Behind Rick Perry's charge that Fed chairman Ben Bernanke would be "almost treasonous" if he printed money between now and the election is a huge worry that has long plagued presidential challengers. What if the incumbent, in secret negotiation with the Federal Reserve, concocted a plan to boost the money supply and juice the economy just as voters were making up their minds?
After all, James Carville was only partially right -- it's ALWAYS the economy, stupid. The shortest road to the White House has long been on a rising economic tide. Juicing the economy through more government spending is too obvious and inconvenient, since it takes too long to push enough projects down the line to boost employment, and the opposition would never allow it. But the Fed can act very fast and can push interest rates very low. The extra-close relationship between the Fed and the Treasury since the 2008 meltdown only deepens the worry that the Fed would end up "Printing money to play politics," as Perry put it.
The possibility that the White House would try to squeeze the Fed at election time might seem outrageous -- but it's happened. At a series of meetings just before Christmas in 1970, Richard Nixon put it bluntly. According to a series of notes taken by presidential assistant John Ehrlichman that he made available to me before he died, Nixon fumed that Fed Chairman Arthur Burns was keeping the money supply far too tight. At one meeting, he told Ehrlichman and economic adviser George Shultz, "we'll take inflation if necessary," but "we can't take unemployment." At another meeting, with Ehrlichman, Shultz, and Bob Haldeman, he pointedly said, "The trend must be IMPROVING in '72."
Burns, however, had dug in. Nixon met with the Fed chairman at the White House to squeeze him on monetary policy, but Burns refused to cooperate. The Fed chairman told Nixon that interest rates were already coming down, but prices were starting to rise. If the Fed boosted the money supply further, inflation could creep up and the dollar would drop in international markets. The real problem, Burns told Nixon, was confidence -- the trust of Americans in the economy's future, and the faith of foreign investors that the dollar would hold its value.
Nixon fumed. He threatened to get tough with Burns and, in a meeting with aides, threatened, "I'll unload on him like he's never had." Unemployment soared, from 4.9 percent in 1970 to 5.9 percent in 1971. Inside the Fed, senior staffers worried that the administration was creating "in the economic policy area, a credibility gap in the public mind as great as the one confronting the previous administration over its Vietnam policy." But they worried as well about the rising jobless rate. They pushed past their concerns about signs of increasing inflation and boosted the money supply.
Even that didn't satisfy Nixon. In February 1972, during a meeting on Air Force One, the president decided to send Ehrlichman to Burns with a message that the Fed chairman was stirring up uncertainty by publicly disagreeing with the White House. The president, Ehrlichman was to tell him, expected loyalty -- and he threatened to hold Burns personally responsible if the money supply didn't fuel enough economic growth.
Burns did increase the money supply, though he and Fed officials said their decision was because of high unemployment, not White House pressure. Nixon was happy in the end. The economy grew during the campaign and the president's campaign obliterated George McGovern in November.
Fast forward 40 years. Take an unemployment rate far higher, a divided Congress that made it difficult to steer the economy with budget policy, worries about inflation bubbling in the background, and international financiers worried about the value of the dollar. Add new cynicism about the government's ability -- or even its proper role -- in steering the economy. Strip away Perry's threat to Bernanke that "we would treat him pretty ugly down in Texas," and Perry's deeper worry isn't quite so strange -- except that the Fed would never get sucked into that trap.
Even back in 1972, both in public pronouncements and in internal discussions, the Fed was careful not to play Nixon's game. Burns had been a presidential adviser before being appointed to the Fed, and Nixon thought he had an inside man with his hand on the right switch. Burns knew that his credibility would evaporate instantly if he were ever viewed as a tool of the White House. Fed board members and their professional staff circled the wagons to prevent that from happening.
The episode, however, profoundly worried Fed officials. When Paul Volcker became Fed chairman in 1979, he firmly separated himself from the White House and its political pressures. His legendary inscrutability was in part theater -- but it was also in large part a strategy to protect the Fed from the an overbearing White House, whose instincts then, as has almost always been the case, ran to too heavy a foot on the money supply pedal, at the cost of inflation that the Fed had to step in to correct.
In digging deeper, Perry is right to worry about the role of the Fed, but not for the reasons he gave. The real problem is that we're in the middle of the biggest economic battle of our lives -- by far the biggest economic crisis since the Great Depression. The budget is off the table as an economic tool. The Fed's monetary policy is all we have left, and it's cut rates so low that there aren't many shots left in its policy gun.
The two driving economic guides of the twentieth century have been pushed to the side. From the left came the argument of John Maynard Keynes, which argued that the government's budget could be used to steer the economy, pumping in stimulus when growth was weak and soaking up extra revenue when growth was strong. To this day the battle continues to rage over whether federal spending or tax cuts fueled the economic growth of the 1960s, but for more than a generation the Keynesian idea ruled: the budget was not only a tool for setting national priorities but also an instrument for steering the national economy. If it could be used, the argument went, it SHOULD be used.
History will decide whether Obama's stimulus program is the last gasp of Keynes, but one thing is for sure: there's no appetite for more stimulus spending now. From Tea Partiers to the international financial markets to the bond rating firms, getting the budget under control (read: slashing the deficit) is the inescapable imperative. The fact that the long-promised day of reckoning has arrived just as the economy is staggering is like a drunk waking up while walking a tightrope, but there's no escape from the budget-balancing imperative.
That leaves monetary policy as the only big tool left, and it frames the debate from the right. As Keynesians were making their case for using the budget to steer the economy, Milton Friedman countered with his case for free-market economics. We're best off, he argued, with a slow and steady expansion of the money supply -- and by not trying to over-steer the economy. Friedman argued that the Fed's mistakes made the Great Depression worse by keeping money too tight, and that in the decades since the Fed has too often unleashed inflation by trying to outguess the economy's direction.
With the economy in free-fall in 2008, however, Bernanke found himself armed with most of the ammo the federal government had left. Fiscal policy was hamstrung by divided-party government and by a crisis that moved faster than Congress and the budget ever could. Having spent his academic career studying the Fed and its mistakes in the Great Depression, he knew the targets to hit with the few bullets he had. Shoulder-to-shoulder with the Treasury, the Fed jumped into the crisis with aggressive action, including effectively buying insurance giant AIG. Bernanke not only used unprecedented policy steps to stave off imminent collapse. He worked more closely with the Treasury and White House than Nixon could ever have hoped.
So it's not unreasonable to worry whether the Fed might now be a bit TOO cozy with the Obama administration. But the Fed knows that if it ever were to be perceived as taking political sides, especially at this super-heated time on this super-critical issue, it would be dead. It's learned the Volcker lesson well, and will do everything possible to avoid creating even the suspicion that it's doing anything for political reasons.
Perry's jab at Bernanke might have been aimed at political motives, but it raises deeper policy puzzles. With fiscal policy off the table and monetary policy under attack, what's left? Do we think that the federal government CAN steer the economy? And, if so, SHOULD it -- and how?
The question poses three puzzles. The burden of Perry's argument is that we should cut back on government, balance the budget and step away from using monetary policy to steer the economy. But with the economy still staggering, could we really leave our hands off if there's a chance that strong monetary steps could help save us from a larger disaster? That, after all, would be bad economic policy and an unacceptable political risk.
A second puzzle is that we're relying on the Fed's management of interest rates and the money supply, but we've long since passed the point where anyone really knows where we are going or how best to get there. Interest rates are close to zero, Bernanke has pledged to keep them there into 2013, unemployment remains stubbornly high, the international economic situation is enormously unstable, and inflation threatens. If we're going to steer the economy, this is the only tool we've got. We've bet the economy on the Fed's ability to sense when to take its foot off the gas and hit the brakes, without hitting them so hard we spin into the ditch. Problems don't come much tougher than that.
But that's nothing compared with the third puzzle. To Perry's chagrin, we've put all our chips on the bet-the-Fed strategy. Congress has shown little appetite for touching the Fed's super-charged role in steering through the crisis, because its members have less taste for getting stuck with any fallout. The White House has little choice but to work closely with the Fed, because failure would bring the president political obliteration. And the Fed, precisely because of Perry's stinging threat, has to insulate itself from political pressure to maintain its ability to operate.
So we're left with the inescapable political need to steer the economy, even though there's little consensus that we even ought to try. We have no choice but to rely on monetary policy, because our budget policy has been out of control for a decade or more. In steering through monetary policy, we are relying on a central bank that's learned the painful lesson that its effectiveness depends on its political independence.
Rick Perry's question is the right one, but for the wrong reason. There's no chance that the Fed will print money to play politics. There's a certainty, however, that we'll bet our political and economic lives on an institution in which the links of accountability have broken, except for the Fed's own instincts about where the nation (and the world) ought to go.
When the dust settles after the presidential election and the current crisis, we'll face the huge challenge of deciding whether we can or should allow our elected leaders to abdicate their responsibility in managing the economy. This is the biggest issue we won't talk about in the political campaign to come.