In late 1971 and early 1972, a series of conversations took place between Richard Nixon and his chosen Chairman of the Federal Reserve (Fed), Arthur Burns. Nixon was terrified that his chances for re-election in November of 1972 could be dashed by unwelcome Fed interest rate tightening. The aim of these talks was to strong-arm Burns into cutting rates before the election, despite signs that the economy was beginning to overheat.
The aim of these talks was to strong-arm Burns into cutting rates before the election, despite signs that the economy was beginning to overheat.
This was by no means the first time that a president had sought to put pressure on the constitutionally independent central bank of the US. Burns’s predecessor, William McChesney Martin, was called a traitor by President Truman in 1953 for refusing to keep rates low after the inflationary pressures caused by the Korean war. During Lyndon Johnson’s presidency, the steadfast Martin was summoned to the president’s Texas ranch and was shouted at that ‘boys are dying in Vietnam and Bill Martin doesn’t care’ – all in attempts to keep rates low, keep the economy booming, and make re-election easier for the incumbent.
Not entirely surprisingly, Nixon’s bullying in 1971/72 scaled new heights: he leaked a made-up story to the press that Arthur Burns was making demands for a 50% increase in salary. This and other pressures brought by the administration saw Burns buckle. He lowered interest rates in early1972 despite his better judgement and so helped unleash a decade-long period of bruisingly high inflation. This was tamed eventually in the 80s by the extreme measures taken by the legendary inflation slayer Paul Volcker. Meanwhile back in 1972, Nixon got duly re-elected by a landslide, but the consequences of his expediency were dire indeed.
To quote just one example: the S&P 500 annual average return for the 70s was -1.4% after adjusting for inflation. To date this is the only decade bar the noughties (which contained both the dotcom burst and the global financial crisis) with a negative real return for the S&P 500 since the 1950s. The following table shows the return results for each decade:
In the aftermath of the 1970s, central banks were regarded as the main bulwark against high inflation and their power and influence grew commensurately. Today, with collective memories of inflation fading post the global financial crisis in 2008, they are under attack again.
Central banks have a history stretching back more than 300 years. Their influence has waxed and waned and their powers variously extended and curtailed depending on the prevailing political climate and economic fashion. In the modern era, the Burns episode has long been held up as a salutary lesson for the need for central bank independence. The thinking goes that politicians should not be allowed to endanger long-run financial stability for the sake of short-term political gain. This was the prime motivation for various forms of central bank independence pretty much in every nation where it was adopted after the inflation scare of the 70s. It prompted countries across the globe to separate the short-term political whims of leaders from the monetary discipline required for the stability of prices, currencies and even the financial system itself. New Zealand was the first country to adopt an explicit inflation target in its central bank brief in 1990 – a practice that was widely adopted thereafter.
The power of central bankers has thus grown steadily over the last 40 years. But the wheel of history is turning again. With memories of high inflation fading in the aftermath of the 2008 crisis (itself often blamed on the excessive power of central bankers) and populist ideas blooming, central banks are under threat all over the globe – and with it, the stability required for the proper functioning of markets everywhere.
Ominously, leaders in the US, India, Turkey, Europe and even here in South Africa have sought to undermine central bank independence.
Since last September, Donald Trump has repeatedly criticised his chosen Chairman of the Fed (Jerome Powell) for raising interest rates, and has even hinted at removing him. Never one to care much for conflicts of interest, he is clearly still both a real estate mogul as well as a president with an eye on the 2020 elections. Trump has recently nominated two poorly qualified sympathisers to the board of the Fed (one of whom has since declined).
Elsewhere, the Governor of the Reserve Bank of India resigned in December after being at loggerheads with Prime Minister Narendra Modi, who wanted looser monetary policies ahead of an election this April. Similarly, the Turkish strongman Recep Tayyip Erdoğan, prior to Turkey’s recent elections, had berated his central bank and interest rates as ‘tools of exploitation’. In the UK, Bank of England Governor Mark Carney has been criticised for his poor analysis of the Brexit crisis, while European Central Bank President Mario Draghi is vilified as ‘poisoning the atmosphere’ by the Italian populist government.
In our own back yard, the South African Reserve Bank (SARB) has historically been no stranger to political interference. Last year SARB Governor Lesetja Kganyago responded to the ANC’s attempts to substitute the bank’s private ownership with the state (and thus effectively end its independence) by saying ‘they have a fight on their hands’. More power to him.
Central banks have been around for centuries, but truly independent ones are a relatively new phenomenon. They owe their existence to the sensible wish, born from painful experience, that monetary policy should be forged without granting the political classes access to the interest rate punchbowl. In the era of populists, investors everywhere are best served when independent monetary experts stay in charge.
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