Warsh Faces Fed Trust Crisis

Commentary

The announcement of Kevin Warsh as the nominee for the next Federal Reserve chair has, predictably, set off a flurry of debate. Market analysts are parsing his record on inflation, while political commentators argue over whether his appointment signals a “politicization” of the temple of American finance.

But the Federal Reserve is at the center of a structural crisis of legitimacy. For more than a century, the Fed has presented itself as the ultimate technocratic institution. Yet it remains a primary target of suspicion from both ends of the political spectrum. This is because of what the Fed is—and the impossible role that it has been forced to play in the modern American social contract.

The Hybrid Paradox

The Fed was born from a century-long struggle to resolve a fundamental American paradox: the need for financial stability versus a deep-seated fear of centralized power. In 1832, President Andrew Jackson dismantled the Second Bank of the United States, viewing it as a threat to the republican government that privileged elites over citizens.

This “Jacksonian” suspicion left a void for decades until the Panic of 1907 nearly collapsed the economy. Stability was only restored when J.P. Morgan and a handful of private financiers coordinated a rescue. This terrified policymakers—not just because markets had failed but because the nation’s survival had become dependent on private individuals.

The suspicion surrounding the Fed is often framed as a reaction to “shadowy” origins, tracing back to the 1910 meeting at Jekyll Island, Georgia. The structural reality is more nuanced and, in many ways, more challenging to resolve. The Fed was designed as a “hybrid” system—a deliberate compromise between public authority and private finance.

At the top sits the Board of Governors, appointed by the U.S. president and confirmed by the Senate, operating as a federal agency. Beneath them are the 12 regional banks, owned by member commercial banks. This architecture was designed to serve as a lender of last resort without creating a financial monarchy.

However, this “structural proximity” to the banking sector creates an optic of “capture.” The Fed does not operate in a vacuum; it stabilizes the economy by stabilizing the “big pipes” of finance. When the system threatens to collapse, the Fed’s mandate requires it to save the institutions that make up the system. The Fed’s crisis is that its primary function—maintaining stability—requires it to reinforce the very hierarchies the public increasingly resents.

How Money Is Actually Born

Much of the current political anger is directed at “money printing,” a term that simplifies a far more complex and privatized reality.

Perhaps the most persistent obstacle to understanding our economy is the “intermediary myth”—the belief that banks are merely warehouses that take in deposits from savers and then lend that same money out to borrowers. In this worldview, the government is the sole “printer” of currency, and banks are simply its distributors.

The reality is far more counterintuitive. In a modern economy, the vast majority of our money supply is not created by the Treasury or the Federal Reserve, but by private commercial banks.

When you walk into a bank for a $500,000 mortgage, the bank does not reach into a vault of physical cash, nor does it subtract that amount from other customers’ deposits. Instead, it creates a new entry on its digital ledger. On one side, it records an asset (your promise to pay back the loan); on the other, it records a liability in the form of a brand-new deposit in your account.

This is the “alchemy” of modern finance: The loan creates the deposit, not the other way around. At that moment, new money is conjured into existence, expanding the economy’s total purchasing power. This “bank money” accounts for roughly 90 percent of what we use to buy groceries, pay rent, and conduct business, while physical bills and coins—the “government money”—represent a mere fraction of the total.

This “elastic” nature of money also explains its inherent fragility. Because money is essentially a claim generated by credit, the system’s health depends entirely on the continued circulation of that credit. If banks stop lending, or if borrowers stop borrowing, money is effectively “destroyed” as loans are paid back without new ones taking their place.

The Federal Reserve does not directly control the “faucet” of this private money creation. Instead, it acts as a “pressure system.” By adjusting interest rates, it changes the price of credit, making it either cheaper or more expensive for banks to engage in this act of creation.

When the Fed lowers rates, it is attempting to lower the barriers for private banks to manufacture more money; when it raises rates, it is trying to tighten the valves. Although during the extraordinary interventions of the past decade, such as quantitative easing, the Fed directly expanded the supply of electronic reserves to lower yields and encourage private lending.

The crisis of legitimacy arises because this “pressure” is not evenly distributed. When credit expands, the newly created money first flows into the financial assets—stocks, bonds, and real estate—that serve as collateral for these loans. By the time that this expansion reaches the “real” economy of wages and services, the prices of the things that people actually need to survive have often already been bid up. Understanding this mechanic is the only way to see why the Fed’s primary tool for “stabilizing” the economy so often feels like an engine for inequality.

Taxation in a Modern Economy

If money creation is elastic—if governments can expand the money supply—why do they need revenue from citizens?

The answer reveals something deeper about how modern societies actually function.

Historically, taxation looked very different. Before the 20th century, most governments were small. They did not attempt to run entire economies. Taxes were episodic and narrow. Monarchies relied heavily on tariffs, land taxes, and excise duties. Many states only expanded taxation dramatically during war, then reduced it afterward.

The idea that the government should permanently collect a large share of national income—and redistribute it through social programs—is a modern development. And once you understand that, modern taxation stops looking like simple revenue collection.

In a fiat monetary system, taxes create the primary demand for the currency itself; by requiring obligations to be settled in a specific tender, the state ensures that participation in the currency is compulsory and universal rather than optional. Once money is in circulation, taxes act as a vital “delete” key, removing money from the system to cancel out purchasing power and prevent inflation. Without this “subtraction” to balance government spending, the system could quickly destabilize.

Taxation also serves as the primary tool for allocating real resources, such as labor, energy, and land. By shifting purchasing power away from certain private actors, the state can claim these tangible resources for public use without triggering runaway scarcity. This process anchors the legitimacy of the state, transforming what could be seen as arbitrary “money printing” into a reciprocal social contract in which financial obligation is exchanged for infrastructure and security.

Finally, the tax code functions as governance, utilizing deductions and penalties to shape behavior and signal societal priorities.

What’s Next

This delicate balance between currency creation and taxation is what allows the modern state to exist, but it is not a perpetual motion machine. When we look at where these resources actually go, we find a system that has become increasingly rigid, trading long-term flexibility for immediate social stability. Taxation is no longer just about “funding” the government; it has become the primary tool for managing a society that is under immense structural strain.

To understand why this domestic social contract feels so fragile, however, we have to look beyond our own borders. The internal pressures we feel today—on our taxes, our wages, and our welfare—are the localized symptoms of a much larger global realignment.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.