Volcker

by William L. Silber

  The president weighed the exchange and issued a ruling, like the judge and jury he was. He sealed the fate of events to come by appointing Connally “the lead man” in making a recommendation about dealing with the crisis, with instructions that Connally “consult with Paul McCracken, Arthur Burns, George Shultz … and your own experts.”68

  Volcker smiled.

  Paul created a briefing book about the size of a New York City telephone directory, detailing all aspects of the New Economic Policy.69 He divided the black loose-leaf binder into two parts. Section A contained an extensive set of bogus plans in case subversives (such as a Washington Post reporter) managed to procure a copy. Section C contained the real plans and was divided into twelve tabs, starting with “Suspension” and extending through “Balance of Payments Controls.” Volcker had purposely omitted a section B, as another confusing diversion should the plans fall into enemy hands.

  Connally had supplemented Volcker’s recommendations on gold convertibility and the wage-price freeze with a proposal for a 10 percent import surcharge. Volcker had warned that the surcharge could spark a protectionist war with U.S. trading partners, but Connally insisted—precisely because it would disturb the Germans and Japanese, forcing them to bargain in good faith.

  On August 2, 1971, John Connally used the briefing book’s details and his considerable personal charm to convince Richard Nixon to act.70 The 4 percent drop in the dollar against the German mark since the Bundesbank allowed the rate to float in May, and the spike in gold to over forty-two dollars an ounce, had brought matters to a head. But the president wanted to wait until Congress returned after Labor Day before implementing the plan. He had heard about the risks of suspension from Federal Reserve chairman Arthur Burns, and worried that closing the gold window “could cause a panic.”71

  Nixon told Connally to bring Paul McCracken and George Shultz up to speed, but to warn them both about leaks. “And that means tell Shultz that he cannot talk with Milton Friedman.”72 Shultz had been relaying to the president Friedman’s arguments for floating exchange rates.

  Volcker liked the presidential embargo on discussions with Friedman but worried about the delay. “I did not want us to wind up implementing the package out of desperation.”73 On Thursday morning, August 12, after reports from Frankfurt, London, Tokyo, and Milan that speculation had pushed the German mark to its highest level against the dollar in more than twenty years, forcing massive intervention by all the world’s central banks, Volcker turned desperate.74 He telephoned Connally at his Texas ranch, where the treasury secretary had gone for a brief vacation. The conversation made it briefer:

  “I think you’d better get back here quick.”

  “Thanks. I’m on my way.”

  George Shultz had met with Nixon a number of times on August 12 and, in keeping with his training as a labor negotiator, had counseled patience. The president did not need much convincing to stick with the original timetable.

  Nixon said, “We’re not really ready. To get everyone ready we have to go to Camp David. September 7 seems like the right time … The decision should be made by you, Connally, Burns, and me. I know Connally will want to bring Volcker … but he’s so obsessed by things international … I don’t know.”75

  Shultz saw an opening to push his agenda. “Volcker also thinks we should solve the international problem by restricting the domestic economy … but I don’t think you want to do that.”

  “Never … Unfortunately, I don’t have a hell of a lot of confidence in Volcker.”

  Connally went directly from the airport to the White House at 5:30 on the afternoon of August 12, joining the president and George Shultz in the president’s office in the Old Executive Office Building. Nixon was pleased to see him, greeting Connally with a loud “I’m glad you’re here,” but the president seemed determined to avoid being stampeded.76

  “I don’t think we should do the whole program right now, especially the freeze and the import surcharge … but if you think shutting the gold window must be done immediately then you can announce it yourself … making it sound like a temporary measure, as a prelude to a complete package.”

  Connally had no intention of getting out in front on this and appealed to Nixon’s addiction to grand gestures. “The problem with doing this piecemeal is that people will keep worrying about what is coming next … especially if we just close the gold window. It will seem clear that we were forced into it. Doing the whole package at once means that you have thought this through carefully … You will seize the initiative.”

  Nixon circled back to his concerns about the gold window. “Actually, Arthur [Burns] wants just the freeze. He thinks the risks of suspension are too great.”

  “Arthur is talking like a central banker. You have the best man in the country down here. Why don’t you talk to Volcker about this yourself.”

  Connally had relied on Volcker’s technical expertise and thought the president should as well, but Nixon had other ideas, courtesy of Shultz. “Volcker thinks we ought to sacrifice the domestic economy to save the dollar. I’m not in favor of that.”

  Connally sounded surprised to hear this. “Well, I certainly don’t think like that and I’m pretty sure Volcker doesn’t either.”

  “Good. That is why we are going to continue with an expansionary policy.”

  “I agree … but the public will believe that you are serious about controlling inflation if you announce the freeze.”

  George Shultz had been listening to the interchange and began discussing the details needed to implement the wage-price freeze. The president interrupted him, in a clear and authoritative voice:

  “What I think we should do, after hearing all of the possibilities, is this … We ought to do the entire program at once, announcing it this coming Monday. We’ll have a meeting at Camp David starting tomorrow afternoon. I’ll have it all set up. But we need total security. The fewer people the better. The three of us will be there, make sure we have McCracken, and of course, Arthur must be involved.” Nixon paused, and then did a graceful pirouette. “And John, you bring Volcker.”

  The meeting began on Friday afternoon, August 13, 1971, at the presidential retreat at Camp David in Maryland’s Catoctin Mountains.77 It ended three days later, on Sunday morning, August 15, 1971. The president’s message to the country that evening lasted a total of twenty minutes.78

  Those twenty minutes changed Paul Volcker’s life.

  5. Transformation

  At 12:00 midnight on Sunday, August 15, 1971, Volcker boarded a refitted military transport plane on the runway at Andrews Air Force Base headed for battle with European finance ministers. Nixon had lit the fuse three hours earlier with his address to the American people on network television outlining the administration’s New Economic Policy. The plan, hatched over the weekend at Camp David, invoked the Trading with the Enemy Act of 1917 to impose some of its emergency measures, and threatened global economic warfare.1

  Most foreigners would not care about the most dramatic announcement, the three-month freeze on wages and prices imposed by the president, except to marvel that a California Republican had adopted a Social Democrat’s approach to controlling inflation. But America’s trading partners would resent the suspension of gold convertibility, which tarnished their dollar holdings, and the 10 percent surcharge on imports, which made their exports less welcome on American shores. Those measures were the equivalent of a declaration of economic hostilities.

  The president had asked John Connally to lead a news conference the next day in Washington, a coveted spotlight for Nixon’s chief economic spokesman. Connally assigned Volcker the task of conducting a private meeting with foreign central bankers and finance ministers in London, launching Volcker’s transformation from monetary technician to international financial diplomat.

  Paul could not wait to embark on his mission. He felt like a wartime emissary dispatched to cool a provocation. Volcker had always regretted missing the call to action during Wor
ld War II, blaming himself for failing to convince the draft board that he was short enough to fight. Now he looked forward to defending his country, to maintaining the supremacy of the American dollar as the world’s premier currency, and to ensuring the stability of international trade within the framework of a revamped Bretton Woods System. It was the beginning of a new career.

  Volcker replayed the whirlwind weekend in his head as he settled into the cavernous hull of the transport plane. The meeting at Camp David had been conducted in total secrecy: no reporters, no phone calls, and by order of the president, no representatives from the State Department. Nixon had been almost dismissive: “I want this kept secret … don’t bother with the foreign relations types.”2 Volcker thought the president’s distrust of the foreign affairs bureaucracy had deep roots, extending back to Nixon’s days as a congressman on the House Un-American Activities Committee, and his pursuit of Alger Hiss, a State Department official accused of espionage in 1948 and convicted of perjury in 1950.

  Volcker noted the president’s attention to detail, especially when it bordered on the absurd. Nixon’s obsession began with instructions that every person sign the guest book as they entered Aspen Cottage on Friday afternoon, August 13, and ended on Sunday morning, with detailed directions during the final picture-taking ceremony.3 Volcker smiled, recalling how Nixon exhorted his valet, “Manolo, quick, Manolo, bring in more chairs, we need more chairs for the picture.”4 The president understood the historic significance of the unfolding events, and participated in every substantive decision.

  The joust with Arthur Burns over the wisdom of gold suspension, with the president as referee, dominated Volcker’s thoughts. Burns had not minced words.5

  “Volcker and Connolly may be right about closing the gold window, but I think they are wrong. We are taking dramatic steps … the wage-price freeze, the border tax, and the government spending cuts. They will electrify the world. On the other hand, there are grave risks in closing the gold window. First, political … Pravda [the Communist Party newspaper] will headline this as a sign of the collapse of capitalism. The second risk is economic … world trade will suffer. Foreign exporters will clamor for action—”

  Connally interjected, “So the other countries don’t like it, so what … We’ll go broke getting their goodwill.”

  Burns protested, “They’ll retaliate.”

  “Let ’em. What can they do?”

  Volcker cringed, having spent the better part of his professional career nurturing America’s international relationships, but said, “I hate to do this. All my life I have defended Bretton Woods, but I think it’s needed … we cannot continue this way. But let’s not just close the gold window and sit. We need to negotiate a new set of exchange rates. This is an opportunity to repair a system that needs fixing.”

  Paul McCracken offered some balance: “People’s reaction to closing the gold window could be negative. On the other hand, they could see it as part of a program of strong action on wages and prices.”

  Volcker tried some historical perspective, “There is a certain public sentiment about a ‘cross of gold.’”

  Paul realized his error too late—a misplaced reference to the denunciation of gold by presidential candidate William Jennings Bryan at the 1896 Democratic convention.

  Nixon put Volcker in his place: “Bryan ran four times and lost.”6

  Arthur Burns’s special relationship with Richard Nixon, extending back to the Eisenhower administration, might have carried the day. His warnings about the dire consequences of suspension worried the president. But Connally’s tongue and Volcker’s expertise won Nixon over. Volcker had lugged a fat briefing book to every meeting, just in case he needed to consult the black loose-leaf binder containing the plans. His preparation paid off. No one else could muster an answer when the president asked how much revenue the import tax would generate.7

  Volcker grounded all his calculations in economic analysis, despite the skepticism he had learned from Morgenstern at Princeton.8 He knew this precision gave him the credibility of a surgeon, but he also recognized the downside. His numerical skills left him vulnerable to being branded an idiot savant.

  Not after his mission abroad.

  The roar of the engines buzzed in Volcker’s ears as the military transport plane, without windows, lumbered into the air. He could hardly believe that he had returned by helicopter from Camp David just a few hours earlier, had stopped at the Treasury to prepare the press release describing the new program, and was now off on a transatlantic journey. He worried about delivering the proper message, considering that the draft apology for abandoning gold he had given to William Safire, the president’s speechwriter, had disappeared entirely from Nixon’s televised talk. The president had written much of the speech himself and turned over detailed notes to Safire with explicit instructions to avoid “the gobbly gook about crisis of international monetary affairs … which seemed to be the thrust of Volcker.”9

  Nixon told H. R. Haldeman, his chief of staff, “Don’t circulate the drafts of the speech. Show the other people only the sections that concern them. I want it to be a surprise.” It was.

  Volcker marveled at what a master politician could engineer with the proper turn of phrase, like the sweep of a magician’s wand. During the first minute of his talk, Nixon had transformed three days of anxiety into victory. “The time has come for a new economic policy for the United States … We must create more and better jobs. We must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.”10

  Volcker knew that Americans would respond well to thwarting unprincipled speculators. He wondered how that would play in London.

  The New York Stock Exchange greeted the president’s plan with thunderous approval, jumping more than 3 percent on Monday, August 16, the first day of trading after the president’s talk.11 The surcharge on imports, raising the cost of Volkswagens and Toyotas, buoyed domestic automakers. Eager buyers pushed up the shares of Chrysler by more than 15 percent, while the larger companies, General Motors and Ford, rose 10 percent each.12 Gold mining stocks declined, suffering from Nixon’s edict, which diminished America’s need to replenish its stock of the precious metal.13

  Nixon won new friends among investors. Clarence Netherland, a petroleum engineer watching stock prices flash across an electronic screen in a Merrill Lynch brokerage office in Dallas, said, “There’s a hell of [a] lot more confidence in the economy now. We have begun to face up to realities.”14 Frederick Papolos, a retired Florida businessman, added, “Mr. Nixon has proved himself to be a real statesman. I’ll vote for him in 1972, although I didn’t in 1968.”

  Consumers went on a buying spree as well.15 Martin Spenser, a personnel consultant in New York City, visited Sherry-Lehman, a fine wine and liquor store on the Upper East Side of Manhattan and bought a case of Château Lafite-Rothschild. “A wise decision,” said the store owner, Sam Aaron. “I assume retailers and restaurants will be buying madly … until present supplies … run out.” Louis Evans, the president of Evans Motor Company in the Forest Park suburb of Atlanta, reported that several people had shown up early Monday morning to buy Toyotas, and he suggested that “the surcharge announcement was the reason.”

  The Wall Street Journal delivered a lecture from its editorial page pulpit, preaching against the inflationary consequences of the wage-price freeze and the foreign exchange uncertainty triggered by gold suspension.

  President Nixon has revealed in his two and a half years in office a predilection for the grandstand play … So it should not come as a surprise that he responded to his growing problems with the U.S. economy as he did in his speech Sunday night … [But] grandstanding is … more likely than not to fail in meeting the popular hopes that it raises … A wage and price freeze could result in rather panicky return to price inflation after it is lifted … The import surcharge and a floating dollar will initially produce confusion; what comes out of it could be bet
ter or worse.16

  Both were valid concerns.

  The suspension of gold convertibility brought foreign exchange markets to a standstill, except for small retail transactions. In London on the day after Nixon’s speech, the press reported a “bewildering variety of exchange rates for tourists … The London Hilton would change up to $50 for a person at $2.60 [per pound sterling] during the morning, but it switched to $2.80 a pound during the afternoon.”17 In Milan, Dr. and Mrs. Lawrence Gould from New York City “were just shocked” when their dollars could not buy them even an ice-cream cone. “Fortunately our trip was ending,” they said, “and we had enough foreign currency to see us home.”18

  Confusion reigned in foreign exchange because Nixon had upended a key pillar of the Bretton Woods edifice: the link between the U.S. dollar and gold. Until Sunday night, August 15, 1971, the U.S. Treasury permitted foreign central banks, such as the Bank of England or the Bank of Japan, to exchange dollars for gold at the official rate of thirty-five dollars per ounce. And because they could exchange dollars for gold, these central banks felt comfortable using dollars as reserves to establish fixed exchange rates for world travelers.

  The Bank of England, for example, would intervene in the market by buying and selling pounds versus dollars, as necessary, to maintain the exchange rate at $2.60 per pound. And the Bank of Italy would intervene in the market by buying and selling lira versus dollars, as necessary, to maintain the exchange rate at 600 lira per dollar. The fixed exchange rate between the dollar and the pound meant that American tourists knew how much they needed to pay their bill at the London Hilton. The fixed exchange rate between the lira and the dollar meant that Dr. and Mrs. Lawrence Gould could enjoy gelato for about fifty cents while on their way to the Milan airport.