Volcker (17 page)

It did, but the country that led its downfall surprised him.

Volcker could not fight the president, so he battled the Federal Reserve chairman instead. On Friday, May 12, 1972, in Montreal, Arthur Burns gave the keynote speech before an international monetary conference sponsored by the American Bankers Association. He confronted the assembled financiers from twenty countries with an apocalyptic threat: “It is an urgent necessity to start the rebuilding process [of the international monetary system] quite promptly … If cooperative efforts … are long postponed … we might then find the world divided into restrictive and inward-looking blocs … a world of financial manipulation, economic restrictions, and political friction.”
⁹

Burns presented a Ten-Point Program to avoid disaster, including a call for responsible domestic economic policies, a confirmation of greater exchange rate flexibility in a revised Bretton Woods System, an endorsement of a diminished role for gold as a monetary asset, and a plea for greater international cooperation. None of these was considered confrontational, except perhaps for the last comment on cooperation, which was a swipe at Connally for his aggressive negotiating
style. The treasury secretary had been referred to as “Typhoon Connally” during his fall 1971 trip to Japan.
¹⁰

Burns then stuck his nose where it did not belong by suggesting that America restore “some form of dollar convertibility into gold” as part of the total package of reforms. Volcker, who represented the Treasury at the conference in Connally's absence, was not pleased. He believed (at least at this point in his career) that U.S. international financial policy was made at 1500 Pennsylvania Avenue, next door to the White House, in the building fronted by a statue of Alexander Hamilton, the first secretary of the treasury, and not in the marble edifice on Constitution Avenue that housed the Federal Reserve Board. “The Treasury was in charge of America's gold, and we had not yet decided what to do about convertibility, except that it was best to say nothing. Arthur had gotten too far ahead. We could never resume convertibility without running a sustained surplus in our balance of payments. And for that we would need further concessions on exchange rates.”
¹¹

Volcker held a news conference repudiating the authority of the Federal Reserve chairman in terms that would have made John Connally proud. He assured everyone that Dr. Burns “is not speaking for the United States government” and added that Burns's statement “certainly wasn't any kind of a model for reform.”
¹²
The press described the Treasury's view of Burns's Ten Point Program as “not being in quite the same class as the Ten Commandments that Moses brought down from Mount Sinai.”
¹³

Arthur Burns did not like having his authority challenged, although the reference to Moses probably fed his ego despite the negative context. When asked why he had spoken out on convertibility when the administration had refrained from putting forward any specific proposals, he said, “In the United States we have an independent central bank. This was my decision.”
¹⁴
Apparently Burns believed in an independent central bank when it came to gold but not interest rates.

On Tuesday, May 16, less than a week after Arthur Burns launched his guided missile at the U.S. Treasury, John Connally dropped a bombshell of his own. He resigned as secretary of the treasury. Connally had been saying that he “was tired after his eighteen months of service in
Washington,” but no one had listened.
¹⁵
The
New York Times
political columnist James Reston speculated that this was a prelude to the national elections in the fall, designed to “give the Republicans Texas in November … on a Nixon-Connally ticket.”
¹⁶
But that prediction never materialized. Spiro Agnew remained Nixon's running mate, and Connally returned to Texas to practice law.
¹⁷
No one in Washington missed him more than Volcker.

“It was a great personal loss,” Volcker deadpans. “I had already thrown out all of my argyle socks.” And then he adds, “I learned how to get things done from a master tactician. His tough talk produced results because he had the political clout to back it up. And that was because he not only ran the Treasury but was also the chief economic spokesman for the administration. He sat at the head of the table, a position that promotes success … if you follow through.”
¹⁸

Connally's rough negotiating style had won grudging admiration abroad. Britain's national daily newspaper the
Guardian
called him “a political superstar, the Nixon administration's John Wayne.”
¹⁹
His record at Treasury also garnered qualified praise from a not-so-friendly domestic press. The
New York Times
editorialized: “History has still to decide whether his tough tactics did more harm or more good. Unquestionably, his threats and pressures did produce a realignment of exchange rates more advantageous … than had been anticipated.”
²⁰
And the
Washington Post
reported, “European finance ministers with whom he came in contact stood in positive awe of him, and found him a shrewd and tough bargainer.”
²¹

The president coupled the announcement of Connally's resignation with the appointment of George Shultz to succeed him. Nothing could have been more threatening to Volcker, except perhaps if Milton Friedman himself had set up a classroom inside the Treasury Building. Shultz had tried to convince Nixon to accept floating exchange rates and had denigrated Volcker's earlier support for the status quo. Moreover, Volcker had thrived under Connally's bare-knuckle diplomacy, perhaps because foreign finance ministers were pleased when Volcker showed up to talk instead. He would not enjoy that advantage compared with Shultz, who was as conciliatory in public as Connally was confrontational.

Volcker should have worried, but he had grown since the last changing
of the guard at Treasury, when John Connally replaced David Kennedy. Serving as the president's international envoy had boosted his self-confidence. He did not even think about tendering his resignation to Shultz, and the new treasury secretary did not ask for it.

George Shultz and Paul Volcker needed each other. Shultz had a doctorate in economics from MIT but had focused his entire career on the domestic economy and labor negotiations. Moreover, he was the proverbial invisible man to America's trading partners across the Atlantic, despite his influence with the president. The
Washington Post
commentator Hobart Rowen said, “The trickiest problem for Shultz may be in the international area. He is almost unknown to the financial men in Europe and Asia and for a while is sure to rely heavily on the irreplaceable technician's brilliance of Under Secretary Paul A. Volcker.”
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Volcker, of course, needed Shultz to complete what he had started: establishing a firm foundation for international finance. The Smithsonian Agreement was a fragile structure that could be easily wiped out by another financial hurricane. Volcker knew how vulnerable the system was and began to consider compromise.

The gold market wasted no time registering concern after the May 16, 1972, announcement that Shultz would replace Connally. The free-market price in London jumped to an all-time high of $57.50 an ounce on the news.
²³
A U.K. bullion dealer said, “Speculators are moving into gold in some force,” and a Montreal coin dealer added “Gold coins are just disappearing from the shelves, everybody wants to hold them to see what happens.”
²⁴
The speculators did not have to wait long to cash in.

On Thursday, June 22, 1972, Volcker testified before the House Banking and Currency Committee on the future of the international monetary system, offering a surprisingly flexible vision. He said that “the reform must have a wide agenda, including the related issues of trading rules, investment and development … it must be deep and not just a patch-up of Bretton Woods … and there is widespread agreement that the future system of exchange rates must provide for greater flexibility than in the past.”
²⁵
Volcker set a generous two-year timetable to complete the process.

He also said, in response to a question triggered by weakness in the
pound sterling, “I certainly have no expectation that Britain would devalue the pound.” He pointed out that “Britain still has a surplus in her balance of payments and nations with a surplus are in no position to devalue their currency.”
²⁶
Volcker meant that only countries with a balance-of-payments deficit should be allowed to gain a competitive advantage through devaluation.

A day later, Chancellor of the Exchequer Anthony Barber announced that the United Kingdom would allow its currency to float, rather than adhere to the bands agreed to at the Smithsonian. Britain had effectively devalued the pound sterling by refusing to buy the excess supply of pounds in the market.
²⁷

“Those SOBs hung me out to dry,” Volcker recalled. “I was embarrassed.”
²⁸

Britain's defection displeased Volcker but bothered almost no one else. When H. R. Haldeman, Nixon's chief of staff, asked the president if he wanted to see presidential assistant Peter Flanigan's report on the British devaluation, his immediate response was “I don't care. Nothing we can do about it.”
²⁹
When Haldeman added that Flanigan said the devaluation showed the wisdom of our refusal to resume convertibility, Nixon responded, “Good. I think he's right. It's too complicated for me to get into.” Finally, Haldeman tried to stoke Nixon's interest with a message from Arthur Burns, saying that the Federal Reserve chairman was concerned about follow-up speculation against the Italian lira. Haldeman's effort clearly backfired when Nixon snapped, “I don't give a shit about the lira.”

This infamous remark cannot compete with other Nixon gems, but it seems strange coming from the man who hailed the Smithsonian Agreement on currency values “the most significant monetary agreement in the history of the world.” Of course, Nixon had other things on his mind on the morning of June 23, 1972, having just finished a discussion with Haldeman to cover up the break-in at the Democratic headquarters at the Watergate hotel and office complex.
³⁰
He had simply lowered his diplomatic guard and said what most Americans would have said.

The British float upended Volcker's two-year timetable for reform. Six months earlier, in January 1972, he had assigned a review of long-range planning to George Willis, a career civil servant who had just
retired but refused to leave. Willis had been at the Treasury longer than anyone could remember, most recently serving as the director of the Office of International Affairs, and then continuing as a consultant. He firmly denied rumors that he had worked on the charter for the Bank of the United States with Alexander Hamilton, but he only smiled when the topic of Bretton Woods came up. Willis had joined Treasury in 1941, the same year that Harry Dexter White, America's technical expert at the New Hampshire conference, wrote the first draft of the U.S. proposals.
³¹

Volcker asked Willis to survey all the recently proposed reforms and to report back. He received little encouragement from Willis's memorandum. The problem for reform was to maintain stability by retaining central values for exchange rates, while forcing countries with balance-of-payments surpluses, such as Germany and Japan, to reduce their surpluses while allowing those with deficits, such as the United States, to reduce them. Willis told Volcker, “The United States can expect to encounter resistance from all other countries when it tries to reduce its deficit. No country wants us to do this.”
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Whenever Volcker promoted the wisdom of a specific scheme with Willis, he received the answer “It just won't work.”
³³
Sometimes Willis varied the refrain by saying, “That won't work, either.” After one lengthy exchange, Volcker exhaled, turned his palms upward, as though checking for rain, and said, “Okay, George, what
will
work?”

Willis thought for a while and said, “Nothin'.” And for emphasis: “Absolutely nothin' will work.”

Willis was right, of course, but Volcker was not ready to admit defeat.

George Shultz ended the foot-dragging on monetary reform after the British withdrawal from the Smithsonian Agreement. The new treasury secretary planned to make his debut on the world stage at the fall 1972 meetings of the International Monetary Fund and wanted to put forth an American proposal.

Shultz asked Volcker, “Where do we stand on planning?”
³⁴

“We're not that far along,” Volcker replied.

“Well, I'd like to have something for the IMF meetings.”

“Are there any guidelines?”

“Yes, something that has a chance to work. A consensus.”

Shultz's directive surprised Volcker. “I saw another side of the man I had considered a potential adversary. Now that he was in charge of international monetary reform, his instincts as a labor negotiator took over. He wanted to build a consensus on a practical proposal—an approach that I believed in.”
³⁵

Shultz and Volcker shared a commitment to pragmatism, a devotion to implementing a workable solution that advanced a cause. Their relationship benefited from another common bond: Princeton basketball. Shultz had played for the Tigers before graduating in 1942, a few years before Volcker arrived at Nassau Hall. Shultz refuses to confirm or deny that he has a Tiger tattooed on his gluteus maximus.
³⁶

Volcker spent the summer of 1972 mixing fixed and floating exchange rate ingredients to get the right proportions. The outcome, designated Plan X (perhaps to preserve some mystery), allowed currencies to bend but not break in response to forces of supply and demand.
³⁷
The proposal specified “central values” for exchange rates, resembling the par values of Bretton Woods but renamed to reflect increased bands of fluctuation around those values. The scheme required countries with persistent balance-of-payments surpluses to raise the central values of their currencies, and countries with deficits to lower their central values. Limited convertibility of accumulated reserves into gold would be permitted to promote compliance with the rules. For example, surplus countries such as Germany and Japan would be allowed to convert dollars into gold if they raised the value of the mark and yen to make their exports less attractive.