With agreement nearly in hand, the Federal Reserve wanted to avoid additional delay. The members were in no mood to compromise when the president called a meeting at the White House on February 26 to discuss a program to prevent inflation. McCabe and Sproul represented the Federal Reserve. In Snyder’s absence Treasury Undersecretary Edward H. Foley and Martin represented the Treasury.233
The president began the meeting by reading a lengthy statement about the need to reconcile stability of the government securities market with restriction of private credit. He sketched a comprehensive program of controls, spending reductions, tax increases, credit restraint, and debt management. Clark described the Federal Reserve’s policy as disastrous for the economy and the government’s credit. Foley talked about the possible destruction of confidence if government securities prices fell. Sproul described the System’s statutory responsibility and claimed that the System’s proposals would strengthen confidence in the market rather than weaken it.
The president again referred to his post–World War I experience with Liberty bonds and said he did not want that experience repeated. Sproul replied that fluctuations in securities prices would not affect World War II savings bonds (Sproul Papers, February 27, 1951, 1–3).
Wilson agreed that something had to be done to slow the growth of bank credit. The president appointed him to take responsibility in Snyder’s absence by chairing a committee to study ways to reconcile credit control and debt management. The president asked that the Federal Reserve maintain current interest rates during the study period, until March 15. The White House released a press statement following the meeting. This time it did not announce the Federal Reserve’s commitment.
232. The Treasury team was able to reconcile acceptance of the Federal Reserve’s proposal with Snyder’s January 18 speech because Snyder had not discussed an exchange issue. The non marketable 2.75 percent bonds “would be consistent with the 21/2 percent rate as announced by the Secretary on January 18” (Martin memo in Minutes, FOMC, March 1–2, 1951, 11).
233. Also present in addition to President Truman: Charles Wilson, director of defense mobilization, Charles Murphy, special counsel to the president, Leon Keyserling, John D. Clark, and Roy Blough of the Council of Economic Advisers, and Harry McDonald, chairman of the Securities and Exchange Commission.
That evening McCabe and Sproul told Wilson that the meeting “had all the appearances of another delaying action. . . . The FOMC could not commit itself to the maintenance of fixed rates” (Sproul Papers, February 27, 1951, 3). Wilson said he understood their position and doubted that his committee could resolve the issue.
Two days later, after additional discussion, Martin told Riefler that “from the standpoint of the Treasury, the matter was sufficiently in hand so that it could be presented to the Federal Open Market Committee as a basis for discussion” (ibid., 12). The discussions now moved from the technical level to the policy level.
Martin and Bartelt met with the FOMC to present the Treasury’s counterproposal. They asked for three principal changes, based on conversations with Secretary Snyder. The first required the Federal Reserve banks to keep discount rates unchanged until the end of the calendar year. The second asked the Federal Reserve to maintain the existing premium on long-term bonds until the Treasury sold the 2.75 percent long-term bond. The commitment had a ceiling of $600 million in open market purchases to be shared with the Treasury. The third was mainly cosmetic; to appear consistent with Snyder’s January 18 speech, the joint statement would say that nonmarketable saving bonds would be available at unchanged interest rates.
After Martin and Bartelt left, the FOMC discussed the proposal. It declared itself unable to commit reserve bank directors to hold the discount rate. And it was reluctant to maintain the premium on the 2.5 percent bonds during the refunding.
The final agreement said that the Board “will approve no change in the discount rate during the rest of the calendar year without prior consultation with Treasury” (ibid., 37). The FOMC agreed to a maximum of $200 million of purchases of the 2.5 percent bonds during the refunding and until April 15.
The Board then approved the following statement, subject to approval by the secretary: “The Treasury and the Federal Reserve System have reached full accord with respect to debt-management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the government’s requirements and, at the same time, to minimize monetization of the public debt” (Board Minutes, March 2, 1951, 1–2). The rest of the statement discussed the conversion of long-term debt, the commitment to support rates during the conversion, and the agreement to let short-term rates rise and to maintain an orderly market.
The FOMC approved the agreement the same day. Secretary Snyder approved it the following day. The joint statement was published on March 4, 1951.234
For the first time since 1934, the Federal Reserve could look forward to conducting monetary actions without approval of the Treasury. The accord ended ten years of inflexible rates, following seven years of inactive and inflexible policies. The System now faced the task of rediscovering how to operate successfully.
On March 9 McCabe resigned. His efforts at conciliation had lost support on both sides. Although his term as a member ran until 1956, President Truman told McCabe that “his services were no longer satisfactory, and he quit” (President Truman in Snyder’s memoirs as quoted in Kettl 1986, 75). He left the System on March 31, after confirmation of his successor. The president named William McChesney Martin Jr. as chairman.235 Martin served for almost nineteen years beginning April 2, 1951, the longest term of any chairman to this time.236
The accord was a major achievement for the country. It was not inevitable. The Truman administration could have appealed to patriotism, to the exigencies of war and to populist sentiment against higher interest rates to keep the support program in place. That decision would have required an earlier end to the Bretton Woods system, a different history than the one we know.
234. The 2.75 percent bond was exchanged successfully in April 1951. Press reports of the accord did not treat the agreement as a major change in policy or independence. See Keech 1995.
235. Concerned that Martin’s appointment meant the Treasury would dominate, Senator Douglas voted against him (Stein 1990, 277). Snyder proposed Martin. Truman and his staff preferred Harry McDonald, chairman of the Securities and Exchange Commission. McDonald was not from an open Federal Reserve district, so he was ineligible (Kettl 1986, 75).
236. Martin was forty-five years old at the time. His father had served as the first chairman and, after 1928, as governor (president) of the St. Louis reserve bank. He had taken graduate courses in economics at Columbia and had studied law. He worked as a broker after graduation. In 1938, at thirty-one, Martin became the first paid president of the New York Stock Exchange after a personal scandal sent his predecessor, Richard Whitney, to jail. He served as president of the Export-Import Bank after World War II and as assistant secretary of the Treasury from 1949 until his appointment as chairman. When he met President Truman before his appointment to the Board, the president retold the story of his loss on government securities in 1920–21. He hoped that would not happen again. Martin’s answer was: “I’ll do my best, Mr. President” (taken from some unpublished remarks by Robert Solomon on October 27, 1998). There are many stories about Martin’s strength of character and integrity. One that he told concerned his possible appointment by President Roosevelt as chairman of the Securities and Exchange Commission. Martin describes Roosevelt as very cheerful until Martin told him that he would gladly accept the chairmanship “but that he thought Mr. Roosevelt should know that there were three members of the commission that he could not get on with.” The president’s mood changed, and he did not appoint Martin (CHFRS, May 19, 1955, 3).
The Immediate Aftermath
The announcement of the accord lifted uncertainty from the securities markets. Considering the strength with w
hich Secretary Snyder had resisted the change, the initial response of interest rates and stock prices seems modest. By the standards of the time, however, the changes in short- and medium-term rates are relatively large; the nine- to twelve-month certificate rate increased as much in March as in the seven months following the August 1950 decision to allow rates to rise to 1.75 percent. Table 7.15 shows rates in the weeks following the announcement and at the end of the month.
The refunding into 2.75 percent nonmarketable bonds in mid-April did not greatly change the yield on long-term debt. After the refunding, the yield rose to 2.62 percent on April 19. Federal Reserve purchases during March may have eased the transition to a freer market. It is difficult to separate open market purchases at that time from the normal seasonal change in bank reserves over the (then) March 15 tax date.237 The monetary base rose more than 5 percent in the second quarter, the largest six-month rate of increase since 1945. As noted earlier, the consumer price index rose very little (0.3 percent) in the next three months. Interest rates were no higher on June 30 than on March 31, suggesting that most of the adjustment had occurred within the month. In June the Treasury carried out a refunding by selling nine-and-one-half-month certificates at 1.875 percent, a yield Sproul described as “generous” (Sproul Papers, FOMC, June 7, 1951).
In less than two years, General Dwight D. Eisenhower became president, with George Humphrey as secretary of the Treasury and W. Randolph Burgess as his deputy. Burgess had testified strongly against pegged rates in 1949. He favored an independent monetary policy. The Federal Reserve was once again independent within the government.238
237. The seasonally adjusted growth of the St. Louis monetary base is smaller in March than in February or April. Monthly numbers contain relatively large random components, suggesting caution in drawing conclusions.
238. This phrasing was used by Martin, and it is often attributed to him. I believe it originated in Sproul’s 1952 letter to Congressman Wright Patman amplifying his testimony in hearings on monetary policy and management of the public debt. Sproul responded to questions about why monetary policy should be independent if defense policy or foreign policy was not. His reply included the following: “I think it should be continuously borne in mind that whenever stress is placed on the need for the ‘independence’ of the Federal Reserve, “it does not mean independence from the government but independence within the government” (Sproul 1980, 144; emphasis added).
Why So Little and So Long?
The Treasury’s warnings about disaster proved empty. A rise of 0.25 percent in long-term bond rates, and about 0.34 percent in medium-term issues, restored equilibrium. There was neither panic nor destruction of confidence in the government’s credit. Apparently, existing market rates had not been far from equilibrium rates. The puzzles are to explain why interest rates rose so little and why the Federal Reserve was so slow in regaining independence.
The principal reason for the modest adjustment was that, despite the Federal Reserve’s repeated concern, inflation remained low. It is true that consumer prices rose, on average, 7 percent a year from 1946 through 1951. Most of the rise was an adjustment to the end of wartime controls. Much more relevant is that the consumer price index at the start of the Korean War was the same as in April 1948. In between, prices had fallen and gradually returned to their earlier level.
Again, despite its protests, the Federal Reserve had not become an “engine of inflation,” the description Eccles was fond of using. The principal reason is not hard to find. The government budget was in surplus most of the time; the net budget surplus for fiscal years 1947 to 1951 was approximately $8 billion. Federal government civilian employment declined from a World War II peak of 3.4 million to 2.1 million in 1950. And President Truman committed repeatedly to fighting the Korean War with a balanced budget. Further, gold flows reduced monetary expansion after 1948. The gold stock reached a peak in September 1949, near the end of the deflation. By the time of the accord, gold holdings had declined 10 percent from their peak. Almost all of the decline came after the start of the Korean War.
With a modest budget surplus, no gold inflow, and given interest rates, money growth depends mainly on growth of private spending and the portion financed by the banking system. The monetary base was about the same in March 1951 as in December 1945. Without sustained growth of money per unit of output, the public had no reason to expect continued inflation, and there is no evidence in market data that it did.
With hindsight, it seems clear that the Federal Reserve could have ended pegged rates much earlier, without harm to the economy, if its officials had been more forceful. Their delay was more for political than for economic reasons, and resistance to change was usually stronger in Washington than in New York.
System officials believed they had no friends in high political office. Secretary Snyder was a Missouri banker, a longtime friend of the president. Although he denied it in the 1949 Douglas hearings, his principal concern was to borrow and refund debt at low interest rates. Until the Douglas hearings, the Federal Reserve had little overt congressional support to end pegged rates. And there was considerable opposition from the more populist members of Congress.239
Through most of the early postwar period, the Federal Reserve lacked a leader who was willing to push the issue forward. During his chairmanship, Eccles preferred to seek new powers over reserve requirements and to pursue his long-standing goal of gaining authority over nonmember banks. Reliance on credit controls, margin requirements, and other non-monetary arrangements reflects an effort to show that the Federal Reserve recognized its legal responsibility to prevent inflation, in part a mistaken belief that the Federal Reserve could control inflation without raising interest rates and controlling money.
Although political concerns were paramount, faulty economic analysis had a prominent role. Eccles did not believe that monetary policy could control inflation without very large increases in interest rates. Like many private and public sector economists at the time, he believed that fiscal policy was powerful and monetary policy was weak or impotent. On many occasions he expressed concern about the size of the change in interest rates required to control inflation. This too reflected political and economic concerns. Memories of 1920–21, when discount rates rose to 7 percent (in a period of high inflation), haunted the Federal Reserve, Secretary Snyder, and President Truman. Since no official at the time distinguished between nominal and real rates of interest, concern that interest rates would rise again to 6 percent or 7 percent deterred action. The existence of a large stock of debt—ten times the size of the federal debt after World War I—re-inforced other concerns about higher rates. A substantial increase in market rates would lower the value of existing debt, causing losses to the public and financial institutions.
239. I worked for the House Banking Committee in 1964 and had several opportunities to discuss some of these issues with the chairman, Congressman Wright Patman (Texas). Patman regarded the period of pegged interest rates as akin to a golden age of monetary policy. His slightly more muted views are on the record in many hearings, including the 1952 hearings on monetary policy and debt management that he chaired. These hearings, coming after the accord, gave opponents of the accord a chance to voice their complaints. By the time he held the hearings, the Treasury was not eager to reopen the issue. The subcommittee recommended many changes in the System, including required reserves for nonmember banks, appointment of labor representatives on reserve bank boards, six-year terms for governors (with reappointment), elimination of geographical requirements for governors, four-year term for the chairman, coterminous with the president’s term, an advisory council to coordinate policy, and an annual audit of the Board’s accounts. It opposed selective credit controls except in “special circumstances,” favored “mutual discussion” to resolve conflicts between the Federal Reserve and the Treasury, and pointed to the Employment Act as the policy mandate (Subcommittee on General Credit Control and Debt Management 1952, 2–7
).
Neither Federal Reserve nor other economists had developed a framework linking debt, money, and interest rates to output and prices. The common belief, repeated many times by officials and economists, was that the large outstanding debt changed the possibility of using monetary policy.240 It was not until the Korean War that Federal Reserve spokesmen pointed out that if inflation rose, the budget saving from holding interest rates low would be more than offset by the rising cost of government purchases.
The System began to change its view near the end of Eccles’s term as chairman. Sproul was often the most forceful proponent of change. Since McCabe was a much weaker chairman than Eccles, leadership shifted to New York. It was Sproul who pushed for the 1949 decision to make policy more flexible and the August 1950 decision to raise interest rates without Treasury approval. And it was Sproul who appeared most determined, in the eight months of conflict that preceded the accord, to regain full independence from Treasury domination. But even Sproul was slow to state opposition to the 2.5 percent rate until concern about wartime inflation and political and press support opened an opportunity in 1951.
GOLD AND INTERNATIONAL ISSUES
The 1949 Douglas Committee hearings also reviewed the role of gold in the monetary system. The hearings came soon after several European countries, led by Britain, devalued against the dollar. Some members questioned whether the president or secretary could change the price of gold without the approval of the International Monetary Fund or Congress. The fund had the right to approve a devaluation, but Congress had retained authority to set the gold price of the dollar.241
A History of the Federal Reserve, Volume 1 Page 104
