JP Morgan Chief Executive Jamie Dimon recently expressed a preference for Kevin Warsh over Kevin Hassett as the next Fed Chairman, on the grounds that Warsh is less likely to be influenced by President Trump’s calls for rate cuts. To one who has followed bankers for several decades (and been one in the distant past) this was surprising; big banks are net beneficiaries of easy money and low interest rates and generally wish such conditions to continue ad infinitum. Dimon is however a very prominent canary in the banking coal mine, and his remarks may suggest banks are finally coming to their senses and hoping for sound money. If so, it is long past time!

In a Gold Standard economy, big banks like higher interest rates. They gather an enormous amount of funding at essentially a zero interest rate from demand deposits, regardless of where interest rates stand, since there is only temporary and self-correcting inflation in a Gold Standard economy. In such a system, the higher the level of interest rates, the more the banks will earn on their loans to corporations and the public. Their capital, being held in gold or in money convertible immediately into gold, is entirely secure provided they make no bad loans. At the same time, the amount they can lend is limited; prudence demands in a Gold Standard economy that they maintain a substantial ratio of capital to loan assets, so their loans are limited to a modest multiple of capital. In such a system, banks with solid deposit bases will have no incentive to stretch their lending to lower quality borrowers, who might default.

In a fiat money system, the incentives are reversed. Money supply is elastic; so also therefore is the volume of loans. Banks make more money on a higher volume of loans; consequently, their incentive is for the money supply to expand as rapidly as possible without setting off inflation – this is generally done by a low interest policy together with massive quantitative easing, a la Ben Bernanke. Leverage is highly attractive, because the value of liabilities depreciates with inflation. With so much money around, lending to small businesses becomes an inefficient way to deploy it, with the high costs involved in the information gathering process and skilled loan officers required to assess credit.

Instead, the bank’s incentive under fiat money is to maximize fees by making large syndicated loans to the largest borrowers, since the massive creation of money means there is no effective limit on their balance sheet size. In such an environment, private equity groups and hedge funds perform an essential service for the banks, in providing lending opportunities to their insatiable loan generation machine. With fees paid up-front, it does not matter that the loans are made at relatively low interest rates, and subject to intensive competitive bidding. The fees earned from a top position in the loans will make up for any deficiencies in their interest rate, since those fees accrue immediately and swell this year’s bonus pool.

The traditional bank preference for rapid money expansion and low interest rates was reduced by the massive wave of quantitative easing since 2010, which has built a total of $3.0 trillion of bank deposits with the Federal Reserve. These pay interest at the Interest on Reserve Balances rate, currently 3.65%, so around the Federal Funds rate, which fluctuates in a band of 3.5% to 3.75% after the latest rate reduction. This high rate paid by the Fed is essentially a giant subsidy to the banking system, since the free deposits controlled by the banks can be invested in Fed reserves with no risk or effort whatever. In these circumstances, the banks naturally favor a resumption of quantitative easing, expanding the amount of free money they can enjoy – the Fed granted them this at the November meeting. You would think therefore that the big banks would be exceptionally happy today and would favor a continuation of current policies.

Dimon’s problem is that with a Fed inflation target of 2% and actual inflation around 3%, injecting more money into the system while keeping interest rates low would almost certainly cause inflation to accelerate. That would bring a visceral popular reaction from an inflation-weary populace and might cause Federal Reserve policy to be reversed in the direction of tighter money. While President Trump would oppose such a move, those around him seeking a continuation of Republican rule would almost certainly demand a rapid rise in rates to battle the popular fear of inflation. That would increase J.P. Morgan’s profits from Fed deposits but a sharp increase in rates would undoubtedly endanger all the leveraged private equity deals the bank has financed, possibly producing a tsunami of credit losses like that of 2008.

It appears that Dimon realizes that an aggressive rate reduction policy, combined with quantitative easing, would be dangerous to J.P. Morgan’s long-term health. That explains his new preference for Warsh over Hassett. A more cautious interest rate policy by Warsh would lower the danger of renewed inflation, even if the Fed continued to purchase Treasuries and finance itself with increased bank deposits. As an additional bonus, the returns on the additional Fed deposits would increase J.P. Morgan’s profits. Win-win all around, it would seem.

Such a policy would not eliminate the plethora of bad lending deals in today’s market. These are being done, not by the banks, but by the private credit institutions that have sprung up like weeds.
By this means, the dozy acquisitions boom will continue (such deals have run at record levels in 2025, much to the benefit of bankers’ bonuses). The vast majority of acquisitions are value-destroying, and the greater their volume, the more average value they destroy per deal (because the truly advantageous transactions get financed in almost any market, and as hustling private equity and private credit bankers stretch for deals, they reach further and further into the value-destroying rubbish).

Three policies are needed to put Fed policy on a proper footing. The simplest and most important is to re-set the Fed’s inflation target from 2% to zero. The Fed’s statutory mandate is to achieve stable prices; a 2% inflation target certainly does not achieve that, especially when there is uncorrected backsliding as in 2021-24. As an additional bonus, once zero inflation has been reached, long-term nominal bond yields can decline, to maintain the real yield on bonds constant.

The second necessary policy is to stop “quantitative easing” immediately and resume a modest volume of the previous “quantitative tightening” policy, selling Treasury and Agency bonds into the market, thereby slowly running down the Fed’s balance sheet and reducing its risk. That would make it marginally more difficult to finance the Federal deficit, which would incentivize politicians to take the deficit seriously and move towards a balanced budget for the first time this century.

It would also reduce the useless sludge of interest-bearing “free money” on banks’ balance sheets, albeit only over several years. That would make the banks resume their proper duty of financing small businesses, a sector that is otherwise forced into the arms of the private finance cowboys or is unable to raise finance at all. Tilting the economic playing field firmly towards small business, instead of away from it as has been the case in recent decades would revive U.S. entrepreneurship outside the tech sector, which badly needs to happen.

The other reform of Fed policy is more difficult. The Federal Funds market now represents very little, since the big banks all have massive deposits with the Fed, so there is not much of an interbank money market. Reducing the return on those deposits is necessary, yet it must not be allowed to reduce overall interest rates excessively through the entire U.S. economy. The best approach would probably be to increase the official Federal Funds rate by say 0.5% to 4%-4.25%, reversing the last two cuts, while at the same time reducing the Interest on Reserve Balances rate by 1% below its current elevated level to 2.65%. That would greatly reduce the attractiveness of Fed deposits to banks, since they would be able to place money with other banks through the Federal Funds market at around a 1.5% yield premium to the return on Fed deposits.

The idea of this policy would be to reduce the subsidy to banks from sitting on Fed deposits, making them more likely to lend to small businesses, without moving the overall level of interest rates much. The objective would be to open a substantial gap between the returns on Fed deposits and those available in the rest of the money market, thus reducing the excessive reward to banks for doing nothing. The precise pairing of policies to achieve this would be for discussion, but the gap between the two rates should probably be around 1.5% initially, as suggested here, to provide through incentives the proper reordering of the market.

Jamie Dimon’s preference for Kevin Warsh over Kevin Hassett looks well founded, much though I respect Hassett. The ideal next Fed Chairman would be Judy Shelton, the most original thinker of the potential candidates and at least partly committed to the Gold Standard, the optimal solution to U.S. monetary woes. But Warsh would probably understand the arguments for an inflation target of zero, a return to quantitative tightening and a substantial gap between the Federal Funds rate and that paid on deposits with the Fed. In the short-term, that policy combination is badly needed.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)