Volcker (26 page)

A report at the beginning of the conference call by Peter Sternlight would have been amusing under different circumstances.
²
“There has been word from our [trading] desk—I think [it] … actually started in the foreign exchange markets—about a rumor that Chairman Volcker has resigned. And this is having a downward effect on the securities market.”

Volcker clarified his position only half jokingly, having been shadowed by reporters since the crisis began. “The answer is ‘not yet.' ”

Joseph Coyne, the board's public information officer, added, “We will be saying ‘absolutely ridiculous.' ”

Volcker knew that such denials could be counterproductive, and he wanted to avoid fanning the speculative fever that had erupted during the week. He concluded with “I'm asking for a Papal blessing of this meeting … I will see you all in the morning at nine-thirty. Thank you.”

The pontiff must have been listening.

The events of the previous seven days had erased any lingering doubts Volcker had about the need for drastic measures. He had returned the three-page draft memo to Stephen Axilrod and Peter Sternlight on Friday, September 28, with instructions to add numerical details for a special meeting of the FOMC on his return from Europe. That evening, he boarded an air force jet, along with Treasury Secretary William Miller and Charles Schultze, chairman of Jimmy Carter's Council of Economic Advisers, to attend a meeting of the International Monetary Fund in Belgrade. They had a scheduled stopover the next day in West Germany to meet with Chancellor Helmut Schmidt. Volcker took the opportunity to brief the president's two top economic aides about his plans. They were not pleased.

Shultze, a traditional Keynesian who had been at the Brookings Institution, the liberal Washington think tank, before joining the administration, complained, “We're not against raising interest rates, but the monetarist links are unproven and inflexible.”
³
Volcker said, “Rest assured that I will not put monetary policy on automatic pilot.” Schultze worried about an exit strategy. “Once you go down this road, it will be difficult to go back.” Volcker emphasized, “Let's take one step at a time. This is an opportunity we cannot pass up.”

Volcker had checked the foreign exchange market before they boarded the plane and reported that the dollar had fallen to 1.74 marks, capping a 4 percent decline since the September 18 discount rate debacle. The U.S. currency had dropped to its lowest level since the record of 1.72 marks reached prior to the dollar-rescue operation in November 1978.
⁴
Volcker worried about a repeat performance. “That is not an eventuality I would like to see and it's important that it not happen.”
⁵
Schultze considered the dollar a sideshow, having cut his teeth on domestic problems as director of the Bureau of the Budget (later Office
of Management and Budget) in the Kennedy administration. Volcker knew that he would gain reinforcements in Hamburg. The U.S. currency would take center stage under the direction of Helmut Schmidt.

The German chancellor did not disappoint. He hosted a lunch for Volcker, Miller, and Schultze, with Otmar Emminger, head of the German central bank, attending as well. While everyone ate, the chancellor talked.
⁶
“The world needs stability much more than anything else,” he said, repeating a message Volcker had heard from him in February 1973, when the dollar was worth three marks. Now Schmidt had to be content with a more modest objective, one that reflected America's diminished status. “I would like to get back into a world in which the dollar would be two marks and stable.”

Schmidt's lecture cheered Volcker but irritated Schultze. “He was at his egotistical worst,” the chairman of the Council of Economic Advisers said.
⁷
Volcker almost concurred: “He was at his egotistical best.”
⁸
A scheduled news conference at the end of the four-hour meeting was canceled, but a joint press release stated, “Both sides agreed [that] … exchange rate stability … and a strong dollar are in the interests of both countries.” A reporter asked Schmidt about the significance of the meeting as he departed in his limousine. The chancellor smiled. “We had a good lunch.”
⁹

A very public lecture by Arthur Burns in Belgrade saddened Volcker as much as Schmidt's private sermon had pleased him. On Sunday, September 30, as a prelude to the gathering of the world's central bankers and finance ministers for the IMF meetings, Burns delivered the annual Per Jacobsson lecture entitled “The Anguish of Central Banking.”
¹⁰
William McChesney Martin introduced Burns with “I am proud to say [he] was my successor at the Federal Reserve,” but that was before Burns's message.
¹¹

Volcker arrived late and had to sit on the floor, cross-legged, with his back to the wall. He flipped through a copy of the talk while listening to the former chairman explain why “central bankers, whose main business … is to control inflation, have been so ineffective in dealing with this worldwide problem.”
¹²
Burns blamed inflation on the “political currents that have been transforming economic life in the United States and elsewhere since the 1930s.”
¹³
In particular, “budget deficits have become a chronic condition of federal finance … [and] when the
government runs a budget deficit it pumps more money into the pocketbooks of people than it withdraws … [and] that is the way … inflation … has been raging since the mid-1960s.”
¹⁴

Volcker recalled how Milton Friedman had told that same story in his
Newsweek
article “Burns on the Outside,” after Carter replaced Burns as chairman. “We have been having inflation not because evil men at the Fed have been willfully turning the printing press, but because John Q. Public has been demanding inflation [by] … asking Congress to provide us with ever more goodies—yet not to raise our taxes.”
¹⁵
The root cause of inflation was excessive government spending, according to Friedman and his former professor, plus the political reality that prevented, in Burns's words, “the Federal Reserve … [from] frustrating the will of Congress to which it was responsible—a Congress that was intent on providing additional services to the electorate.”
¹⁶

Volcker knew that government deficits made life difficult for the central bank, forcing a Fed chairman into the role of a Marquis de Sade tightening interest rates to painful levels to restrain private spending to make room for Uncle Sam. But blaming the inflation of the 1970s on government deficits ignored the Federal Reserve's timidity under Burns's leadership.

Volcker recalled a conversation between Nixon and Burns during the weekend of August 13, 1971, at Camp David that came closer to the truth. Nixon had suggested labeling his proposed tax relief for business an employment tax credit.
¹⁷
“The businessman will not give a damn what it's called as long as he gets it.” Burns thought for a moment and said, “I would add in [a] personal tax break.” The president smiled. “You are too softhearted, Arthur, to be a banker.” Burns sighed. “I have not been at it long enough.”

Nixon may have been a crook, but he was a perceptive crook.

The press attending the Belgrade meeting painted Burns's talk as an “insider's view of the relations between the Fed and other parts of the Government.”
¹⁸
The
Wall Street Journal
concluded that “Arthur Burns … contributed to the uneasy mood here … [His] main conclusion was that given the political and economic forces feeding inflation in the industrial nations ‘it is illusory to expect central banks to put an end' to the wage price spiral by themselves.”
¹⁹

The reaction in the marketplace suggested that Burns had irritated
the speculators as well as the central bankers. On Monday, October 1, the day after the former Fed chairman's speech, gold rose to $414.75 an ounce, a jump of 4 percent from the previous close on Friday, September 28.
²⁰
The new speculative burst convinced Volcker to cut short his stay in Belgrade and return to Washington to complete work on the Axilrod-Sternlight memorandum. William Miller and Charles Schultze urged him to remain a little longer to avoid the appearance of a panicked departure. The delay did not help.

Volcker's exit the following day from Belgrade created more confusion than Burns's apologia. The London gold fixing, normally a fifteen-minute negotiation to find a consensus price to clear the market, took more than two hours on Tuesday, October 2, 1979.
²¹
The price of the yellow metal hit an all-time high of $442 an ounce, up more than 6 percent from the previous day, before settling at $426 at the close of London trading.
²²

The
Wall Street Journal
explained: “Gold skyrocketed … and then plummeted … all touched off early in the European business day when it was learned that Paul Volcker … had left a meeting of the International Monetary Fund … while the session was still under way.”
²³
Rumors that “South American central banks were dumping their dollar reserves … for gold … and Arab oil producing countries also were giving up the United States currency” fed the gold-buying spree.
²⁴
Speculation that Volcker's departure meant that “a new dollar-defense program would be initiated” triggered the subsequent sales of the precious metal.
²⁵

The speculative gyrations convinced Volcker to meet on Thursday, October 4, with members of the Board of Governors in the Special Library, an intimate setting down the marble hallway from the board-room in the Fed's headquarters. It was the day before the conference call inviting the entire membership of the FOMC to their clandestine gathering, and he wanted to build a consensus beforehand. “I had to avoid a repetition of the September 18 division over the discount rate, when Partee, Teeters, and Rice dissented.”
²⁶

The smell of leather-bound books and furniture polish give the Special Library, a wood-paneled room resembling a formal den, a sense of
Federal Reserve history. The original board table from the Fed's early home in the U.S. Treasury dominates the center of the room, and builtin bookshelves filled with Annual Reports since 1914 line the walls. Fixed to the lip of the mahogany tabletop are brass nameplates about two inches wide, each identifying a member of the original Federal Reserve Board.
²⁷
It is as though the seats along the sides of the rectangular table are reserved for the ghosts of Adolph Miller, Charles Hamlin, and Paul Warburg. Only the nameplate at the head has disappeared, leaving two well-lacquered tiny holes as a reminder of the vanishing.

The missing nameplate belonged to the secretary of the treasury, the ex officio chairman of the Federal Reserve Board until 1935, who sat at the head of the table whenever he chose to attend meetings.
²⁸
Resentment toward the Treasury runs deep within the Federal Reserve bureaucracy, dating back to 1914, when the board became a reluctant tenant on the second floor of the Treasury Building, and continuing through the accord in 1951, when the Treasury finally freed the Fed from its obligation to maintain a ceiling on U.S. interest rates.
²⁹
The Special Library celebrates Federal Reserve history by honoring the original board table and by suppressing the treasury secretary's nameplate. Volcker's plan to focus on the monetary aggregates and set interest rates free would bury the remnants of the Treasury's influence.

The meeting in the Special Library identified “speculative activity in the gold market which appeared to be spilling over into other commodity markets.”
³⁰
Charles Partee, a dissenting troublemaker back in September, sounded the alarm.
³¹
“I was extremely bothered by the market developments of the last two weeks. I think the spreading of the gold [market psychology] into the more remote metals is very bothersome. Silver we understand and platinum we understand, but the spreading to copper, zinc and lead is very bothersome … It leaves one with the thought that because of a run from currency—a desire to get into goods and out of money—we might have now a new development in our economic experience.”

The touch of panic in the Special Library pleased Volcker.

“We wouldn't be here today if we didn't have a problem with the state of the markets, whether international or domestic,” Volcker said to the
FOMC shortly after ten o'clock on Saturday morning, October 6, 1979. “I think the rumors that were floating around in the market yesterday—first that I had resigned and then that I had died—are symptomatic … that the psychology … is ready to crack open, depending upon what decisions they see coming out of here.”
³²

Volcker recalled his admiration for former treasury secretary George Shultz, who built a consensus for floating exchange rates with an even-handed approach, suppressing his preferences to promote an exchange of views. The crisis atmosphere encouraged Volcker to follow suit and present the alternatives to the committee like a judge instructing a jury. “I think there are broadly two possibilities. One is taking measures … thought of as the traditional type … a discount rate move … a significant increase in the federal funds rate … some reserve requirement changes … The other possibility is a change in … our operations as outlined in the memorandum that was distributed … with a greater effort to … achieve a money supply target … recognizing that would require a wider range for the federal funds rate.”
³³

Volcker paused to assess the somber mood at the table and then continued to underplay his hand, like a poker player holding a pair of aces.