In twelve days, regime change comes to the Federal Reserve Board, as it elects Kevin Warsh to be its new chairman. He will chair a board that he has said talks to the media too often, has an erroneous measure of inflation, bows to the false precision of its models, meddles outside its lane, and commits policy errors that reduce its ability to contain inflation.
This policy regime that Warsh says needs changing has willed the incoming chairman an economy that continues to grow; has reduced the Fed balance sheet from its pandemic peak of $9 trillion to $6.7 trillion — still $2.3 trillion higher than when Jerome Powell took the chair — maintained maximum employment; avoided systemic challenges to the financial system without unduly constraining lending; and pursued a policy that has permitted corporate earnings and share prices to soar in the face of tariffs and a war with Iran.
Yes, inflation is running hot, with the measure preferred by the Fed coming in at a 3.2 annual rate in March. Elevated prices of petrol, important groceries, electricity and other items are turning consumers into anti-administration voters, even as they continue to spend. Which explains why several Fed governors indicated last week that they were reluctant to signal any easing of monetary policy. Vigorous discussions with the chairman to follow.
There is more to Warsh’s job than such discussions about monetary policy. Two were barely discussed in his confirmation hearings.
The first is the growth of private credit, loans made by asset managers such as Blackstone, Apollo and Ares to companies that do not or cannot borrow from traditional banks. These loans, which now total about $3.5 trillion by some estimates, yield higher returns because they “do not to have great transparency or rigorous valuation”, as Jamie Dimon, CEO of JPMorgan Chase, put it. The higher returns also compensate for the risk associated with loss of liquidity. Investors in some of these vehicles are running into limits on allowed withdrawals as what the Financial Times estimates to be some $20.8 billion in redemption requests hit the sector.
The default of software maker Medallia on a $3 billion loan was one of more than a few. It can be seen as a minor matter, or the veritable canary in a coal mine or, as Dimon more graphically put it, “when you see one cockroach, there’s probably more”, confident that no such infestation infects his bank’s better-vetted $50 billion exposure to private credit. Warsh knows that Wells Fargo ($36 billion), Citi ($22 billion) and other large banks have invested in these funds, and has called the growth of private credit a “blind spot” in the regulatory framework.
The other item requiring his attention is the possible effect of AI on the labour market and the economy. Warsh has professed faith in the ability of AI to improve productivity so that the economy can produce more while employing fewer workers, and by keeping costs down permit more rapid growth without triggering inflation. But he seems appropriately uncertain.
The trickle of lay-offs to make up for over-hiring after the pandemic has become a flood, as cash saved on staff is needed for capital investment. Famously, Jack Dorsey’s financial services company Block fired 40 per cent of its 10,000 workforce because AI allowed smaller teams to do the work once performed by larger ones. United Parcel, Amazon and Oracle, 30,000 lay-offs each; Citigroup, 20,000; Meta and Microsoft, about 8,000 each; Dell, 10,000. Economists at Stanford University reckon that young (ages 22-25) workers such as software developers and customer service representatives are being hardest hit.
Although it is not yet the consensus view, many worry about a structural change in the labour market. Verizon CEO Dan Schulman, who has begun laying off 13,000 of his employees, predicts the unemployment rate will reach 20-30 per cent within two to five years. The Boston Consulting Group puts that figure at 10-15 per cent in perhaps five years — 25 million jobs. Lost pay cheques on that scale would mean the disappearance of lots of purchasing power from an economy heavily reliant on consumer spending. There is a hot debate over whether new jobs will be created, and if so, when.
The labour market is not the only one affected by AI. Google, Microsoft, Amazon and Meta last week — assuming mounting Nimbys can be overcome — announced plans for as much as $725 billion in capital expenditures this year, a non-trivial 2 per cent of GDP. Warsh has said that “considerable work needs to be done” and that we need “better data” before making policy decisions about the macro consequences of both success and a possible bust.
Which leaves at least one more matter, this one a challenge to Warsh’s charm and powers of persuasion — the reaction of President Trump should Warsh fail to engineer a cut in the Fed’s benchmark interest rate soon. High inflation and increases in the rate on the ten-year treasury note are not acceptable excuses for failure. Trump will insist Warsh redeem his promise of lower rates, just as he redeems his.
Irwin Stelzer is a business adviser