"In April 1942, after the entry of the United States into World War II, the
Fed publicly committed itself to maintaining an interest rate of 3/8 percent
on Treasury bills. In practice, it also established an upper limit to the term
structure of interest rates on government debt. The ceiling for long-term
government bonds was 2 1/2 percent......since its meeting on June 13, 1950, the FOMC had chafed
at the straitjacket imposed by the rigid regime of rate pegging......."
truman
"[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 prospect of a prolonged war created the likelihood of government
deficits and the issuance of newgovernment debt. Additional debtwould force
down the price of debt unless the Fed monetized it. That is, to prevent yields
from rising above the 2 1/2 percent rate peg, the Fed would have to buy debt
and increase bank reserves. Banks would then fuel an inflationary expansion
through increases in credit and the money supply"2.
The
threat of a major, protracted war created the real possibility that the bond rate
would rise to its 2 1/2 percent ceiling. Life insurance companies, which held
the bonds, then had an incentive to sell them immediately to avoid a capital
loss as bond prices declined.
12 The Fed did not want to monetize an avalanche
of bond sales. For that reason, it wanted to eliminate the above-par price on
the bonds. The Treasury, in contrast, saw the problem as one of the Fed’s own
creation. If the Fed would only publicly commit to maintaining indefinitely
the current price of bonds, it believed, bond holders would no longer have an
incentive to sell.
New York Times
: “[L]ast Thursday constituted the first occasion in history on which the head of the
Exchequer of a great nation had either the effrontery or the ineptitude, or both,
to deliver a public address in which he has so far usurped the function of the
central bank as to tell the country what kind of monetary policy it was going
to be subjected to.”
Truman had compelling reasons to freeze interest rates. On January 25,
1951, he froze wages and prices, apart from farm prices. Raising the cost of
borrowing, especially on home mortgages, while freezingwageswas poison.
14
More important, in January 1951 Truman confronted the possibility of world
war. Treasury communication with the Fed referred to a possible Soviet attack
on the United States “within the foreseeable future” (FOMC Minutes, 3/1/51,
p. 119). Truman and Snyder wanted to keep down the cost of financing the
deficits that would emerge from a wider war
Truman and the leadership in Congress believed that deficit financing
had caused the World War II inflation (Goodwin and Herren 1975, p. 70;
Donovan 1982, p. 325). At the urging of the Administration, Congress raised
taxes sharply in September 1950 with the Revenue Act of 1950 and again in
January 1951 with an excess profits tax (Goodwin and Herren 1976, p. 71).
However, if the war widened to include China and possibly the Soviet Union,
there would be government deficits
eccles january 51
"As long as the Federal Reserve is required to buy government securities
at the will of the market for the purpose of defending a fixed pattern of
interest rates established by the Treasury, it must stand ready to create
new bank reserves in unlimited amount. This policy makes the entire
banking system, through the action of the Federal Reserve System, an
engine of inflation. (U.S. Congress 1951, p. 158)"
--------------------------------------------------------------
exchange congressman patman / eccles
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
-------------------------------------
more eccles
"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"---------------------------
ny fed president and major mephisto sproul
"[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. "
"the FOMC’s 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). The letter expressed hope for
an agreement with the Treasury, but ended by saying that if such agreement
were not possible “[W]e will have no defensible alternative but to do what, in
our considered judgment, is for the best interests of the country, in accordance
with our statutory responsibilities” (FOMC Minutes, 2/14/51, p. 89)."
The Fed then forced resolution of the dispute. It informed theTreasury that
as of February 19, it “was no longer willing to maintain the existing situation
in the Government security market” (U.S. Treasury 1951, p. 266). Sproul
(1952, p. 522) recounted that the Fed informed the Treasury that “unless there
was someone at the Treasury who could work out a prompt and definitive
agreement with us. . . we would have to take unilateral action.” At the time,
the Treasury faced a sizable need to refund existing debt. For the first time,
it also faced the prospect of issuing new debt. To quiet uncertainty in themarkets, the Treasury believed it had no choice but to end the public dispute
On the morning of February 26, McCabe and Sproul attended a meeting
in the White House with the President and other government policymakers.
(Snyder remained in the hospital.) Truman read a memorandum stating that
“Changing the interest rate is only one of several methods to be considered for
curbing credit expansion.” He then asked the Fed chairman and other policymakers
“to study ways and means to provide the necessary restraint on private
credit expansion and at the same time to make it possible to maintain stability
in the market for government securities” (FOMC Minutes, 2/26/51, p. 102).
As an alternative to a rise in interest rates, Truman asked for selective credit
controls (“direct Government controls”) to limit credit extension (FOMC Minutes,
2/26/51, p. 102). When Chairman McCabe “commented on the situation
created by the continued purchase by the System of. . . bonds,” Treasury Under
Secretary Foley countered “that the proposed action by the Federal Open
Market Committee might cause a crisis which should be avoided.” While the
meeting was underway, the White House released the contents of the President’s
memorandum to the press.
The Treasury maintained the position that direct controls on credit were
preferable to increases in interest rates (FOMC Minutes, 3/1/51, p. 117). However,
the Treasury also believed that an end to the dispute with the Fed would
restore market confidence and allow it to continue to sell bonds at 2 1/2 percent
(FOMC Minutes, 3/3/51, p. 153). Moreover, as became apparent later,
the Treasury still had another weapon to use.
When Snyder went into the hospital, he left negotiations with the Fed
in the hands of the Assistant Secretary of the Treasury, William McChesney
Martin.
22 Martin notified the Fed that he desired negotiations based on the
FOMC’s February 7 letter. He reestablished staff contact between theTreasury
and the Fed, which Snyder, as Leach recalls, had forbidden some years earlier.
William McChesney Martin and Fed staff members Robert Rouse, Woodlief
Thomas, and especially Winfield Riefler, negotiated an agreement between
the Treasury and the Fed (FOMC Minutes, 2/26/51, p. 93; FOMC Minutes,
3/1/51, pp. 112–13).
As presented to the FOMC on March 1, the resulting agreement reflected
Riefler’s original ideas. The Fed would keep the discount rate at 1 3/4 percent
through the end of 1951. The Treasury would remove marketable bonds
from the market by exchanging them for a nonmarketable bond yielding 2 3/4
22
Martin had exceptional qualifications. In 1938, at age 31, he became president of the
New York Stock Exchange. Newspapers called him the “boy wonder of Wall Street.” After the
Army drafted him in World War II, he helped run the Russian lend-lease program. In 1946, he
became head of the Export-Import Bank. In December 1948, Treasury Secretary Snyder, a fellow
Missourian, convinced Martin to join the Treasury. Finally, Martin’s father had been Governor of
the Federal Reserve Bank of Saint Louis.
R. L. Hetzel and R. F. Leach: New Narrative Account 51
percent.
23 To make those bonds liquid and thus more attractive to the market,
the Treasurywould exchange them upon request for a 1 1/2 percent marketable
five-year note. During the exchange, the Fed would support the price of the
five-year notes. That support was central because the value of the nonmarketable
bonds depended upon the price of the five-year note. However, the
Fed made no commitment to support the note’s price beyond purchases of
$200 million.
On March 1, Martin presented the compromise to the FOMC. The minutes
make clear that he displayed the charm for which he is legendary. He began by
saying, “Iwant to say for the Treasury people we could not have had pleasanter
or more frank or more open discussions” (FOMC Minutes, 3/1/51, p. 118).
The main sticking point for theFOMCwas whether theTreasury had accepted,
during the bond exchange, a limitation both on the duration and dollar amount
of its intervention in support of the five-year note (FOMC Minutes, 3/1/51,
p. 136). Also, theFOMCwanted to make sure that its commitment to maintain
“orderly markets” did not imply a rate peg.
The FOMC met again on March 3, 1951. Chairman McCabe said that
Mr. Murphy, Special Counsel to the President, had inquired on behalf of
President Truman whether long-term bonds would drop below par. McCabe
had replied to Murphy that he could not say. During the meeting, Riefler
received a telephone call from Martin informing him that Secretary Snyder,
who was still in the hospital, had accepted limitations on Fed support during
the exchange of the marketable for the nonmarketable bonds. However, Martin
requested that there be no written record of that point (FOMC Minutes, 3/3/51,
p. 158).
The FOMC then voted to ratify the Accord and to issue the following
statement the next day: “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” (FOMC Minutes, 3/3/51, pp. 156, 163).
The FOMC then voted to ratify the Accord and to issue the following
statement the next day: “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” (FOMC Minutes, 3/3/51, pp. 156, 163).
The Administration had one more hope that it would prevail.
24 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. On March 15,
23
About $40 billion in 2 1/2 percent bonds were outstanding (U.S. Treasury, 1950 Annual
Report,
Table 17).
24
Donovan (1982, p. 328) wrote, “Truman forced McCabe out as chairman of the Board of
Governors.” This paragraph summarizes Donovan (1982, p. 331).
52 Federal Reserve Bank of Richmond Economic Quarterly
the President appointedWilliam McChesney Martin to replace McCabe. The
Senate confirmed Martin on March 21. McCabe left office on March 31, and
Martin took office April 2.
Leach recalls that the initial reaction both among Board staff and onWall
Street to Martin’s appointment was that the Fed had won the battle but lost the
war. That is, the Fed had broken free from the Treasury, but then the Treasury
had recaptured it by installing its own man. However, as FOMC Chairman,
Martin supported Fed independence. Some years later, Martin happened to
encounter Harry Truman on a street in NewYork City. Truman stared at him,
said one word, “traitor,” and then continued.
25 Leon Keyserling (1971, p. 11),
chairman of the Council of Economic Advisers from 1950 through 1952, said
later: “[Truman] was as strong as any President had ever been in recognizing
the evils of tight money.. . . He sent Martin over to the Treasury to replace
McCabe. Martin promptly double-crossed him.”
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.
The Treasury’s offering of the new 2 3/4 percent nonmarketable notes in
exchange for the 2 1/2 percent marketable issues took place from March 26
through April 6. During this period, as provided for in the Accord, the Fed
purchased the five-year notes as needed to support their price. However, the
Fed spent the entire amount agreed to in the first three days. “[D]ismayed
Treasury officials asked for continued support. The request was refused, and
there was nothing more the Treasury could do about the matter” (Hyman
1976, p. 351). The Fed just said “No.” Thereafter, the Fed bought only small
amounts of the bonds to prevent “disorderly conditions in the market.” Their
price went from around 100 3/4 before the Accord to around 97 in the last
half of the year “when the bond market was on its own” (Board
1951 Annual
Report,
p. 5).
Under its new leadership, the FOMC had issued its ultimate challenge to
the White House. Why did Truman finally walk away from the conflict? For
Truman to triumph over the Fed, he would have had to prevail in Congress;
however, his precarious political position in early April 1951 made that impossible.
Truman’s political popularity had plummeted in part because of scandal.
Earlier that year, Senator Fulbright (D. Arkansas) had released a report
25
Telephone interview, Robert Mayo, April 10, 1998.
R. L. Hetzel and R. F. Leach: New Narrative Account 53
accusing two directors of the Reconstruction Finance Corporation (RFC), one
a politically well-connected Democrat, of favoritism (Donovan 1982, p. 333).
More important, shortly after the conclusion of the Accord, a much more
serious and long-simmering crisis boiled over: the tension between President
Truman and General Douglas MacArthur. MacArthur had opposed Truman’s
policy of limited war, saying that it amounted to “surrender.” Truman had
made the decision to seek peace in Korea through its partition at the 38th
parallel rather than to engage China in a wider war, which he feared would
involve the Soviet Union and atomic weapons. On February 13, MacArthur
called Truman’s policy “unrealistic and illusory.”
26
On March 24, MacArthur claimed that he could defeat China if only
Washington would stop restricting him militarily. He even offered “to confer
in the field with the commander-in-chief of the enemy forces.” His statements
sabotaged secret negotiations to settle the war. Representative Joseph (Joe)
Martin (R. Mass.) advocated the use of Chiang Kai-shek’s forces in Formosa
to open a second front against China. MacArthur supported Martin in a letter,
which included the phrase “There is no substitute for victory” (Donovan
1982, p. 352). On April 5, Martin read MacArthur’s letter in the House of
Representatives.
On April 10, four days after the end of the bond exchange, Truman fired
MacArthur. Truman biographer Robert Donovan (1982, p. 358) wrote that
Truman “knew well enough that he would awake in a political climate raised
to a pitch of hatred and recrimination so severe that it could not fail to stain the
remainder of his term in office. Of all the storms he lived through as President,
the one about to break was the worst.” To aggravate Truman’s problems,
MacArthur learned from the radio that Truman had fired him. The
Chicago
Tribune
wrote in a front page editorial: “Truman must be impeached and
convicted.. . . [H]e is unfit, morally and mentally, for his high office” (Donovan
1982, p. 359).
Subsequent events gave the Fed time to incubate its fragile independence.
Inflation abated sharply. CPI inflation averaged just over 3 percent from
1951Q2 through 1951Q4 and just less than 1.5 percent in 1952. Also, Dwight
D. Eisenhower, Truman’s successor and President from 1953 through 1960,
and his Treasury secretaries shared the Fed’s goal of price stability (Saulnier
1991).
3. CONCLUDING COMMENT
The March 1951 Accord marked the start of the modern Federal Reserve
System. Under Chairman Martin, the Fed’s overriding goals became price
stability and macroeconomic stability.
26
This paragraph and the next are from Donovan (1982, pp. 349–51).
54
The Administration had one more hope that it would prevail.
24 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. On March 15,
Sproul
About $40 billion in 2 1/2 percent bonds were outstanding (U.S. Treasury, 1950 Annual
eccles
martin
"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."
---------------------------------------------------------------------------------------------------------------------
"Some years later, Martin happened to
encounter Harry Truman on a street in NewYork City. Truman stared at him,
said one word, “traitor,” and then continued.
25 Leon Keyserling (1971, p. 11),
chairman of the Council of Economic Advisers from 1950 through 1952, said
later: “[Truman] was as strong as any President had ever been in recognizing
the evils of tight money.. . . He sent Martin over to the Treasury to replace
McCabe. Martin promptly double-crossed him.”
