When white flags go up, a surrender is going down. Ukraine has just sent one up. Bill Gates did too. I believe the US Federal Reserve will ultimately send one up. Britain and France may be sending one up (to the IMF). Bill Gates. The Mayor of Washington DC. Surrender is not really the right word for a white flag. The white flag simply serves as a signal that the social contract arrangements are being revised. Agreements are taking shape even if the words are not on a piece of paper. Similarly, the broad agreements President Trump is hammering out with foreign nations and his domestic opponents are unlikely to be written down. White flags are a metaphor for the start of a new understanding, a new configuration of the social contract.
To remind everyone, there is always a social contract. It’s a deal between states and citizens that constitutes the foundation of the social fabric. Think of the social contract as a series of promises and assumptions between citizens and states. Citizens agree to obey the laws and rules, and pay taxes in exchange for a national defense, an education system, a legal system that protects citizens, a police force, a system for approving what constitutes safe medicine, and other essential services.
The interesting thing these days is how various parties are utterly unable to acknowledge that they’ve broken the old social contract while feigning utter surprise that a new one needs to be put in place. I’d put the Federal Reserve at the top of that list. Surely, after having made the decision to bail out the banks and socialize the losses and permit inflation to run hot, they cannot be surprised that the public is having a “hey wait a minute” moment. They were treated as heroes for saving the system and Ben Bernanke received a Nobel Prize for their efforts. How dare anybody question the decisions now? However, the questions are very real and important because the price America and the world paid for their inability to prevent the crisis, combined with how they chose to manage it to the benefit of asset holders and against the interests of everyone else, is no longer viewed as heroic. No doubt Trump’s bully tactics are profoundly offensive to classical central bankers. But central bankers had their own Gangsta approach to managing the Great Financial Crisis. Remember Financial Repression? You WILL buy more Treasuries, or (implied, you’ll face a ton of audits). It reminds me of the moment in Casa Blanca where the French Police Officer who oversees the illegal gambling feigns surprise and says, “I’m shocked to see gambling going on here,” even as he takes his winnings from a waiter.
The situation at the Fed reveals something much deeper. Central Bank independence is a religion. It contains sacred books, sacred sayings, and symbols (literally, on the money), as well as sacred beliefs. But, the core function of an independent central bank is to protect price stability. Instead, in the heat of the meltdown in 2007/8, the Fed chose to protect the speculators at the expense of the savers and citizens. It abandoned its central role in the social contract as an instrument of justice that balances the interests of both the citizenry and the speculators. The Fed wanted to be popular. They chose to save the system. They believed they averted another 1929. They then have basically pretended that there was no cost associated with these decisions and choices. They said they could control inflation. Well, that turned out to be untrue. As the public has felt the pain of higher prices wash over them, they clocked that the Fed allowed the bankers to socialize their losses and keep their pirated gains, while the regular Joe now got inflation. This was a breach of the social contract. It’s a realization that Wall Street pirates stole their livelihood. They’ve just been slow to figure this all out.
Now the issue of political partisanship comes into this, too. The prevailing narrative is that Trump is politicizing the Fed. But how we forget about the rate cut that the Fed threw to the Democrats just before the last election, seemingly in a bid to support Kamala Harris and prevent Trump from winning. Even if not true, the optics were terrible. Also, remember that Paul Manafort, Trump’s former advisor, not only went to prison but was placed in solitary confinement for 23 hours a day for his mortgage fraud. We often forget that financial impropriety has been a long-standing issue among Federal Reserve officials, particularly after several Fed officials had to resign due to suspicious stock trading in recent years.
Also, the relationship between the Fed and the Federal budget has changed over time. So, the current situation is not sacred. The new Fed Governor, Stephen Miran, says we need a new kind of cooperation between the Fed and the Treasury, meaning the Fed should support the Treasury’s need to fund itself. This “voluntary cooperation” reeks of religious heresy today. But it was not so long ago that this relationship used to be standard. We have forgotten about the 1951 Treasury-Fed Accord. Robert L. Hetzel and Ralph F. Leach wrote an excellent summary (here) of how the relationship worked after the Second World War until 1951. In short, the Fed supported fiscal borrowing from 1941 to 1951 because the country was at war. It was a national emergency. Today, the Trump team says “we have a national emergency” because the US National Debt is exploding upwards, in large part because of the Fed-led bailout, and because the political arena is willing to cut or reallocate assets or take responsibility for the debt.
We are also at war. Yes, it’s an undeclared war, but it is what I have called here, in this substack, The Hot War on Cold Places, and the Cold War in Hot Places. These wars are expensive, even if undeclared. Add to this the fact that we are in a race for the technological frontier, a race with existential consequences for both the winners and the losers. That race is costly. From a fiscal perspective, we are in a state of emergency. The emergency in other countries may be worse. Rumors that Britain may need to turn to the IMF for a bailout are circulating on the internet. Japan’s debt market is imploding. The French Finance Minister, Eric Lombard, responded to the rising risk of a no-confidence vote in France, which made French 10-year yields go over 3.5%. He is reported (by The Times) to have said, “I bet that within a fortnight, our debt will be costing more than Italy’s.” But, he later denied that a crisis is inevitable, saying, "I don't believe in a financial crisis." "The country is rich, the country is growing, the country is managed, it is under control, and France's businesses are doing their job". Good. Nothing to see here. Though, let’s just say that