Presidential Fed bashing not new

Trump comments latest in long-standing tug-of-war over rates

THE RETIRED INVESTOR

Many on Wall Street are horrified that a presidential candidate might want to erode the independence of the Fed. Some have even called the idea the biggest threat to the U.S. economy. Any student of central bank history would beg to disagree.

We all would like to think that the Federal Reserve Bank's independence is sacrosanct. Once appointed by the president, the chairman of the Fed has the right and the duty to make decisions solely based on what is best for the economy and the labor force. The problem has been that many past presidents thought they knew best and sometimes they did. The question of presidential control over the Fed was raised again last week when former President Donald Trump, the Republican nominee in November's election, said the president should have a say in setting interest rates, according to The New York Times.

A president can indeed both appoint and fire the Fed chair as well as most member officials, although he is not the sole judge of who takes those seats. Congress has a say in the matter. It is true that the president cannot bar the Fed from raising interest rates but can voice his concerns and participate in the conversation. A look back into history reveals presidential "conversations" have occurred often.

The first time a president attempted to push the Fed into taking a specific action was in the Roaring Twenties. President Herbert Hoover was concerned with the speculation he witnessed on Wall Street. He attempted to make the Fed raise interest rates before the economy overheated. Not only did the Fed refuse but it chose instead to cut interest rates.

By 1929, with the stock market crashing, Hoover pressured the Fed to slash rates, which he hoped would initiate a recovery and at the same time save his presidency. Instead, the Fed raised rates, froze borrowing and tipped the country and the world into the Great Depression. One wonders what would have happened if Hoover had more power to influence the Fed. Would the Depression of the 1930s and the succeeding World War in the 1940s turned out differently?

After World War II, President Harry Truman declared open warfare on the Fed Chairman Thomas B. McCabe. At the time, inflation was heading toward 20 percent while government bond yields were capped (a legacy of World War II). Fiscal spending, thanks to the Korean War, was going through the roof. McCabe was concerned that rock-bottom government-controlled interest rates, combined with huge government spending, were a recipe for inflationary disaster.

He warned Congress that Truman's policies made "the entire banking system nothing more than an engine of inflation." He was right. Fortunately, he had enough political backing to successfully negotiate the central bank's total control over monetary policy while ending its obligation to monetize the debt of the U.S. Treasury at a fixed rate.

This flew in the face of a president who stood on the verge of what could have been a nuclear war via the Korean conflict. Truman was infuriated with McCabe and accused him of doing "exactly what Mr. Stalin wants."

Truman failed in his fight with the Fed, but in the end, McCabe was forced to resign. Truman thought his replacement, William McChesney Martin, would be his yes-man at the head of the Fed, but in the words of Truman's chief economist, Martin "double- crossed" the president. Martin, who chaired the Fed from 1951-70, continued to pursue the path of an independent central banker.

But presidents continued to try and get their way. John F. Kennedy had regular meetings with Martin telling him exactly what he wanted to do on rates. In 1965, Lyndon B. Johnson, after embarking on a powerful stimulus program, asked the Fed to keep interest rates as low as possible to help finance the Vietnam War.

Martin refused and instead raised rates by a half-point on inflation fears. Johnson was livid. He summoned Martin to his Texas ranch where he shoved him around his livingroom, yelling in his face "Boys are dying in Vietnam, and Bill Martin doesn't care."

Richard Nixon successfully used Arthur Burns' Republican party ties to pressure him frequently. He wanted to win reelection. To do so, he browbeat Burns to improve short-term employment by maintaining easy-money policies. He is caught on the White House tapes demanding that Burns do nothing to "hurt us" especially in the lead-up to the 1972 elections.

Ronald Reagan and George H.W. Bush round out this list of presidents who have tried sometimes successfully, sometimes not, to influence the direction of the Fed and interest rates.

The fact that there has been a decade or two of reprieve in which the Federal Reserve Bank has been left to its own devices does not mean that future presidents will refrain from having their say in managing the path of monetary policy. The Fed's top-down approach in managing monetary policy over the last 40 years, while enhancing economic growth, has also led to enormous income inequality in the United States.

In 2008, the Fed made a historic policy change with the introduction of qualitative easing. Since then, the Fed's balance sheet has skyrocketed. It has more power than it ever has over the economy and the allocation of credit through bond buying of agency securities.

In addition, many Americans are demanding a more bottom-up approach in monetary and fiscal policy. In this budding era of populism, it does not surprise me that a potential president might want more control of the Fed for better or worse.

Bill Schmick is registered as an investment adviser representative of Onota Partners Inc. in the Berkshires. He can be reached at 413-347-2401, or email him at [email protected].

One wonders what would have happened if Hoover had more power to influence the Fed. Would the Depression of the 1930s and the succeeding World War in the 1940s turned out differently?