The last time a US president put such pressure on the Federal Reserve was Nixon in 1971. Two years later, the United States entered an era of stagflation.

Original author: Ye Zhen, Wall Street News

Trump is threatening the independence of the Federal Reserve with tweets, and the last time a US president put such pressure on the Federal Reserve was in 1971, on the eve of the Great Stagflation in the United States.

In 1971, the US economy was already facing the dilemma of "stagflation", with unemployment reaching 6.1%, inflation exceeding 5.8%, and the international balance of payments deficit continuing to expand. In order to win re-election, President Nixon exerted unprecedented pressure on then-Fed Chairman Burns.

White House records show that Nixon's interactions with Burns increased significantly in 1971, especially in the third and fourth quarters of 1971, when the two had 17 formal meetings each quarter, far exceeding the frequency of normal communication.

This intervention was manifested in policy operations: that year, the US federal funds rate dropped sharply from 5% at the beginning of the year to 3.5% at the end of the year, and the M1 money supply growth rate reached a post-World War II peak of 8.4%. In the year when the Bretton Woods system collapsed and the global monetary system changed dramatically, Burns' compromise with politics laid the groundwork for the subsequent "great inflation", which was not resolved until Paul Volcker raised interest rates sharply after 1979.

Burns has thus been vilified by history. Powell today does not want to repeat Burns' fate.

Burns' compromise: political interests trump price stability

In 1970, Nixon personally nominated Arthur Burns as the chairman of the Federal Reserve. Burns was an economist at Columbia University and had been an economic adviser to Nixon during his campaign. The two had a close personal relationship. Nixon had high hopes for Burns—not as a gatekeeper of monetary policy, but as a “cooperator” of political strategy.

At that time, Nixon was under great pressure to seek re-election in the 1972 election, and the US economy had not yet fully recovered from the 1969 recession, with high unemployment. He was in urgent need of a wave of economic growth, even if it was a false prosperity created by "flooding the market with money".

As a result, he continued to put pressure on Burns, hoping that the Federal Reserve would cut interest rates and issue more money to stimulate growth. Internal recordings of the White House recorded many conversations between Nixon and Burns.

On October 10, 1971, in the Oval Office, Nixon told Burns:

"I don't want to go out of town fast...If we lose, this will be the last time conservatives govern Washington."

He hinted that if he lost reelection, Burns would face a future dominated by Democrats and a completely changed political atmosphere. Faced with Burns' attempt to delay more easing policies on the grounds that "the banking system is already loose," Nixon directly refuted:

“The so-called liquidity problem? That’s just bullshit.”

In a phone call not long after, Burns reported to Nixon: “We’ve got the discount rate down to 4.5 percent.”

Nixon responded:

"Good, good, good... You can lead'em. You always have. Just kick'em in the rump a little."

Nixon not only exerted pressure on policy, but also made clear his stance on personnel arrangements. On December 24, 1971, he told White House Chief of Staff George Shultz:

"Do you think we've had enough influence over Arthur? I mean, how much more pressure can I put on him?"

"If I have to talk to him again, I'll do it. Next time I'll just bring him in."

Nixon also stressed that Burns had no authority to decide who would serve on the Federal Reserve Board:

"He's got to figure this out, just like Chief Justice Burger ... I'm not going to let him name his people."

These conversations come from the White House recordings, which clearly show the systematic pressure exerted by the US president on the central bank chairman. And Burns did "do it" and used a set of theories to justify his actions.

He believed that tight monetary policy and the resulting rise in unemployment were ineffective in curbing the inflation of the time because the roots of inflation lay in factors beyond the Fed's control, such as labor unions, food and energy shortages, and OPEC's control of oil prices.

From 1971 to 1972, the Federal Reserve lowered interest rates and expanded the money supply, which promoted a short-term economic boom and helped Nixon achieve his re-election goal. But the cost of this "artificial" economic boom soon became apparent.

The Nixon Shock that Bypassed the Fed

Although the Federal Reserve is the executive body of monetary policy, Nixon did not take Burns' objection into account when he announced the decision to "suspend the convertibility of the dollar into gold" in August 1971. From August 13 to 15, 1971, Nixon convened 15 core staff members for a closed-door meeting at Camp David, including Burns, Secretary of the Treasury Connally, and then-Under Secretary of International Monetary Affairs Volcker.

During the meeting, although Burns initially opposed closing the dollar-gold exchange window, under Nixon's strong political will, the meeting directly bypassed the Federal Reserve's decision-making procedures and unilaterally decided:

Close the window for exchanging dollars for gold and suspend the right of foreign governments to exchange dollars for gold; implement a 90-day wage and price freeze to curb inflation; impose a 10% additional tax on all taxable imported goods to protect American products from exchange rate fluctuations.

This series of measures, known as the "Nixon Shock", broke the foundation of the Bretton Woods system established in 1944, causing gold prices to soar and the global exchange rate system to collapse.

Initially, wage and price controls suppressed inflation in the short term, and in 1972, US inflation was suppressed to 3.3%. But in 1973, Nixon lifted price controls, and the consequences of the large amount of US dollars in circulation and the imbalance between supply and demand quickly became apparent. Coupled with the first oil crisis that broke out in the same year, prices began to soar.

The U.S. economy then fell into a rare "double kill" situation. The inflation rate reached 8.8% in 1973 and reached 12.3% in 1974. The unemployment rate also continued to rise, forming a typical stagflation pattern.

At this time, Burns tried to tighten monetary policy again, but found that he had already lost his credibility. His reliance on political compromise and non-monetary measures laid the groundwork for the "Great Inflation". It was not until Paul Volcker took office after 1979 and completely "suppressed" inflation with extreme interest rate hikes that the Federal Reserve regained its independent prestige.

Powell doesn't want to be the next Burns

Burns’ tenure left inflation averaging 7% per year and undermined the Fed’s credibility. Internal Fed documents and Nixon recordings show that Burns put short-term political demands over long-term price stability, and his tenure became a textbook example of central bank independence.

A financial commentator joked:

"Burns is not a fraud, he is not a murderer, he is not even a pedophile... His only crime is cutting interest rates before inflation was fully under control."

In contrast, Burns' successor, Paul Volcker, "strangled" inflation with an interest rate of 19%, which caused a severe recession, but he became a hero in the eyes of Wall Street, economic history, and even the public for ending inflation. History has proven that Americans can forgive a Fed chairman who caused a recession, but will not forgive a chairman who ignited inflation.

Powell knows this very well and never wants to be the next Burns.