“Not only the fact of independence but also the appearance of independence is key to the Federal Reserve’s design.” – US Supreme Court Chief Justice John Roberts
Twelve and a half minutes into his Jackson Hole interview with Kathleen Hays, my friend Jacob Frenkel offered an elegant metaphor about Kevin Warsh:
You know, because the world is so interdependent, we need to think about it like we think about it like an orchestra, you have various players. You have these instruments. How do they play together? Well, first of all, they must have the music in front of them to see that there is potential harmony. But how do you ensure it? You need to have a conductor. And in the current world economy, in the past, the US was the conductor, the leading force that brought about stability. It brought about coherence. What we see today is a world where globalization was the objective, is now getting disintegrated. We have fragmentation. We have protectionism. We are departing from the world in which you have a music orchestra with a good, good conductor.
I advise readers to spend the full 15 minutes and listen to this interview in its entirety. If you are unfamiliar with Jacob, please do read his bio. Here is Kathleen’s full interview with Jacob, along with Kathleen’s introduction and highlights:
“Frenkel: Warsh Signals “Back to Basics,” Stresses Price Stability Key to Reaching All Fed Goals” | Kathleen Hays Presents: Central Bank Central
Kevin Warsh’s Jackson Hole speech included specific comments about money and policy. Bill Nelson of the Bank Policy Institute kindly gave me permission to provide an extensive excerpt from his recent analysis, sent out via email on September 1. Bill invites serious observers of monetary policy to subscribe to his commentary. I read it on receipt every time he publishes. Readers who would like to be added to Bill’s email list may contact him by email.
Bill wrote,
On July 20, 2026, I observed that the inclusion of a paragraph on M2 in the Monetary Policy Report for the first time in a decade indicated that Chairman Warsh would be emphasizing money (“Forward guidance: Inflation may be a choice, but resolve is not a plan”). In his Jackson Hole speech, Warsh stated that one of his seven principles for central banking was that money matters. It’s worth unpacking his statement:
“Sixth, money matters. It’s not fashionable these days, but my view is that money has something important to do with monetary policy. We should pay attention to money created by the central bank and money that comes from the banking and financial systems. It’s true that financial innovations and other factors alter the mechanics that link the monetary base, the velocity of money, and the broader economy. But that is scarcely a reason to ignore the ultimate effects of money on financial conditions and prices.”
As I explained in my earlier email, the fact that it is called “monetary policy” doesn’t mean money is still relevant for the Fed’s understanding and management of the macroeconomy. After all, the Fed no longer holds the country’s gold reserve backing the currency and reserve requirements are zero and irrelevant, but it is still called the Federal Reserve System. Money was not abandoned because it fell out of fashion, it was abandoned because there is no correlation between money and the economy and between the Fed’s balance sheet and the broad monetary aggregates. In response to my earlier email, Don Kohn, founding director of the Fed’s Monetary Affairs Division and ultimately Vice Chairman of the Fed’s Board wrote:
“I agree with all of this…We expended considerable resources in R&S and then MA trying to get some value from the aggregates relative to future nominal GDP or inflation, to no avail. It’s a dry hole.”
I also pointed out that a belief that money matters can always be sustained by switching to another monetary aggregate (Divisia money, a monetary aggregate that weights the components of the money supply based on their ease of use and usefulness in transactions, seem likely to be next; see Ireland, Miran and Roubini “A return to monetarism?”). Warsh refers to “money created by the central bank”, but the type of money that is supposedly linked to economic activity and inflation is money in public hands. Of that, only currency is created by the central bank, and currency is neither important nor controlled by the Fed. The key liability the Fed controls is reserve balances. Reserve balances are in the monetary base, but they are not a means of payment for the public, are not included in M1, M2, M3 (or Divisia money) and are not part of the money in “too much money chasing too few goods” or “inflation is always and everywhere a monetary phenomenon”. (See “Forward guidance: Shrinking the Fed’s balance sheet will not reduce inflation”).
It’s noteworthy that in Warsh’s extensive discussion of economic activity and inflation in his speech, which touched on a wide range of indicators and included a discussion of financial conditions, he did not mention money.
Readers may access the post in its entirety on LinkedIn:
“Forward guidance: The Fed’s Q2 profits and Warsh on the money at Jackson Hole” | Bill Nelson at LinkedIn
Kotok’s Last Word
Jacob Frenkel and Bill Nelson, read together, sum up the global theme and the direct monetary policy application theme. As I see it, Warsh is being very clear about his intentions. He is giving guidance, not “forward guidance.” He knows he must stay on course with a 2% PCE inflation target or his credibility will be lost. Bill Nelson explained some of the plumbing. Jacob Frenkel demonstrated the global context.
To use Jacob’s elegant metaphor, we shall see if Warsh can conduct the orchestra.
Having said that, the orchestra has now been interrupted in the middle of a concert. CNBC’s Steve Liesman fully reported all sides of the issues, including the disruptive comments of Peter Navarro. See
Trump turns up the heat on Warsh as Fed rate hike looms | CNBC
Trump has muddied things, and that only introduces more market turmoil. If market agents believe Warsh is succumbing to Trump’s pressure, the dollar may weaken and market-based interest rates may rise. Financial market agents are rightly worried about inflation. The services sector inflation is likely to rise in the next reporting period.
But if we look in the weeds at the recent employment report, it is not so strong as headlines discussed. We will discuss anomalies in a coming KR that addresses the distortions in labor data. Bottom line: politically motivated factors are now at work in the formerly politically neutral data agencies. Second bottom line: revocation of TPS status removed workers from the cohorts, which do not count people who are declared “illegal.”
New Fed Chairman Warsh can delay a rate hike by declaring he is waiting for the task forces to complete their work. There is no reasonable expectation that the Fed will cut rates. And thanks to Trump, the markets will struggle about how to interpret a “no change.”
Trump has poked the orchestra conductor in the eye with a baton.
Further Reading/Viewing
Let’s examine how the China Daily reported Trump’s outrageous threat to use trade as leverage to force the Fed to lower interest rates. Why do I use the China report? China has an evolving yuan-based payment system centered in Shanghai, and it has grown from zero to about 3% of global payments. Yes, the USD Western system is still much larger, but the global competition is there. Trump’s behavior and threats are counterproductive. One at a time, market agents open a second payment channel through Shanghai. They continue their use of the USD-based system, but they expand the yuan system usage, too. Trump’s craziness is driving the marginal global user to Shanghai. His latest attack on the Warsh Fed will make the situation worse for America. My forecast? By the end of 2026, Shanghai warrants balances will boldly set a new record high. The Shanghai payments system will set a new record high. Thank you, President 47. You are the responsible person. You own this.
“Trump demands Fed lower rates, reviving pressure” | China Daily
China patiently manages the yuan/dollar relationship to keep it from wild volatility. Here’s an example.
“Chinese banks purchasing Treasuries after wooing dollar deposits, sources say” | Reuters
I’d like to thank Vance Barse and Jim Bianco for their kind words and shoutout in Vance’s excellent 55-minute interview with Jim. They cover the Fed, Warsh, and other issues such as AI and housing with a meaty, detailed analysis.
“Inside the Modern Economy: Jim Bianco on Kevin Warsh, AI, and the Next Market Shock” | Your Dedicated Fiduciary, Vance Barse
Hanno Lustig’s two-part explanation of yields warrants consideration by serious investors:
“What are US Treasury markets really telling us? Part I” | The Two Cents (Hanno Lustig)
“What are U.S. Treasury markets really telling us? Part II” |The Two Cents (Hanno Lustig)
In the next recommended essay, David Marsh lays out the parallels between the struggle unfolding between Trump and Warsh today and the one that evolved between West German Chancellor Helmut Schmidt and Bundesbank President Karl Otto Pöhl back in 1981–82.
“Lessons of history as ECB and Fed decide interest rate moves” | OMFIF
Labor data problems. Politics has allegedly distorted facts. Does anyone remember Kelly Anne Conway originating the term “alternative facts”?
“The quiet storm threatening Washington data” | Politico
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