In the first days of December 1950, Thomas McCabe picked up the telephone at his home and found the President of the United States on the line.
McCabe ran the Federal Reserve. Harry Truman had put him there himself two years earlier, and now Truman had an instruction for him: keep interest rates at 2.5%.
Since 1942 the Fed had held the yield on long-term Treasury bonds at a low 2.5% by buying every bond the market wouldn’t take at that price, and printing the money to do it.
That had financed World War II, but never went away after. Inflation had hit nearly 20% in 1947, and by the end of 1950 it was climbing again, heading back toward 9%.
The problem was, there was a new war in Korea and just weeks earlier 300,000 Chinese soldiers surged into it against the US.
The US, already deeply in debt from WWII, needed to borrow more, but lenders were not willing to lend at such low rates.
Truman had bought Liberty Bonds himself in the First World War and watched them lose value after it. He didn’t want the same thing to happen to those patriotic Americans who helped finance WWII.
But unless he could convince the Federal Reserve to keep buying at 2.5%, new higher-yield bonds would make those old bonds collapse in value.
The pressure campaign didn’t end with that phone call. Truman wrote a letter to McCabe saying that if the bottom dropped out of government bonds, that would be exactly what America’s adversaries wanted.
Then on January 17 Truman and his Treasury Secretary, John Snyder, sat him down at the White House and asked for a public promise to hold the peg.
McCabe wouldn’t commit. He tried to explain to the President that printing the money needed to defend those low rates was causing inflation.
Regardless, the next day Snyder gave a speech announcing that Chairman McCabe had agreed to keep financing the government at 2.5%.
McCabe didn’t publicly contradict the White House. Instead, on January 29 the Fed let the price of the long bond slip by one thirty-second of a point. Tiny, but Wall Street understood the message… and so did Snyder, who went straight to Truman and asked him to summon the entire Federal Open Market Committee to the White House.
No President had ever done that. But on January 31, the committee that sets interest rates found itself in the White House, being stared down by the guy who dropped the atomic bomb on two cities.
He told the Fed committee this was “the greatest [emergency] this country has ever faced, including the two World Wars”… and that if people lost faith in government bonds, everything the war effort hoped to gain “might be jeopardized.”
They refused to agree. Yet the next morning the White House press secretary announced that the Fed had “pledged its support to President Truman to maintain the stability of Government securities as long as the emergency lasts.”
It was the second lie in two weeks. The Fed had answered the first one quietly. This time, someone went to the newspapers.
Marriner Eccles, a Fed governor Truman had demoted from chairman three years earlier, told the New York Times the Fed had promised nothing. Truman hit back by releasing a letter claiming he had McCabe’s “assurance.” So Eccles leaked the Fed’s own written record of the meeting, and on February 4 the Times headline read “Truman Is Disputed by Reserve Board.”
For two weeks the pressure came from every direction: senators warning McCabe off, a congressman threatening hearings, big banks refusing to back the Fed. Then Snyder went into the hospital for eye surgery, and the Fed made its move. On February 19 it told the Treasury to make a deal, or it would stop buying bonds at 2.5% whether the Treasury liked it or not.
With Snyder in the hospital, the job of answering that ultimatum fell to his assistant secretary, William McChesney Martin. Martin and the Fed worked out a compromise within two weeks, and on March 4 the two sides announced they had reached “full accord.” The Fed would no longer be forced to buy bonds at 2.5%. The peg was dead.
Truman had one move left. He forced McCabe out, and on April 2 installed Martin, the Treasury’s own man, as chairman of the Fed. Wall Street figured the Fed had won the battle and lost the war.
Instead, Martin ran the Fed for the next 19 years and kept it independent the entire time. Years later, Truman passed him on a New York street, looked at him, said “traitor,” and kept walking.
That’s the story economists tell about how the Fed won its independence.
They leave out that, at the time, the government could afford to lose.
Debt had peaked at 106% of GDP in 1946, and by 1950 it was under 80%. The budget was running surpluses. The Treasury could pay its interest with or without the Fed’s printing press.
Today, the national debt is 126% of GDP and growing and nearly 20% of every tax dollar collected already goes to interest on that debt.
This time, the government cannot afford for the Fed to win.
The way out is the same one it has always been: print the money needed to buy the bonds to keep interest rates low.
Which is exactly why real assets are having the moment they’re having.
You can print money. You can’t print oil, industrial metals, or gold.
– Peter Schiff & James Hickman
Written by Karl Bagga – Chief Investment Strategist
The Kevin Warsh era as head of the Federal Reserve officially started on May 22nd. He came to the position with a frankly unenviable task. When Jerome Powell took the helm in early 2018, US debt was already at $20 trillion, yet by the time Warsh took over just 8 years later that figure had…
