Clients will recall that, during his first term, Donald Trump nominated Judy Shelton, a frequent monetary-policy commentator, to the Federal Reserve Board. However, her nomination sparked outrage among Congressional Democrats and many pundits that doomed confirmation. Ms. Shelton nonetheless remains a trusted adviser to many with the President’s ear, making renomination and, this time, confirmation a strong possibility should Ms. Shelton still want a seat on the Board of Governors. We thus took notice when she last week posted an attack on the payment of interest by the Fed on balances held by foreign branches and agencies. She drew in part on another post adding foreign central banks to the complaint. This might seem a remote or even improbable concern, but so does much else in CEA head Stephen Miran’s proposal positing a “user tax” that’s now in the House reconciliation bill attacking foreign investors. Ms. Shelton’s complaint should thus be taken very seriously, especially given all the other demands to curtail interest on reserve balances (IORB).
Ms. Shelton finds that foreign branches and agencies get 42 percent of interest payments from the Fed, or about $78 billion based on total interest payments to banks of $186 billion in 2024. Rates now on IORB stand at about 4.4 percent – one of the very best deals on offer for super-safe, overnight funds. Another post calculates interest payments to foreign central banks at around $16.5 billion a year. In short, it’s a lot of money which the posts rightly say comes from taxpayers given the Fed’s ongoing losses.
The usual argument banks use to defend interest on reserve balances is that terminating it would constitute a tax hike on banks that undermines their lending capacity. Foreign branches and agencies might mount the same argument to defend their IORB receipts, but they are in a far less persuasive position from which to push the point. For one thing, foreign branches and agencies are not major lenders in the U.S., making only nine percent of total loans in May. For another, they are not the major providers of emergency liquidity to the Treasury market for which the Fed thinks “ample” reserves will prove essential. Further, foreign central banks in other major banking centers pay far less in IORB and sometimes, as in Japan, almost nothing even though these central banks and many of their nation’s banking organizations get sizeable payments from the Fed. This, Ms. Shelton says, is unfair to U.S. banks doing business abroad. Payments to central banks are on deposits at the Fed essential to ensuring dollar-clearing stability in a crisis, but it’s nonetheless U.S. money out the door to the EU and other places not to the liking of anyone around the President this time around.
What might come next? An Administration determined to kick foreign students out of the United States will not hesitate to bar payment of IORB to foreign banks and maybe even central banks if the issue arises to its notice. Discriminating against foreign banks might be deemed a violation of the International Banking Act, but that’s unlikely to stop the Trump team even if it’s a valid argument. Many in Mr. Trump’s ambit oppose the payment of interest on reserves to all banks, not just foreign ones, but foreign ones are the easiest place to start and surely appealing to the President given his current trade-talk travails.
If U.S. banks think they can save their IORB if foreign banks are thrown to the wolves, then they’ll stand back and let their competitors take a big hit. But, if a credible attack on IORB for all is launched, then a coalition defending one of the banking industry’s biggest income sources will prove a formidable line of defense.
Will it be enough? Let’s see who runs the Fed next year and then we’ll know.