The US Federal Reserve That Went Head-to-Head with the President... Why It Clings to Independence [Seungseop Song's Financial Light]

Former President Trump Challenges Central Bank Independence
Federal Reserve Grew by Gaining Independence from Treasury
'The President Lied'... Open Rebuttal Not Ruled Out

Former President Donald Trump, the Republican presidential candidate in the United States

"I believe the president should at least have a voice there (at the U.S. Federal Reserve). I have made a lot of money and have been very successful. Considering many cases, I think I have better instincts than the Fed people or the chairman."

These were the words of former U.S. President Donald Trump during a press conference held on the 8th (local time) at his Mar-a-Lago residence in Palm Beach, Florida. He criticized the Federal Reserve, the U.S. central bank, for making many mistakes and said that the current chairman, Jerome Powell, is not making proper interest rate decisions. He also argued that the U.S. president should participate in interest rate decisions. Trump's remarks sparked significant controversy as they were seen as a statement that he would break the long-standing independence of the central bank if he became president.

The Early Federal Reserve Borrowing Treasury Department Buildings

The independence of the central bank is a very sensitive and important issue in the United States. The U.S. Federal Reserve is institutionally guaranteed independence. The Fed's monetary policy is officially free from government intervention. The same applies to interest rate decisions. The terms of Federal Reserve Board members are 14 years, and they cannot be dismissed even if they refuse orders or decisions from the president or Congress. They do not need approval from the president or the executive branch, nor do they receive funding from Congress.

A meeting of the Federal Reserve Board held in early 1914 at the U.S. Treasury Department building. At that time, the Federal Reserve Chairman was Charles Sumner Hamlin (front row, far right), but the seat of the chairman was occupied by William Gibbs McAdoo (far left), who was the Secretary of the Treasury. Photo by the U.S. Federal Reserve System

The central bank was not always like this. The current Federal Reserve was established on December 23, 1913, under the Federal Reserve Act. At that time, the central bank was not an independent institution. The board included the Secretary of the Treasury and a 'Monetary Auditor' from the executive branch. The meetings were chaired by the Secretary of the Treasury, and the offices and meeting rooms were rented from the Treasury Department building.

Concerns about the independence of the central bank persisted. This was due to worries that the benchmark interest rate could be influenced by politicians. Politicians tend to prioritize winning the next election. They are easily tempted to keep interest rates low to gain votes from the public. Low interest rates stimulate the economy and increase popularity. If politicians interfere with interest rates, there is a risk that appropriate measures may not be taken when inflation is high and interest rate hikes are necessary.

The independence of the central bank was established after the 1929 Great Depression in the U.S. The central bank needed to make decisions but waited for instructions from the Secretary of the Treasury and did nothing. Feeling the adverse effects, then-President Franklin D. Roosevelt began reforming the Fed system. Through reforms, the Federal Open Market Committee (FOMC), which we know well today, was created in 1935. This laid the foundation for the FOMC to independently decide interest rates. Officials like the Secretary of the Treasury, who used to participate in meetings, were excluded from the interest rate decision-making body.

The Korean War, a Spark for Treasury-Fed Conflict

Thomas McCabe, Federal Reserve Chairman

Although the system was established, politicians still tried to intervene in the central bank. Eventually, an incident occurred in 1950. The trigger was the Korean War. Then-President Harry Truman wanted to finance the Korean War costs through U.S. government bonds. To cover war expenses, the price of U.S. government bonds needed to be high. Bond prices vary according to the benchmark interest rate; the higher the interest rate, the lower the bond value. Therefore, the Truman administration thought the Federal Reserve should not lower interest rates.

However, the central bank thought differently. Thomas McCabe, the 8th chairman of the Fed at the time, judged that interest rates should be raised. Inflation was severe due to increased government spending caused by the war. He was concerned that if interest rates were not raised, prices could soar in the future.

When the central bank showed no intention to cooperate, President Truman summoned FOMC members to the White House. In the meeting, Truman proposed to Chairman McCabe not to raise interest rates to maintain bond prices. Of course, Chairman McCabe refused Truman's request. Nevertheless, the White House did not back down. After the meeting, the White House unilaterally issued a statement saying that after discussions with FOMC members, they decided to maintain bond prices. This was a false announcement.

The Fed judged that the independence of the central bank was severely damaged and, to correct the facts, released all confidential meeting minutes to The New York Times. They exposed that the claim of not raising interest rates to maintain bond prices was untrue. The top central bank official directly accused the president of lying.

Letter sent by Thomas McCabe, Chairman of the Federal Reserve, to President Harry Truman on February 7, 1951. Photo by Federal Reserve Bank of St. Louis.

Article from The New York Times covering the agreement between the U.S. Department of the Treasury and the Federal Reserve System.

As the situation escalated, the Treasury Department and the Fed moved to resolve it. The Fed chairman even wrote a letter directly to the president. On March 4, 1951, an agreement was reached. The core was to respect the independence of each party, and the Fed would officially be free from government intervention. This allowed the Fed to freely conduct monetary policy and interest rate decisions. Although the official U.S. Independence Day is July 4, Fed officials reportedly consider March 4 as their independence day.

Independence is the Fed's Pride... "Thanks to It, We Are Protected from Politics"

Based on the Fed's independence, central bank chairmen have made tough decisions. Paul Volcker, who took office in 1979, implemented ultra-high interest rate policies to control inflation despite numerous criticisms and pressures. Within three years, interest rates soared to 19.29%, and unemployment surged from 6% to 10%. He had to carry a pistol due to personal threats but is credited with curbing chronic inflation.

On November 2, 2017 (local time), then-President Donald Trump (right) introduced Jerome Powell as the new nominee for Chairman of the Federal Reserve at the White House in Washington, DC, USA. Photo by Reuters Yonhap News

Current Fed Chairman Jerome Powell is no different. Former President Trump nominated Powell as chairman in November 2017 during his term. Powell then declared he would return the nearly decade-long accommodative monetary policy to normal levels. Trump, who wanted the economy to recover, began harshly criticizing the person he nominated. He even threatened to remove Powell. Nevertheless, Chairman Powell ignored this and raised interest rates four times within a year.

Of course, not all central bank chiefs were so steadfast. Some Fed chairmen succumbed to presidential pressure. Arthur Burns is considered the worst Fed chairman. Taking office in January 1970, Burns was known for being swayed by then-President Richard Nixon. Following Nixon's wish for economic recovery, Burns ignored signs of inflation and lowered interest rates from 8% to 3%. This decision later caused severe damage to the U.S. economy during the oil shock.

Arthur Burns, Chairman of the Federal Reserve

Because of this history, U.S. Fed officials strongly feel pride and necessity for the independence of the central bank. Chairman Powell's remarks at a symposium hosted by the Swedish central bank in January last year clearly show how much he values the independence of the central bank.

"The independence of monetary policy is an institutional device that is both beneficial and important to the public. We should not engage in matters unrelated to the goals of maximum employment and price stability but focus solely on achieving these goals. In this regard, the independence of monetary policy protects the Fed's decisions from various political considerations. (Omitted) To stabilize high inflation, unpopular short-term measures such as raising interest rates to slow the economy may be necessary. Without direct political control, the Fed can take necessary actions without considering political factors."

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