Volcker (9 page)

Volcker was not happy. He did not want Kissinger sticking his Harvard nose where it did not belong. The position of undersecretary of the treasury for monetary affairs reported to the secretary of the treasury and not to the president's national security adviser, which is what Kissinger was at the time. Volcker's responsibilities covered domestic finance, including managing the public debt of the United States, and international economic affairs, covering balance-of-payments analysis and foreign exchange operations. Volcker believed that the mix of domestic and international responsibilities “made it the best job in the government for an economist.”
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Charls Walker, the undersecretary of the treasury, administered the politically sensitive areas: the Internal Revenue Service, the Secret Service, the Bureau of Customs, and the Bureau of the Mint. Kissinger should have been poking around in Walker's business, the sexier side of the Treasury.

But Volcker knew that the balance of payments could provoke national security concerns. He recalled JFK's threat years before to cut off military aid to Europe unless the Europeans promised not to attack the dollar as the world's currency. At a presidential news conference, the first broadcast live to Europe via the Telstar satellite, Kennedy had
said: “The United States will not devalue its dollar. And the fact of the matter is the United States can balance its balance of payments any day it wants if it wishes to withdraw its support of our defense expenditures overseas and our foreign aid.”
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According to the
New York Times
, the Telstar transmission ended abruptly at this point (perhaps not accidentally), allowing the Europeans time to think about whether they wanted America's guns and its dollars, or neither.

At a fundamental level, Volcker believed in the strong currency/ strong country connection. “Those of us on the financial side certainly thought that the stability and strength of our currency was important to sustaining the broad role of the United States in the world.”
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He recalled with a smile the words of William McChesney Martin during a confrontation with McGeorge Bundy, the White House national security adviser under Kennedy and Johnson: “The stability of the dollar would be more important to American security … than precisely how many troops we had in Germany.”
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Volcker had no interest in letting the new national security adviser extend his tentacles into the Treasury. Not a cuddly type by temperament, he considered Kissinger's embrace somewhat premature; they hardly knew each other at the time.

Henry Kissinger began his tenure as Nixon's national security adviser well before Paul Volcker arrived on the scene, and had used the head start to extend his bureaucratic reach. Volcker could not help admiring Kissinger's turf building, and would follow that blueprint going forward, but he would have enjoyed it more had it not come from his backyard. Volcker knew that Kissinger had the president's ear and could not be shut out entirely. He built a boundary by adding the following sentence to Kissinger's memo, leaving only a narrow opening for national security concerns: “The Secretary of the Treasury will refer those issues of importance for basic defense and foreign policy decisions … to the NSC for early consideration.”
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Volcker then walked the revised memo to his boss, Treasury Secretary David Kennedy, for a ratifying signature.

Volcker never heard another word about National Security Memorandum Number Seven, perhaps because Kissinger had more important things to worry about. But Kissinger had confirmed Volcker as chairman of a working group to make recommendations on U.S. international monetary policy. This interagency task force, with representatives from the Department of State, the Council of Economic Advisers,
the National Security Council, and the Federal Reserve Board, became known as the “Volcker Group.”
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The Volcker Group monitored international financial policy between 1969 and 1974. Paul should have sent Kissinger a birthday present—every year in perpetuity.

Volcker had expected trouble before becoming manager of Nixon's balance-of-payments team. He had watched the free-market price of gold rise steadily from thirty-eight dollars on April 1, 1968, to forty-two dollars on January 21, 1969, the day he negotiated his détente with Kissinger. Less than three weeks later, Volcker provoked an outcry from the White House that would not end so pleasantly.

On February 12, 1969, Volcker appeared at a news conference in Paris during a meeting with European bankers and finance ministers to discuss reforms of the international monetary system. The price of gold had made an all-time high in the London market, signaling a red alert. A reporter asked Volcker whether allowing greater flexibility in foreign exchange rates would prevent a further breakdown of the system. Volcker knew exactly where that particular line of thinking had originated, and he responded as though he were swatting a pesky horsefly. “It's being discussed in academic circles, and that's where it can stay.”
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The previous evening, Volcker had been initiated into an exclusive clique of international financiers, known as Working Party 3 (WP3), with a warning about such radical ideas.
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A confusing drive after dark brought him to a Parisian home in a wooded suburb that resembled a mysterious hideaway. After crackers and cheese, Cecil de Strycker of the Belgian central bank took him aside for a private chat in a dimly lit basement that smelled from wine fermenting in wooden kegs. De Strycker summarized the WP3's complaints by shaking his European finger at Volcker and saying, “If all this talk about flexible exchange rates brings down the system, the blood will be on your American head.”

Volcker did not need much encouragement to belittle floating exchange rates, Milton Friedman's pet proposal for monetary reform. He recalled with distaste Friedman's debate with Roosa over the merits of Bretton Woods and fixed exchange rates.
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The two men had battled to a standoff, like champion sumo wrestlers locked in the middle of the ring, except when Friedman took the argument to a personal level. He
said that floating exchange rates would “put an end to the occasional crisis, producing frantic scurrying of high government officials from capital to capital … Indeed this is, I believe, one of the major sources of the opposition to floating exchange rates. The people engaged in these activities are important people and they are all persuaded that they are engaged in important activities. It cannot be, they say to themselves, that these important activities arise simply from pegging exchange rates.”
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Friedman's cynical reference to “scurrying of high government officials” and “important people … engaged in important activities” displeased Volcker. They were not-so-veiled indictments of his mentor, Robert Roosa, who had done more than his share of “frantic scurrying” while at the Treasury. And now Volcker occupied the same position.

Volcker believed in the benefits of Bretton Woods for international trade, just as Roosa did: “Under a fixed-rate system, there is an established scale of measurement, easily translatable from one country to another, which enables merchants, investors, and bankers of any one country to do business with others on known terms.”
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Bretton Woods creates for world trade the type of stability enjoyed by a businessman in New York who exports to Hell, Michigan, or Paradise, Pennsylvania: A dollar in Hell or Paradise is the same as a dollar in New York.

The White House, however, launched a frontal attack on Volcker's suggestion to quarantine floating exchange rates in the ivory tower. The
Washington Post
headlined a rebuke from “high officials” in the administration, identified as Nixon's Council of Economic Advisers (CEA): “We would not be doing our job if we were not exploring the question [of floating exchange rates].”
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The CEA was “at a loss to explain Volcker's comment, except to suggest that it must have been off the cuff and not completely thought through.”
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Secretary of Labor George Shultz, a Nixon favorite who would head two other cabinet departments, supported the CEA. In a subcommittee meeting of the cabinet, he urged the CEA to testify before the congressional Joint Economic Committee in favor of these “new approaches.”
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Shultz, a labor economist by trade, had been a dean at the University of Chicago, home base of Milton Friedman, and would provide a direct pipeline into the administration for Friedman's views.

Volcker understood the arguments in favor of floating exchange
rates as well as anyone, having heard them from just about every academic economist he respected, including Lawrence Ritter, his good friend and confidant.
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Ritter, a finance professor at New York University, had written two bestselling books, one on baseball and another on banking—Volcker's favorite intellectual interests.
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Ritter's congressional testimony in favor of floating exchange rates had triggered a dismissive “What's wrong with your friend?” from Roosa.
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According to the academics, floating exchange rates would cure U.S. balance-of-payments deficits by allowing the price system to work its magic. For example, a U.S. balance-of-payments deficit occurs when Americans import more from the United Kingdom than the British import from America. Under floating exchange rates, the extra dollars chasing after pounds sterling in the foreign exchange market forces up the price of British pounds, making British goods more expensive for New Yorkers and making American goods cheaper for Londoners. A higher price for the pound sterling encourages New Yorkers to buy the MADE IN USA label, rather than ordering snobby English tailoring; and a lower price for the American dollar encourages Londoners to do the same. The U.S. balance-of-payments deficit shrivels through market forces.

Volcker considers flexible exchange rates the easy way out, a deceptively simple solution laced with long-run costs. “There is nothing to anchor the exchange rate at any particular level under floating rates. A rootless exchange rate encourages speculators to pounce on a depreciating currency, pushing it even lower.”
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Roosa had made that point during his debate with Friedman, arguing that depreciating currencies could spiral downward under a system of floating exchange rates.
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Milton Friedman countered that when speculators sell low, hoping to buy even lower, they usually lose money. Speculators might enjoy the excitement, like a day at the races, but they run out of money before long. Roosa claimed that they could inflict considerable damage before going bankrupt.
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Volcker favored fixed exchange rates because it places international financial stability on a giant pedestal, and then anchors the system in fiscal discipline. “A country that runs a balance-of-payments deficit cannot sit back and relax while its currency depreciates. It must retrench and live within its means, just like everyone else.”
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The appropriate
medicine, a tablespoon of tight money, would quiet an overheated economy and bring imports into line with exports. The problem is that swallowing the prescription, which includes a dose of high interest rates, leaves a bad taste.

The red-light alert from the London gold market never flickered during the first half of 1969.
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Preserving the dollar's status had been the focus of Volcker's favorite committee—now called the Volcker Group by everyone who mattered—until April, when France took center stage. President Charles de Gaulle resigned on April 28, 1969, after losing a referendum on his proposal for constitutional reform.
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The Paris newspaper
France-Soir
explained, “The general needs a new coronation every two or three years.”
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He left in a huff when he did not get it.

No one at the Treasury shed a tear; the French president's fetish for American gold still rankled. An earlier Treasury Department memorandum had warned Richard Nixon prior to a meeting with de Gaulle that “the basic French attitude toward the international monetary system is fundamentally different from ours.”
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But de Gaulle had lost his popular mandate because of the discipline he administered six months earlier to preserve the value of the French franc. Perhaps it was selfish, for the “Glory of France,” but it was also a beachhead in the battle for fixed exchange rates—so everyone at the Treasury paid attention.

The French had been spending too much in Germany, primarily because of Prussian efficiency but also because Parisians enjoyed Hamburg night life more than Berliners liked Place Pigalle. (Prices were too high in Paris for reasonably similar services.) French francs were piling up in Germany, and the Bundesbank, the German central bank, had to buy the French currency to prevent a price decline. The exchange rate between francs and marks, or between any two currencies, remains fixed only when central banks make it so, by buying a currency that is in excess supply and selling a currency in excess demand. That was how exchange rates were maintained in the Bretton Woods System.

De Gaulle knew that the Bundesbank would absorb a temporary excess of francs in the marketplace, but would gag on a continuous influx. Prolonged purchases threatened Germany with inflation because whenever the Bundesbank bought francs with marks, the German
money supply increased.
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France would have to cut back on imports from Germany, including Hamburg's favorite attractions, or watch the franc depreciate.

De Gaulle implemented an austerity program in November 1968—fiscal discipline to prevent a devaluation of the French franc … just what the Fixed Exchange Rate Doctor ordered. He rallied support with a somewhat incoherent patriotic plea, “Frenchwomen! Frenchmen! What is happening in regard to our currency proves to us once again that life is a struggle, that effort is the price of success, that salvation demands victory.”
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Government budget restraint succeeded in maintaining the franc's value, but within five months it cost de Gaulle at the polls. A young worker in the Orléans railway station explained the problem: “I've no confidence in anybody. I vote my pocketbook, and it says no.”
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