Nixon and “Goosing the Money Supply”

I have no inside knowledge on whether Janet Yellen or Larry Summers is most likely to be given the job as the next chairman the Federal Reserve. It is not an exaggeration however to suggest, however, as many commentators have already noted, that this is probably the most important appointment that Mr Obama is likely to make in the course of his second term.  If the media reports are to be believed, the White House is pushing the claims of the imperious Mr Summers over those of Mr Bernanke’s deputy, even though the former will face the tougher ride at Senate confirmation hearings.

It would be fascinating to listen in on how the President’s discussion of the issue is being conducted. History has of course spoiled us – no, make that appalled us – by allowing us to listen in, courtesy of the Nixon tapes, on the discussions that went on in the White House about its relationship with Arthur Burns, the chairman of the Federal Reserve during the Nixon era, and the man widely blamed since for letting inflation get out of hand in the aftermath of the Vietnam war.

At the time of his nomination in 1969 Mr Burns had a secure reputation as an academic economist, but was also a longstanding Republican sympathiser who had known Mr Nixon for a number of years, and had given him advice in the run-up to the 1960 election campaign which Nixon lost, by the narrowest of margins, to Jack Kennedy.  According to Mr Nixon, Burns had called him in March 1960 to warn him that the economy was likely to dip before the election in November 1960 and “urged [him] strongly that everything possible be done to avert this development”, including “loosening up on credit and, where justifiable, by increasing spending for national security” – measures that the Eisenhower Cabinet subsequently rejected.

After Nixon had successfully nominated Mr Burns as the Federal Reserve chairman in 1969, he made a typically poor stab at humour at the welcoming ceremony in the White House, noting that while “as you all know” the Federal Reserve was independent of the White House, the President also had his own strong views on the economy, which he intended to convey to the chairman of the Fed in forceful terms. He concluded: “I respect his independence. However I hope that independently he will conclude that my views are the ones that should be followed”.

This clumsy opening, we now know from the tapes and other subsequent testimony, turned out to be anything but a joke, as over the next three years Mr Burns was subjected to a series of subtle and not so subtle attempts to cajole him into following the President’s wishes on the economy, those pressures increasing as his re-election campaign in 1972 approached.  Those steps included blocking his recommendations on new members of the Federal Reserve’s open market committee, leaking unhelpful stories to the media and threatening him that he would not be re-elected, while all the time urging him to loosen monetary policy.

On 26 July 1971, Nixon was captured on tape making a typical observation about his chances of re-election: “I’ve never seen anybody beaten on inflation in the United States. I’ve seen many people beaten on unemployment.” On another occasion, one of the senior White House staffers recalls being told to urge the Fed chairman to increase the money supply more rapidly. I said to the President, “Do you really want to do that? The only effect of that will be to leave you with a larger inflation if you do get re-elected.” And he said, “Well, we’ll worry about that after we get re-elected.”  On 19 March 1971, Nixon urged Burns “We’ve got to think of goosing it [the money supply] . . . late summer and fall of this year [1971] and next year [1972]. As you know, there’s a hell of a lag”.

Although Mr Burns and other economists of the day, including Milton Friedman, warned Mr Nixon about the risks of loosening monetary policy prematurely, in due course the Federal Reserve did just that, with disastrous consequences.  Several years later, in a paper for the Federal Reserve Bulletin, entitled The Anguish of Central Banking, Mr Burns said: “It is illusory to expect central banks to put an end to an inflation . . . that is continually driven by political forces.. . . Persistent inflation . . . will not be vanquished . . . until new currents of thought create a political environment in which the difficult adjustments required to end inflation can be undertaken”.

In the end it was left to Paul Volcker to wring inflation out of the US economy, albeit at a huge cost in terms of unemployment, which then ushered in a long period of economic advance. At least one recent academic study has sought to defend Mr Burns against some of the harshest critics, arguing that the policy measures the Fed adopted at the time were not unreasonable, given the unprecedented conditions and the state of economic understanding at the time. The blame for the hyperinflation of the 1970s cannot be laid solely at the Fed’s door.

The challenges facing the Federal Reserve today are also however, undeniably, unprecedented, albeit of a completely different nature. No central bank has ever had to steer an economy out of a financial crisis on the scale of 2008 before. None has ever presided over such an enormous programme of asset purchases as the world’s central banks currently have in place.  None has had to test in real life the limits of monetary policy in a zero interest rate environment, at a time when unemployment remains high by historical standards and outstanding debt is at unprecedented levels. The new chairman will to some extent inevitably be flying blind in this tricky environment.

In a recent issue of the New York Review of Books, Mr Volcker makes a strong case for the importance of the central bank acknowledging the limitations of monetary policy and effectively warning the central bank against the dangers of being dragged by the ambiguities of its dual mandate into going soft on inflation. Few Presidents, fortunately, have displayed such crude and obsessive political instincts as Mr Nixon –it is certainly hard to think of Mr Obama talking about “goosing the money supply” –  but we all have to hope that the next chairman of the Fed, in addition to possessing good judgment and effective communication skills, will be as sensitive to the subtler modern risks of political pressure as his or her hapless predecessor proved not to be.