"Our purpose is to lean against the winds of deflation or inflation, whichever way they are blowing." -William McChesney Martin Jr., Chairman, Board of Governors of the Federal Reserve System

During his tenure as Chairman of the Fed from 1951 through 1970, William McChesney Martin Jr. saw the transition from America at war, with the government controlling much of the economy, to a peace time economy where wider financial ebbs and flows were possible.  His experience in confronting both inflation and deflation during his term is instructive today.

The carefully managed, low-interest rate policy which the Fed maintained during WWII ended under Martin’s predecessors, Mariner Eccles and Thomas McCabe.  These two Fed Chairmen defied President Harry Truman and raised interest rates to forestall inflation.  Even when the Chinese Red Army attacked American military forces in Korea, the Fed under Chairman McCabe stood its ground and eventually won its independence from the Treasury in 1951.

Martin was picked by Truman to replace McCabe and thereby bring the Fed to heel.  Instead Martin proved to be an independent man who helped make the central bank independent as well.  Martin, for example, defied President Lyndon Johnson and raised interest rates in the 1960s.  See Robert Bremmer’s 2004 book, “Chairman of the Fed: William McChesney Martin Jr., and the Creation of the Modern American Financial System.”

But Martin recognized that the Fed ultimately could not prevent Congress from funding spending with debt and thereby fueling inflation, Alan Meltzer wrote in his classic “A History of the Federal Reserve.” That judgment has been proven correct in today’s market volatility, which is driven by the excessive accumulation of both public and private debt.  But withdrawing liquidity from solvent borrowers risks a repeat of the Bear Stearns and Lehman Brothers failures.