In recent weeks, President Donald Trump has further persisted in his criticism of the Chairman of the Federal Reserve Board Jerome Powell and the overall institution itself. Powell’s recent speeches, and recent data indicating a weakening of the economy, suggest that the next move by the Fed will likely be to lower interest rates in September. And that appears to be appropriate. It should make the President happy—at least for the moment.
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But the Fed doesn’t operate only for the moment.
It takes a longer-term perspective. And Powell has indicated that the 12-voting-member Federal Open Market Committee (FOMC), which rather than Powell alone actually sets interest rates, will be guided by the data it receives about the economy. This includes inflationary expectations, employment, and the growth outlook.
Because of this data-driven process, Chair Powell cannot provide the President with long-term guarantees as to whether, or how quickly, the FOMC will lower interest rates. No Fed Chair can.
Despite Powell’s inability to provide future guarantees, Trump’s drumbeat of demands and personal criticisms are likely to continue—even though the vast majority of people in the financial community here and abroad have great respect for Powell and his colleagues. Added to this, the President has attacked Powell for the cost of renovation of the Fed’s headquarters in Washington. Having personally spent a lot of time there over the years (my office at the State Department was right across the street), it has clearly needed serious renovation for decades.
Tensions between an American president and the Federal Reserve are not new. And repeatedly have occurred over the years. So a certain amount of pressure from Trump is in keeping with that of some of his predecessors. But Trump has taken this tension to a much higher level—and personalized it by threatening to fire the Fed Chair. Even attempting to do so would be unprecedented and severely cripple the work of the Fed to make sound economic decisions.
In the past, wise leaders from both parties saw to it that there were limits on criticism and such threats—protecting the independence of the Fed and ensuring its continuation as the bedrock of the American financial system and, indeed, the global financial system.
Truman’s tension with the Fed
The experiences of the 1950s are especially instructive to understanding the importance of preserving the independence of the Fed.
During and just after WWII, pursuant to an agreement made by the Roosevelt Administration, the Fed “pegged” long term interest rates on Treasury securities at low levels to contain the cost of war financing. But as consumer spending surged after the War, and in the early 1950s Korean War spending increased, the economy overheated. This caused inflationary pressures to grow. Fed officials pressed President Harry Truman to be relieved of their pegging commitment.
Truman resisted. He wanted to maintain stable interest rates to help finance this new War. He also feared that if the Fed allowed interest rates to rise, the bond market would deteriorate, and the economy would weaken.
To assert his view in a personal and visible way, in early 1951 Truman took the unprecedented step of summoning to the White House the entire Federal Reserve Open Market Committee. No President before or since has done this. And it was considered a serious breach of Fed independence at the time. The action caused deep anxiety in the financial markets concerned about excessive presidential pressure on the Fed—similar to some of the concerns being expressed now.
To make matters worse, the White House announced that the Fed had agreed at the meeting to continue pegging “for as long as the emergency lasts,” although there were serious doubts as to whether there actually was an “emergency ” at the time.
This was considered an outrage by many in the financial community. Shortly thereafter Fed board member Marriner Eccles, who had been Fed Chair under Roosevelt, but was not reappointed to that job by Truman, informed the press that the FOMC had made no such commitment.
Tensions grew—as did market volatility. A highly-regarded senator from Wyoming, sensing the dangers to the country then in the midst of the Cold War, warned that “the Soviet dictators are convinced that the capitalist world will wreck itself by economic collapse arising from the inability or unwillingness of different segments of the population to unite upon economic policy.”
If you substituted the phrase “Russian dictators” for “Soviet dictators,” that same warning might well be issued today.
Undermining the authority of one of the most respected pillars of the American financial system, and the entire government, would be seen, as the senator said, AS the capitalist world “wrecking itself.”
Weighing arguments like these, Truman—formerly a Missouri Senator, with little financial experience—came to recognize the dangers of a sustained confrontation with the Fed. His ire at the Fed remained, but in the end he relented. And the economy benefitted. The Fed preserved its autonomy. Through a series of actions taken by the Truman Administration, including budgetary restraint (a missing factor today), and continued Fed independence in fighting inflation, prices began to fall in mid-1951.
Eisenhower’s victory
In another confrontation, in April 1956 during the Eisenhower Administration, the Fed was challenged again when its Chairman, William McChesney Martin, who had been appointed by Truman earlier in the decade, raised interest rates. Martin did not forewarn the White House or Treasury Department. Instead he simply informed Treasury Secretary George Humphrey afterwards that concerns about coming inflation led the Fed to do so.
But it was an election year. President Eisenhower was concerned that higher rates leading to a slower economy could endanger his prospects. Humphrey encouraged Eisenhower to strongly oppose the Fed’s decision, as did many in his party. Martin met with the President and told him that unless the Fed had taken this decision immediately, inflation could have gotten out of hand.
Eisenhower decided that, after considering arguments on both sides, he had to rise above politics. In a press conference shortly after the Fed’s action, he responded to a question as to whether the Fed should be accountable to the Administration: “It is not under the authority of the President,” he said. “I really personally believe it would be a mistake to make it definitely and directly responsible to the political head of State.” With those words he bolstered the independence of the Fed for a generation. The debate ended then and there. And despite concerns of opponents of the Fed’s decision to raise interest rates on grounds that it would weaken the economy, the economy continued to grow; Eisenhower won in a landslide.
The wisdom of both Presidents, one Democrat and one Republican, during the fraught times of that era in which the economy and politicians were both having to cope with wartime conditions and financial stresses considerably greater than today, should be instructive for those currently in power.
Confidence in our economic leadership role in the world, our dollar, and our key financial institutions, both among many Americans and many abroad, is deteriorating. Undermining the Fed or its Chairman would seriously exacerbate that downward trend.
The 12 members of the FOMC will meet several times in coming months. And they will probably lower interest rates soon. But as Eisenhower so compellingly put it, they are not “under the authority of the President.” For decades they have earned public confidence by avoiding politics and effectively performing their duties to try to curb inflation and boost jobs in the best interest of the American people as a whole. In war and in peace, they have credibly carried out these responsibilities. That was what they did in the 1950s and in other decades as well.
History tells us that if the Chair and the institution as a whole are not subject to undue pressures which undermine their independence to make sound economic decisions, the odds are high that they will continue to do so.