by James Rickards
When you say “Independence Day” to most Americans, they think of the Fourth of July. That’s not true for the Federal Reserve. At the Fed, “Independence Day” is the fourth of March.
Unfortunately, this may be the Fed’s last “Independence Day” for a long time!
Why the fourth of March? On March 4, 1951, the Federal Reserve reached an agreement with the U.S. Treasury that restored policy independence to the Fed after nine years of domination by the Treasury.
Beginning in April 1942, shortly after the U.S. entered World War II, the Fed agreed to cap interest rates on Treasury bonds to help finance the war effort. The cap meant that the Fed gave up its control of interest rate policy.
The cap also meant that the Fed surrendered control of its balance sheet because it would have to buy potentially unlimited amounts of Treasury debt to implement the rate cap. (Such asset purchases had inflationary potential, but in World War II, inflation was managed separately through wartime price controls.)
We are now entering a new period of fiscal domination by the Treasury.
The Fed will again have to give up control of its balance sheet and interest rate policy to save the U.S. from secular stagnation. The Fed will subordinate its policy independence to fiscal stimulus coordinated by the White House and the Treasury. The implications for you are enormous.
The history of the Treasury-Fed Accord of March 4, 1951, is revealing.
Why did Treasury not restore Fed independence in 1945 when the U.S. and its allies won the war?
After World War II, the Treasury was reluctant to give up its domination of the Fed. President Truman felt strongly that patriotic investors in U.S. bonds should not have to suffer capital losses if rates rose. The White House insisted that the wartime cap on long-term rates be maintained.
The Fed resisted this, but their resistance was soon overcome by the Korean War. This new war was used by the Treasury as an excuse to continue the rate cap.
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