ILLUSTRATION: KATMANDU JOURNAL
JEROME POWELL, the chair of the Federal Reserve, America’s central bank, has spent years fighting inflation. He now finds himself fighting a criminal probe. On January 11th the Department of Justice served the central bank with subpoenas. The ostensible target is a $2.5bn renovation of the Eccles Building, the headquarters of the Fed, in Washington. Yet the timing suggests a more pointed motive. President Donald Trump has spent months yelling that interest rates fall to 1%. The Federal Open Market Committee has stayed stubborn: it prefers to keep the target range between 3.50% and 3.75%. In the world of high finance, a subpoena can be shorthand for, “I don’t like your basis points.”
Central bankers were once untouchable, meaning they were an autonomous technocrat, shielded from the grubby demands of election cycles. This was the great consensus of the late twentieth century. It was a truce born of the 1951 Treasury-Fed Accord. Before that deal, the Fed was little more than a cash machine for the Treasury. It kept interest rates low to fund the costs of the second world war. The Accord liberated it. It allowed William McChesney Martin Jr, Fed chair from 1951 to 1970, to “lean against the wind”. For seventy years, that independence was the yardstick of a serious economy. It suggested that a country cared more about long-term stability than short-term votes. That truce is now crumbling.
Across the globe, the firewall between fiscal and monetary authority is being breached. The weapons vary by jurisdiction. In America it is the judicialisation of policy disputes. In Europe it is the cold reality of fiscal dominance. In South Asia it is the executive suspension of governors. The underlying cause is obvious. Sovereign debt has reached levels that make interest-rate decisions a matter of national survival. When a state owes $35trn, a single percentage point is a fiscal catastrophe. Politicians have noticed. They want their cash machines back.
The Fed is currently the most visible battlefield. The criminal investigation into the Eccles Building is merely the opening salvo, meaning it serves to weaken the institutional prestige of the bank. More significant is the attempt to dismantle the “for cause” protection of governors. Lisa Cook, a Fed governor, is currently fighting for her job in the supreme court. The administration wishes to fire her over historical mortgage paperwork, alleging fraud. If the court agrees, the president could dismiss any governor who disagrees with his Truth Social posts. Independence would become a fiction. Potential successors for Mr Powell, whose term ends in May, are now being vetted for their loyalty. The warning is that only “team players” need apply.
The markets have reacted with predictable jitters. Gold and silver prices have surged. The dollar index has faltered. Ten heads of major central banks, including Christine Lagarde of the European Central Bank (ECB), have issued a rare joint statement. They argue that the Fed is being treated like a bank in a struggling emerging market. This is a stinging rebuke. It suggests that the institutional infrastructure of the world’s reserve currency is fraying.
The pressure is no less intense in Europe. The ECB is legally the most insulated central bank in the world. It is protected by treaty. Yet it is increasingly a prisoner of “fiscal dominance”. This occurs when the insolvency of a member state dictates the path of interest rates. France is the current worry: its debt-to-GDP ratio surpasses 115%. And its deficit is a cavernous 5%. Hard-right figures like Jordan Bardella have suggested the ECB should underwrite French debt. They view the central bank as a backstop for national social programmes. The ECB wants to hit its 2% inflation target. But if it raises rates to do so, it might bankrupt the second-largest economy in the euro zone. It is a game of chicken where the central bank has no steering wheel.
In Britain the attack is more subtle. It focuses on the balance sheet. Both Reform UK, a populist outfit headed by unpredictable Nigel Farage, and the Green Party have eyes on the interest the Bank of England pays on commercial bank reserves. During the pandemic the bank created vast sums of money to buy bonds. Now the interest bill on those reserves is enormous. Politicians see a “cash machine” to fund their manifestos. They propose scrapping these payments. That would effectively turn the Bank of England into a taxing authority. It would compromise its ability to manage the money supply. Once a politician learns how to spend central-bank profits, they rarely stop.
The developing world provides a grimmer preview of what happens when the siege succeeds. Sri Lanka is the cautionary tale. In 2022 its central bank was forced to finance reckless tax cuts. It maintained an artificial exchange rate to please the ruling family. The result was a total collapse of the financial system. It was the “hard way” to learn about autonomy, as Governor Nandalal Weerasinghe noted. Sri Lanka has since passed a new law to prohibit “monetary financing”. It is a desperate attempt to lock the door after the horse has bolted.
Other nations are moving in the opposite direction. Indonesia has revived a “burden-sharing” scheme. Bank Indonesia (BI) now buys government bonds to fund public housing and cooperatives. Half of the interest income is shared back with the government. This is debt monetisation by another name. Governor Perry Warjiyo argues this maintains stability. In reality it merges the national budget with the central bank’s printing press. It is a dangerous template for any populist leader with a big deficit and a small stomach for austerity.
Nepal provides a more colourful example of institutional friction. The central bank here is full of executive drama. In 2022 Governor Maha Prasad Adhikari was suspended after a feud with the finance minister, Janardan Sharma. The official reason was a leak of information. The real reason was his refusal to release funds for a politically connected businessman. The supreme court eventually reinstated him. It called the suspension “arbitrary”. Yet the law still states that the bank must “abide by” government directives. When Mr Adhikari’s term ended last year, the government left the post vacant for forty days. They could not agree on a successor who was sufficiently compliant. The appointment of Biswo Nath Poudel was a victory for political consensus over technocratic expertise.
The logic of the siege is fueled by a public that is tired of the “affordability crisis”. A recent survey by the Bank for International Settlements (BIS) across 31 economies is revealing: it shows that households are increasingly angry. They do not blame central banks for the initial inflation. They blame supply chains and wars. However, they do blame central banks for the “solution”. High interest rates are seen as a choice not a necessity. In Britain a third of the public believes the 2% inflation target is “too high”. They would prefer 4% inflation if it meant cheaper mortgages. This provides populists with a democratic mandate to bring the “inflation nutters” to heel.
This sentiment creates a paradox. The central bank’s primary job is to be unpopular. It must take away the punch bowl just as the party gets going. But in an era of $1trn annual interest bills, the party ended long ago. Now the central bank is being asked to pay for the cleanup. If it refuses it is accused of being undemocratic. If it complies it risks the currency.
The result is a new era of “managed autonomy”. The old model of total independence is dead. Central bankers are learning to navigate a world where their budgets, their buildings as well as their legal protections are all on the table. They are becoming politicians by necessity. They must trade rate cuts for institutional survival. This is a fragile arrangement, meaning it relies on the hope that a “team player” can still be a credible guardian of price stability.
The history of the twentieth century suggests that hope is misplaced. When the line between the treasury and the central bank blurs, inflation eventually follows. The 1951 Accord was not a gift from the government: it was a surrender. The government realised that it could not manage its own debt without destroying the dollar. Today’s leaders seem to have forgotten that lesson: they view the central bank as an obstacle to sovereignty. And they fail to see that a central bank under the thumb of the executive is merely a money printer.
The criminal charges against Mr Powell is a test of whether the world’s most powerful economy still believes in the separation of powers. If the Fed falls the rest of the world’s central banks will likely follow. The technocrats have held the fort for seventy years. The walls are now looking very thin. ■
