Volcker, who had not expected to be appointed—no New York Fed president had become chairman before—greeted the news diplomatically. “I’m not surprised that [the president] picked someone from the business community. It might be a good thing.”66 And Milton Friedman, the leading monetarist critic of the Fed, welcomed a practical man of affairs running the central bank: “Money is too important a matter to be left to the bankers.”67
Volcker quips, “The wisdom of Miller’s appointment is one of the few things that Milton and I ever agreed on.”68 And they both were wrong.
William Miller brought a CEO’s penchant for efficiency to the Board of Governors. He grew impatient with the collegial spirit of FOMC meetings, where everyone seated at the twenty-seven-foot-long mahogany table had a chance to speak. Most participants showed about the same restraint as a politician working a fund-raising breakfast. After six months on the job, Miller had had enough. He brought hourglass egg timers to the board meeting on Tuesday, August 15, 1978, and told his colleagues,69 “I’m going to try to set them up when each of you starts to talk and [board secretary] Murray [Altmann] is going to show a mean streak—since I’m a gentleman—[and tell you when your time is up].”
Charles Partee, who had been a top staffer at the Fed before becoming a board member, wanted more details. “What are they—three minutes?”
“Yes. And when your three minutes is up, he’s going to say ‘next speaker.’ ”
Volcker sensed a loophole. “How many times can you talk, though?” Altmann, who had just become the board secretary, recognized trouble. “I’m not sure yet whether you’re serious.”
The chairman smiled. “We are having a lot of fun but we are serious.”
Members of the FOMC dismissed William Miller’s egg timers as an ill-conceived practical joke, just as they ignored the THANK YOU FOR NOT SMOKING sign he had placed on the boardroom table.70 Everyone talked and smoked, led by Henry Wallich, the board’s resident expert in international finance, who considered it his constitutional right to enjoy a fine cigar. Meanwhile, Volcker puffed away on his favorite ten-cent stogie and lamented the plight of the dollar in the foreign exchange market.
Volcker had watched gold reach a new high during the last week of July 1978, so he was not surprised, during the first half of August, when the U.S. dollar sank to new lows against the German mark, seconding the vote of no confidence in America.71 On August 15, 1978, he told the FOMC, “I think it’s important particularly in view of the international situation that we correct the misapprehensions about our lack of concern over inflation. I do think it would be wise to put a specific mention of the international situation in the directive at some point.”72
Volcker thought “domestic and international price stability went hand in hand,” and he wanted this reflected in the FOMC Directive, the instructions for monetary policy voted on at the end of each meeting. During his tenure as undersecretary of the treasury, he had urged Arthur Burns to protect the dollar with high interest rates. Now that gold and fixed exchange rates had become the dinosaurs of international finance, Volcker believed that the dollar’s role in world trade depended even more on price stability than it had before. Americans could no longer consume more cars and televisions than they produced if foreigners were unwilling to hold dollars as international money. According to Volcker, “Our moral obligation to prevent a debasement of our currency coincided with our self-interest.”73
Volcker championed America’s international responsibilities, but had to shoulder some of the blame for the greenback’s decline. He had voted with the majority of the FOMC, slowly pushing up the federal funds rate, the overnight interest rate on loans of reserves between banks, to discourage excessive spending and inflation. If banks had to pay more for reserves, the raw material needed to make loans, they would charge more to consumers and businesses. But the FOMC operated with a delicate touch, mimicking a team of brain surgeons, raising interest rates in quarter-percent increments at each meeting. According to Volcker, “I don’t think we could be accused of not having been prudent and cautious and gradual.”74
Mark Willes, a member of the FOMC by virtue of his position as president of the Federal Reserve Bank of Minneapolis, wanted to use a sledgehammer rather than a scalpel in tightening credit. He would leave the Fed in 1980 to become president of General Mills, the food conglomerate most famous for bringing Cheerios to the breakfast table, but in mid-1978, Willes had urged Volcker privately to “push up rates more aggressively to convince people that we are serious about controlling inflation.”75
Volcker said, “The FOMC doesn’t operate that way.”
Willes, who dissented eight times during the year, said, “Perhaps we should.”76
Volcker recognized in himself the tendency to procrastinate. Staffers at the Federal Reserve Bank of New York joked that he never made a decision before its time, and the hereafter counted in the calculation. He recalled that dawdling in London had destroyed his doctoral dissertation. But he dismissed those thoughts when answering Willes. “Maybe, but I can do more by building a consensus within the committee.”
He would change his mind before long.
The FOMC increased the federal funds rate to 9 percent in October 1978, a jump of more than two percentage points over a six-month period, but Mark Willes was not impressed, and lectured the group.77 “I’d just make one comment … since there seems to be so much concern about rising interest rates. We seem to accept easily the notion that if we want to look at real wages we adjust for inflation, and that if we want to look at what is happening to profits and depreciation, we adjust for inflation. Most of the economic theory that I know says that if you want to look at the real bite of interest rates, you also adjust for inflation. And interest rates adjusted for inflation are not high at all.”
The “buy now, pay later” philosophy of people such as Tessie Rogers and Kathy Neuhas confirms that an interest rate of 9 percent is not high if wages and prices are increasing at about the same rate. It pays to borrow and buy something tangible, such as a big house, a small diamond, or a tightly wrapped bar of gold, to reap the capital gain and repay the loan in cheaper dollars.
The rate of inflation averaged over 9 percent during the three months prior to the FOMC meeting of Tuesday, October 17, 1978, and Volcker began to think that Willes had been right.78 He said openly at that meeting, “I do have some question about whether we pitched it at the right level in the last year. I suppose … having looked back, that we’ve been a little too easy … and meanwhile inflation has gotten worse.”79
No one commented, except for William Miller. “I don’t think inflation has accelerated since I’ve been at the board, to put it bluntly.”
“I was thinking of a period of probably fifteen or eighteen months.”
Miller smiled. “Well, you fellows fouled it up before!”
Volcker had not been trying to assign individual blame, but he admitted without excuse, “There is something to what you say.” And then added, “But I also think inflationary expectations have hardened … And that is a problem. I do think this is a critical period.”
The foreign exchange market noticed. On October 30, 1978, one dollar purchased 1.72 German marks, an all-time low, representing a decline of more than 20 percent in a year.80 A currency analyst in Frankfurt said, “It’s the same old story—lack of confidence in U.S. government policies.”81 And a London financial analyst concurred: “It will take a lot to change sentiment and a long time to restore confidence.”82 But a taxi driver in Frankfurt hurt the most: “I would rather not take any dollars at all. If somebody offered me dollars, I would drive him to the nearest bank to check the rate … I don’t know what it’s going to be tomorrow, do I?”83
A massive dollar-rescue operation launched on Wednesday, November 1, 1978, delayed Volcker’s first substantive FOMC dissent for five months. Treasury Secretary Michael Blumenthal, the former president of Bendix Corporation, a company that made home washing machines and antilock
braking systems for cars, convinced President Jimmy Carter of the need for drastic measures, including a significant increase in U.S. interest rates.84
Anthony Solomon, who held Volcker’s old position as undersecretary of the treasury for monetary affairs, then orchestrated a $30 billion intervention in the foreign exchange market, the equivalent of total warfare on anti-dollar speculators.85 Solomon implied that the Treasury would abandon the policy of benign neglect toward the dollar that had ruled since floating exchange rates had replaced Bretton Woods. “The point has come where Adam Smith had to be curbed.”86 Adam Smith was not a speculator, of course, but he took the blame as the founder of modern economics.
Volcker participated in the dollar rescue by requesting an increase from 8½ percent to 9½ percent in the discount rate charged by the Federal Reserve Bank of New York for lending reserves to its member banks. Unlike most changes in the discount rate that occur after a fundamental shift in policy by the FOMC, the November 1 increase signaled a new initiative. Establishing the discount rate is one of the few prerogatives left to the regional Federal Reserve banks, but the Board of Governors in Washington must approve all changes. Volcker recalls, “I was only too happy to conduct a special telephone meeting of my directors to vote for an increase once I knew Washington would approve.”87
Foreign exchange markets painted a new outlook. On the day the rescue package was announced, the dollar rose by 6 percent against the German currency, and a month later it had jumped to 1.93 marks.88 Had the Frankfurt cabbie not spurned the greenback, he would have earned a profit of more than 10 percent during November.89 The program also punished gold speculators. An ounce of the precious metal declined from its peak of $243.65 on October 31, 1978, to $193.40 at the end of November, a decline of more than 20 percent.
The rise in U.S. interest rates restored a shine to the tarnished dollar, but Volcker expected the gains to fade without follow-through, especially if inflation accelerated. He had good reason for concern. Corporate borrowing showed no signs of tapering off with the increased cost of funds. The controller of R.H. Macy, Mortimer Leavitt, said that the department store’s “aggressive capital spending program hasn’t changed in light of any recent events. The company … will just go along with interest rate increases. If you want to eat … you pay the price. You don’t stop eating.”90 A spokesman for St. Joe Minerals Corporation, the largest producer of lead and zinc in the United States, added, “Much of our spending is on a long lead-time basis and we certainly wouldn’t leave things sitting there half or three-quarters finished.”91
By the March 20, 1979, meeting of the FOMC, almost five months had elapsed since the Treasury’s rescue of the dollar, and the annual rate of inflation had moved into double digits.92 Volcker sounded the alarm.
I think we’re in retreat on the inflation side; if there’s not a complete rout, it’s close to it. And in my view that poses the major danger to the stability of the economy … It’s an obvious danger for international stability [especially] … if the dollar … should [return to] the panicky situation we had earlier … There’s no doubt in my mind that … this is the time for some firming rather than the reverse. I think we are at a critical point in the inflation program, with the tide against us.93
Volcker faced a battle.
Frank Morris, a friend of Paul’s ever since they shared an office at the Treasury when JFK was president, served on the FOMC in his capacity as president of the Federal Reserve Bank of Boston. Morris had been on the committee for over ten years, more than twice as long as Volcker. He had been appointed president of the Boston Fed in 1968 from a select list of candidates that included one six-foot, seven-inch financial economist from Chase Manhattan Bank. Volcker recalls: “They chose well. Frank is a first-rate economist and a devoted central banker … but it did rankle at the time. It is the only job I was ever turned down for, unless I count when the Federal Reserve Board refused to hire me right after I finished Princeton in January 1949.”94
On Tuesday, March 20, 1979, Morris staked out a position diametrically opposed to Volcker’s. “I think we’re facing an emerging conflict between the domestic and international requirements of monetary policy … I think we’re approaching a cyclical peak in the economy sometime around midyear … If it’s our objective to avoid a recession, I think we have to [ease] today; I don’t think we can wait for another month … I think the issue is whether we seriously are concerned about avoiding a recession or not.”95
Frank Morris knew from his long experience on the FOMC that members responded more to the domestic economy than to international finance, in keeping with its congressional mandate to “promote full employment … and reasonable price stability.”96 In 1913, Congress conferred its constitutional right “to coin money and regulate the value thereof” on the Federal Reserve System. The central bank’s obligations have changed over the years, in response to economic circumstance and political pressure, but the Full Employment and Balanced Growth Act of 1978, also known as the Humphrey-Hawkins Act, formalized the goals of full employment and price stability. Foreign exchange remained in the Senate cloakroom.97
Morris argued that Volcker’s recommendation to tighten credit was inconsistent with those priorities. “Paul, I think, is resigned to a recession; I think the international constraint may be more of a factor in his thinking than he let on.”98
Volcker felt cornered. He had gone on record with an incriminating message a few months earlier, in a speech at the University of Warwick in Coventry, England, that received considerable attention.99 “It has been a difficult matter to bring … exchange market stability to bear on a Congress … preoccupied with the domestic economy … In retrospect the case can be made that … more forceful response to pressures on the dollar would have ultimately been helpful in promoting domestic as well as international stability … Today, a stronger and stable dollar is plainly in the interest of the United States and the rest of the world.”100
Volcker tried to navigate a response to Morris that would salvage the case for tighter credit while avoiding perjury. “Inflation is a factor in my thinking.”101 He told the truth, but Morris’s speech carried the day.102 The FOMC refused to tighten, and Volcker, with three others, voted against the decision. The press labeled the FOMC dissenters “the Volcker minority.”103
In the three months ending June 1979, prices increased at nearly 13 percent per annum, a relentless acceleration in the rate of inflation that caused both resignation and resentment across the country.104 Terry Grantham, a college student and painter’s helper in Lubbock, Texas, said, “Every day that goes by it seems like the money I have doesn’t buy as much … I was raised as a steak and potatoes boy, but now it ain’t that way no more. Forget the steaks and go with hamburger or bologna.”105 But Ron Gordon, a baseball fan in San Francisco, rebelled. He refused to accept the nickel increase in the price of hot dogs and beer at Candlestick Park, where the Giants played their home games.106 Gordon assembled an inch-thick folder of statistics and protested before the San Francisco Recreation and Park Commission, which had approved the five-cent price increases. His effort attracted the attention of Alfred E. Kahn, President Carter’s chairman of the Council on Wage and Price Stability, who praised his “heroic and unflagging campaign.”107
Ron Gordon prevailed on hot dogs—the price increase was rescinded—but he lost on beer. His batting average, a respectable .500, exceeded Jimmy Carter’s by a wide margin. The president’s approval ratings declined to 30 percent in June 1979.108 At a meeting of the National Association of Broadcasters in Dallas, he had been asked whether the federal government was not the main cause of inflation.109 It was the same question he had gotten earlier, in Elk City, Oklahoma. The president smiled and said, “That seems to be the most popular question.” Wayne Hardrow, of the North Carolina Association of Broadcasters, summed up the mood with “Where do we go from here?” as if inflation were a mysterious fourteenth-century plague.
On Sunday evening, July 15, 1979
, President Jimmy Carter delivered his diagnosis to the American people in a televised speech from the Oval Office. The president had spent the previous ten days at Camp David discussing the country’s problems with industrialists, labor leaders, economists, pastors, and ordinary Americans (not necessarily in that order). His thirty-three-minute talk addressed the details of the country’s dependence on foreign oil, but his broader message focused on “the crisis of confidence” that he considered “a fundamental threat to American democracy.”110 Carter lamented that “for the first time in our history a majority of our people believe that the next five years will be worse than the past five years.” He recognized that “the phrase ‘sound as a dollar’ was an expression of absolute dependability until ten years of inflation began to shrink our dollar and our savings.”
Two days after his speech, Carter requested the resignation of his entire senior staff, a housecleaning to signify a fresh start. Instead, it created confusion. The president removed five of his cabinet members, including Treasury Secretary Michael Blumenthal, who had run afoul of the so-called Georgia Mafia in the White House.111 In November 1978, Blumenthal had convinced Carter to support the discount rate increase that had accompanied the dollar rescue package. He compounded his offense in April 1979, by publicly calling for an increase in interest rates soon after the “Volcker minority” had urged a tightening of credit conditions.112 When asked at his final news conference whether he had jumped or was pushed, Blumenthal answered, “I took advantage of an opportunity to get paroled with time off for good behavior.”113
Blumenthal’s firing provided fodder for talk show hosts such as Johnny Carson on The Tonight Show. “Treasury secretary Blumenthal did not handle his job too well. He asked for his severance pay in Krugerrands.”114 No one had to tell the late-night television audience that the Krugerrand was South Africa’s gold coin. Carter’s cabinet shakeup had triggered an overnight jump in gold to over $300 an ounce, a new record.115 The New York Times commented that the resignations “significantly intensified European worries” and quoted a specialist at Samuel Montagu & Company, a leading London gold trading firm: “Seen from over here this looks pretty awful.”116
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