25. Paul Volcker and Toyoo Gyohten, Changing Fortunes: The World’s Money and the Threat to American Leadership (New York: Times Books, 1992), p. 199.
26. See Kraft, The Mexican Rescue, p. 4.
27. The following discussion is based on ibid., pp. 9–14; Volcker and Gyohten, Changing Fortunes, pp. 200–207; and the recollection of Paul Volcker.
28. The telephone numbers appear in the document “U.S. Bank Claims on Mexico (end-1981: adjusted for guarantees),” Personal Papers of Paul Volcker.
29. See Ron Chernow, The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance (New York: Atlantic Monthly Press, 1990), p. 127.
30. At the FOMC meeting on August 24, 1982 (Transcript, Federal Open Market Committee Meeting, August 24, 1982, p. 1), Volcker says, “Mr. Solomon made a little introductory statement … indicating that there was some expectation of some private new money as part of this [negotiation].” According to the New York Times (August 21, 1982, p. 32): “The Mexican government and United States officials put heavy pressure on commercial banks … to agree to a program under which the banks would postpone repayments of $10 billion in Mexican debt … Despite denials by the Federal Reserve that it had anything to do with the meeting and that it had merely provided the group with a room, Anthony Solomon, president of the Federal Reserve Bank of New York, made an opening statement to the participants … that the Federal Reserve fully supported the plan that was presented by Mr. Silva Herzog.”
31. Transcript, Federal Open Market Committee Meeting, August 24, 1982, p. 18.
32. International Financial Markets and Related Problems: Hearings Before the House Committee on Banking, Finance and Urban Affairs, 98th Congress, February 2, 1983, p. 76, Table V.
33. The federal funds rate was 14.73 percent on July 1, 1982, versus 9.03 percent on August 24, 1982. The ten-year rate was 14.4 percent on July 1, 1982, and 12.35 percent on August 24, 1982.
34. Transcript, Federal Open Market Committee Meeting, August 24, 1982, p. 23.
35. Transcript, Federal Open Market Committee Meeting, October 5, 1982, p. 38.
36. Transcript, Federal Open Market Committee Meeting, August 24, 1982, p. 30.
37. Transcript, Federal Open Market Committee Meeting, October 5, 1982, p. 19.
38. See Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, NJ: Princeton University Press, 1963), pp. 313–14.
39. Transcript, Federal Open Market Committee Meeting, October 5, 1982, p. 20.
40. Ibid., p. 70.
41. The transcript for the October 5, 1982 meeting (esp. pp. 10–11 and pp. 34–42) cites technical problems associated with the All-Savers certificate program, making the narrow money supply figures suspect. But this was only a temporary phenomenon. See Allan Meltzer, A History of the Federal Reserve, vol. 2, book 2 (Chicago: University of Chicago Press, 2009), pp. 1104–31, for further discussion.
42. Transcript, Federal Open Market Committee Meeting, October 5, 1982, pp. 53.
43. See Marvin Goodfriend and Robert G. King, “The Incredible Volcker Disinflation,” Journal of Monetary Economics 52, no. 5 (2005): 1003.
44. Ibid., p. 985, claims that the Volcker disinflation did not gain credibility until much later. Goodfriend and King argue that “the behavior of intermediate and long term interest rates is evidence that the [Volcker] disinflation” was not credible. They cite the rise in the ten-year rate from 13 percent to 14 percent from the beginning of 1981 to 1982 as evidence. I argued in the previous chapter that this increase in rates was a consequence of the increase in the budget deficit and the uncertainty over the magnitude of the increased deficit.
45. See Transcript of the Press Conference at the Business Council Meeting, Hot Springs, Virginia, October 9, 1982. He had told the FOMC at the October 5 meeting that he would indicate the change in policy before the release of the minutes six weeks later to avoid concern in the markets about movements in the money supply. See Transcript, Federal Open Market Committee Meeting, October 5, 1982, p. 53.
46. New York Times, October 13, 1982, p. A30, and October 14, 1979, p. E18.
47. New York Times, October 13, 1982, p. A30.
48. New York Times, October 12, 1982, p. D1 continued.
49. International Debt: Hearings Before the Senate Subcommittee on International Finance and Monetary Policy of the Committee on Banking, Housing and Urban Affairs, 98th Congress, 1st Sess., February 14, 1983.
50. See Board of Governors of the Federal Reserve System, Federal Reserve System: Purposes and Functions, Washington, DC, 9th ed., 2005, chapter 5, for the supervisory responsibilities of the Federal Reserve and other agencies.
51. International Debt: Hearings Before the Senate Subcommittee on International Finance and Monetary Policy of the Committee on Banking, Housing and Urban Affairs, 98th Congress, 1st Sess., February 17, 1983, p. 258.
52. Ibid., p. 237.
53. Ibid., p. 239.
54. For this and the remaining quotes immediately following, see International Debt: Hearings Before the Senate Subcommittee on International Finance and Monetary Policy of the Committee on Banking, Housing and Urban Affairs, 98th Congress, 1st Sess., February 14, 1983, p. 247.
55. New York Times, July 6, 1978, p. D1.
56. PIPAV.
57. See Board of Governors of the Federal Reserve System, Federal Reserve System: Purposes and Functions, Washington, DC, 5th ed., 1963.
58. New York Times, December 10, 1985, p. B6. This comment by Martin came after the failure of Continental Illinois (discussed in the next chapter) and was not a response to Mexico per se.
59. PIPAV.
60. Washington Post, January 28, 1983, p. C9.
61. See Volcker’s Daily Planner, 1983.
62. This conversation is based on the recollection of Paul Volcker.
63. Volcker had received an honorary degree the previous June at Princeton. The valedictorian at the graduation ceremony applied Churchill’s words to mark the end of their tutorial on life. See New York Times, June 9, 1982, p. B2.
64. The monthly inflation rates announced in January 1983 through May 1983 were 0.2, 0.1, 0.1, 0.7, and 0.4. Annualizing those numbers (add them up and divide by 5 and then multiply by 12) produces an inflation rate of 3.6 per annum.
65. On May 4, 1983, the federal funds rate was 8.64 percent and the ten-year bond rate was 10.12 percent, compared with October 5, 1982, the day of the FOMC meeting, when the funds rate was 10.27 percent and the ten-year bond rate was 11.69 percent.
66. In July 1975 the federal funds rate had declined to a monthly average of 6 percent compared with an average of 13 percent a year earlier, while over that same period, the ten-year government bond rate rose from an average of 7.8 percent to over 8.0 percent (see chapter 10).
67. See Transcript, Federal Open Market Committee Meeting, October 5, 1982, p. 38.
68. New York Times, November 22, 1980, p. 9.
69. On May 31, 1983, the dollar bought 2.52 German marks compared with 1.97 marks on December 31, 1982.
70. See Benjamin Friedman, “Learning from the Reagan Deficits,” American Economic Review 82, no. 2 (May 1992): 299–304, for a discussion of the unprecedented size of the Reagan deficits as a percentage of GNP compared with the post–World War II experience until then, and the transformation of the United States from a net exporter of capital to a net importer.
71. Washington Post, May 12, 1983, p. A23.
72. On May 31, 1983, the dollar bought 7.54 French francs compared with 4.55 French francs on December 31, 1980.
73. Washington Post, May 12, 1983, p. A23.
74. See Martin Anderson, Revolution: The Reagan Legacy (Stanford, CA: Hoover Institution Press, 1990), p. 239.
75. Washington Post, April 19, 1983, p. A1.
76. See William Safire “To Pay Paul,” New York Times, May 16, 1983, p. A19.
77. Friedman’s remark is quoted in Harry Anderson and Rich Thomas, “Voting for Volcker to Stay,�
�� Newsweek, June 20, 1983, p. 53.
78. In describing the incident, William Safire wrote, “The Friedman savaging continued … Paul Volcker did not feel the need to respond.” See New York Times, May 16, 1983, p. A19.
79. Washington Post, April 21, 1983, p. D11.
80. The discussion and conversation that follow are from the Transcript, Federal Open Market Committee Meeting, May 24, 1983. See p. 31 for “snugging up” and 59–60 for the rest.
81. The following conversation is based on the recollection of Paul Volcker.
82. The quote is as written in the June 6 entry to Reagan’s diary, with the exception that the question mark in the diary appears before the word Do. See Douglas Brinkley, ed., The Reagan Diaries, vol. 1 (New York: HarperCollins, 2009), p. 233.
83. Washington Post, June 9, 1983, p. A1 continued.
84. See New York Times, June 19, 1983, p. 26. Also see “Reagan’s ‘First Friend,’” New York Times, March 21, 1982, p. SM26.
85. See “Final Choice of Volcker Is Attributed to His Experience and Solid Support,” New York Times, June 19, 1983, p. 26.
86. See entry for June 7, continued on page 234, Brinkley, ed., The Reagan Diaries, vol. 1.
87. See Greenspan’s note, dated July 28, 1983, Personal Papers of Paul Volcker.
88. Washington Post, June 19, 1983, p. A1 continued.
89. Reagan made the following entry for June 18 in his diary: “About 11am I phoned Paul Volcker in N.Y. & asked him to accept re-appointment as Chmn. of the Fed.” See Brinkley, ed., The Reagan Diaries, vol. 1, p. 238.
90. Washington Post, June 19, 1983, p. A1 continued.
14. Follow-Through
1. The Re-nomination of Paul Volcker: Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, U.S. Senate, 98th Congress, 1st Sess., July 14, 1983, pp. 1–2.
2. Ibid., pp. 3–4.
3. New York Times, July 22, 1983, p. D11.
4. The Re-nomination of Paul Volcker: Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, U.S. Senate, 98th Congress, 1st Sess., July 14, 1983, p. 10.
5. Personal Papers of Paul Volcker.
6. Ibid.
7. New York Times, July 28, 1983, p. D20.
8. Ibid.
9. The unemployment rate was 10.8 percent in November 1982 and 7.8 percent in February 1984.
10. The Federal Reserve’s First Monetary Policy Report for 1984: Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, 98th Congress, 2nd Sess., February 8, 1984, pp. 12–13. Volcker’s remarks also cited the balance-of-payments deficit.
11. See Annual Report of the Council of Economic Advisers, February 1984, Washington, DC, p. 37.
12. New York Times, March 18, 1984, p. SM34.
13. See chapter 12 for a discussion of the difficulty of testing the general proposition that deficits increase real interest rates. That discussion provides evidence from the 1981 tax cut of a positive impact of the deficit, and uncertainty over the deficit, on interest rates, but that evidence certainly does not resolve the issue more generally. The evidence presented here will also show that the persistence of the structural deficit under President Reagan during 1984 pushed up real interest rates as the economy recovered. For a contemporaneous dismissal of the relationship between deficits and interest rates, see Shadow Open Market Committee, Policy Statement and Position Papers, March 11–12, 1984 (available at shadowfed.org/archives/1984/september-30-1984-washington-d-c), which begins by saying (p. 5), “There is no careful study showing a direct connection between actual or expected budget deficits and market interest rates.” That statement is correct because “initial conditions” in the economy matter a lot in whether the deficit raises real rates, which is a good reason for looking at each particular historical episode as a separate case study.
14. See Economic Report of the President, transmitted to the Congress, February 2, 1984, Washington, DC, 1984, pp. 4 and 6.
15. The Federal Reserve’s First Monetary Policy Report for 1984: Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, 98th Congress, 2nd Sess., February 8, 1984, pp. 106 and 107.
16. Ibid., p. 107.
17. Heinz’s position on the 1981 tax cut is discussed in David Stockman, The Triumph of Politics (New York: Harper & Row, 1986), pp. 252–53.
18. Transcript, Federal Open Market Committee Meeting, August 14, 1979, p. 22.
19. See Ellen Meade and David Stasavage, “Two Effects of Transparency on the Quality of Deliberation,” mimeo., September 2005: “In 1993 the FOMC began releasing verbatim transcripts of its meetings, albeit with a five year delay. Before 1993 the FOMC did not release transcripts, but as was subsequently revealed, all pre-1993 meetings had been taped, and contrary to the expectations of participants, these earlier records had been preserved. After 1993 the verbatim records of these earlier meetings were also released to the public.”
20. See “Contingency Planning: Options for the International Monetary Problem,” March 14, 1971, Papers of Paul Volcker, Federal Reserve Bank of New York Archives, Box 0108477, p. 59, and the discussion in chapter 4.
21. Volcker weighed 240 pounds at this time and has caught Atlantic salmon weighing 35 pounds. Even the biggest fish stories do not report Atlantic salmon exceeding 100 pounds. Volcker claims he once caught a 120-pound tarpon.
22. This quote and those that follow are from The Federal Reserve’s First Monetary Policy Report for 1984: Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, 98th Congress, 2nd Sess., February 8, 1984, p. 108.
23. The discount rate was last increased on May 5, 1981, from 13 to 14 percent. It was then reduced in nine steps to 8.5 percent. It remained at that level from December 14, 1982, until April 9, 1984, when it was increased from 8.5 to 9.0 percent.
24. On February 1, 1984, the ten-year rate equaled 11.64 percent. On May 30, 1984, it reached 13.99 percent.
25. The long-term rate might increase a little because long-term rates reflect the current and expected future short-term rates, but that need not occur if inflationary expectations are reduced in the process.
26. See “Coming Out of the Recession: The Economy in 1984,” an address before the Wharton Entrepreneurial Center, April 30, 1984, p. 2, available at fraser .stlouisfed.org/historicaldocs/831/download/29536/Volcker_19840430.pdf. Also see Allan Meltzer, A History of the Federal Reserve, vol. 2, book 2 (Chicago: University of Chicago Press, 2009), p. 1165.
27. The Shadow Open Market Committee was founded in 1973 by Karl Brunner of the University of Rochester and Allan Meltzer of Carnegie Mellon University. For this quote, see Shadow Open Market Committee, Policy Statement and Position Papers, March 11–12, 1984, p. 6, available at shadow fed.org/archives/1984/.
28. Meltzer’s quote refers to August 1984. See Meltzer, A History of the Federal Reserve, p. 1167.
29. Transcript, Federal Open Market Committee Meeting, March 27, 1984, p. 85.
30. Ibid., p. 52. Wallich repeated his concern at the May 22, 1984, meeting of the FOMC (p. 5).
31. Goodfriend wrote, “The Fed tightened in an effort to resist the ongoing inflation scare, raising the funds rate to an 11.6 percent peak in August of 1984.” See Marvin Goodfriend, “Interest Rate Policy and the Inflation Scare Problem: 1979–1992,” Federal Reserve Bank of Richmond Economic Quarterly 79, no. 1 (Winter 1993): 14.
32. The afternoon London gold fixing was $277.50 on the last day of June 1979 and ended the year at $524.00.
33. See chapter 10.
34. The monthly averages are of the daily afternoon London gold fixing. The price at the beginning of the period and the end of the period show almost no change: The London afternoon fixing on February 1, 1984, was $378, and on May 31 it was $384.
35. See the discussion of 1981 in chapter 12.
36. Steinhardt Partners was one of the most successful hedge funds ever, earning a gross annual return of 30 percent during its first twenty-one years of existence, compared wi
th an annual return of 8.9 percent in the S&P 500 index over the same period. See the chapter on Michael Steinhardt in Jack Schwager, Market Wizards: Interviews with Top Traders (New York: New York Institute of Finance, 1989), esp. pp. 207–209, for a discussion of his speculation in Treasury bonds. Also see Dan Dorfman, “Superstar Betting $400 Million on Falling Interest Rates,” Chicago Tribune, May 24, 1984, p. A1.
37. Dorfman, “Superstar Betting $400 Million.”
38. Ibid. attributes this view to Steinhardt, but it is not a direct quote from him.
39. See Prepared Statement by Paul Volcker in The Federal Reserve’s First Monetary Policy Report for 1984: Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, 98th Congress, 2nd Sess., February 8, 1984, p. 18.
40. Ibid., p. 108.
41. See “How the Panic Followed the Sun in Debacle at Chicago Bank,” Chicago Tribune, May 27, 1984, p. 1.
42. Continental is mentioned as the seventh-largest bank in 1984 in History of the Eighties: Lessons for the Future (Washington, DC: Federal Deposit Insurance Corporation, 1997), p. 236. Table 7.1 on the following page shows Continental as the eighth-largest in total assets at the end of 1981.
43. See Managing the Crisis: The FDIC and RTC Experience, 1980–1994 (Washington, DC: Federal Deposit Insurance Corporation, August 1998), p. 548.
44. Wallace’s quote is from the Chicago Tribune, May 20, 1984, p. W1. Continental’s balance sheet showed that only 16 percent of its funding came from core deposits of local customers. See George Hanc, History of the Eighties: Lessons for the Future (Washington, DC: Federal Deposit Insurance Corporation, 1997), p. 255, Table 7A.1.
45. See Table 7A.1, ibid., p. 255, for foreign office deposits. The Chicago Tribune, May 27, 1984, p. 1, gives the $8 billion that was renewed each day.
46. See Chicago Tribune, May 20, 1984, p. W1.
47. The $3.6 billion is reported in the Chicago Tribune, May 27, 1984, p. 1. Volcker told the Federal Reserve Board on Monday, May 14, 1984, that “Continental Illinois had been borrowing 3–5 billion daily at the discount window.” (See Federal Reserve Board Minutes, May 14, 1984, p. 8.)
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