This story appears in the December 30, 2018 issue of Forbes. Subscribe
THE FEDERAL RESERVE backed off its plans for aggressive interest rate hikes next year after President Donald Trump relentlessly and personally bashed chairman Jerome Powell--a recent Trump appointee, no less.
The Federal Reserve and its defenders stress the importance of its independence from outside interference. Otherwise, they maintain, election-worried Washington politicians and special interests would distort decision-making, which would end up doing real economic harm.
Our central bank has done a remarkable job over the years creating an aura that those who attack it are either ignoramuses or cranks outside the boundaries of respectable and responsible opinion. This achievement comes in the face of several major blunders, most notably the terrible inflation of the 1970s and early 1980s, and the lead-up to the crisis of 2008–09.
Nonetheless, the reality is that if the executive branch pushes hard, the Fed backs off. It is not a fourth branch of government enshrined in the Constitution but a creature of Congress. Moreover, by law it is the Treasury department, not our central bank, that sets policy on the dollar.
The Fed's actual but hidden weakness has been a fact of life since its inception in 1913. During WWI, President Woodrow Wilson's Treasury chief made it clear that interest rates were to be kept low, and they were. The same was true during WWII. After the war President Harry Truman insisted that the low-rate policy continue. He was wrong, but only after several years and two guillotined Fed heads later did rates go up. In the 1960s President Lyndon Johnson put fierce pressure on our central bank to keep rates low. The Fed buckled, and the dollar weakened. President Richard Nixon appointed a chairman with whom he spoke behind the scenes to run the printing presses to help his reelection, actions that ultimately destroyed the gold-based Bretton Woods monetary system. The George W. Bush Treasury department wanted--and got--a weakening of the dollar, which played the pivotal role in the housing debacle and subsequent recession.
The basic problem isn't the Fed's independence, but a true understanding that money is a measure of value and that it works best, as Alexander Hamilton well understood, when its value is fixed to gold. Such a fixed value no more restricts the growth of the economy than the 12 inches in a foot restricts the size of a building.
