Washington's three major challenges: the Federal Reserve, inflation, and Trump.

Kevin Warsh has been harshly criticizing the Federal Reserve for the past 15 years for being too large in size, poor inflation management, and compromised independence. Now, as the next nominee for the Federal Reserve chair chosen by Trump, he will have to personally address and resolve these issues. On January 31, Greg Ip, chief economics commentator for The Wall Street Journal, pointed out that if appointed and confirmed, Warsh will face three tricky balancing tasks: shrinking the Federal Reserve's balance sheet without disrupting the market, pushing inflation back to and stabilizing at 2%, and avoiding presidential interference that undermines the central bank's independence. Each of these tasks is much more difficult than it sounds. Shrinking the Federal Reserve's "systemic bloating" Warsh served as a Federal Reserve governor from 2006 to 2011, participating in the response to the global financial crisis under Ben Bernanke's leadership. He eventually resigned due to his opposition to the quantitative easing (QE) policy. QE involved purchasing trillions of dollars in bonds and injecting reserves into the banking system to lower long-term interest rates. From 2008 to 2022, the Federal Reserve's assets expanded from $900 billion to $9 trillion, and although it has since declined, it still stands at $6.6 trillion, which Warsh still sees as excessively large. Warsh believes that this policy distorts market signals and enables fiscal deficits, ultimately leading to higher inflation. "Every time the Fed takes action, it expands its size and power," he said in April last year. "Debt accumulates more and more, capital allocation becomes more distorted, and institutional boundaries are crossed time and time again." This view was echoed by Treasury Secretary Scott Besen, who accused the Federal Reserve of "mission creep" and being "bloated." However, shrinking the balance sheet is not without its costs. Firstly, the banking system now relies on ample reserves to maintain financing and market operations. As a result, the Fed halted further shrinkage at the end of last year. Secondly, selling bonds could push up long-term yields, thereby raising mortgage rates - a move that would directly anger Trump, who advocates for low rates. Inflation theories and internal "regime change" At the time of Warsh's nomination, the core inflation rate in the US was still close to 3%, far exceeding the Fed's 2% target. He not only needs to propose a plan to lower inflation but also needs to persuade the "12-person Federal Open Market Committee (FOMC)" to accept it. Unlike Powell, who has an economics background, Warsh has a background in law and finance. He often criticizes mainstream macroeconomic models and the "economics establishment" behind them, preferring to explain inflation through indicators such as commodities, stock prices, and money supply. This unorthodox view has raised concerns about internal conflicts within the Fed. Warsh has hinted at the need for a thorough reform of the Fed, stating in July last year, "What we need is a regime change at the Fed... This isn't just about the Chairman, it's about a set of people. Breaking some heads, breaking some rules." Former Fed Vice Chairman Don Kohn pointed out that while he agrees with some of Warsh's criticisms, he disagrees with his "bitter tone." However, Nellie Liang, who has served at the Fed, believes that Warsh may be more inclusive than his remarks suggest. He will not be constrained by staff models but will also not completely ignore professional opinions. For the market, Warsh may be lucky in the short term as tariffs and housing pressures ease, leading to lower inflation this year. But if the winds change, Warsh will need to present an inflation theory that can convince both the market and his FOMC colleagues. Who can say "no" to Trump? Warsh's supporters believe he is more independent than another competitor, White House advisor Kevin Hasset. However, the reality is that his appointment comes from a president who openly questions the central bank's independence. Trump has made a commitment to substantial rate cuts a condition for the nomination, and Warsh accommodated this demand last October, stating "we can cut rates significantly to make 30-year fixed-rate mortgages affordable." However, the most difficult part of monetary policy is adjusting rates based on data. If inflation rebounds, data will require the Fed to hold or even raise rates - will Warsh dare to defy Trump? Trump has expressed concern that Warsh, once in the job, will become "surprising", indicating that he is worried that Warsh will not comply. Trump's attacks on Jerome Powell - including allowing criminal investigations and attempting to dismiss governors - have shown that he will not sit idly by if the Fed chairman disappoints him. While the Supreme Court may limit the president's power to dismiss the Fed chairman, Trump can still make Warsh's days difficult through public attacks and the appointment of compliant governors. Warsh has acknowledged the importance of independence and stated, "I read in the newspapers how tough politicians are on central banks. Well, grow up. Be tough. The secret to central bank independence? Achieve the goal and do the job well." For investors, whether Warsh can hold the line between Trump's political pressure and the Fed's data-driven approach will be the biggest tail risk for the market in the coming years. This article is reproduced from the "Wall Street View" app, written by Long Yue, GMTEight Editor: Song Zhiying.