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The ghosts of Presidents past

| July 12, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

An independent Fed is considered sacrosanct by most financial market participants. For the last 25 years successive Administrations have mostly refrained from open criticism of the Fed, preferring to appoint people who share their economic and political views to the Federal Reserve Board. Although President Trump’s vocal and frequent criticism of Chairman Powell and the Fed has been particularly bracing, there are historical precedents. There are striking similarities between the current episode and the two years leading up to President Nixon’s 1972 re-election campaign – a period of time where the President’s entreaties and threats for easy policy were publicly resisted, but policy eventually moved in the direction that the President sought.

Central bank independence

Economists nearly universally agree that an independent central bank is the best arrangement for monetary policy.  Most major central banks enjoy a high degree of independence today, but that is a relatively recent norm. The Bank of England and Bank of Japan were only granted operational independence about 20 years ago, and most pre-ECB European national central banks did not gain independence until very late in the 20th century. The Bundesbank was a notable exception due to the crippling hyperinflation suffered by the Germans after both World Wars. The Federal Reserve effectively gave up its independence during World War II to support the war effort, and did not get it back until the Treasury-Fed Accord of 1951.

Setting the stage

Reflecting those prior arrangements, the Federal Reserve paid a significantly higher degree of deference to the President (and the political system more broadly) back in the 1960s than it does today.  For example, Fed Chairman William McChesney Martin, who had been in the position since the early 1950s, called President Johnson in 1964 to inform him personally when the Board raised the discount rate.  The two appeared to get along reasonably well until 1965, when Martin began to suggest publicly that the economy might be overheating. Left unsaid was that the overheating was being caused by Johnson’s “Guns and Butter” fiscal policies.  Johnson was incensed and privately asked his Attorney General if he could legally remove Martin.

Martin let the Treasury Secretary know ahead of time that he was planning to push for a rate hike in December 1965. The Administration asked Martin to hold off. The Federal Reserve Board hiked anyway, even though Martin was fully aware that the move might jeopardize the Fed’s independence.

A few days later, Martin was summoned to President Johnson’s ranch in Texas to explain himself.  Reports are that Johnson got Martin alone and physically pinned him to a wall, shouting that his “boys” were dying in Vietnam and that Martin needed to print the money that the government needed to prosecute the war.

Martin stood his ground in December 1965, establishing his reputation as someone who resisted political pressure and relentlessly guarded the Fed’s independence. Even so, the Fed ultimately appeared to run a too-easy policy in the years after that December 1965 meeting, and inflation began to trend up in the 1960s, a precursor to the ultimate disaster from the 1970s.

Nixon and Burns

While Fed Chairman Martin and President Johnson were thrown together, the next pairing, President Nixon and Fed Chairman Burns, was a much more cooperative relationship. Arthur Burns was a very prominent and well-regarded economist, but was also a Republican loyalist. He called then-Vice President Nixon in 1960 offering recommendations for economic policy to help Nixon’s presidential campaign. When Nixon was elected President in 1968, he appointed Burns to the newly-created cabinet-rank position of “Counselor to the President” – a placeholder until Martin’s term of Fed Chairman ended.

Burns was installed to run the Fed in early 1970 with a mandate to help Nixon get re-elected in 1972.  Burns was regularly included in high-level meetings at the White House on economic policy and was considered part of the team. While Burns did not entirely satisfy Nixon, monetary policy was eased substantially in late 1971 over the objections of some other key Fed officials.

President Nixon continued to press hard, nixing Burns’ preferred candidate for a Board opening to show Burns that he had control over the Fed. The Administration also reportedly offered up a series of leaks to pressure Burns, including one trial balloon to expand the size of the Federal Reserve Board so that Nixon could pack the Fed with sympathetic Board members.

In the end, Nixon got what he wanted.  Burns lowered rates substantially in late 1971, the fed funds rate went from around 5½% in September 1971 to around 3½% in early 1972, just in time to supercharge the economy. Real GDP growth averaged about 8½% annualized in the first half of 1972, and the unemployment rate declined from 6% in late 1971 to around 5½% by election day. President Nixon was re-elected in a landslide, but Burns’ actions are now widely blamed for triggering the 1970s inflation nightmare that took a decade and a severe recession to clean up.

Conclusion

President Trump’s verbal attacks on Chairman Powell and the Fed have been well outside the norm of the last 25 years, though there is ample history of Presidents exerting political pressure on the Fed, particularly during re-election cycles. The experience of Nixon and Burns probably helped to make the case for a fully independent central bank. Even politicians backed off from openly challenging the Fed for a long time after the 1970s debacle.

Chairman Powell is certainly no Arthur Burns. He has kept his distance from President Trump and has strongly resisted Trump’s threats to fire him. President Trump’s not-so-subtle attacks on the Fed seem to harken back to a time when the Fed’s independence was less widely accepted, and monetary policy appeared to bend to the political winds.

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