knew our lives had changed. For the worse.

I’ve never met an American who could empathize with that story.

In the United States, currency crises are the stuff of academic seminars—bone-dry grist for economists’ mills. For all the talk about privilege, Americans are uniformly blind to the big one they all share: dollar privilege. America issues the world’s reserve currency, and the U.S. dollar’s peg to itself can never collapse. For that reason, the country is exempt from the kind of macroeconomic fuckery that periodically blights people in the rest of the world.

If you’re an economist, why this matters is obvious. If you’re not, it can be hard to wrap your mind around. Think of it as denominator privilege—the United States issues the thing the world does business in, the denominator in every trade deal. When Ghana sells a boatload of cocoa to Singapore, they have to pay for it in U.S. dollars, which means Singapore needs to keep U.S. dollars in a pot in its central bank in order to transact with the rest of the world. Every country does.

It’s as though a group of guys huddled around a conference table in Washington, D.C. was given the power to determine the supply of gold in the world. And that’s barely an overstatement, because since the collapse of the gold standard in the Nixon era, the U.S. dollar has played the role gold used to play in the international financial system.

For the United States, that’s an incredible advantage—but just abstract enough to be invisible. Macroeconomics textbooks expound on “the dollar’s role as a reserve currency”—but that obviously means nothing to the uninitiated.

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Yet it tilts the global playing field in favor of the United States in all sorts of ways. For one, the value of America’s debts to the rest of the world can’t balloon from one moment to the next, because what America owes the rest of the world is the dollars America itself issues. The kind of rapid immiseration you’re prone to when you borrow in somebody else’s money is off the table.

Hell, America issues the currency other countries keep their savings in. As a result, the debt the U.S. government issues is regarded as risk-free even though it’s denominated in a currency the U.S. itself controls. It’s a setup other countries can only dream of.

Normies don’t get that.

And they really don’t get that this whole setup is at risk.

Certainly Donald Trump hasn’t the foggiest clue why the dollar’s role as a reserve currency matters. His second term can be read as a determined campaign to blow up the dollar’s denominator role.

But the world’s willingness to transact its business in U.S. dollars isn’t some unalterable fact of nature. It’s not (just) a function of U.S. military power. It is, for the most part, the result of a diffuse worldwide consensus that U.S. monetary policy is responsibly run by technically astute central bankers who are politically independent of the people who run the government, who are themselves believed to be more or less competent and more or less sane.

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Both of these pillars of dollar hegemony are now under severe strain. The first and most ominous signs of breakdown come from the White House’s determined campaign of harassment against Jerome Powell, the chairman of the Federal Reserve, whom the president rants against basically every week now.

In late June, Trump said he wished Powell would just quit already and explicitly announced that, for his successor, he would only consider candidates who will lower interest rates.

Whether you take that seriously, literally, or both, this announcement ought to terrify you. Announcing explicitly that henceforth Fed chairs will be subject to policy demands from the executive wipes out the first of the pillars holding up denominator privilege. When governments start to borrow more, they normally have to pay higher interest rates to ensure people keep lending to them. Higher interest rates prevent people fleeing the currency, and its value tanking.

But if the government puts a bunch of stooges in charge of the Central Bank, they can just tell them to keep interest rates down as they keep borrowing more—which is precisely what Trump is saying he will do. In normal circumstances, this leads to a big sell-off of that country’s debt, a harsh devaluation, a spike in inflation and that country making a bee-line to the IMF to ask for a bailout. We can only guess at what happens if that dynamic takes hold in the place that issues the world’s reserve currency and backstops the IMF, because nothing like that is supposed to be even imaginable.

American debt is only accepted as risk free because investors around the world believe that if the U.S. government runs up too much of it, that government won’t be able to just order the Fed to print up extra dollars to make up the difference—that way lies hyperinflation. But when the U.S. president straight-up announces that the Fed will be run by governors willing to keep short-term interest rates artificially low to suit his political interests, that assumption starts to look shaky. A Fed that can’t say “no” to the White House is a Fed that can’t credibly defend the value of the dollar.

And there’s just no reason to think the rest of the world will want to denominate its savings in a currency Donald Trump—or any U.S. president—can debase with a tweet.

But the victims of macroeconomic nonsense—from Venezuela and Argentina to Turkey and Zimbabwe—know that this sort of monetary policy skullduggery isn’t quite enough to do your country in. Real trouble comes when fiscal policy—the government’s taxing, spending and borrowing decisions—takes a leave-of-absence from common sense. Messing with the Fed is bad. Messing with the Fed while you’re on an almighty spending and borrowing spree is much, much worse.

And yet that’s exactly what’s happening. Trump’s “One Big Beautiful Bill” includes $3 trillion worth of deficit spending, and it’s estimated that it will push the country’s debt-to-GDP ratio to a shocking 130% by 2034—much higher even than it was at the end of World War II, when it topped out at 106%. Which means the United States is going to need to borrow a lot more.

Big deficits + cheap money are the textbook recipe for out-of-control inflation. That’s no way to run a reserve currency.

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Atrophied by years of denominator privilege, Americans’ macroeconomic nonsense spidey senses have simply not registered the threat this all implies. Instead, they’ve tended to process it all through the lens of regular old right-left partisan politics. The public square is crammed full of analyses of the distributional impact of Trumponomics in areas like taxation. And those are serious, within normal parameters.

But the systemic risks Trump is taking with the macroeconomy are serious on an entirely different scale.

There are already some early tremors. Interest rates on long-term U.S. debt have been inching up all year, while the dollar’s been losing value against a basket of other currencies. This is not the way things are supposed to work for a denominator currency.

When long-term bond rates rise, that’s supposed to lure investors into buying them to take advantage of those better rates. (When someone buys a treasury bond, they are lending money to the government.) More money flowing into U.S. bonds should strengthen the dollar against other currencies. That this isn’t happening is a clear signal that international investors just don’t trust the American financial system the way they once did.

In the rest of the world, they call that “capital flight”: investors are already shying away from holding U.S. debt even as interest rates rise. What we’re seeing is not quite Argentina-before-a-meltdown in scale, but the direction of travel is the same.

Stock markets, high on their tax-breaks and gorging on their TACOs,¹ refuse to take it all quite seriously. I watch it all and pinch myself, wondering if I’m the last sane one around. The United States is now very much pledging to go on a world-historic borrowing binge while it puts its monetary policy in the hands of political hacks. That cannot end well.

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Look, I can’t tell you when and how exactly this all comes to a head. It could take decades or years, or it might be months. Does a bond rout happen quickly or gradually? Or does the rush to safety lead investors, paradoxically, back towards the assets causing the instability in the first place, reasoning that bad as they are they’ll be less unstable than the rest? Does capital instead rush headlong to Shanghai, and the world start to denominate value in yuan? Does it bolt for Frankfurt? Or London? Does it fracture and give way to long-term instability? I have no idea. No one does.

We’ve never really been through a situation like this, where the world’s investors, as a group, lose faith in the soundness of the denominator asset. What comes after the era of U.S. dollar hegemony is anybody’s guess. But if Trump follows through on his promise and picks a lunatic or a stooge (or a lunatic stooge) to run the Fed, markets are liable to panic in ways that have long-lasting effects.

In the Venezuela of 1983, people woke up one morning to find everyone in the country was substantially poorer than they’d been the day before: their savings bought less, everything cost more, lifestyles that had been within reach one day were out of reach the next—and economic life became topsy-turvy and unpredictable in ways it hadn’t been in decades.

Once macroeconomic stability is gone, it’s hard to get it back. People hate this experience: within a couple of decades, our democracy had collapsed. In the United States, with democracy already under strong pressure, things could happen much more quickly. What gets me is that there are already plenty of eyes on America’s institutional decay—but barely any on the way macroeconomic instability could accelerate it.

Worry more.

Quico Toro is Director of Climate Repair at the Anthropocene Institute, a contributing editor at Persuasion, and writes the Substack One Percent Brighter.

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