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This week Kevin Warsh faced two and a half hours of Congressional grilling over his bid to be the next Federal Reserve chair. Unsurprisingly, there was extensive debate about monetary policy, and whether Warsh will be a “sock puppet” for US President Donald Trump. In other words, that he will cut interest rates to please him. Warsh claimed not.
However, another brief exchange during Warsh’s testimony was highly significant but went almost entirely ignored. When he was asked about the dollar, the putative next Fed chair declared that “there are risks to the US position in the world, including economic”, which made “the economic statecraft agenda” led by Scott Bessent, Treasury secretary, and Marco Rubio, secretary of state, very important.
So, he added, “the Fed will play a supporting role in ensuring that the financial system is as safe as it can be and work with [Bessent and Rubio], because it’s outside of the conduct of monetary policy”. In plain English: under Warsh, the Fed will embrace geoeconomics.
This is very notable — particularly given that, a day later, Bessent revealed that the United Arab Emirates and “numerous” other Gulf and Asian countries have asked the US government for dollar swap lines.
Trump seems keen to comply. “If I could help them, I would,” he said. And this sends two big messages to markets. The first is that some governments fear there is a real — and rising — risk that the Iran war will create financial instability. For while Yousef al-Otaiba, Emirati ambassador to the US, insists that “any suggestion that the UAE requires external financial backing misreads the facts”, it seems Gulf governments are wisely bolstering their defences.
But the second message revolves around the Fed. Back during the global financial crisis of 2008, it was the New York Fed, under Timothy Geithner, that led efforts to calm markets. And back then it used its own dollar swap lines, since the Fed has permanent arrangements to address short-term strains with five western central banks, and had temporary arrangements with nine more.
Then, after 2008, the Fed got more bank supervisory powers and responsibility for financial stability. This seemed unremarkable by global standards, since the European Central Bank also oversees financial stability and the Bank of England has a Financial Policy Committee alongside its Monetary Policy Committee.
But last year Bessent slammed this arrangement. “Post-crisis reforms dramatically enlarged the Federal Reserve’s supervisory footprint [and] the results are disappointing,” he wrote in an essay. “The Fed now regulates, lends to, and sets the profitability calculus for the very banks it oversees [which is] an unavoidable conflict that blurs accountability and jeopardizes monetary policy independence.”
And Bessent is now quietly grabbing more power from the Fed. Last year, for example, the White House issued two executive orders undercutting the Fed’s role in bank oversight. More recently, Bessent has arranged to meet insurance companies to discuss private credit risks — and, separately, bankers to discuss the Mythos AI model.
Late last year the Treasury offered a pioneering $20bn swap line to Argentina, without the Fed, by using an exchange rate facility. Any UAE dollar swap line will probably repeat this template.
Is this a good thing? Yes — in some ways. Bessent is skilled at handling financial markets and has brought a market-savvy team to the Treasury. This is welcome, particularly since some financiers mutter that the New York Fed’s market expertise seems to have declined since 2008. And new financial jolts could ensue from the Iran war (and Warsh’s determination to stop the Fed gobbling up long-term bonds, even as Bessent scrambles to sell $10tn in Treasuries next year). Furthermore, that $20bn Argentina swap line was implemented successfully — even though many observers (including myself) were initially sceptical.
But one risk in this power shift is that domestic financial regulation becomes more politicised, and prone to White House meddling. Another is that dollar swap lines will become increasingly weaponised. For while the Fed has always tried to downplay the role of geopolitics in its own swap lines, Bessent says he wants to use swaps to promote American dominance and reward allies, “locking in dollar supremacy”.
Unsurprisingly, this leaves some European financial officials fretting that these lines might be withdrawn from them if they challenge Trump.
Bessent (and Warsh) might retort that this is simply the nature of geoeconomics. But, if so, it raises another crucial question: who will organise a collective global response if another financial crisis hits? Washington was able to do that effectively in late 2008 because the other western central banks trusted the Fed, and each other — and other governments respected Washington’s lead.
Thankfully, central bank trust remains strong. But will other governments still take orders from Washington in a financial crisis, given the rise of geoeconomics and Trump’s capriciousness? It is dangerously unclear.
Either way, Warsh should have been grilled about this, alongside that “sock puppet” point. Yes, inflation matters. But global financial stability matters now enormously, too. Just ask the UAE.
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