When one thinks of the early 1950’s, things that often come to mind are fries and milkshake, muscle cars, Little Richard, and greased hair. Things that rarely come to mind are that the US and China were openly at war over a little piece of land called Korea, that the Treasury market did not exist, that short and long end rates were “fixed” by the Fed at 0.125% and 2.5% respectively, even as inflation was at the highest it has ever been in the post war period at over 20%. What absolutely never comes to mind, is that on March 3, 1951, the world as we know it changed forever, after a little noted event known as the Fed-Treasury Accord of March 3, 1951 took place, and mutated the role of the Federal Reserve, which set off on a path that would ultimately lead to the disastrous economic state the world finds itself in today.
Oh and another thing that never comes to mind, is that while the current iteration of the Fed, various recent voodoo economic theories, and assorted blogs, all claim that excess bank reserves are never an inflationary threat, it is precisely two Federal Reserve chairmen’s heretic claims that reserves will light an inflationary conflagration, that forced then president Truman to eliminate not one but two Fed Chairmen, and nearly result in the “independent” Federal Reserve being subsumed by the Treasury to do its monetization and market manipulation/intervention bidding. Which then begs the question: who is telling the truth about the linkage of reserve accumulation to inflation – the Fed of 1951, or every other Fed since, now firmly under the control of the Treasury-banker syndicate. Because they cannot both be right.
Why is March 3, 1951 such an important date? Because, more than anything, the confluence of events that led to the “Accord” signed on this day have extensive parallels to our current situation, as the attached paper by the Federal Reserve of Richmond shows in exquisite detail, yet 100% in reverse.
In a nutshell what happened in the late 1940s and early 1950s was that in the aftermath of WWII, and the outbreak of the Korean war, America found itself in a very odd situation… one never really encountered until today. The country had soaring inflation – as in real inflation, not just core inflation measured by hedonic adjustments and excluding all those thing that actually do go up in price. More importantly, it had the 1950’s version of ZIRP – only then it was called a peg, in this case of 0.375%, and subsequently 0.125% on short end Treasurys, and 2.5% on long-dated paper. In other words, the monetary situation in 1951 was one where both the short and long end of the curve were artificially boosted (think ZIRP and Twist), just so holders of Treasury paper (at that time only insurance companies as banks were not allowed to invest in TSYs) did not experience losses and get further “demoralized” in addition to the war that Truman was currently waging.
In fact, the following quote from none other than Truman is as idiotic, yet as valid today, as it was 61 years ago:
[T]he Federal Reserve Board should make it perfectly plain… to the New York Bankers that the peg is stabilized….I hope the Board will…not allow the bottom to drop from under our securities. If that happens that is exactly what Mr. Stalin wants. (FOMC Minutes, 1/31/51, p. 9)
The FOMC met with President Truman late in the afternoon of Wednes- day, January 31.17 Truman began by stating that “the present emergency is greatest this country has ever faced, including the two World Wars and all the preceding wars.… [W]e must combat Communist influence on many fronts.… [I]f the people lose confidence in government securities all we hope to gain from our military mobilization, and war if need be, might be jeopardized.”
This is arguably the earliest recorded iteration in modern history of a “the world will come to an end unless you don’t do what I tell you” type of threat uttered by a member of the administration (ahem Hank Paulson) to a governing body. We will skip commenting on the supreme irony that according to Truman, Stalin would win if the US did not engage in the same central planning that ultimately brought the Soviet empire down.
Yet what is so very different about this date in history, is that while it was the Treasury pushing tooth and nail for endless bond pegging by the Fed (apparently nobody had thought of QE back then yet, because it would have been all the rage), the body warning about the potential threat of runaway inflation from a surge in reserves, as well as the dangers associated with central planning was… The Federal Reserve.
The same Fed that can not withhold its exuberance in encouraging ZIRP, Twist, LSAP, selling of Treasury Puts, and every other form of market intervention known to man, warning the president these very same actions would lead to ruin? And not only that but Truman being forced to get rid of not just Fed veteran Marriner Eccles (after whom the building in which centrally planned schemes are hatched every single day in yet another supreme irony), but also his successor Thomas McCabe who also refused to follow the precepts of central planning… who in turn was replaced by a Treasury muppet, or someone who will gladly monetize US debt whenever needed, at which point the scene for the final outcome was set.
That is impossible you say. Oh, not only is it impossible but it gets much better.
Because not only did the two veteran Fed chairmen warn against the state’s incursion into central planning, but they explicitly said something which the Fed, or at least its modern versions, have rejected over and over, especially during congressional committees: that a build of bank reserves is the surest way to spark hyperinflation.
But….but….but…. this is what fringe tin-foil hat blogs allege…. not Fed chairmen who between them have over 20 years of tenure.
Well, here are the facts:
“We have marched up the hill several times and then marched down again. This time I think we should act on the basis of our unwillingness to continue to supply reserves to the market by supporting the existing rate structure and should advise the Treasury that this is what we intend to do—not seek instructions” (FOMC Minutes, 8/18/50, p. 137).
[Fed member] Sproul would state the idea that a central bank controls inflation through the monetary control made possible by allowing market determination of the interest rate: “[T]he Committee did not in its operations drive securities to any price or yield….[M]arket forces had been the determining factor, and that only in resisting the creation of reserves had the committee been a party to an increase in interest rates. That…was the result of market forces, and not the action of the Committee. (FOMC Minutes, 3/1/51, pp. 125–26)”
In response to Truman’s ceaseless demands for pegging interest rates even as inflation was spiking over 20%, NY Fed president Sproul said that…
…this “would make the Federal Reserve System a bureau of the Treasury and, in light of the responsibilities placed in the System by the Congress, would be both impossible and improper” (FOMC Minutes, 1/31/51, p. 23).
In other words, pegging (i.e., ZIRP, Twist, LSAP)… is “impossible and improper”… is unconstitutional another word for it?
In retrospect perhaps we were a little too rought on Mr. Martin, who despite being a Treasury puppet, had these words to say:
In his speech accepting an appointment to the Board of Governors, Martin (1951, p. 377) said:
“Unless inflation is controlled, it could prove to be an even more serious threat to the vitality of our country than the more spectacular aggressions of enemies outside our borders. I pledge myself to support all reasonable measures to preserve the purchasing power of the dollar.”
There are those who claim the Fed has become the bankers’ puppet. It was not always so. In fact, the bankers loathed the Fed… Until the “Accord”
The banking community contributed to the Fed’s isolation by refusing to support its position. On February 2, the Board had met with the Federal Advisory Council, which represents the views of large banks. At that meeting, Eccles accused bankers of a lack of “courage and realistic leadership” (Board Minutes, 2/20/51, p. 389).
The Executive Committee refused to withdraw the FOMC’s letter to the President. Furthermore, it wrote a defiant letter to Senator O’Mahoney. The initial substantive paragraph began with the famous quote from John Maynard Keynes: “[T]hat the best way to destroy the Capitalist System was to debauch the currency” (FOMC Minutes, 2/14/51, p. 87).
It just gets better, as Marriner Eccles puts it into overdrive:
“We favor the lowest rate of interest on government securities that will cause true investors to buy and hold these securities. Today’s inflation. … is due to mounting civilian expenditures largely financed directly or indirectly by sale of Government securities to the Federal Reserve.… The inevitable result is more and more money and cheaper and cheaper dollars.” (FOMC Minutes, 2/7/51, p. 60)
Yet punchline #1:
[We are making] it possible for the public to convert Government securities into money to expand the money supply….We are almost solely responsible for this inflation. It is not deficit financing that is responsible because there has been surplus in the Treasury right along; the whole question of having rationing and price controls is due to the fact that we have this monetary inflation, and this committee is the only agency in existence that can curb and stop the growth of money.… [W]e should tell the Treasury, the President, and the Congress these facts, and do something about it….We have not only the power but the responsibility….If Congress does not like what we are doing, then they can change the rules. (FOMC Minutes, 2/6/51, pp. 50–51)
And #2 and final:
Governor Eccles and Representative Wright Patman, who was a populist congressman from Texarkana, Texas, went head-to-head:
Patman: Don’t you think there is some obligation of the Federal Reserve System to protect the public against excessive interest rates?
Eccles: I think there is a greater obligation to the American public to protect them against the deterioration of the dollar.
Patman: Who is master, the Federal Reserve or the Treasury? You know, the Treasury came here first.
Eccles: How do you reconcile the Treasury’s position of saying they want the interest rate low, with the Federal Reserve standing ready to peg the market, and at the same time expect to stop inflation?
Patman: Will the Federal Reserve System support the Secretary of the Treasury in that effort [to retain the 2 1/2 percent rate] or will it refuse?… You are sabotaging the Treasury. I think it ought to be stopped.
Eccles: [E]ither the Federal Reserve should be recognized as having some independent status, or it should be considered as simply an agency or a bureau of the Treasury. (U.S. Congress 1951, pp. 172–76)
And there you have it folks, clear as daylight, every aspect of the tension of the “independent” Fed brought to the surface. Because the few men who dared to stand up against Truman, the doctrine of central planning, “pegging” Treasury prices, and the banking cartel whose sole prerogative has always and only been cheap and easy money, all got their just deserts:
Fed president #1:
Eccles also reported in his memoirs that shortly before this event he had completed a letter of resignation to the President. He then decided to postpone his resignation. Eccles had been Chairman of the FOMC from its creation in 1935 until 1948. He did not intend to leave Washington with the Federal Reserve under the control of the Treasury. According to a Truman staff member, Truman had failed to reappoint Eccles as Board Chairman in 1948 to show him “who’s boss” (Donovan 1982, p. 331).
And Fed president #2…
While in the hospital, Snyder conveyed to Truman the message that he felt he could no longer work with McCabe. Without a working relationship with the Treasury, McCabe could not function as Chairman of the Board of Governors. McCabe sent in a bitter letter of resignation, but resubmitted a bland version when asked to do so by the White House. McCabe, however, conditioned his resignation on the requirement that his successor be acceptable to the Fed.
As a reminder Snyder was the Secretary of the Treasury.
And whom did Truman replace McCabe with?
On March 15, the President appointed William McChesney Martin to replace McCabe.
Martin was undersecretary of the Treasury: the same institution that wanted all objectors to central planning scrapped. His position? Quote the Fed:
Truman and Snyder were populists who believed that banks, not the market forces of supply and demand, set interest rates. Truman felt that government had a moral obligation to protect the market value of the war bonds purchased by patriotic citizens. He talked about how in World War I he had purchased Liberty Bonds, only to see their value fall after the war.
Yet by keeping bonds pegged at ridiculously low prices during the late 1940s, and early 1950s, inflation exploded.
And that is what marked the beginning of the end, as while the Fed may have gained its independence, the US presidency, acting on behalf of the banks and populism (to keep capital losses to a minimum) made it all too clear anyone who steps out of line would be fired.
Call it a Stalinist putsch.
Actually hold on, did we say Stalin lost? Perhaps we may need to revise that. And while we got closure on that, we are still confused: is the real seed of inflation in reserves?
“Forced by the rate peg issue to make a stand on the role
of a central bank in creating inflation, Eccles expressed the nature of a
central bank in a fiat money regime. It was not private
speculation or government deficits that caused inflation, but rather
reserves and money creation by the central bank.” [The Treasury-Fed Accord: A New Narrative Account, Richmond Fed, Robert L. Hetzel and Ralph F. Leach]
Ok, now we get it.
And should we listen to the Fed or the… Fed?
Read the full absolutely must read Rchmond Fed narrative of the 1951 accord here. We can only hope someone in Congress can ask Bernanke for his take on the allegations made by the man responsible for the name of the current Fed headquarters.