The Ghost Of Arthur Burns: Why The 1970s Fed Chair Is Still Important Today
Chair Powell achieved a lot with his Jackson Hole speech. It wasn't what investors necessarily wanted to hear but it was both sensible and accurate.
We wrote about all of that back in August
Despite the very negative market reaction, his remarks were strangely reassuring - at least for us.
The reason?
Because it means he grasps the seriousness of his (and our!) economic predicament.
The Fed Chair and his fellow Board of Governors may have made a very colossal error in 2021 (and perhaps another one by acknowledging that inflation was non transitory in November but doing nothing concrete until March!) but they seem at least conscious of the critical importance of not compounding their initial misstep.
That is critical because mistakes do happen but it how you react to them that keeps a crisis from becoming cataclysmic.
In this, they likely have one eye on the 1970s and the damage that the Federal Reserve did to its reputation and credibility during that decade.
In particular, Chair Powell may be thinking about the then Fed Chair, Arthur F. Burns and how he is remembered today.
We think that this history lesson might be worth remembering for two reasons:
The first has already been answered once: the Federal Reserve will be very careful about easing (or even simply pausing) monetary policy any time soon.
Looking forward, the real question may be what the central bank will do in a recession. And here, as we will see below, the 1970s Arthur Burns scenario might be both particularly apt and rather sobering.
Now, it is true that, generally speaking, we find a lot of the 1970s "stagflation" analogies rather unhelpful. They seem either misinformed about what actually happened in the 1970s or heavily biased towards hyperbolic and frankly very politicized statements.
This ends up looking like commentators are trying to shove a round peg in square hole for ulterior motives or that they simply don't know what they are talking about.
As a result of the above we have gone back and forth a fair about whether we should make any sort of 1970s comparison whatsoever. But we think when it comes to Burns and the recession of 74/75 a careful exception can be made.
Arthur Burns was a serious economist with a distinguished pedigree and a long track record when he took office at the Federal Reserve. Like Powell he faced high inflation part of which was caused by factors outside of his control (the OPEC-led oil shock that rapidly spread from energy to food costs) as well as a lot of political pressure by then President Nixon ahead of the 1972 election.
By 1974 Burns was confronted by double digit inflation and reacted by strongly raising interest rates. These reached 12% by mid-1974, which sliced inflation down by more than half.
But then the incoming recession caused Arthur Burns to sharply cut interest rates in early 1975 which meant that inflation stabilized at an elevated level which only deepened the problem.
The biggest mistake might have been cutting interest rates far too quickly before inflation had returned to a manageable level. Burns had assumed that prices would begin to fall as the downturn deepened and so he was safe stimulating the economy.
Ahem.
It is true that it is difficult not to feel for the former Chair. He is much maligned for following a policy that every other leader of the Federal Reserve system has also done: cutting interest rates in a severe economic downturn.
But by allowing inflation to stabilize the argument is that he then allowed inflationary spiral to become further entrenched and setting the US up for another ruinous spiral to double digit price increases at the end of the decade.
Burns' error in the recession of 1974-75 may be on Powell's mind more than investors realize at present.
We have little proof, of course, but we suspect that when Chair Powell said "History cautions against prematurely loosening policy." at Jackson Hole that he was referring directly to Arthur Burns legacy - and with a mind on his own, of course.
This suggests that growth will not just have to slow but truly have to crack for them to consider a shift in approach. The Federal Reserve may wait for inflation to truly plunge before considering stimulating the economy. That is not just sobering, it should hopefully cause you to be very cautious about trying to front run a recessionary dip in the same way that others tried to anticipate the CPI report.
Let this past week be a warning you do not forget.
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