During his nearly 20 years as Chairman of the Fed, Martin helped to establish the institution's independence and to keep inflation relatively low, despite numerous pressures to follow a different course
By John H. Wood
A chance meeting on a tennis court in 1965 forged a relationship between former Fed Chairman William McChesney Martin, Jr., and Robert Bremner. Thirty years later when Bremner realized that his friend's remarkable career was "going into the dustbin of history," he decided to work on Martin's biography. The result is Chairman of the Fed: William McChesney Martin, Jr., and the Creation of the Modern American Financial System.
"Martin's career tells us a lot about the evolution of the U.S. financial system," notes Bremner, a former investment banker and management consultant who currently serves as a public trustee for a large mutual fund management company. "More importantly, Martin's personal qualities of integrity, determination, independence, and humility have much to teach today's readers about real leadership in trying times."
The Research Department at the Federal Reserve Bank of Richmond invited Bremner to discuss what he learned about Martin at a lecture on March 29, 2005. An edited version of his remarks follows, including links to related information on our web site. The views expressed are Bremner's and are not necessarily those of the Richmond Fed or the Federal Reserve System.
The Making of the Accord, and a New Chairman
As of this date, William McChesney Martin, Jr., is still the longest-serving chairman of the Federal Reserve System and the man who, in the 1950s and 1960s, created Alan Greenspan's job. The subtitle of my book is "The Creation of the Modern American Financial System" and Martin did this by reforming the New York Stock Exchange and overhauling the Federal Reserve System, two of the fundamental pillars of the U.S. financial system. These two institutions still reflect the qualities that he implanted in them.
Some of you may be familiar with some of the highpoints of Bill Martin's 19 years at the Fed, but his public career actually began 14 years earlier when he was elected president of the New York Stock Exchange at the age of 31. I'll cover those important early years, but I want to start by taking you back to 1950, when the Fed had been fighting bitterly and publicly with the Treasury for over four years in order to terminate a system of controls over interest rates, called the peg, established during World War II.
The Fed wanted to return to rates determined by the marketplace in order to restore its ability to influence credit conditions and to deal with the inflation that was infecting the post-war economy. President Harry Truman and Treasury Secretary John Snyder were absolutely opposed to any increase in rates. Marriner Eccles had lost his Fed chairmanship over the dispute and his successor, Tom McCabe, was on his way to losing his.
By early 1951, the struggle had escalated into a highly public crisis involving emergency meetings in the White House, leaked memoranda, and collapsed negotiations. One of Snyder's closest advisors at this time was Assistant Treasury Secretary Bill Martin. Martin persuaded Snyder to allow him to carry out "technical discussions" with a Fed team led by Winfield Riefler. While Snyder and McCabe continued to battle in public, their two assistants quietly negotiated a series of mutual undertakings, called the Treasury-Fed Accord, to resolve the situation.
The genius of the Accord was that it described the Fed's primary responsibility — controlling credit — as equal in importance to the Treasury's primary responsibility — financing the government. When these responsibilities came into conflict, the Accord committed both parties, as equals, to negotiate compromise solutions.
Neither Truman nor Snyder believed that the Fed was equal to the Treasury nor did they believe the Accord would work. They grudgingly went along with it because their preferred solution — a cumbersome interagency board of appeals — was rejected by both organizations. It was a typical Bill Martin solution: Men of good will would sit together to negotiate their differences in the light of the public interest.
The Accord was completed and Fed Chairman McCabe resigned. John Snyder proposed his assistant, Bill Martin, as the successor and Truman, highly uncertain about Martin's allegiance but willing to give another Missourian the benefit of the doubt, agreed. So Bill Martin, age 45, with no commercial or central banking experience, was to run the Fed under the terms of an agreement that was controversial, not supported by the Truman administration, purposely vague, and based on completely unproven assumptions.
Now I want you to envision the Fed that Martin inherited in March 1951:
It would be an understatement to say that the Fed had been marginalized by these developments.
What Martin Brought to the Conference Table
I've told you that Martin had no prior experience as a central banker. However, he had an unusual amount of useful experience that would enable him to rebuild the Fed from top to bottom.
First, Martin had a remarkably strong set of personal values. He came from a close and deeply religious family. Hard work and living by the rules were part of his early life. When his teenage sons began to argue at the dinner table, Martin's father required that they disagree by beginning, "Sir, I perceive you are in error" and laying out their argument logically to their parents. If one son was particularly desperate, he could resort to, "Sir, I perceive you are in gross error." Martin, who had a very strong temper as a youth, learned to pursue self-control early in life.
Second, Martin was steeped in the traditions of the Fed. His father was the founding chairman of the Federal Reserve Bank of St. Louis in 1914. He served as a living model for courageously opposing vested interests and building support for the Federal Reserve System during its difficult early years.
Third, Martin really understood financial markets and the difficulty of regulating them. He spent eight years on the floor of the NYSE during the free-wheeling years of the market manipulators of the late '20s and early '30s.
Martin was elected NYSE president when he was only 31. His election was part of a reform movement that took over the Exchange following the conviction of Richard Whitney, the leader of the anti-reform "Old Guard," for embezzlement.
Once in office, Martin was squeezed between New Deal reformer and SEC Chairman William Douglas (a passionate reformer very much like New York Attorney General Eliot Spitzer) and the Old Guard who still controlled his membership. Martin negotiated a compromise reform program that Douglas reluctantly accepted. Despite depending on a weak coalition of moderates and reformers, and in the face of dedicated resistance by the Old Guard, Martin eventually implemented his reform program.
Fourth, Martin had already overhauled one federal agency. He was appointed president of the U.S. Export-Import Bank, the government's export financing agency, in 1946. The government wanted to use the agency as a piggy bank to fund the post-war recovery of its political friends, like the corrupt Nationalist Chinese government of Chaing Kai Chek. (To stop that loan, 42 year-old Martin had to face down General of the Army George C. Marshall, no mean feat!)
Martin undertook a new approach at the Export-Import Bank. He pursued the agency's legislative mandate for creditworthy lending and created a business-like financing institution that made loans that would be paid back. Defending his policies against the Treasury and State departments took him into the White House, where Martin succeeded in persuading President Truman to go along with him.
Fifth, Martin arrived with a well-developed philosophy for regulating the financial markets. He believed that regulators must understand the business and economic realities of the markets and exercise great care in setting rules that could undermine the functioning of free market forces.
Also, he believed that innovation is the lifeblood of the financial markets and that regulation must embrace it and evolve with it. Therefore, regulatory rules must be as clear as possible, deal with the difficult issues, and be rigorously enforced. Technology should be used to monitor the markets. Finally, he believed that legislation is not effective in regulating the financial markets on a continuing basis; only capable and flexible regulatory institutions are.
How Martin Created the Modern Fed, Part I
Now the question is: What steps did Martin take to create the Modern Fed? Two of his most significant moves were to democratize the monetary policy making process and to strengthen the Treasury bond market by restricting the Fed's intervention in it.
Martin described his approach to democratizing the FOMC in typical fashion: "I knew I wasn't the smartest kid on the block, but here I was, so I just had a 'go round' where everyone expressed their opinion and I just summed things up." Through the years Martin became a master at summing up some very heated differences with the deceptive introduction, "I believe we're all basically in agreement here," and then picking and choosing among the various comments to reach his desired conclusion.
The Fed's staff was continually amazed that individual board members accepted Martin's summation despite their strong differences. As former FOMC secretary and Fed Governor Bob Holland describes it, it was "because they trusted Bill and knew he wanted to do the right thing." Martin's ability to generate trust by his honesty and forthrightness, coupled with the absence of a personal agenda and his unfailing good humor, won over opponents throughout his career.
To strengthen the Treasury bond market, Martin persuaded the FOMC that its frequent interventions in the market "drove investors to the sidelines" because they feared losses if they misjudged the Fed's moves. Martin decided that the FOMC would no longer intervene proactively to relieve stress in the market — "preserving orderly conditions" — but would adopt a more reactive and restrictive mandate of "correcting disorderly conditions." Martin wanted a more freely functioning bond market that was less dependent on the actions of the Fed and more able to accommodate market forces through the actions of investors and market makers. Further, he restricted open market operations to the more liquid Treasury bill market (enshrined as the "Bills Only" policy).
Martin's moves brought him into sharp conflict with Allan Sproul, the best known and most skilled central banker in the country. Sproul was the star of the Fed's traditional meritocracy system, occupying the historic leadership role of the New York Fed and ably defending the Fed before Congress during debates over interest rate controls. He believed that monetary policy should be made in New York City, near the financial markets and far from political interference in Washington. He also believed in continued Fed intervention in the bond market and had practiced it for a decade. In short, Sproul actively opposed all of Martin's early initiatives.
Martin and Sproul overlapped for five years and the two debated continuously about many fundamental aspects of the way the Fed should be run. Even though their disagreements were often heated, they remained civil to one another and, to his great credit, Sproul did not engage in divisive politicking for his positions. Over the years, Sproul's resistance to so many of Martin's initiatives — particularly the democratizing of the FOMC's decisionmaking — cost him his support on the Committee.
On his retirement, Sproul wryly observed about Martin: "Bill was very easy to agree with and very difficult to disagree with." Martin's comment about Sproul was less charitable: "No one at the Fed should be indispensable." Bill Martin could be very resolute in the pursuit of his goals.
How Martin Created the Modern Fed, Part II
Martin's leadership experience and free market instincts led him to his early policy decisions, but he was not an economist and had no experience in monetary policy formulation. Fortunately, he inherited an unusually talented trio of staff economists who provided him with the theoretical framework he needed to be effective: Ralph Young, Woody Thomas, and Winfield Riefler, an extraordinary economist who had a broad grasp of policy issues and understood political realities. As Bob Holland says, "In the realm of monetary policy, it was hard to tell where Win Riefler left off and Bill Martin began."
With their help, Martin introduced two new monetary policy priorities: (1) assigning the Fed's highest priority to fighting inflation and (2) establishing a fully flexible monetary policy under the title of "leaning against the winds of inflation or deflation, whichever way they are blowing."
Martin believed that stable prices promoted long-term economic growth and that early control of inflationary pressures limited the buildup of an economic boom and the bust that inevitably follows. (His own grandfather's grain storage business had been bankrupted by the financial crisis of 1893.) He also used the pioneering research on inflationary expectations organized by Ralph Young to further justify early action against inflation. Prior to Martin's arrival, the Fed's commitment to fighting inflation had waxed and waned, but Martin made price stability his primary goal throughout his chairmanship.
Martin moved in other areas. He believed that the Fed was too secretive. His first step as NYSE president had been to re-build investor trust by using personal interviews with the press to get out the positive story of reform. To persuade the Fed toward more openness, he referred continually to a 1923 Fed statement that monetary policy was easier to implement when the public understood the policy's goals.
Martin wanted the financial markets to understand the Fed's intentions. He believed in modest, incremental monetary policy changes that were well telegraphed. He encouraged Fed leaders (usually Allan Sproul) to explain the Fed's position to the financial community, but he carefully monitored what was being said and took much of the communication role on himself. As we all know, Alan Greenspan continued this practice.
Martin tried to keep Congress informed, but this was no easier in the 1950s than it is today. U.S. Representative Wright Patman, a die-hard financial populist from rural Texas, held a series of influential financial committee chairmanships. He was a fierce Fed critic and had a special passion for criticizing Martin, calling him "the most expensive public servant in history."
Throughout Martin's term, Patman resolutely pursued a set of potentially debilitating changes to the Fed's legislation, forcing the Fed into continual lobbying to neutralize his efforts. Martin was committed to appearing personally to defend the Fed at congressional hearings. In a typical response, Martin would admit, "Monetary policy decisions are a matter of judgment. We can always do better."
To get congressmen to understand the Fed's position, Martin used folksy images to get his messages across. He became famous for his description of the Fed: "It's our job to take the punch bowl away just as the party really gets going."
Martin was also committed to reestablishing a strong regional Reserve Bank system, spending approximately one-third of his time on system issues. The Fed's original legislation awarded considerable independent power to the Reserve Banks, but the Banking Act of 1935 and Eccles' dominating personality had centralized many important functions in Washington and in the office of the chairman.
Martin led the FOMC by consensus decisionmaking, thereby giving the Reserve Bank presidents who held five of the 12 positions on the Committee more influence on monetary policy. In addition, he took a strong interest in selecting capable candidates for Reserve Bank presidents and board members. Finally, he encouraged the banks to expand their capacity for economic research. Many of the leading economists in the private and public sectors got their initial experience at one of the Reserve Banks. I believe that is still true today.
A More Independent Fed Under Martin; Butting Heads with Presidents
Martin and Allan Sproul used a congressional hearing in 1952 to define a conceptual framework for the Fed's independence. Working with Illinois Senator Paul Douglas, they defined the Fed as a creature of Congress and developed a potential ally in the event of a crisis with the executive branch. Sproul used the immortal phrase, "The independence of the Federal Reserve does not mean independence from the government, but independence within the government."
In a memorable response to a question about how the Fed and the Treasury would work together, Martin observed, "We will sit around a table and hammer it out. Solutions require some experimentation, some probing, some accommodation of views. Constructive public policy in the financial field is something that can only come from long, tortuous, persistent, humble study." This statement is a perfect description of Martin's view of policymaking in the public interest.
Most importantly, Martin revitalized the concept of the Fed's independence by his actions over his long chairmanship. First, he had to live into the Accord's concept of the Fed and the Treasury as equals. His crucial judgment that the bond market would respond positively to the end of the Fed-Treasury struggle and that interest rates would not increase significantly proved correct. This success moderated the antagonism of Harry Truman and John Snyder to the Accord and allowed the Fed to complete the return to market-based rates.
Moderating their antagonism did not mean eliminating it, however. Martin loved to tell a story about Truman's feelings by describing a chance encounter with the President near the end of his term on Park Avenue in New York. Martin's greeting of "Good to see you, Mr. President" was met by a one-word response: "Traitor."
But independence cannot be achieved without taking a stand for that principle. An early example occurred with Treasury Secretary George Humphrey in 1956 in the heat of a re-election campaign.
Humphrey, a blunt former CEO and the most powerful member of the Eisenhower cabinet, told Martin that the administration wanted lower interest rates to stimulate the economy. If Martin intended to continue leading the Fed in opposition to the will of the president, he should resign. Martin, who had worked for four years to establish a solid working relationship with Eisenhower, could only hope that his effort had been effective. He replied, "If I am violently opposed by the administration, I will resign."
Again, Martin's judgment was proven correct. Eisenhower supported Martin and Humphrey backed off.
From that point on, Martin was always confident that, despite strong differences of opinion, he could maintain an effective working relationship with the President and his administration. Throughout the remaining 13 years of his term, he never used the threat of resignation when he was disagreeing with a President.
At other times, Martin exercised the Fed's independence in ways that were more tactful and persistent than confrontational, as he did with President John Kennedy. Kennedy had won the election in 1960 in part by criticizing the Eisenhower administration and the Fed for "stop and go" economic policies. It was well known that Kennedy did not approve of the Fed's policies under Martin. For his part, Martin was deeply concerned about the administration's commitment to faster economic growth without any apparent regard to its inflationary implications.
After a rocky start that included a very public spat, Martin found he could not only work with Kennedy but could also disagree with him. Nevertheless, when his four-year chairmanship term was up in early 1963, Martin still expected to be replaced. Kennedy surprised him by asking him to stay on by saying, "I know you don't always agree with what we're doing, and my people don't always like what you're doing. But in our dealings, I've found you to be independent-minded and willing to speak up for your position. There are too few of such people, and they are what a President needs above all."
Finally, there are times when independence must be exercised in a confrontational setting. Bill Martin and President Lyndon Johnson engaged in a four-year struggle over the Johnson administration's failure to deal with growing government deficits and the buildup of inflationary pressures.
Part of that struggle involved a well-telegraphed decision to raise the discount rate in December 1965, the first increase in almost five years. It was taken in the face of enormous administration opposition. Martin warned the board before the vote that "There is the question of whether the Federal Reserve is to be run by the administration in office." He also reminded them that their decision could result in an "important revamping of the Federal Reserve System" by the President and his congressional allies.
In a classic confrontation with Johnson after the vote, Martin defined his move using a carefully circumscribed view of the Fed's independence. Fortunately for Martin, Johnson had often used this separation of powers argument when he was Senate majority leader to defy an administration, so he recognized the truth of Martin's position.
Another of Martin's major contributions was to solidify the Fed's reputation for non-partisan competence and to personify its commitment to working with the executive branch in the nation's interest. He was the first Fed chairman to be reappointed by presidents from both parties.
Martin regularly acknowledged that the President had the responsibility for setting the nation's economic goals and for implementing them through budgetary spending and other fiscal policies. He felt the Fed should cooperate with those priorities, unless it concluded that they jeopardized the prospects for stable prices and long-term economic growth. For example, the Fed's cooperation with the Treasury Department led to the restoration of market-based interest rates during the Truman Administration. Similarly, its cooperation with the Eisenhower administration ended the inflation that had infected the U.S. economy off and on since the end of World War II.
When it came to the Kennedy administration, the first one to pursue an activist economic agenda, Martin took a remarkably flexible approach to cooperation. He modified monetary policy practices that he had initiated a decade earlier in order to accommodate the administration's desire to "twist" the interest rate curve by keeping short-term rates relatively high (for balance of payments purposes) and long-term rates relatively low (to encourage economic growth).
In the end, however, the Fed did not move to the extent that the Kennedy administration wanted. On the other hand, the Fed did accommodate its monetary policy in light of the reality that the administration's fiscal policies were producing strong, steady growth with low inflation. As the expansion continued well beyond the length of previous post-war cycles, the Fed resisted its normal practice of slowing the economy down. Instead, it maintained a posture of "watchful waiting."
When the Johnson administration chose to ignore a rapidly overheating economy and rising inflationary pressures, Martin abandoned his posture of cooperation. The credit tightening initiated in late 1965, despite the administration's opposition, crushed homebuilding and threatened to liquidate the savings and loan industry before the FOMC decided that it had to ease up.
One of Martin's strongest beliefs was that monetary policy had inherent limitations and that it was most effective when working in concert with fiscal policy. Martin pleaded with the Johnson administration for a tax increase to complement monetary policy, but the administration stonewalled him. So, Martin took his case to the public. He believed that it was the Fed Chairman's job to speak out on the principles of the nation's financial and fiscal responsibilities, whether they involved individual Americans or the administration, and whether or not they wanted to hear it.
Martin recognized that these public lectures often made him sound like Cassandra and he occasionally lampooned himself with statements like, "There's old Martin complaining again, he's always doing that." But he never gave up.
His public campaign included a step that violated one of Martin's cardinal principles: never using the press to advance a cause. Martin had good political contacts and knew that Vietnam War spending was rising sharply, even though Johnson and Robert McNamara were keeping it secret. In May 1967, Martin leaked the extent of the buildup in order to focus the need for a tax increase to finance the war.
The uproar caused by the leaked information helped convert Treasury Secretary Henry Fowler to support the tax increase. Working with Martin, the two finally persuaded Johnson and Congress to agree. Unfortunately, it took until June 1968 before the increase was passed. In the interim, inflationary pressures grew considerably stronger. In the end, neither monetary policy nor the tax increase were sufficient to slow down the economy.
The Great Inflation and Martin's Legacy
This raises the question, "Why wasn't Martin, who devoted himself to fighting inflation, more effective in dealing with what became known as the 'Great Inflation' of the 1970s?" There are a number of reasons that help to answer that question.
One was that most of the economists at the Fed and on the FOMC at that time were influenced by the Keynesian school of thought, which accepted that a certain amount of inflation was the price of sustained economic growth. They further believed that sufficient spending power would be taken out of the economy by the 1968 tax increase to cool the economy and lower inflationary pressures. Martin was skeptical of this conclusion, but he could not sustain a sufficiently strong majority on the FOMC for further tightening.
Another reason was that the general population had little experience with inflation, so Martin's lonely anti-inflationary campaign did not generate a groundswell of public support. Finally, he just ran out of time. Martin's non-renewable 14-year term on the board ended in January 1970 and Nixon's choice for his successor, Arthur Burns, had made it clear that he would not sustain the Fed's credit restraint.
However, the Great Inflation was not Bill Martin's true legacy. The modern Fed is. It resides in the Fed's unequalled reputation and its relationship with its sister agencies, the Congress, foreign central banks and, of course, the President. It resides in a strong marketplace for U.S. Treasury securities, through which the government finances its deficits and the Fed influences credit conditions. It resides in 12 Reserve Banks that enjoy solid local support among industry and banks in their districts. It resides with the Fed's history of pragmatic policymaking that balances the eternal tension between price stability and economic growth. It resides in a regulatory philosophy that balances the virtues of free markets, competition, and innovation with the protection of the public interest. It resides in a reputation for nonpartisanship, competence, and a commitment to the public interest enjoyed by the Fed and personified by its Chairman.
That is Bill Martin's remarkable legacy and why I am so delighted to tell you about his life story.