by Neil Irwin
It took the United States two more years, when Franklin Delano Roosevelt became president, to abandon a dollar pegged to gold. By that point, a quarter of the U.S. population was unemployed. In each of the major industrial countries, however, the abandonment of gold signaled the end of a great economic contraction and the beginning of the long slog back from depression.
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In 1933, the United States and the major powers of Western Europe all had more or less the same productive capacity that they’d had in 1929: the same factories, the same farmland, the same people with knowledge and ability and eagerness to toil. But when prices are falling and credit is collapsing—the sort of deflationary cycle that the central bankers allowed to take hold in the early 1930s—the whole system shuts down. Goods become less valuable; debts become more onerous. Despair sets in. Studs Terkel interviewed an Iowa farmer named Oscar Heline: “Grain was being burned. It was cheaper than coal. Corn was being burned. A county just east of here, they burned corn in their courthouse all winter, ’32, ’33. In South Dakota, the county elevators listed corn as minus three cents. Minus three cents a bushel. If you wanted to sell ’em a bushel of corn, you had to bring in three cents.” This when there was mass hunger in the cities.
Too much money and rapidly rising prices can be profoundly damaging, as Germany in the early 1920s showed. And too little money and falling prices can be too, as all the Western powers in the 1930s demonstrated. As the damage bounced from financial markets to the economy to banks to government finances and back again, it also bounced back and forth across the Atlantic from the United States to the financial capitals of Europe. And the world’s central bankers were essentially helpless to stop it, limited by their rigid adherence to the gold standard and an inability—or unwillingness—to cooperate with one another.
But both German hyperinflation and the Great Depression also teach a more basic lesson: When central bankers fail, so do societies.
FIVE
The Anguish of Arthur Burns
All the president’s men would require two helicopters that Friday—and for the sake of the world economy, they had best leave from separate locations. If the members of the press who watched Marine One take off from the South Lawn of the White House had known the full list of officials who were joining Richard Nixon at his country retreat in Camp David that August weekend in 1971, they would have been tipped off that some major shift in the nation’s currency policy was in the offing, which could have ruined the whole thing.
The second helicopter had to depart instead from Bolling Air Force Base, away from public view. On the car ride over, Nixon economic adviser Herbert Stein told speechwriter William Safire, “This could be the most important weekend in the history of economics since March 4, 1933,” when Franklin Delano Roosevelt declared a bank holiday to stop runs on stricken American financial institutions.
After the twenty-eight-minute flight, Nixon gathered the men in the living room of the Aspen Lodge, overlooking Maryland’s Catoctin Mountain. There was Treasury Secretary John Connally, who had been seated in the car with John F. Kennedy when the president was shot, and who was also wounded. There was White House aide Pete Peterson, who would later become a pioneer of the private equity industry. There were, among others, budget director George Shultz and his deputy Caspar Weinberger, who in the 1980s would guide the end of the Cold War as secretary of state and secretary of defense respectively. The tall, quiet treasury undersecretary who was present, Paul Volcker, would have as large an imprint on history as any of them.
The men were there to brainstorm about the dollar. The currency had been pegged to gold at $35 an ounce for decades, but that peg was coming under attack: Other nations had become convinced the dollar’s true value was less, so they were taking advantage of its “convertibility” to swap dollars for gold. Rumors that the value of the dollar would be reset at a lower level only fueled more redemptions—better to get gold while the getting was good. If the officials assembled at Camp David couldn’t find an answer, the United States would eventually run out of gold. In the interest of total secrecy, Nixon explained, there were to be no outgoing phone calls. Volcker mused at one point that given a billion dollars and a free hand, he could have made enough in trading profits from his knowledge of what was about to happen to cover the nation’s entire $23 billion deficit.
One answer would have been for the Federal Reserve to raise interest rates, to try to bring the value of the dollar up to be more in line with its gold peg. But with unemployment already at 6 percent and the president running for reelection the next year, that was a nonstarter as far as Nixon and his aides were concerned. He already blamed his loss of the presidency in 1960 on monetary tightening by the Fed in the run-up to the election. So Nixon instructed his team to find ways to deal with the crisis that wouldn’t blow a hole in the U.S. economy. Arthur Burns, chairman of the nominally independent Fed, pledged his full support, despite his opposition to what seemed would be the summit’s inevitable result: the abandonment of the gold standard. “Mr. President,” he said, “I’ll help in any way I can.”
At the end of the weekend, each member of the fifteen-man team received a spiffy Camp David windbreaker embroidered with his name, and Nixon interrupted Bonanza to give an address from the Oval Office. The United States was putting in place wage and price controls, attempting to reduce inflation by legal fiat. And the nation was closing down the “gold window,” ending convertibility of the dollar to gold. The financial architecture that the world leaders had created in 1944 in Bretton Woods, New Hampshire, to prevent a recurrence of catastrophe that was the Great Depression was over. And what followed was the twentieth century’s other great failure by the world’s central bankers.
The windbreaker bunch hoped that they had finally found a way to halt inflation that wouldn’t spark a recession. As it turned out, however, the Great Inflation had only begun. Although this failure would have less ghastly consequences than the central bankers’ mistakes of the 1920s and ’30s, Burns was convinced that it would lead to no good.
“My efforts to prevent closing of the gold window . . . do not seem to have succeeded,” the Fed chairman wrote in his diary on the eve of the meeting. “The gold window may have to be closed tomorrow because we now have a government that seems incapable, not only of constructive leadership, but of any action at all. What a tragedy for mankind!”
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Arthur F. Burns was the consummate professor, with white hair parted down the middle, thick glasses, and a pipe perpetually in his hands. He was “invariably courteous, with an old-world flair,” one profiler wrote. Having been born in 1904, he had a deep-seated fear of letting the economy again lurch toward the mass unemployment he witnessed as a young man. “He is a creature of the Great Depression,” a former student said of him in 1969. “That was a period when he was growing to professional maturity, and he saw the whole economic system disintegrate before him. The lesson he learned was that the avoidance of catastrophic change is the first objective of economic policy.”
Nixon made clear that he expected Burns to ensure that the American postwar economic boom didn’t falter on his watch—particularly in the run-up to the 1972 election. “I respect his independence,” Nixon said at Burns’s swearing-in in the East Room of the White House in January 1970. “However, I hope that independently he will conclude that my views are the ones that should be followed.” Lest there be any confusion about what sort of views those were, Nixon continued, “That’s a vote of confidence for lower interest rates and more money.”
Senior Fed staffer Stephen Axilrod recalled being summoned to the White House to give a briefing on the finer points of monetary policy. Toward the end, John Ehrlichman, one of the president’s closest aides, stopped by in a surprise visit. “When you gentlemen get up in the morning and look in the mirror while you are shaving,” Axilrod recalled Ehrlichman saying, “I want you to think carefully abou
t one thing. Ask yourselves, ‘What can I do today to get the money supply up?’” Of Nixon, Burns wrote in his diary, “I knew that I would be accepted in the future only if I suppressed my will and yielded completely—even though it was wrong at law and morally—to his authority.”
When Burns showed flashes of independence, the Nixon administration found nasty ways to apply pressure. Charles Colson, a presidential adviser who would later be implicated in the Watergate break-in, spread the story that Burns had asked for a 50 percent pay raise at a time when he was urging policies to rein in pay hikes nationally. Another rumor spread by the White House held that the administration was contemplating changing the governance of the Fed, putting it under the authority of the executive branch and doubling its board of governors to fourteen members, diluting the chairman’s authority. Burns compared it to FDR’s ill-fated plan to pack the Supreme Court forty years earlier.
Still, the Fed chief responded just as Nixon and his aides had hoped. When meeting with the president, Burns even adopted the language of a political operative. “Time is getting short,” he told the president on December 10, 1971, less than a year before the election, according to Oval Office tapes. “We want to get this economy going.”
Apart from political pressure, Burns’s actions were influenced by some fundamental economic misunderstandings. It was an era of supreme confidence in the ability of wise policymakers to fine-tune the economy, as well as a time that any amount of unemployment seemed unacceptable, even when the trade-off was higher inflation. Two of the greatest economists of their generation, Paul Samuelson and Robert Solow, argued that even 3 percent unemployment—stunningly low by any historical standard—was a “nonperfectionist’s goal.” Inflation had averaged only 2 percent from 1950 to 1968, but in pursuit of exceptionally low unemployment, the Federal Reserve began tolerating prices rising at a faster pace—first 4.7 percent inflation in 1968, then 5.9 percent in 1969. By the end of 1970, Time had published a cover featuring a massively enlarged dollar bill, with a single tear running down George Washington’s cheek and “Worth 73 cents” scrawled in red.
In just a few short years, inflation had lodged deep in the postwar American psyche. Businesses and consumers began to accept ever-rising prices as the new status quo. In a contract negotiated in 1970, the Teamsters union won 15 percent annual pay increases, railway workers got 13.5 percent, and construction workers averaged 17.5 percent. It’s fair to assume that the economic output of truck drivers, railway workers, and construction tradesmen wasn’t in fact rising at double-digit rates during that period. Instead, the higher pay was the result of higher prices. It, in turn, led to even higher prices—for bread and milk and everything else.
This vicious cycle was taking hold in the early 1970s, and Burns did little to stop it. The Fed even cut its interest rate target at the start of 1971, when annual inflation was over 4 percent, then eased policy again in the fall in the aftermath of the abandonment of the gold standard.
The Fed chief also had some bad luck. The weather was lousy for agriculture in the United States in 1972, driving up prices for all manner of food products in 1973. The price of meat, poultry, and fish rose more than 40 percent in the twelve months ending in August 1973—so fast, noted author David Frum, “that steakhouse menus arrived with stacks of little white handwritten stickers over their printed prices.”
And in October 1973, Egypt launched a surprise attack on Israel on the Jewish holiday of Yom Kippur. The United States soon came to Israel’s aid. In retaliation, on October 16, the Organization of Petroleum Exporting Countries hiked the price of oil 70 percent. The action shook confidence in the future availability of oil so much that companies began hoarding it. The price of gasoline in the United States soared from 42 cents a gallon to 55 cents a gallon over the course of only six months, and the psychological toll on Americans may have been even worse than the economic: With rules in place that made it hard to shift supplies away from areas with plenty of fuel to those with shortages, parts of the country simply ran out of gasoline. The iconic image of the era became that of dozens of heavy, inefficient cars lined up at one of the few stations without a SORRY, NO GAS sign out front.
Just as they would three decades later, spikes in commodity prices created a difficult dilemma for central bankers. Higher prices for food and gasoline are normally viewed as one-time jumps beyond the control of central bankers, who don’t generally respond by raising interest rates. But if higher prices feed into self-fulfilling expectations of high inflation, there’s more of a case to raise rates (though the importance of inflation expectations was not widely accepted then, at least among leading policymakers like Burns). For Burns and the Fed, the oil price shock came at the worst possible time, when those self-fulfilling expectations were already getting out of control. Consumer prices rose 8.9 percent in 1973, then 12.1 percent in 1974.
Even after Nixon had resigned in disgrace and the less thuggish Gerald Ford took over in August 1974, Burns and the Fed had no answers. To raise interest rates enough to bring inflation down to a more manageable level, they thought, would cause an unacceptably deep economic downturn. Haunted by the Depression of their youth, it seemed a trade-off they could not abide. In 1978, Burns’s final year in office, the consumer price index rose 9 percent.
To succeed Burns, President Jimmy Carter appointed the hapless G. William Miller Fed chairman. Miller was a corporate chief executive from Oklahoma, a lawyer by training, and had no real background in economics. He placed an egg timer on the table at board meetings to limit the verbose intellectuals to three minutes of talking each. He also put out a THANK YOU FOR NOT SMOKING sign, which his colleagues ignored as they lit up. He viewed the Federal Reserve, a staffer once said, “as a diversified conglomerate of which he was chairman of the board.”
Most significantly, Miller, fearful of a recession, refused to tighten the money supply to fight inflation. By the summer of 1979, with inflation at 10 percent, Carter had had enough. He “promoted” Miller to treasury secretary as part of a cabinet shake-up, a job with less concrete authority. That left him with a vacancy in the Fed chairmanship. He turned to the nation’s most accomplished shaper of economic policy, a man who’d been a civil servant under four presidents and played a crucial role in remaking the international financial system earlier in the decade, including at Nixon’s Camp David retreat during the summer of 1971. It was a personnel decision that would shape the world economy for decades to come—and help ensure Carter’s loss to Ronald Reagan in his 1980 reelection campaign.
Paul Adolph Volcker was a six-foot-seven giant of a man, hired for a giant job. Carter picked him to be Fed chair because, at a time when world financial markets were fast losing confidence in the U.S. economic system, Volcker, then president of the New York Fed, offered something no other candidate could: instant credibility. In his meeting with the president before the appointment, Volcker told Carter he was inclined to tighten the money supply to fight inflation. That’s what Carter was looking for—but he almost certainly didn’t understand just what he was getting.
Volcker, a jowly man with a tendency to mumble, had done brief stints in banking but never spent enough time in the private sector to acquire much wealth. The son of a town manager in Teaneck, New Jersey, he smoked cheap Antonio y Cleopatra cigars, lived in a tiny, cluttered apartment in Washington, and ate dinner in a dingy Chinese restaurant rather than the grand salons of Georgetown. In a quirk of the Federal Reserve System, he had to take an approximately 50 percent pay cut to accept his promotion. (Heads of regional Fed banks, viewed as similar to private-sector employees, are paid more than members of the Board of Governors, who are considered more purely public servants.) The second most powerful man in America made about $60,000 a year.
Consumer prices rose 13 percent the year Volcker took over. One Fed governor, Henry Wallich, had been a boy in Germany during the German hyperinflation of the early 1920s. “I used to say that I never, never
thought this could happen in the United States,” Wallich once said. “But now I only say one ‘never.’” By September, Volcker had concluded that the entire Fed playbook needed to be scrapped. Instead of just raising interest rates here and there to try to target the price of money a different approach would be needed—one that would almost certainly drive up the cost of borrowing to unprecedented levels.
On an air force jet en route to an International Monetary Fund conference in Belgrade, Volcker explained his plans to Carter’s economic advisers. They didn’t like them one bit. Sure, Carter wanted lower inflation. But higher interest rates affect the economy with a lag of many months. There was barely a year to go until the president would be running for reelection, which meant that just as their boss was asking voters for another term, unemployment would be skyrocketing due to the new Volcker policy.
As it happens, the retired Arthur Burns was also headed to Belgrade, where he gave a lecture. He described how central bankers, no matter how much they may wish to fight inflation, can’t really do so without the support of political authorities. The speech, full of self-justification and excuse making, had the melodramatic title “The Anguish of Central Banking.”
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October 6, 1979, was a historic day in Washington. John Paul II was in town for the first papal visit to the White House. And Paul Volcker had summoned the Federal Open Market Committee to a grand boardroom overlooking the National Mall to try to finally end the Great Inflation. The meeting began a few minutes after 10 a.m., three and a half hours before Carter greeted His Holiness at the North Portico. “Scylla and Charybdis have now come together,” Volcker said, meaning that there were simultaneous great risks of economic contraction and continued rapid inflation. “The idea that we can absolutely thread the needle between the risks is probably a nice hope, but it may be an illusion. At this stage you’ve got to place your bets one way or the other and move.”