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

In 1971, the US economy was already facing the dilemma of "stagflation", with the unemployment rate reaching 6.1%, the inflation rate exceeded 5.8%, and the balance of payments deficit continued to expand. In order to fight for re-election, President Nixon put unprecedented pressure on then-Federal Chairman Burns.

White House records show that in 1971, Nixon and Burns interacted significantly, especially in the third and fourth quarters of 1971, the two met 17 times a quarter, far exceeding the frequency of regular communication.

This intervention is manifested in the policy operation level: that year, the US federal funds rate plummeted from 5% at the beginning of the year to 3.5% at the end of the year, and the growth rate of M1 money supply reached a peak of 8.4% after World War II. In the year when the Bretton Woods system collapsed and the global monetary system was drastically changing, Burns's compromise on politics laid the groundwork for the later "big inflation", and it was not until after 1979 that Paul Volker's sharp interest rate hikes were resolved.

Burns also bears the infamous historical reputation. Today, Powell never wants to repeat Burns' fate.

Burns' Compromise: Political interests overwhelm price stability

In 1970, Nixon personally nominated Arthur Burns as chairman of the Federal Reserve. Burns is an economist at Columbia University and a former economic adviser to Nixon's campaign. The two have a close relationship. Nixon had high hopes for Burns - not as a gatekeeper of monetary policy, but as a "coordinator" of political strategy.

At that time, Nixon faced great pressure to fight for re-election in the 1972 election, when the U.S. economy had not yet fully recovered from the 1969 recession and high unemployment. He urgently needs a wave of economic growth, even if it is a false prosperity created by "release of water".

So he kept putting pressure on Burns, hoping that the Federal Reserve would cut interest rates and issue more currencies to stimulate growth. The internal recording of the White House recorded multiple 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, it will be the last time Washington is ruled by conservatives."

He hinted that if he failed to reelection, Burns would face a Democrat-led future and the political climate would be completely changed. In the face of Burns' attempt to delay more easing policies on the grounds that "the banking system is already very loose", Nixon directly refuted:

"The so-called liquidity problem? That's just bullshit."

"We reduced the discount rate to 4.5%," Burns reported to Nixon shortly afterwards.

Nixon responded:

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

Nixon not only put pressure on policy, but also made a clear statement on personnel arrangements. On December 24, 1971, he told White House Chief of Staff George Schultz:

"Do you think we have almost enough influence on 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 has no right to decide who the Fed Council:

"He has to figure it out, it's the same as Chief Justice Berg...I'm not going to let him name his people."

These dialogues come from White House recordings, clearly showing the systemic pressure the US president has put on the central bank chairman. Burns did "do as he did" and used a set of theories to defend his approach.

He believes that tight monetary policy and the subsequent rise in unemployment are ineffective in curbing inflation at the time, because the root cause of inflation lies in factors beyond the control of the Federal Reserve, such as unions, food and energy shortages, and OPEC's control of oil prices.

From 1971 to 1972, the Federal Reserve lowered interest rates, expanded the money supply, promoted a brief economic prosperity, and also helped Nixon achieve his re-election goal. But the cost of this "artificial" economic prosperity is soon revealed.

Bypassing the Fed's "Nixon Shock"

Although the Federal Reserve is the monetary policy executive, Burns' objection was not taken into account when Nixon announced the decision to "suspend the exchange of US dollar and gold" in August 1971. From August 13-15, 1971, Nixon convened 15 core aides to hold a closed-door meeting at Camp David, including Burns, Treasury Secretary Connery and then Deputy Secretary of International Monetary Affairs Volker.

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

Close the exchange window between the US dollar and gold, suspend the right of foreign governments to exchange dollars for gold; implement 90-day wage and price freezes to curb inflation; impose a 10% surcharge on all tax-related imported goods to protect US 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, and gold soared, and the global exchange rate system collapsed.

At first, wage price controls suppressed inflation in the short term, and in 1972, U.S. inflation was suppressed at 3.3%. But by 1973, Nixon lifted the price controls, and the consequences of large-scale circulation of US dollars and imbalance in supply and demand quickly emerged. Coupled with the first oil crisis that broke out in the same year, prices began to soar.

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

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

Powell never wants to be the next Burns

Burns' term left an average annual inflation rate of 7% and weakened the Fed's credibility. Internal Fed documents and Nixon recordings show that Burns puts short-term political demand above long-term price stability, and his term becomes the opposite of central bank independence.

A financial commentator joked:

"Burns didn't cheat, didn't kill, and wasn't even a pedophile... the only crime he committed was to cut interest rates before inflation was fully controlled."

By contrast, Burns' successor Paul Volker "strangled" inflation at an interest rate of 19%. Although it created a sharp recession, it became the hero to end inflation in Wall Street, economic history, and even the public's eyes. History has proven that Americans can forgive a Fed chairman who caused the recession, but not a chairman who ignited inflation.

Powell knew this well and never wanted to be the next Burns.