Submitted by Erico Tavares of Linares & Co.
The Fed Then and Now – Remembering William McChesney Martin, Jr.
These days, central banks have become so intertwined with the economy and capital markets that every word uttered by just about any senior Federal Reserve official is endlessly scrutinized to gauge what their next step might be.
But it wasn’t always like this. There were times when the Fed actively defended the strict independence of monetary policy, as well as the role of free markets in creating prosperity and even preserving civil liberties. And those were the days of William McChesney Martin, Jr.
An Experienced Central Banker
Born in 1906, Martin was associated with the Fed from the very start. His father, a prominent banker from St. Louis, was part of the team that helped write the Federal Reserve Act and subsequently served as President of the Federal Reserve Bank of St. Louis from 1929 to 1941.
After graduating from Yale with a B.A. degree in Latin and English, Martin started his professional career at the Fed of his native St. Louis. He then left to become the head of the statistics department at A. G. Edwards & Sons, a local brokerage firm. He was promoted to partner just after two years, marking the beginning of a meteoric rise in the world of finance. He moved to New York to become the firm’s representative at the New York Stock Exchange, and eventually became the first paid President of the latter at the tender age of 31 – prompting the newspapers to label him the "boy wonder of Wall Street”.
Wall Street in the 1930s of course was “no country for old men”. Throughout the decade, Martin had witnessed firsthand the wild gyrations of the stock market, and at one point worked for the SEC to reestablish investor confidence and prevent future crashes. He also pursued graduate studies in economics at Columbia University, but did not get a degree.
In 1941, he was drafted into the US Army, supervising the disposal of raw materials on the Munitions Allocations Board and also liaising with Congress on lend-lease programs with the Soviet Union. Martin was discharged as Colonel at the end of the war, and soon after was nominated by President Harry Truman to lead the Export-Import Bank of the US. He then served as Assistant Secretary of the Treasury from 1949 to 1951.
Therefore, by the time he was about to be appointed Chairman of the Board of Governors of the Federal Reserve in March 1951, Martin was already an extremely well-rounded finance professional, pursuant to his roles on Wall Street, the US Army, sponsoring the nation’s exports and finally the US Treasury. And he was ready to make his mark.
Preserving the Fed’s Independence
While at the Treasury, Martin was part of the team which negotiated the March 1951 Treasury-Fed Accord, which gave the Fed control over monetary policy and ended its obligation to monetize the government’s debt at a fixed rate.
However, the Truman administration was keen to regain control of the Fed, and after the resignation of the then Chairman Thomas B. McCabe, they saw the perfect opportunity to step in. Once again Truman turned to Martin, a fellow Missourian Democrat, to be the next Chairman, hoping that he would play along with his plans. However, Martin fiercely resisted any attempts of government interference from the get-go. And he kept at it during the nineteen years he served at the Fed – the longest tenure of any Chairman.
In a 1955 speech he said, “Congress entrusted to the Federal Reserve System responsibility for managing the money supply. This was an historic and revolutionary step. In framing the Federal Reserve Act great care was taken to safeguard this money management from improper interference by either private or political interests. That is why we talk about the overriding importance of maintaining our independence.”
Martin had a job to do and he stuck with it. He stood up not only to the pressures from the politicians – the people who actually appointed him, but also from his former colleagues on Wall Street. At the bottom of one economic slump, he warned Congress that you can't “spend yourself prosperous”. He also remarked, “A perpetual deficit is the road to undermining any currency.” In 1965, he famously clashed with President Lyndon Johnson over the discount rate, raising it despite Johnson’s objections.
And it was Martin who coined the now iconic phrase “take away the punchbowl just as the party gets going”, as a metaphor for the Fed’s role in reigning in the animal spirits at the appropriate time.
Economic and Political Views
While staunchly defending the Fed’s independence, Martin also had some strong economic and political views of his own, after working through some very pronounced business cycles and geopolitical events. Those were the heydays of the Cold War, with each side competing for supremacy and the hearts and minds of people all over the world.
The following quotes exemplify his views, and appear to be as relevant today as they were back then:
“That experience [of substantial government intervention in the 1930s and 1940s] led to growing concern over the effect of a straitjacket of controls on the economy's productive capacity, and the price that would be exacted in terms of individual liberty if the harness of wartime economic controls were carried over into the postwar years. Such a straitjacketing of the economy is wholly inconsistent with our political institutions and our private enterprise system. The history of despotic rule, of authoritarian rule, not merely in this century but throughout the ages is acutely repugnant to us. It has taken a frightful toll in human misery and degradation.
“If businessmen, bankers, your contemporaries in the business and financial world, stay on the sidelines, concerned only with making profits, letting the Government bear all of the responsibility and the burden of guidance of the economy, we shall surely fail. I am as weary as you are of pious platitudes and after dinner preachments about leadership and financial statesmanship. But the fact is that the Government isn't something apart and remote from you. It is you – all of us.”
However, despite his strong convictions he was not a purist, acknowledging that extraordinary times might require extraordinary measures. He once said “it is true that in a great emergency we have been willing to make a departure from our market structure, but our mood has been that of the man who has to leave home for the confines of a bomb shelter. When a war comes on, we are willing to put up with all sorts of economic controls and dictation of even small details of our economic life. When peace is restored we do not continue to ignore it. We cannot substitute the judgment of a few in authority for the free and independent judgments of the community as they are expressed in the market place. We cannot do so, that is, and retain our concept of freedom in a competitive, private enterprise economy.”
Martin was not only the longest serving Chairman of the Fed; he was arguably the most effective post World War II.
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Prof. Robert Shiller, Federal Reserve.
Martin’s tenure, the economy and the stock market clocked some remarkable gains, with very little inflation and moderate credit growth. The favorable backdrop provided considerable positive momentum. The world economy was recovering from the devastation caused by the war, the baby boomers were starting to roll into the workforce, the international financial system was stable, commerce and trade were expanding, and technical progress was rampant.
Philosophically speaking, it is inconsistent to preach the virtues of the free market while seeking praise for the results it delivers. But the fact remains that the US has never seen such low inflation rates during a period of prolonged economic expansion since Martin’s days at the Fed.
The Fed Then and Now
Comparing Martin’s views with those of his successors, it becomes clear that the Fed has progressively changed its views over the years on how it should conduct monetary policy and the role it should play in economic affairs.
As Chairman, Martin was well known for his tight money policies and anti-inflation bias (see the relevant cover of Time Magazine above), while at the same time pushing for the Fed to have flexibility and discretion in its policymaking. He was able to retain the confidence of five different administrations, even when he had opposed them. His thinking was rooted around facts, emphasizing the importance of statistics over economic theory.
In contrast, his successors particularly since Alan Greenspan all have brilliant academic credentials in economics, but very little hands-on experience in real world affairs (it is insightful to compare the biographies of the heads of the Fed over time and see how much the profile has changed). Accordingly, substantial emphasis is now placed on managing expectations, models and projections, which often have been at odds with some very significant economic outcomes in recent years.
Consider the following. Martin fought against a proposed 2% inflation target, stating that “there is no validity whatsoever that any inflation, once accepted, can be confined to moderate proportions.” At a hearing, he summarized his views on how to steer policy in a free society: "We are dealing with waste and extravagance, incompetency and inefficiency, the only way we have in a free society is to take losses from time to time. This is the loss economy as well as the profit economy."
Now the Fed seems to be diametrically opposed to these views. It is openly pursuing a 2% inflation target; and its actions since the 2008 financial crisis have been specifically designed to prevent losses. After almost six years of massive liquidity injections and pitiful interest rates, we have never left the “bomb shelter”, to paraphrase Martin’s earlier quote.
These losses of course are politically unacceptable today. The government’s debt has ballooned to over 100% of GDP, with no signs of abating over the foreseeable future. When Martin left the Fed in early 1970, financial industry profits as a percentage of total stood at 15%. Today it is double that amount, meaning that out of every dollar in profits generated by Corporate America nearly 30 cents comes from finance.
Therefore, if the Fed were to take away the punchbowl, the economic and political consequences would be very severe today – in the US and abroad. As a result, the Fed can no longer be regarded as truly independent. Martin warned us of the consequences several decades ago: we will continue to deal with waste and extravagance, incompetency and inefficiency for many years to come, and an erosion of the liberties of society.
The Fed’s Legacy
After leaving the Fed, Martin served on the boards of several corporations and nonprofit organizations, including IBM, American Express and the National Geographic Society. Throughout his career he was praised for his competence and honesty. He passed away in 1998, at age 91.
For someone with his pedigree and extensive financial experience, Martin was remarkably humble and also keenly aware of the uncertainties and limitations associated with setting the course for the nation’s monetary policy.
Here’s what he told himself when he took office: ''My gracious, here I am, the new Chairman of the Fed, and I'm doing my best. I'm not the brightest fellow in the world but I'm working hard on this, and I haven't the faintest idea of how you figure the money supply. Yet everybody thinks I have it at my fingertips. They don't really know what the money supply is now, even today. I'm not trying to make fun of it but a lot of it is just almost superstition.”
It appears that such superstition will now be the Fed’s legacy.