June 1999
The Tale of Another Chairman
Richard H. Timberlake
Professor of Economics, Retired
University of Georgia
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 executives—presidents 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, 1951—the 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 Eccles Becomes Chairman of the
Federal Reserve Board
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
Department—much 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.
Fed Policy during the Depression and War Years
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' Postwar Fiscalism
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.
Frictions Between the Fed and the Treasury
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 Fed-Treasury War
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 obvious—that 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
Congress' Role in the Fed-Treasury Dispute
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"15—and
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.
Endnotes
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