The rhetorical battle between President Donald Trump and Federal Reserve Board Chairman Jerome Powell is nothing if not amusing. But beneath the political theater is a darker reality: the longer-term drift of America’s economics from the old world prudence of the 19th century to the silly socialism of the 21st.
The battle between democratic free markets and state socialism has deep roots stretching back more than a century to World War I, the Great Depression, and World War II.
Augustus “Gus” Hawkins of “Humphrey-Hawkins” fame was born in 1907 in Shreveport, Louisiana. The country was then going through the first significant financial calamity of the 20th century: the Knickerbocker Crisis, named after a fast-growing trust company by that name. Unlike the financial crises of the 1800s, which tended to track the ancient liquidity cycle of the farm sector, the Crisis of 1907 caused stocks and bonds to suffer.
Hawkins and his contemporaries grew up in a time of political turmoil and growing economic uncertainty. The reality of privation provided the political impetus for the creation of the Federal Reserve System less than a decade later and saw the rise of the Democratic Party as an alternative to the hegemony of the Republicans during the 1930s. The political environment in which the Federal Reserve was created helps explain how the central bank gradually came to be an engine of state socialism.
The Fed began as a mere provider of credit in the 1910s and 1920s. It changed into a more centralized economic planning agency during the 1930s under FDR and the New Deal. And with that change, it assumed an overtly political and largely liberal/socialist role in American life that belies its claims of political “independence.”
Walker Todd wrote in his classic 1995 study of the Federal Reserve Board:
It is particularly distressing, after a century of evolution of the corporatist model in American political life, to understand that an unbroken chain of doctrinal belief runs from the “classically corporatist” World War I years and early 1930s through what could only be described as a kind of “left corporatism” during the Roosevelt and Truman years, a “right corporatism” during the Eisenhower and Kennedy years, a “left corporatism” during the Johnson years, and a “right corporatism” again during the Nixon-Ford-Carter years. Only with the ascendancy of Ronald Reagan in 1981 did the rhetoric (if not the actual practices) of those who govern us shift toward the pre-1931, pre-corporatist political economy model.
The transformation of the Fed into an activist exponent of the corporate state tracks the rise of the New Deal and the related enfranchisement of the Democrats in Washington. When Gus Hawkins was first elected to Congress in 1962, he was one of only six African-American members of the House and the first from California. He represented south-central Los Angeles, including Watts. Hawkins had seen his solidly Republican parents lose everything in the Great Depression, an experience that led him and many other blacks to embrace the Democrats and FDR’s New Deal. After the elections in 1970, he helped found the Congressional Black Caucus, served as chairman of several committees, and was widely regarded as an effective insider in Washington. Hawkins described the migration of African-American voters during the 1930s away from the Republicans in a 1988 interview:
Things were shifting rapidly after several Republican administrations, and after prosperity seemed to be well established, suddenly the whole thing came to an end in 1929 with the stock market crash. I think that a lot of blacks felt it keenly, because they were thrown out of jobs.
Those who were so-called middle-class lost what they had. The banks closed up. In my particular instance, my family suffered along with the others in that my father, who had accumulated substantial wealth in real estate and transportation in the Deep South and brought it to Los Angeles, overnight lost what he had. He represented one of those who was a dyed-in-the-wool Republican, was a very devout Hooverite.
Suddenly he was faced with a loss of what had been accumulated. This, I think, was widespread throughout the black community. It was a matter of survival. In the early days of the thirties, 1930 and ’31, and before Roosevelt became president, bread lines developed.
Hawkins had many accomplishments during his four decades in the House, but he is best known as the co-author of the Humphrey-Hawkins legislation that provided the explicit economic policy goals for the Federal Reserve Board and the Federal Open Market Committee (FOMC). Co-authored by Senator Hubert Humphrey, the legislation sought to address the economic stagnation and inflation of the 1970s.
With the end of the Second World War, the political debate in the U.S. focused on jobs and other benefits for the returning troops. Republicans were interested only in promoting an economic recovery in the private sector, while Democrats sought a government guarantee of jobs for all. The Employment Act of 1946 sought “to foster and promote free and competitive enterprise and the general welfare, conditions under which there will be afforded useful employment for those able, willing, and seeking work, and to promote maximum employment, production, and purchasing power.” But Republicans rejected an explicit job guarantee.
When Congress passed the Humphrey-Hawkins legislation three decades later, it again tackled the issue of jobs by giving the Fed a “dual mandate” of full employment and price stability, two policy objectives that are clearly at odds. Combined with the neo-Keynesian framework of using ever lower interest rates to stimulate growth, the Humphrey-Hawkins legislation gradually forced the FOMC to embrace inflation to ensure full employment, but with less and less efficacy and little real thought about price stability. Indeed, as market volatility has grown since 2008 due to the Fed’s radical actions, price discovery has suffered or even disappeared entirely.
Today, Fed policy as designed by progressives like Hubert Humphrey and Gus Hawkins ensures lower consumer purchasing power through inflation and gradually robs public and private institutions of even a meager return on their savings. The focus of the FOMC is entirely on consumption rather than investment and long-term growth. The Humphrey-Hawkins law neither helps employment nor encourages long-term investment that might bolster the key ingredient of economic expansion, namely higher productivity on labor and capital.
“The unintended consequences of public policies are usually more consequential than the ones the policy makers had banked on,” notes Jim Grant in Barron’s. “Lest the central bankers forget, interest rates are prices, not policy levers. And as prices, they set investment hurdle rates and measure credit risk.” (Grant goes on to liken the FOMC to both arsonist and fireman.) But whereas former Fed chairman Paul Volcker explicitly made fighting inflation the priority of the U.S. central bank, his successors have instead focused on boosting nominal employment, even as real wages adjusted for inflation steadily decline.
“Stable money is the only proper foundation for capitalism,” notes Judy Shelton, U.S. executive director of the European Bank for Reconstruction and Development, in a Wall Street Journal interview. “When you start to use money as a tool of government, for regulating the economy, then that’s at the expense of what money is meant to be—which is a reliable measure of dependable stored value.”
Shelton, who was nominated by President Trump to be a possible member of the Federal Reserve Board, could not be more different than the current members of the FOMC. She adds: “Money should not reward wealthy investors, who can borrow vast sums on margin, at the expense of ordinary savers who earn next to nothing on their bank accounts. Monetary favoritism is demoralizing.”
In order to meet the requirements of the “dual mandate,” the FOMC is compelled to take more and more radical actions, including the ultimate madness of negative interest rates. Indeed, Fed officials are the leading intellectual authors of using negative interest rates as a form a “stimulus,” the modern day equivalent of the medieval practice of bloodletting. Current Fed policies artificially inflate asset prices, deprive investors of a fair return on savings and investments, and increase market volatility, all in the name of pursuing the utopian goal of full employment.
When President Trump suggests that Powell and the other FOMC members don’t understand the economy or interest rates or the impact of their own policies on the markets, he is more right than he knows. Yet the FOMC’s hands are literally tied so long as the dual mandate remains the law of the land. That means the boom and bust cycle of pursuing full employment while paying lip service to price stability will continue so long as politicians see monetary policy as a panacea for job creation, a fool’s errand that will only lead America to economic malaise and social turmoil.
Christopher Whalen is an investment banker and chairman of Whalen Global Advisors LLC. He is the author of three books, including Ford Men: From Inspiration to Enterprise (2017) and Inflated: How Money and Debt Built the American Dream (2010). He edits The Institutional Risk Analyst, and appears regularly on such media outlets as CNBC, Bloomberg, Fox News, and Business News Network. Follow him on Twitter @rcwhalen.