The Treasury-Fed Accord: How the Fed Won Its Independence, 1951

On the afternoon of 31 January 1951 the entire Federal Open Market Committee filed into the Cabinet Room of the White House. Presidents summon the chairman of the Federal Reserve; they do not summon the Committee. Harry Truman had called in all nineteen men because what he wanted was not a favour from Thomas McCabe, the Scott Paper executive he had installed as chairman of the Board of Governors in 1948, but a commitment from the institution, and he wanted witnesses to it.

Truman talked about Korea, about the Soviet Union, and then about Liberty bonds. He had bought them as an artillery captain in the First World War, and after the armistice he had watched them trade below par, which he regarded as a swindle worked on men who had been asked to lend their savings to their country. He did not propose to preside over a second one. Government securities, he told the Committee, would be maintained at par.

Nobody in the room agreed to anything. Minutes taken by the Fed's own secretary record no commitment on rates or on prices, only a presidential monologue and a good deal of polite silence. On 1 February the White House issued a statement announcing that the Committee had "pledged its support to President Truman to maintain the stability of Government securities as long as the emergency lasts." Truman sent McCabe a letter of thanks for the pledge the same day, and the Fed's press office found itself holding a document that said the opposite of what its own minutes said.

Five weeks later the central bank of the United States stopped taking orders from its Treasury.

The Pattern of Rates

Wartime finance had made the arrangement. In April 1942, four months after Pearl Harbor, the Federal Reserve agreed at the Treasury's request to hold the yield on 90-day Treasury bills at three-eighths of one per cent and to stand ready to buy any bill offered to it at that price. Around that anchor grew what everyone in the market called the pattern of rates: seven-eighths of a per cent on certificates of indebtedness of nine to twelve months, a graduated scale through the notes, and a ceiling of two and a half per cent on the longest bonds.

What the pattern did was convert every Treasury security into something close to cash. A bank holding a bill knew it could sell to the Fed at a known price on any business day, which made the bill a reserve asset with a coupon, and made refusing to buy the next auction irrational. Gross federal debt rose from roughly $49 billion in 1941 to $269 billion in 1946 and the government never once failed to sell an issue. Financing the largest war in history at an average cost under two per cent was, by the standard the Treasury applied, a complete success.

Cost fell on the other side of the Fed's balance sheet. System holdings of government securities went from about $2.25 billion at the end of 1941 to roughly $24.3 billion at the end of 1945, every dollar of it created. An institution that has promised to buy a security at a fixed price has surrendered control of its own liabilities to whoever chooses how many of those securities to issue. Marriner Eccles, chairman of the Board from 1934 until Truman declined to reappoint him in 1948, put the point in a phrase that followed him for the rest of his life: under the peg the Federal Reserve was "an engine of inflation."

Wartime price controls hid the engine's output. Rationing, the Office of Price Administration and a shortage of anything to buy meant that the money created between 1942 and 1945 accumulated in deposits and war bonds rather than in prices. Consumer prices rose 2.3 per cent in 1945. The stock of purchasing power sitting behind that number was the problem the next five years would be spent arguing about.

Decontrol

Controls came off through 1946, and the deferred inflation arrived in a rush. Consumer prices rose 8.3 per cent that year and 14.4 per cent in 1947; between June 1946 and June 1947 the increase was 17.6 per cent, and between June 1947 and June 1948 a further 9.5 per cent. A central bank with an inflation problem raises rates. This one had promised not to.

Some ground was recovered by negotiation. In July 1947 the Treasury let the Fed abandon the three-eighths peg on bills, and the bill rate drifted up towards one per cent by December; the certificate rate was allowed to rise in steps through 1947 and 1948. Congress temporarily restored the Board's authority to raise reserve requirements in August 1948, and it was used at once. Each of these was a concession on the short end. The two and a half per cent ceiling on long bonds — the number Truman cared about, because it was the number that determined whether a war bond bought by a schoolteacher traded at par — did not move.

Then the 1949 recession arrived, prices fell 1.2 per cent over the year, and the argument went quiet for eighteen months. John Snyder, Truman's Treasury Secretary and his poker companion from Missouri, spent that interval treating the ceiling as settled policy rather than as a wartime expedient. A Joint Committee subcommittee chaired by Senator Paul Douglas of Illinois — an economist before he was a senator, and a Marine before he was either — took testimony through 1949 and reported in January 1950 that monetary policy belonged to the Federal Reserve and that the Treasury's convenience was not a monetary objective. Snyder's department disagreed in writing. Nothing changed.

Korea

North Korean forces crossed the 38th parallel on 25 June 1950, and American households, having learned what wars did to prices, began buying. Consumer prices rose about eight per cent between June 1950 and February 1951. Bank credit expanded sharply. Every forecast the Fed's staff produced said the same thing, which was that the peg plus a war would reproduce 1946 and 1947 at a higher level of federal spending.

On 18 August 1950 the FOMC voted to let short rates rise and the Board announced an increase in the discount rate from 1.5 to 1.75 per cent, effective the 23rd. Snyder's Treasury announced on the same day that the September and October refundings would be done with a thirteen-month note carrying a coupon of 1.25 per cent — a rate the market would not pay. Nobody in Washington could pretend the collision was accidental. Having also pledged to maintain orderly conditions in the government securities market, the Fed then had to buy the unsold portion of the Treasury's own issue, which meant that its first act of independence was to create several billion dollars of the reserves it had just voted to restrain.

Snyder went into hospital for cataract surgery that winter and left the negotiation to his assistant secretary for monetary affairs, a former president of the New York Stock Exchange named William McChesney Martin Jr. It was the single most consequential delegation of the episode.

The Leak

Four days after the Cabinet Room meeting, the Fed's account of what had actually been said reached the press. Eccles, who had stayed on as an ordinary governor after losing the chairmanship and had nothing left to lose, gave the Committee's memorandum of the meeting to reporters. The New York Times printed the full text on 4 February 1951 under the headline "Truman Is Disputed by Reserve Board."

Presidents are not usually contradicted in a newspaper by an agency of their own government using that agency's minutes. The effect inside the Fed was to make retreat impossible: the Committee could no longer quietly accept the White House characterisation without confirming that its own record was false. On 19 February McCabe wrote to Snyder informing him that the Federal Reserve would no longer support the two and a half per cent rate on the long bond. Support was withdrawn in practice over the following days as the Committee let the price of the 2.5 per cent bonds of 1967–72 slip below par.

Congress was watching, and its sympathies were not with the Treasury. Senator Douglas and others made clear that legislation to confirm the Fed's authority was available if the administration forced the question. Hetzel and Leach, working from the Richmond Fed's archive half a century later, concluded that this congressional backing was the decisive factor: the Fed did not defeat the Treasury so much as demonstrate that the Treasury could not win in the open (Hetzel and Leach, 2001).

Four Sentences on 4 March

Terms were settled by Martin for the Treasury and by Winfield Riefler, Woodlief Thomas and Robert Rouse for the Fed, over about ten days. On Sunday 4 March 1951 the two institutions issued a joint statement of a single paragraph:

"The Treasury and the Federal Reserve System have reached full accord with respect to debt management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government's requirements and, at the same time, to minimize monetization of the public debt."

That is the whole of it. There is no schedule, no rate, no mechanism, and the word independence does not appear. Its force lay in the last five words, because minimising monetisation of the public debt is precisely what a pegged bond price prevents.

Operationally the Accord had two parts. Holders of the 2.5 per cent marketable bonds callable in 1967 were offered an exchange into a new non-marketable 2.75 per cent investment bond of 1975–80, convertible into marketable five-year notes. Roughly $13.6 billion of the old bonds were tendered, including $5.6 billion from Treasury trust accounts and the System Open Market Account itself. The Fed, for its part, agreed to support the exchange while the books were open and to unwind its holdings gradually thereafter. When the conversion closed on 6 April 1951, fixed support for the long bond ended, and the yield on long-term governments was set by whoever wanted to own them.

The Bill

McCabe had been the administration's man and was now the man who had broken with it. He resigned effective 31 March 1951. Truman replaced him with Martin — the Treasury official who had negotiated the Accord, and therefore, as far as Snyder was concerned, a reliable appointment.

Martin took office on 2 April 1951 and stayed for eighteen years and ten months, serving five presidents. He adopted in March 1953 the doctrine that open market operations would be confined to Treasury bills, on the reasoning that a central bank that traded the long end would drift back into pricing it. He described the job in October 1955 to the Investment Bankers Association in a sentence that has outlived every policy he made: the Federal Reserve "is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up." Years later Truman is said to have passed Martin on a New York street, called him a traitor, and walked on.

Consequences showed up in the bond market quickly. Long-term government yields, held at 2.5 per cent for nine years, rose through 1952 and 1953; the Treasury's 3.25 per cent bond of 1978–83, issued in April 1953 and the first genuinely long-dated offering since the war, met a market that repriced the entire curve around it and forced the new regime's first liquidity intervention that June. Prices behaved. Inflation ran at 7.9 per cent in 1951, then 1.9 per cent in 1952 and below one per cent in each of the two following years.

Whether the Accord caused that disinflation is harder to establish than the folklore suggests. Korean-war buying had largely exhausted itself by mid-1951, and Eichengreen and Garber argued that the public's expectations of price stability, formed over decades of a gold standard and never fully dislodged, were doing much of the work throughout the period (Eichengreen and Garber, 1991). Meltzer's reading of the archive is closer to the conventional one, that the Fed after 1951 could finally respond to inflation and did (Meltzer, 2003).

What is not in dispute is the institutional change. Before March 1951 the Federal Reserve set the price of money subject to the Treasury's financing needs; after it, the Treasury financed itself at whatever price the Federal Reserve's policy produced. Every later episode in which a central bank fixed a bond yield has been argued in the vocabulary the Accord established — the Bank of Japan's purchases under zero rates and quantitative easing, the Bank of England's emergency gilt buying during the 2022 pension-hedge crisis, and the Federal Reserve's own conduct under Paul Volcker, whose campaign described in the Volcker shock of 1979–1982 would have been unavailable to an institution still answering to a debt manager.

The institution that won in 1951 had been designed in 1913 by men who assumed it would never face the question, an assumption examined in the founding of the Federal Reserve. Its independence is statutory in almost no respect. It rests on a paragraph of sixty-one words, published on a Sunday, that two agencies of the same government wrote because neither could afford to keep arguing in public.