“Clueless.” “Boneheads.” “Going loco.” Those were a few of the epithets that Donald Trump hurled in 2018 and 2019 at the Fed, in particular Chair Jerome “Jay” Powell. Fixated on the Dow Jones Industrial Average as a metric that he hoped would boost his chances for reelection, the president blew his stack over a Fed interest rate hike in the fall of 2018 that caused stocks to dip.

The news media were full of reports about Trump’s inquiries to aides about whether he could fire Powell, whose appointment in 2017 he lamented as the worst decision of his presidency.

Advisers reportedly persuaded Trump to drop the idea in late 2018; they explained that Fed governors, who are appointed to 14-year terms, could only be removed for serious dereliction of duty, not a policy dispute, although the law was less clear about the president’s authority to revoke the four-year term of the chair. That didn’t stop Trump from repeatedly expressing his displeasure in following months, especially during downdrafts in the Dow, over what he viewed as the Fed’s overly tight policy. Refusing to acknowledge that his trade war with China was at least partly responsible for falling stocks, Trump tweeted: “My only question is, who is our bigger enemy, Jay Powel [sic] or Chairman Xi?”

This was quite a departure from presidential civility toward the Fed that had prevailed since the consecration of the central bank’s independence during the Volcker era. Under an informal rule laid down in the early days of the Clinton administration by Robert Rubin, who then chaired the National Economic Council, the Fed was off-limits for criticism by the White House or other parts of the executive branch – and the rule was scrupulously followed during Clinton’s two terms and the two administrations that followed. The reasoning was simple: pressuring the Fed, especially in public and especially for monetary easing, would only sow doubt about its commitment to maintaining price stability. Counterproductive consequences would likely ensue, including market jitters, and Fed officials might well dig in their heels to avoid any appearance of political servility.

Fed independence was not the only pillar of dollar dominance that Trump battered. Another was rule of law – for example, when he used threats of government crackdowns to strong-arm individual companies into keeping factories open, and most infamously when he tried to reverse the outcome of the 2020 election. But the dollar’s primacy would not only survive the Trump years but end up strengthened by the time he left the White House, a trend that would continue when Joe Biden took over. The fortification of the dollar’s status would be attributable in large part to actions taken by the very institution that so irked Trump – the Powell-led Fed.

Powell is not an economist, like the three economics PhDs (Alan Greenspan, Ben Bernanke and Janet Yellen) who preceded him as Fed chair. Growing up in Chevy Chase, Maryland, the second of six children, he attended Georgetown Prep, an all-boys Jesuit high school, and from there went to Princeton and Georgetown Law School, from which he graduated in 1979. But he had ample experience in the intersection between financial markets and government, having moved from law to investment banking in 1983 and following his boss to the Treasury, where he rose to undersecretary for domestic finance in the early 1990s.

More valuable than any formal training or professional background, perhaps, were his natural people skills. Upon being appointed to the Fed as a governor in 2012, he devoted himself to gaining economic expertise by reading extensively – books, articles, blogs, anything he could find – and asking staffers for briefings, which enhanced his reputation for modesty. As chair, his disarming congeniality served him well in harnessing the talents of others in the Fed’s top policy echelons who boasted sterling economic credentials, including Vice Chair Lael Brainard, Vice Chair Richard Clarida, and New York Fed President John Williams.

Throughout the barrage of invective from Trump, Powell maintained an imperturbable stance in public, refraining from firing back and sticking to economic issues. When asked point-blank whether Trump’s comments were influencing Fed decisions, he had a stock reply: the central bank would neither allow itself to be swayed by politics nor feel compelled to prove its manhood; monetary policy would be dictated solely by economic considerations. He did his utmost to quell any doubt about his resolve, telling Nick Timiraos of The Wall Street Journal in an off-the-record conversation: “I’d rather go in the books as a terrible Fed chair than somebody who knuckled under.”

But the presidential assault complicated his job by adding a new and crucial priority: ensuring that the Fed’s institutional integrity would endure. Awkwardly, Powell and his colleagues were coming around to the view in early 2019 that they had gone too far in raising rates in 2018; inflationary pressures were much more subdued than they had expected. Accordingly, they decided to make a course correction toward an easier policy – a step fraught with humiliating potential because it carried the implicit admission that Trump’s complaints had been well-founded. Extremely nuanced communication would therefore be necessary to show the economic justification for every policy move.

The Fed lowered rates three times in 2019, enabling the economy to barrel along in the longest expansion on record, with the unemployment rate at 3.5 percent, the lowest since 1969. Those easing measures didn’t go fast or far enough for Trump, who continued blasting away, accusing Powell of having “no guts” and a “horrendous lack of vision.” Asked by a reporter in August 2019 whether he wanted the Fed chief to resign, the president replied, “Let me put it this way: If he did, I wouldn’t stop him.”

Trump’s intimidation of the Fed reached its zenith – or nadir, depending on your perspective – on March 14, 2020, at a press conference with his recently formed Coronavirus Task Force. The virus had then killed 50 Americans, the president said, far lower than the death toll in other countries, which he cited as proof of how effectively and energetically his team and every part of the U.S. government was responding – except the Fed; it “should be much more proactive,” he griped.

A reporter then asked, given Trump’s constant carping over the Fed, “why don’t you dismiss the chairman? Or do you think you’re powerless to do so?” In reply, Trump strongly hinted that he might order Powell’s demotion: “No, I think I have the right to do that or the right to remove him as chairman. He has, so far, made a lot of bad decisions in my opinion. … I have the right to remove, I’m not doing that . … I have the right to also take him and put him in a regular position and put somebody else in charge and I haven’t made any decisions on that.”

It will never be known how much further

Trump might have gone in trying to bend the Fed to his will, or what that might have done to the standing of the central bank and the currency it issues. Fast-moving events were confronting Powell with bigger worries than Trump, and vice versa.

By the dawn of the 2020s the market for U.S. Treasury securities had evolved in ways that would have been unfathomable to government bond traders of the mid-1970s – the hotshots riding limousines out of Wall Street saloons. First there was the market’s sheer size, with $18 trillion in Treasury obligations outstanding, of which about 40 percent were held overseas, and trading running at an average of nearly $600 billion a day. (By comparison, $30 billion of daily trading in Treasuries was viewed as a staggering volume in the mid-1970s.) Another feature of the 2020s market that was undreamt of in the mid-’70s was the prevalence of “high-frequency trading” involving the holding of positions for just fractions of a second based on algorithmic formulas.

Trillions of dollars! High frequencies! Algorithms! What could go wrong?

The liquidity of this market is crucial for the dollar’s global standing. Confidence that there are so many buyers and sellers of Treasuries, and that even in a crisis a purchase or sale will amount to little more than a drop in a big bucket, makes the dollar attractive to multinational banks, Asian pension schemes, Middle Eastern sovereign wealth funds and a myriad of other institutions and businesses. Treasury securities don’t yield a high return compared with other, riskier investments, but they do provide assurance that, when obligations are coming due under emergency conditions, the necessary cash can be obtained immediately.

Beyond that, proper functioning of the Treasury market can fairly be described as important for economic well-being in virtually every corner of the globe, because the daily churn of hundreds of billions in Treasuries sets the yield for the closest thing in the world to a risk-free asset. That yield in turn serves as a benchmark against which investors and lenders assess all sorts of debts, such as bonds issued by other governments, shortterm commercial paper issued by companies, business borrowings from banks, home mortgages, auto loans – the list goes on.

The yield on Treasury bills due to mature in three months or six months is the risk-free standard that enables investors and lenders to determine what interest rate will induce them to extend credit for a few months. The yield on two-year Treasury notes or ten-year Treasury bonds provides similar information for the extension of credit for longer terms.

Now suppose the assumptions in the previous two paragraphs about the workings of the Treasury market were to prove misplaced. What if the world’s safest asset couldn’t be readily sold, or if sales of sizable amounts could only be consummated at sharp or unpredictable discounts from the latest prices? Since Treasuries could no longer be deemed safe under such circumstances, how high would their yields have to rise to compensate investors for the heightened risk, how badly would all other markets be discombobulated as a result, and how much more costly would it become for anyone, anywhere, to obtain credit?

This Time Really is Different

The outbreak of the Covid-19 pandemic gave the financial world a brief but terrifying encounter with the chaos that could ensue from a Treasury market breakdown. In the second week of March 2020 as minds reeled from the virus’s proliferation, wild swings in Treasury yields began materializing on bond traders’ screens along with a sudden blowout of gaps between bids and offers – that is, the prices buyers were willing to pay and sellers were willing to accept. A couple of similar episodes had occurred in previous years, but none were comparable to this one.

“There’s a fundamental problem in the Treasury market. It’s just not functioning,” Gregory Peters, a senior portfolio manager at PGIM Fixed Income, told the Financial Times after a day of particularly glitchy and distorted trading conditions on March 11. “It is freaking people out.”

Traders at another firm, TwentyFour Asset Management, tried to sell a “modest” holding of 30-year Treasuries that week. But when they asked three major banks for prices, two refused even to bid, according to a message to clients from the CEO, Mark Holman, who wrote: “This was extraordinary, and unprecedented in our experience.”

A report issued on March 12 by Mark Cabana, a strategist at Bank of America, said the market had become “overwhelmed by liquidity concerns” and warned that “if the U.S. Treasury market experiences large-scale illiquidity it will be difficult for other markets to price effectively and could lead to large-scale position liquidations elsewhere.” Echoing that view in a New York Times article, Rick Rieder, chief investment officer of global fixed income at BlackRock, said: “If you don’t know where the safest asset in the world is, it becomes next to impossible to figure out where everything else is.”

The stress was exacerbated by the disarrangement of working from newly rigged home offices. As another fund manager told the Financial Times, traders “can’t communicate with colleagues properly” because they were “isolated at home in their sweatpants.”

Grounds for economic pessimism would only intensify in March as America began to shut down in response to evidence of the virus’s infectiousness and lethality. During the second week of that month, Seattle became the first major U.S. city to close its public schools, the U.S. government banned incoming travel from Europe, the World Health Organization officially declared a global pandemic, and Anthony Fauci, the federal government’s top infectious disease expert, told Congress that Covid-19 was ten times as deadly as seasonal influenza. In following days Disneyland closed, Broadway went dark, the National Basketball Association suspended its season, New York City ordered thousands of bars and restaurants to stop serving customers, Detroit’s Big Three automakers ceased production, and Washington closed U.S. borders with Canada and Mexico to all but essential traffic.

Stocks fell so steeply during the first three weeks of March that temporary trading halts, called circuit breakers, were triggered several times on U.S. stock exchanges. A decline in share prices was a rational response to the certain loss of corporate income from widespread cessation of business operations, and by itself did not signal anything systemically amiss. Much more troubling was a simultaneous drop in Treasury bond prices and rise in their yields, the result of a worldwide “dash for cash,” as the media aptly called it.

Everyone wanted dollars: the greenback surged over 8 percent in value against a basket of major currencies between March 8 and 20. But a desperate scramble for liquid resources needed to pay bills meant that equally intense efforts were underway to sell Treasuries, which the market couldn’t accommodate nearly as efficiently as participants had come to expect. Just as it had during the Global Financial Crisis, the Fed would fulfill the lender-of-last-resort responsibilities that central banks bear in such situations.

What about international lender of last resort, though – would the Fed reprise that role? Acute demand for dollars overseas was increasingly manifest during the first couple of weeks of March, and calls were mounting for the Fed to arrange swaps of currencies – dollars for euros, dollars for yen, dollars for Swiss francs, etc. – of the sort it had implemented with foreign central banks a dozen years earlier. Whether it would be able to do so was far from clear, given Trump’s penchant for conducting diplomatic relations like New York real estate deals. Financial Times columnist Gillian Tett quoted a former central banker who was involved in the 2008 swap lines as wondering: “Is the White House going to demand a quid pro quo from places like Europe or Japan?”

In early March, the Fed responded to the contractionary impact of the pandemic with emergency cuts in interest rates, but the ructions in the Treasury markets showed unmistakably that the crisis was of a different category than an economic downturn. In part, the problem with Treasuries reflected the abnormal degree of selling pressure – mutual funds, for example, were experiencing massive investor withdrawals, and they sold Treasuries to generate the cash needed to satisfy demands for redemptions. But another factor was the volatility engendered by the aforementioned computer algorithms.

Orderly trading in Treasuries, as in many other types of securities, depends on market makers who buy and sell throughout the trading day – a thin-margin, high-volume business. For Treasuries, this function has traditionally been played by an elite group of financial institutions, many with household names (Citi, JP Morgan, Goldman Sachs and Morgan Stanley), that hold special status with the Fed as “primary dealers.”

Among their most important roles is to transact directly with the New York Fed’s trading desk as it buys and sells Treasuries in its efforts to influence interest rates. In exchange for that privilege, these financial institutions are expected to make markets in Treasuries, maintaining a narrow spread between bids and offers, whether overall prices are rising or falling. Of course, they are allowed to protect themselves against injurious losses that might result from selling bonds for less than they have paid: if prices slide, they can adjust their bids and offers. But after the Global Financial Crisis, these big dealers pulled back somewhat from the Treasury market, mostly because of new regulations aimed at bolstering the financial soundness of major banks.

It is not necessary to go into the details here other than to say that algorithmic trading, some of which was conducted by hedge funds, filled much of the void. These computerized systems facilitate vast numbers of transactions each day, matching buyers and sellers with bid and offer quotes in a blink of an eye, and they perform especially well in calm markets. But in March 2020, with prices oscillating violently from minute to minute, the algorithms – which are programmed to widen bid-asked spreads as risk increases – caused already illiquid market conditions to become even more so.

In automatic obeisance to their models’ recognition of greatly heightened money-losing dangers, market makers retreated from trading large amounts and in some cases stopped quoting prices altogether, which exacerbated the panicky atmosphere. To make matters worse, losses that the hedge funds were suffering on their Treasury-market bets caused their lenders to hit them with margin calls. And to satisfy those obligations, the hedge funds themselves had to unload tens of billions of dollars’ worth of Treasuries at a time when buying had all but evaporated.

To keep the U.S. economy afloat, the Fed’s response included many of the measures taken in 2008 – cutting interest rates to zero, which Powell announced at a Sunday press conference on March 15; deploying an alphabet soup of facilities to incentivize the funneling of credit throughout the private sector; and creating special entities to purchase risky assets. In 2020 Powell and his colleagues would go many steps further, both quantitatively and qualitatively, crossing red lines that the Bernanke Fed had only tiptoed up to.

The 2020 initiatives included purchasing bonds newly issued by large U.S. corporations, in effect lending directly to them; buying municipal bonds along with exchangetraded funds that invest in “junk” (low-rated) bonds; and establishing a “Main Street Lending Program” to buy bank loans to small and medium-sized businesses. “Quantitative easing” also took place at an unheard-of scale and speed – the Fed purchased about $2 trillion worth of Treasuries and related securities, all within the first two months after the start of the Covid-19 outbreak. By hoovering up so many Treasuries, the Fed played the role of dealer of last resort, serving as buyer to pretty much anyone who wanted to sell, restoring normality to the market and giving market makers the confidence to intermediate transactions as they had before.

On March 23, 2020, the Fed issued what was essentially a “whatever it takes” statement, vowing to buy Treasuries “in the amounts needed to support smooth market functioning.” Some of these measures generated controversy over the degree to which the Fed was inserting itself into the functions of private markets. But the overall rationale was straightforward and unassailable: averting a collapse of the U.S. economy and the financial system on which it depended.

Unlike in 2008, fundamental blame for the crisis lay with a microscopic pathogen, not reckless behavior by Wall Street. Therefore it would have been illogical for the Fed to be much bothered by concerns about moral hazard (the precedent in rescuing people from the consequences of their mistakes). It was bailing out firms and institutions facing financial devastation for reasons completely beyond their control. Easily defensible, too, were the actions taken to stabilize trading in Treasuries. Taking a hands-off stance to the snarling of such an important market would have constituted the financial policy equivalent of criminal negligence.

The Powell Fed surpassed the crisis-fighting actions of its predecessor on the global front as well. Trump turned out to be no obstacle; at a time when he was battling criticism over his administration’s handling of the pandemic he had little time to focus on the fine points of international financial policy. Powell and his colleagues were therefore able (with support from Treasury Secretary Steven Mnuchin) to address the problems caused by foreigners’ frantic efforts to obtain dollars in the spring of 2020, which included large-scale selling of Treasuries similar to that occurring in U.S. markets.

On March 15, the Fed expanded and eased the terms of swap lines with the European Central Bank and central banks of Japan, Britain, Switzerland and Canada. Four days later swap lines were extended to nine other central banks, resulting in total swaps of over $440 billion by the end of April. And this time the Fed took the novel step of offering to help central banks that had been excluded 88 The Milken Institute Review from swaps during the Global Financial Crisis, which included the central banks of India, China, Taiwan, and Thailand.

Under the “FIMA repo facility” (formal name: Temporary Foreign and International Monetary Authorities Repo Facility), central banks holding U.S. Treasuries could exchange them with the Fed for dollars; the foreign central bank would be obligated to repurchase (repo) the Treasuries at maturity. For the second time in a dozen years, the Fed was acting as backstop for the entire global economy. “One may argue whether the U.S. is still the indispensable nation. What is clear is that, in a crisis, the Federal Reserve is the indispensable central bank,” wrote Robert Dohner, a former Treasury economist, in a commentary published on April 2, 2020.

The Fed’s readiness to ensure the supply of dollars worldwide – and the urgency of the demand to which it was responding – drove home the lessons of 2008 about the U.S. currency’s international status. The dollar’s peerlessness was further beyond question than ever.

All was forgiven as far as Trump was concerned. On March 23, the president phoned Powell to congratulate him on the raft of measures announced that day, and told reporters: “He’s really stepped up over the last week. I called him today and I said, ‘Jerome, good job.’”

There was even more for Trump to cheer in the months that followed, as the economy recovered from the Covid-19 shock at a faster clip than forecasters had expected and the stock market recouped its losses by August. Credit belonged to the Fed for its boldness as well as a fiscal package bigger than any previously enacted, the Coronavirus Aid, Relief and Economic Security Act, also known as the CARES Act, which provided $2.7 trillion in support for American households and businesses, including direct payments of up to $1,200 for adults and $500 for children under 17.

But unseeing what had happened was both impossible and inadvisable. Looking back in an October 2020 speech, Fed Vice-Chair Randy Quarles observed that, “for a while in the spring the outcome was – as the Duke of Wellington said of Waterloo – ‘a damn, closerun thing.’”

For the dollar, that point was worth brooding over. “Damn, close-run things” shouldn’t be possible in the Treasury market, which is supposedly the financial world’s safest haven. The dollar’s dominance may have been freshly reaffirmed, thanks to the Fed’s reassertion of its role as international lender of last resort. But the vulnerabilities exposed in the trading of U.S. government debt during the March madness of 2020 would need addressing.

Moreover, the Fed’s interventions in the Treasury market, while undoubtedly helping in the short run, may have created longer-run concerns about moral hazard that were not so easy to dismiss. By pouring its bottomless supply of liquidity into the parched market, the Fed saved hedge funds that had bet heavily on tiny differentials between prices for Treasuries and related Treasury futures (instruments for buying or selling bonds at a set price on a future date). Some market veterans warned that, having seen that Fed officials will do everything in their power to prevent such illiquidity from reaching a critical stage, traders might be emboldened to take everriskier positions, increasing the likelihood of another burst of turmoil in the future.

Inflation Off Target

Broader issues for the dollar loomed in 2021 as the Biden administration took over in Washington – notably a bout of inflation that would raise the first significant doubt in 40 years about the dollar’s purchasing power. But events would show again that, for better or worse, it’s a dollar world; we all just live in it.

Ever since its inclusion in a 1955 speech by William McChesney Martin, who chaired the Fed at the time, the “punch bowl” quip has served as a guiding principle for how Fed officials, and central bankers in many other countries, think about their jobs. As Martin put it, the Fed must be prepared to act like “the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

The central bank’s mandate for price stability cannot possibly be fulfilled, in other words, without a willingness to restrain the economy from growing too robustly lest businesses and workers embark on a self-reinforcing cycle of rising wages and prices. For all the debates that have raged over macroeconomic policy in subsequent decades, punch-bowl removal has remained a Fed imperative.

In August 2020, as America’s pandemic struggles continued, Powell served notice of a subtle but significant modification in the Fed’s approach in a speech laced with jargon – “flattening of the Phillips Curve,” for example, along with “natural rate of unemployment,” “proximity of interest rates to the effective 90 The Milken Institute Review lower bound,” and “equilibrium real interest rate.” If the Fed chief had boiled it all down to layman’s terms, he might have put his message this way: we’re going to leave the punch bowl out longer than we have in the past.

This was no sudden whim. It went back to a review that Powell had initiated in 2018 of the Fed’s basic framework for setting policy to determine whether an updating was needed to reflect changes in the way the U.S. economy worked. Time after time in the years since the Global Financial Crisis, worries about inflation had proven almost comically exaggerated. When the Fed, aiming to promote recovery from the Great Recession, held interest rates at or near zero and embarked on successive rounds of easing that pumped up the central bank’s asset holdings from $900 billion before the crisis to $4.5 trillion in 2014, conservatives howled that the dollar was being ruinously debased. Yet the overall price level remained stable – so stable, in fact, that the Fed’s annual inflation target of 2 percent, established in 2012, was repeatedly undershot.

Desirable as that was in many respects, it carried seeds of danger. Public expectations of negligible inflation would mean interest rates would remain stuck at rock-bottom levels, too. So if the economy fell into recession the Fed would be almost powerless to use one of its most potent recession-fighting tools: cuts in the cost of borrowing.

Furthermore, economic data aplenty indicated that the Fed’s conventional models weren’t reflecting more recent realities. Among the most surprising bits of evidence was the quiescence of inflation in 2018 and 2019 even though the unemployment rate had dropped well below levels once thought certain to ignite wage-price pressure.

What really cinched it for Powell and other top Fed officials was a series of events around the country called “Fed Listens,” at which members of the public – small business owners, union leaders, and representatives of community organizations – were invited to tell how monetary policy affected their livelihoods. “Just riveting” was how Powell described one such event in Chicago in June 2019, where he heard speakers from lowincome communities talk about the benefits that a strong labor market could provide by creating employment opportunities for people at the margins of the economy.

Therefore, while carefully emphasizing determination to maintain price stability, the Fed’s new approach gave higher priority than before to full employment. Under “Flexible Average Inflation Targeting” (FAIT), the central bank would maintain its 2 percent target, but treat it as less sacrosanct. If inflation exceeded the target, that would be fine, even welcome if it was making up for periods below target. Most important – and here’s where the punch bowl came in – the Fed wouldn’t act preemptively to tighten as it had before when demand for labor was strong. Instead, it would wait for unmistakable evidence that inflation was materializing at an unacceptably high pace and react only then.

Well-intentioned as it was when Powell unveiled it in August 2020, FAIT would be put to the test – and fare poorly – under classic conditions of too much money chasing too few goods. The too-much-money part came mainly from a huge slug of government spending, including another round of “economic impact payments” for individuals. The American Rescue Plan, initiated by Biden in the early days of his presidency, added $1.9 trillion in outlays atop the CARES Act and a $900 billion bill approved in the closing days of the Trump administration.

Having gained control of both houses of Congress, Democrats were dismissive of lectures about fiscal prudence from Republicans, who had shown little concern about a 2017 tax cut that had helped swell federal debt to nearly 100 percent of U.S. GDP by the end of Trump’s first term. Nor were Democrats deterred by reservations expressed by those within their own camp, the most outspoken being former Treasury secretary Larry Summers, who argued that the stimulative effect would be excessive. It was best to “go big,” according to proponents of the spending, given the uncertainty about whether the recovery might be subpar like the one that had followed the Great Recession. And in any case, the Treasury could borrow the money cheaply.

The too-few-goods part came mainly from pandemic-related supply-side problems. Autos were the canonical case. Hertz, Avis, Enterprise and other car rental companies had sold much of their fleets during the lockdowns. So when newly vaccinated Americans began traveling again, a shortage of available vehicles caused rental prices to skyrocket. Automakers eager to crank up assembly lines were hamstrung by supply-chain disruptions in the production of semiconductor chips, the result of factory closures in East Asia. Container ships were stuck in ports, and the average wait time for goods manufactured in China increased by nearly a month.

Chemicals, electronics, shoes, almost any manufactured item – if just one of the many components necessary for production was unavailable or held up in transit, producers had to shut down or inform customers that delivery would be delayed. As such bottlenecks multiplied throughout the economy, scarcity was rationed with higher prices.

“Transitory” was thus the word widely applied by Fed and Biden administration officials – along with many private sector economists – when inflation began ticking up in the spring of 2021, with the consumer price index reported at 4.2 percent higher and 5 percent higher, respectively, than the year-earlier figures for April and May. According to this soothing forecast, once shortages eased, bottlenecks loosened and other supply constraints were resolved, inflation would subside on its own.

But the conviction of “Team Transitory” weakened as more data in the fall showed that rents and housing prices were jumping – much harder to explain away – along with the cost of other items in the basket of goods and services used to measure ordinary Americans’ living expenses. “Team Permanent” gained the upper hand and rumblings of discontent over the decline in the dollar’s purchasing power turned into a roar. Asked on November 30 whether inflation was transitory, Powell said, “I think it’s probably a good time to retire that word.”

That month the Fed began phasing out monthly purchases of Treasury and mortgage- backed securities – in effect taking its foot off the monetary accelerator. Even so, it wasn’t until March 2022, when the CPI leaped by 8.5 percent on a year-over-year basis (the fastest rise since 1981), that the Fed stepped on the brake by raising the federal funds rate from its near-zero level. Having adopted FAIT, and vowed to stick by it, Powell and his colleagues feared that they would lose credibility were they to act sooner.

For failing to tighten the previous fall, the Fed was lambasted as fumbling its most important mission. But once the central bank began lifting interest rates, it did so unhesitatingly, 11 times in 2022 and 2023 including four consecutive increases of three-quarters of a percentage point. The model he would follow, Powell averred, was that set by Volcker, whom he described at a March 2022 congressional hearing as “the greatest economic public servant of the era.”

Was he prepared to do whatever it took to tame inflation, even if it meant dampening growth? “I hope that history will record that the answer to that question is yes,” Powell replied. In keeping with that statement, the Fed resisted calls for rate cuts in the first half of 2024 to the point that critics were accusing it of allowing the economy to weaken dangerously in the late summer. But as the effects of the Fed’s anti-inflation policies took hold, the world got a reminder of another memorable phrase in monetary history uttered half a century earlier by then Treasury Secretary John Connally: “The dollar is our currency, but it’s your problem.”

Living in a Dollar World

For millions of people in countries such as Ghana, Egypt and Pakistan, it wasn’t just the inflationary pressure driving up the price of bread, fuel and medical supplies that was squeezing their livelihoods in 2022. It was also the rapidly rising exchange rate of the currency in which those items are often priced on world markets.

The dollar was on a tear. Having already strengthened on foreign exchange markets in the second half of 2021, the greenback zoomed further upward in 2022, reaching multi-decade highs in the fall of that year. Higher U.S. interest rates, combined with evidence of the Fed’s resolve to maintain price stability, rendered the dollar far more attractive to investors than other currencies. By the end of September the yen had depreciated 20 percent against the dollar. The euro – worth more than a dollar for two decades, as much as $1.57 at one point – was trading at $0.96, down 16 percent since the start of 2022. And sterling was also perilously close to dollar “parity” at an exchange rate of $1.03 per pound, a level not seen since 1985. Emerging-market currencies had also fallen sharply against the dollar, the biggest swooners including the Egyptian pound, Hungarian forint and South African rand.

A global economy already battered by the pandemic and the Russian invasion of Ukraine looked even wobblier as a result of the dollar’s might. Currency depreciation can be a blessing in disguise for a country by making its exports more competitive. But that isn’t nearly so valid when the dollar is surging, because so many exports are invoiced in dollars. For that reason IMF economists, who had dug deeply into trade statistics, warned in a 2020 study that a strong dollar could dampen the recovery from the Covid-19 shock in many parts of the world, especially emerging and developing countries.

The arithmetic was unpleasant on the import side as well. Past spikes in world food prices in 2007-8 and 2010-12 had coincided with declines in the dollar’s exchange rate, which buffered the effect on food import bills for many developing countries. But in 2021- 22, those countries were being hit with a double whammy in the form of higher food prices and depreciation of their currencies against the dollar, making it harder to keep their citizens from going hungry.

World wheat prices, for example, were up 89 percent in October 2022 compared with the average in 2020. But thanks to the strong dollar, the cost of imported wheat in local currency was 106 percent higher in Peru, 112 percent higher in Egypt, 132 percent higher in Pakistan and 176 percent higher in Ethiopia. Countries and companies that had borrowed in dollars faced the bleakest situations. Their debts would have to be repaid in a currency that was worth considerably more than when the obligation was incurred.

Memories were invoked of the early 1980s when debt burdens crushed economies in Latin America and sub-Saharan Africa, and of the late 1990s when financial panics ravaged Thailand, Indonesia, South Korea, Russia and Brazil. “Dollar’s Rise Spells Trouble for Global Economies,” stated a headline in The Wall Street Journal on September 18, and a New York Times headline put it even more gravely a few days later: “A Strong Dollar Is Wreaking Havoc on Emerging Markets. A Debt Crisis Could Be Next.” A prime example, The Times reported, was Ghana, where a 40 percent plunge in the Ghanaian cedi against the dollar meant that each barrel of oil the country imported – which is priced in dollars – cost nearly twice as much in terms of cedi.

The dollar’s wrecking-ball effect was not a new phenomenon. It had been observed often in the past, and one of the most striking facts about it is its heads-you-lose, tails-you-lose quality. The global economy may be destabilized when a tight Fed policy leads to dollar strength; it may also be destabilized, albeit in a different way, when an easy Fed policy leads to dollar weakness. In the “global financial cycle” (a term coined by the economist Hélène Rey of the London Business School, who has carefully documented it), a Fed easing and the associated lowering of U.S. interest rates causes a rise in investors’ appetite for risky assets, resulting in a rush of capital into emerging markets. And the whole process reverses when the U.S. central bank tightens. Either way, an unholy ruckus may erupt in foreign capitals.

One such ruckus came in 2010, during the Bernanke-led Fed’s quantitative easing program aimed at imparting more vitality to the anemic U.S. recovery. Much to the displeasure of officials abroad, the dollar fell and American capital flooded into emerging markets, which raised fears there about overheating and inflation. The Brazilian real had risen about 25 percent against the dollar. And with the country’s exporters suffering from an erosion of international competitiveness, Finance Minister Guido Mantega lobbed an unsubtle verbal grenade at the Fed, depicting Brazil as caught “in the midst of an international currency war.” His German counterpart, Wolfgang Schäuble, chimed in with an accusation that Fed officials were “steer[ing] the dollar exchange rate artificially lower with the help of their printing press.”

At the November 2010 summit of Group of Twenty leaders in Seoul, members of the U.S. delegation took plenty of heat for the Fed’s allegedly irresponsible actions. A mere three years later, the opposite problem arose. When Bernanke hinted in 2013 that the Fed would raise interest rates, emerging markets were hit with a slowdown resulting from a sudden outflow of capital. Amid much anxiety about the “fragile five” (Brazil, India, Indonesia, South Africa and Turkey), critics again spoke out against Washington’s imperviousness to the international implications of its monetary policies.

There has been no shortage of proposed remedies. Many are inspired by the international currency dreams of Keynes and the Belgian- American economist Robert Triffin. In 2019, Mark Carney, then the governor of the Bank of England, gave a speech suggesting that a Libra-like digital instrument combining several currencies and managed by the world’s central banks – Carney called it a “synthetic hegemonic currency” – would help “dampen the domineering influence of the U.S. dollar on global trade.” A book by Columbia University’s José Antonio Ocampo, a former finance minister of Colombia, likewise urges creation of an internationally issued global reserve asset to protect the world against the boom-bust cycles of the dollar-dominated system.

Someday – decades in the future? Centuries? Millennia? – the human species may evolve to the point where nationalist sentiment is sufficiently subdued for multilateral cooperation of the sort Carney and Ocampo propose. For now, there is no viable alternative besides resignation to the fact that the Fed is a “monetary superpower,” as the economists David Beckworth and Christopher Crowe have put it and foreign economic policymakers would be well advised to adapt accordingly.

The Fed has to keep its eye squarely on domestic conditions in the United States; that’s its legal mandate, and it isn’t about to modify its monetary policies to take account of circumstances abroad. Imagine what would have happened in early 2022 if Powell and his colleagues had waited even longer before taking anti-inflation tightening measures out of concern that a rise in the dollar would damage economies in Europe, Latin America, Asia and Africa. Quite apart from the political tantrum that Congress would have thrown, such a decision would have been lousy policy-wise. Inflation would surely have risen higher and faster than it did, which would have meant putting the economy through even more of a wringer to restore price stability. Risking a deep recession in the United States does no favors for economies around the globe.

Fortunately, speculation about a major debt crisis in 2022-23 turned out to be a false alarm, a few scattered defaults notwithstanding. Many governments had learned lessons from the crises of the late 20th century and fortified themselves against a spike in the dollar. Most importantly, large emerging economies – among them Brazil, India, and South Africa – were borrowing mainly in their own currencies rather than in dollars even though the interest cost they had to pay was a little higher.