Richard Nixon, who was the President of the United States between January 1969 and August 1974, appointed Arthur C Burns as the Chairman of the Federal Reserve Bank of the United States (the American central bank) on 30 January 1970.
“I respect his (i.e. Burns) independence. However, I hope that independently he will conclude that my views are the ones that should be followed,” Nixon said on the occasion.
Burns did not disappoint Nixon and especially when it was election time in 1972. From the start of 1972, Burns ran an easy money policy and pumped more money into the financial system by simply printing it. The American money supply went up by 10.6 percent in 1972.
The idea was that with increased money in the financial system, interest rates would be low, and this would encourage consumers and businesses to borrow more. Consumers and businesses borrowing and spending more would lead to the economy doing well. And this would ensure the re-election of Nixon who was seeking a second term in 1972. That was the idea. And it worked. Nixon won the second term with some help from Burns.
As investment newsletter writer Gary Dorsch wrote in a column earlier this year, “Incumbent presidents are always hard to beat. The powers of the presidency go a long way….Nixon pressured Arthur Burns, then the Fed chairman, to expand the money supply with the aim of reducing unemployment, and boosting the economy in order to insure Nixon’s re-election…Nixon imposed wage and price controls to constrain inflation, and won the election in a landslide.” (you can read the complete column here)
History is expected to repeat itself
Something similar has been expected from the current Federal Reserve Chairman Ben Bernanke. It has been widely expected that Bernanke will unleash the third round of money printing to revive the moribund American economy. Bernanke has already carried out two rounds of money printing before this to revive the American economy. This policy has been technically referred to as quantitative easing (QE), with the two earlier rounds of it being referred to as QE-1 and QE-2.
The original idea was that with more money in the economy, banks will lend, and consumers and businesses will borrow and this, in turn, would revive the economy. But the American consumer had already borrowed too much in the run-up to the financial crisis, which started in September 2008, when the investment bank Lehman Brothers went bust. The consumer credit outstanding peaked in 2008 and stood at $2.6 trillion. The American consumer had already borrowed too much to buy homes and a lot of other stuff, and he was in no mood to borrow more.
The wealth effect
The other thing that happened because of the easy money policy of the American government was that it allowed the big institutional investors to borrow at very low interest rates and invest that money in the stock market. This pushed stock prices up, leading to more investors coming into the market.
As Maggie Mahar puts it in Bull! : A History of the Boom, 1982-1999: What drove the Breakneck Market--and What Every Investor Needs to Know About Financial Cycles: “In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vacations. Conversely, lower prices usually whet our interest: colour TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure.”
As more money enters the stock market, stock prices go up. This leads to what economists call the “wealth effect”. Stock market investors feel richer because of stock prices going up. And because they feel richer they tend to spend some of their accumulated wealth on buying goods and services. As more money is spent, businesses do well and so in turn does the economy.
As Dorsch puts it, “Historical observation reveals that the direction of the stock market has a notable influence over consumer confidence and spending levels. In particular, the top-20 percent of wealthiest Americans account for 40 percent of the spending in the US economy, so the Fed hopes that by inflating the value of the stock market, wealthier Americans would decide to spend more. It’s the Fed’s version of “trickle down” economics, otherwise known as the “wealth effect.”