Richard H. Timberlake - Professor of Economics (Retired), University of Georgia
Published June 1, 1999 | June 1999 issue
In the September 1998 issue of The Region, former Federal Reserve Board Governor Andrew Brimmer offered an appreciative remembrance of William McChesney Martin Jr., former Fed Board chairman who had recently died. Brimmer noted Martin's long-tenured chairmanship of the Fed Board and his initiation of the highly effective consensus system for making policy decisions.
Brimmer also praised Martin for the late chairman's part in two political episodes that tested the Fed's independence from improper political pressure by the executive branch. Any central bank's independence is measured by the ability of its decision-making committee to carry out policies that are economically appropriate, even if such policies are not altogether tolerable to politicians in high office. Through the ages, the politicians most sensitive to central bank operations have been executivespresidents and prime ministers, and their associated secretaries of the treasury and chancellors of the exchequer.
The first event Brimmer discussed was the Fed's attempt to rid itself of the price and interest-rate peg on marketable government securities in late 1950 and early 1951, and this is the episode with which I will concern myself.* In discussing this issue, Brimmer correctly gives Martin some deserved credit for helping to fashion "the accord" of March 3, 1951the agreement that allowed the Fed finally to shake off the Treasury's yoke and manage its own house. However, Brimmer errs in giving Martin further accolades for waging the battle with the Truman White House that led up to the accord. The hero of that conflict was another Fed Board member and ex-chairman, Marriner S. Eccles. Because Eccles had little to do with the accord itself, Brimmer may have overlooked the part Eccles played in the early stages of the conflict. In the spirit of keeping the record straight and giving credit where credit is due (especially with respect to a central bank where "credit" has always been so important!), I offer the following correction and supplement to Brimmer's narrative.1
Marriner S. Eccles, a Mormon and banker from Utah, was the first Fed Board chairman after Congress passed the Banking Act of 1935. He wrote much of the Act and was an indirect force in promoting its journey through Congress. The Act effectively remodeled the Federal Reserve System so much that Congress might better have labeled it "The Central Banking Act of 1935." As just reward for his efforts, President Franklin Roosevelt nominated Eccles in late 1935 to be the first chairman of the new Board of Governors.
Eccles at the time had a subordinate position in the U.S. Treasury Departmentmuch as Martin had some 15 years later just before he became chairman. The secretary of the Treasury at the time, Henry Morgenthau Jr., had worked closely with Eccles. Morgenthau liked Eccles' ideas and was instrumental in persuading Roosevelt to appoint Eccles chairman.
Morgenthau's support for Eccles was not entirely selfless. Eccles was a convinced and outspoken fiscalist. He argued that the Great Depression, then in full force, was the result of inadequate aggregate spending. Total spending in the private sector, he noted, was greatly reduced from its 1929 levels and nowhere near enough to promote full employment in spite of what everyone regarded as a loose and easy monetary environment. The fiscalist solution was for federal and state governments to undertake expanded spending programs that would propel the U.S. economy into a full employment mode. The principal role of monetary policy, Eccles argued, was to serve as a catalyst for this expansionary fiscal policy. By keeping interest rates "low," monetary policy would enable the Treasury to borrow cheaply and finance expediently the various government spending programs. Such a spending-and-interest-rate philosophy was music to the ears of Treasury officials. A monetary policy that enhanced fiscal policy was just what they wanted for their big-spending programs.
Before the Banking Act of 1935, The secretary of the Treasury had been the ex officio chairman of the Federal Reserve Board and generally had run the Board the way he wanted. However, with a fiscalist as chairman of the Board, the central bank would be operating in the manner the Treasury wished, without the secretary even in view. Eccles, the new chairman, was virtually an assistant secretary of the Treasury for monetary affairs.
The big spending programs of the 1930s did not require much monetary stimulation from the Fed. Interest rates were so low that they were almost out of sight. Through much of the 1930s and later, the Treasury bill rate was around 3/10 of 1 percent, and often lower.
Formally stated, the Federal Reserve System's original purpose had been to accommodate the credit needs of commerce, banking and industry. After 1935, the Fed's primary, but unstated, goal became the maintenance of an "orderly" market for government securities. "Orderly" came to mean a nearly fixed pattern of rates on several classes of government securities. If the rates tended to rise and their market prices to fall, the Federal Open Market Committee (FOMC) would intervene by buying enough securities to keep rates close to the agreed-upon pattern. The unprecedented fiscal deficits the Treasury was financing, although very modest by comparison with what came during World War II and later in the 1970s and 1980s, prompted Treasury officials to maintain continuous pressure on the Fed to hold rates at these substandard levels.
The Fed's discretionary money-creating powers were also in abeyance after passage of the Banking Act due to the massive inflows of gold from Europe. Federal Reserve purchases of the gold in conformance with federal law monetized the gold. World War II saw the end of most of the gold inflows, but financing the substantial deficits the government assumed to fight the war made the government securities market an even more critical factor in Treasury operations. With the full approval of Federal Reserve officials, the Treasury mandated a wartime pattern of yield rates and prices on three types of marketable government securities: 3/8 of 1 percent for 90-day Treasury bills, 7/8 of 1 percent for one-year Treasury certificates and 2 1/2 percent for the longest-term marketable bonds. This configuration was known as "the peg." Eccles often argued that these rates were "too low." He observed later: "The pattern of war finance had been firmly established by the Treasury; the Federal Reserve merely executed Treasury decisions."2 Throughout the war and for years thereafter, monetary policy remained hostage to the Treasury's imperatives.
In February 1944, Roosevelt appointed Eccles for another 14-year term as a member of the Federal Reserve Board, and for another four-year term as chairman of the Board. During the following four years, Roosevelt died, Harry S. Truman became president of the United States and the war ended.
Financing war expenditures with the pattern of fixed rates that the Treasury prescribed had generated unprecedented increases in U.S. money stocks. From November 1941 to August 1945, the M2 stock of money grew at an average rate of 19 percent a year, and the total increase for the period was 102 percent.3 Prices correspondingly increased by approximately 65 percent for the five-year period, 1941-1946.4
Maintaining the pattern of Treasury-dictated interest rates guaranteed a subsequent inflation. As the Treasury sold its securities to finance the government's spending excesses, security prices tended to fall and their yield rates to rise. To fulfill its commitment to maintain security prices and keep market rates low, the FOMC had to buy securities in the open market and create the money to pay for them. More money in circulation put upward pressure on prices. These dynamics further aggravated the pressures on the government securities market. As long as the Treasury prescribed monetary policy, the Fed was the engine of inflation infamously portrayed in economists' treatises.
Eccles, as I noted above, was an ardent fiscalist. However, he recognized early in the war period that the time for expansionary fiscal and monetary policies was past, and that inflation was now the malady to be resisted. Accordingly, he proposed several programs that would have restrained the wholesale creation of money and the developing inflation.5 However, Secretary Morgenthau and other politicians in the Roosevelt and Truman administrations, and in Congress, were not sympathetic to such things as higher taxes and gradually increasing interest rates. Consequently, the Fed continued its administration of the money supply according to Treasury demands.
Eccles, reviewing the period some years later, noted: "In the five years between V-J Day and Korea [June 1950] the repeated efforts [that] the Federal Reserve made to deal with a prime source of inflation got nowhere. ... [T]he Treasury Department, with its chronic institutional bias toward cheap money, had the final say on monetary and credit policies."6 Eccles admitted that he "favored" a cheap-money policy during the Depression, and he "went along with a cheap-money policy during the war years." However, "there was no justification for such a policy [after V-J Day], when we had budgetary surpluses and lived under mounting inflationary pressures. ... [The support policy] fostered the unwarranted growth of bank reserves that fed the inflationary fires; and these fires slowly consumed the real purchasing power of the dollar."7
Eccles had been an ally and supporter of Roosevelt. Because of his conservative fiscal stance after the war and other factors, he was not a favorite of President Harry Truman. Therefore, when his four-year tenure as chairman ended in 1948, Truman did not reappoint him to that office.8 His membership on the Board, however, was not affected by his removal as chairman, and Eccles decided to stay on the Board as an ordinary member.
The Treasury's insistence that the Fed continue its support of the government securities market at all hazards greatly aggravated the developing inflation in the months following the outbreak of the Korean War. The price support program had been in effect since about 1940, and its predecessor, an "orderly" market, for five years before that. One could surmise, therefore, that Federal Reserve officials were conditioned to the dominance of the Treasury. They were not alone. Many prominent economists argued that the "peg" was well advised.9
Resumption of excessive spending, both private and public, in the latter half of 1950 encouraged the Fed to waffle slightly on its support policy for the government securities market. Treasury Department officials, particularly John Snyder the current secretary, then began the campaign that became a cause celebre. In a speech to a business group in late 1950, Secretary Snyder stated that the then-Fed Chairman Thomas McCabe and the FOMC had agreed to continue indefinitely the peg of government security prices.
This false announcement shocked some members of the FOMC, particularly Eccles. Certain newspaper journalists also noted this high-handedness, and not only criticized it on its own terms but asked Eccles for an explanation. After a few public responses by Eccles and Allan Sproul, then president of the New York Fed, the Truman administration "invited" the entire FOMC to the White House for a conference. This move was unprecedented in the history of the Federal Reserve System. In fact, President Woodrow Wilson had eschewed just such a tactic in the early years of the Fed because of its obvious political implications.
The meeting between the members of the FOMC and President Truman took place as scheduled on the afternoon of Jan. 31, 1951. The detailed minutes of the meeting show clearly that no agreements on interest rates or security prices were either discussed or made. Primarily, the topic of conversation was on the need to carry out sound taxation and fiscal policies to deal with the Korean War. At the end of the meeting, Chairman McCabe asked the president what would be the general nature of the statement he would make to the press. Truman replied that his press release would include discussions about the budget, taxes, the defense effort, the need for public confidence in the government's credit, but nothing about the government securities market.10
On the following day two accounts of the meeting appeared on newspaper ticker tapes. The first was from the president himself and stated that the Fed Board had "pledged its support . . . to maintain the stability of Government securities as long as the emergency lasts." The second was by a Treasury spokesman who interpreted the White House statement to mean that the Fed would support the market for government securities "at present levels."11
Journalists then contacted Eccles to verify the substance of the Truman-Snyder statement. Eccles replied that no such agreement had even been discussed much less reached. The next day Eccles' refutation without his name appeared as news items in the Washington Post and New York Times. Concurrently, individual members of the Fed Board were given copies of a letter the president had just sent to Chairman McCabe. In it the president thanked McCabe for assuring him that the "market on Government securities will be stabilized and maintained at present levels." This letter had not been released yet to the press, so Board members, including Eccles, thought its patent prevarication could be squelched by a meeting between McCabe and the president. However, the White House released the letter to the press before the FOMC could muster its protest.12
It was late Friday afternoon before a newspaper reporter called Eccles for an explanation of the now-public White House press statement. By this time the other members of the FOMC had left Washington or were otherwise unavailable for concerted action. In fact, no other members of the committee had objected to the earlier Treasury misstatements. Consequently, if Eccles did not offer some correction, the White House-Treasury declaration would go unchallenged. Knowing he was the only FOMC member who could or would do anything, Eccles released his response on the Truman-Snyder stratagem to a reporter for the New York Times who also made it available to other major newspapers. With his statement Eccles also gave the reporter a copy of the minutes of the FOMC-Truman conference that had occurred three days earlier.13
Eccles did not declare the obviousthat Truman and Snyder were trying to strong-arm what was supposed to be an independent government agency to do their will for purely political reasons. The minutes of the White House meeting were a clear enough refutation of the executive's claims. Eccles acted solely on his own responsibility, and he spoke only for himself. Subsequently, Sproul commended him for it, but no one else on the committee either approved or criticized his action.14
Treasury-Federal Reserve tensions had caught the attention of Congress as early as 1949, and had become the object of an investigation by the Subcommittee on Monetary, Credit and Fiscal Policies chaired by Sen. Paul Douglas. Douglas had been a professor of economics at the University of Chicago, and he knew the difference between a dollar and a government bond. The subcommittee made its report in January 1950, a full year before the conflict that Eccles chronicled.
The essence of the Douglas Committee Report was that both the Fed and Treasury should follow the norms for employment, production, purchasing power and price levels implied by the Employment Act of 1946. The Report also stated that "the will of Congress" was for the Fed to have "primary power and responsibility" over the cost of credit, and that the Treasury's actions with respect to money and credit should "be made consistent with the policies of the Federal Reserve"15and not the other way around.
The Truman administration's role in the controversy that Eccles finally spiked a year later suggests that the executive did not take congressional resolutions too seriously. So, after Eccles' public resistance in early February 1951, influential congressmen insisted that the Treasury and Fed iron out their differences and thereafter stay clear of each other's turf. It is here that Brimmer's account of Martin's influence becomes meaningful. Martin was instrumental in fashioning the accord to which the Fed and Treasury agreed just a month after Eccles' disclosure. For his good offices in this regard, Martin became the next Fed chairman.16
Eccles retired from the Fed Board a few months after the conflict. Professor Lloyd Mints, who was my teacher at the University of Chicago shortly after these events happened, did not much agree with Eccles' monetary theories or policies. Nonetheless, he credited Eccles with the courage to speak his convictions to anyone, "... and be damned to you if you don't like them." Eccles was an adversary that even Harry Truman could not browbeat nor outmaneuver.
The drama of the Fed-Treasury dispute aside, the lasting reason for the separation of monetary and debt-management powers was the patent failure of cheap-money, low-interest-rate programs to achieve acceptable results. Many others both in government and academia shared Eccles' fiscalism. Aggressive fiscalism, the practical policy aspect of Keynesianism, proved to be both ineffective and harmful-although that is another story. Monetary policy, after the failures of fiscal excesses, seemed to deserve a place in the sun. And William McChesney Martin, the new Fed chairman, showed by the record he left that he was up to the task.
*The second episode described by Brimmer involved President Nixon's attempt to encourage Martin to accept the Treasury post in 1968 so that Nixon could appoint Arthur Burns as chairman of the Fed. Martin said "no thanks" and Burns was appointed in 1970, upon Martin's retirement.
1 For this account I refer to Eccles' autobiography, Beckoning Frontiers, Public and Personal Recollections, edited by Sidney Hyman, (New York: Alfred A. Knopf, 1951), to Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960, NBER (Princeton: Princeton University Press, 1963), to Donald Kettl, Leadership at the Fed, (Yale University Press: New Haven and London, 1986, and to some material in my own book, Monetary Policy in the United States, (Chicago: University of Chicago Press, 1993).
2 Eccles, Beckoning Frontiers, 358, 382.
3 Friedman and Schwartz, A Monetary History, 548, Table 23.
4 Richard H. Timberlake, Monetary Policy in the United States, (Chicago: University of Chicago Press, 1993), 306-309. This figure is a re-estimation of Consumer Price Index values for the war period.
5 Eccles, Beckoning Frontiers, 352-366.
6 Ibid. 481.
8 Kettl, Leadership at the Fed, 63.
9 Friedman and Schwartz, Monetary History, 624, note 21.
10 Eccles, Beckoning Frontiers, 487-490.
11 Ibid. 491.
12 Ibid. 492.
13 Ibid. 493-494.
14 Ibid. 495.
15 U.S. Congress, 81st Cong., 2nd sess., Monetary, Credit and Fiscal Policies: Report of the Subcommittee of the Joint Committee on the Economic Report, Sen. Doc. No. 129, January 1950 (Washington: Government Printing Offices, 1950).
16 Kettl, Leadership at the Fed, 74-75.