Volcker
The Triumph of Persistence
WILLIAM L. SILBER
Introduction: More Than a Central Banker
Prologue: The Three Crises of Paul Volcker
Part II: Confronting Gold, 1969â1974
Part III: Fighting Inflation, 1979â1987
Part IV: The Twenty-First Century
Personal Records and Correspondence
In Memory of Pauline R. and Joseph F. Silber
More Than a Central Banker
Five American presidents, three Democrats and two Republicans, spanning nearly half a century, have called on Paul A. Volcker to serve the government and the people of the United States. John F. Kennedy made him deputy undersecretary of the treasury for monetary affairs in 1963; Richard Nixon named him undersecretary of the treasury for monetary affairs in 1969; Jimmy Carter appointed him chairman of the Federal Reserve Board, America's central bank, in 1979; Ronald Reagan reappointed him chairman in 1983; and in 2008, President-elect Barack Obama named him chairman of the President's Economic Recovery Advisory Board.
Carlo Ciampi, the former president of Italy, sent Volcker a three-word letter upon hearing of President Obama's assignment. The message sits in a chrome frame on Paul's desk: “We trust you.”
Volcker earned his unparalleled credibility over the course of his professional career by approaching public service as a sacred trust. His contributions spread beyond the narrow confines of finance, including investigating the oil-for-food scandal at the United Nations and chairing the commission to settle claims against Swiss banks by victims of the Holocaust. But his tenure as chairman of the Federal Reserve Board between 1979 and 1987 built his legacy. During that time, Volcker did nothing less than restore the reputation of an American financial
system on the verge of collapse. In the last great economic crisis, the epic battle against the Great Inflation of the 1970s, Paul Volcker was the hero. Jack Kimm, a resident of Anchorage, Alaska, penned the following message to him when Volcker left office in 1987. “Losing you at the Fed seems and feels like losing George Patton in the middle of war.”
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This book began as the story of a determined central banker who confounded the critics while defeating an entrenched inflation in America, but turned out to be much more. I will show that Paul A. Volcker not only restored price stability in the United States, but also led a battle for fiscal responsibility in America. Volcker never held elective office, but his refusal to accommodate the Reagan-era budget deficits by creating moneyâwhat economists call monetizing the deficitâforced up real interest rates during the mid-1980s until Congress delivered a plan to balance the budget.
Volcker relied on public opinion, integrity, and persistence to overcome the political pressure to finance government spending the easy way, by printing money rather than by taxation. Congress created the Federal Reserve System, America's central bank, and can abolish it with a simple majority vote. Volcker deflected repeated threats, including a bill of impeachment, and stuck to his principles. His tenure at the Federal Reserve began the process of reining in the deficit. Volcker promoted the goal of fiscal integrity that Ronald Reagan had promised to the American people, turning Reagan into Reagan.
Foreigners rewarded the United States for its monetary and fiscal discipline by investing in U.S. securities and by treating the dollar as a safe haven currency. The United States enjoys lower interest rates and a higher standard of living because countries from China to South Korea send clothing and children's toys to America in exchange for U.S. dollars. Current Federal Reserve chairman Ben Bernanke credits Volcker's policies with setting “the stage for decades of economic growth and stability.”
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Volcker's linkage of responsible monetary policy with fiscal virtue carries a message for today, as the United States emerges from the greatest financial crisis since the Great Depression. Unprecedented low
interest rates and easy money policies to lower unemployment provoke fears of rekindling inflation when the economy recovers, and the enormous structural budget deficit confronting America fans those fears. The Federal Reserve promises to reverse field to contain inflationary pressures, but that commitment is suspect, with the memory of recession still fresh, unless Congress and the president agree to a balanced budget at full employment. Reckless fiscal policy threatens the dollar's status as a reliable international store of value and the exorbitant privilege that confers on American consumers.
The need to integrate monetary and fiscal policies gained intellectual currency in 2011, when Thomas Sargent was awarded the Nobel Prize in Economics. The New York University economist considers that “Good monetary policy is impossible without good fiscal policy.”
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Sargent advanced the concept of rational expectations in economic behavior and offered historical evidence from the hyperinflations of the 1920s that credible monetary policy needs grounding in fiscal responsibility. Volcker learned the power of expectations while an apprentice on the trading desk at the Federal Reserve Bank of New York. I will show that his subsequent policies revealed an appreciation of rational expectations before that principle gained acceptance.
This book is divided into four parts. Part 1 sets the stage, describing Volcker's formative years at home, in school, and his early work experience at the Federal Reserve Bank of New York. part 2 chronicles his role surrounding President Nixon's suspension of the dollar's convertibility into gold on August, 15, 1971, America's final break with the gold standard, which Volcker considers “the most significant single event” in his career.
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Part 3 traces Volcker's actions as chairman of the Federal Reserve Board from 1979 through 1987 to defeat an escalating inflation that President Jimmy Carter cited as promoting a “crisis of confidence” in America.
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Part 4 describes his role in formulating what President Obama labeled the Volcker Rule in 2010, designed to protect the American taxpayer from having to repeat a bailout of a crippled financial system. A brief prologue weaves the common theme underlying the three crisesâ1971, 1979, and 2010âthat tested Paul Volcker.
This biography of Volcker's professional life tells the story of how principle, determination, and pragmatism blend into effective leadership. Volcker understood the need to compromise, and some of his concessions, such as the bailout of Continental Illinois, the seventh-largest U.S. bank in 1984, set a costly precedent in public policy. But he knew where to draw the line, when to build credibility and when to spend it. And that good judgment turned Paul Volcker into an American financial icon.
Paul cooperated in this project by arranging for the release of thousands of documents from the U.S. Treasury and the Federal Reserve System that are the foundation of this biography. He added a personal touch by sitting (not always happily) for one hundred hours of interviews. He also shared his school records and reports that had been carefully guarded by his mother, Alma Volcker. However, this is not an authorized biography: Paul did not think it appropriate to exercise editorial control over the final product. He refused to read it until after it went to press. Nevertheless, Volcker's presence towered over this project despite his efforts to impose distance. He is alive and well at the writing of this final draft, and that surely had an impact on my thinking.
I have tried to remain objective by drawing on a lifetime studying the intricacies of money and finance, but my choosing to unravel the Volcker mystique did not occur by accident. In 1966, at age twenty-three, I taught my first class to twelve graduate students at what is now called the Stern School of Business at New York University. Most of the students in this seminar in money and banking were older than I, including Alan Greenspan, who had just returned to school to begin his work toward a doctorate. (He got an A.) I later served for almost ten years with Ben Bernanke on the Economic Advisory Panel of the Federal Reserve Bank of New York. Greenspan and Bernanke followed Volcker as Federal Reserve chairmen and acknowledge standing on the shoulders of a titan, and that perspective is close to where I was when this project started. Upon further review, I agree with that assessment, but as I have outlined in this introduction, for much broader reasons than I originally thought.
A letter from Paul Volcker dated March 17, 2008, launched this venture
. His note to me, written a day after the Federal Reserve System, America's central bank, arranged a bailout of the investment banking firm Bear Stearns, read, “Thanks so much for that messageâall the more on a day that I'm feeling rather depressed about current problems taking the âFed' to or beyond the limits!”
My message to Paul Volcker, sent a week earlier, had nothing to do with Bear Stearns, the Federal Reserve, or the crisis that refused to die. It had to do with a conversation I had relayed to Paul about my student Rebecca Solow. Rebecca had told me, “I have been keeping my grandfather up-to-date about your lectures. He was most pleased with what I have learned, especially when you told us that Paul Volcker was the greatest Federal Reserve chairman in American history.” That observation may not be controversial today, but it was far from the consensus a generation ago.
Rebecca's grandfather is Robert Solow, winner of the 1987 Nobel Prize in Economics. Bob is witty and personable, in addition to being very smart. He is also a die-hard Keynesian who, like so many public intellectuals, lamented Paul Volcker's anti-inflation policy of the early 1980s, and the accompanying unemployment, as it unfolded. He described the Federal Reserve as “stuck in the embarrassing position of having their finger in the dike and believing they are the country's last hope.”
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If
he
wants his granddaughter to appreciate the Volcker legacy, which requires historical perspective, then so, too, should everyone else.
The Three Crises of Paul Volcker
On Thursday, January 21, 2010, Paul Volcker and Vice President Joseph Biden flanked Barack Obama behind the lectern in the White House's Diplomatic Reception Room, site of Franklin Delano Roosevelt's fire-side chats during the Great Depression. After a yearlong battle among the administration's economic advisers, the president was about to unveil the financial regulatory plan Volcker had advocated. Volcker's main adversaries, Treasury Secretary Timothy Geithner and White House National Economic Adviser Lawrence Summers, stood like soldiers at parade rest awaiting the president's orders. Volcker radiated his usual cheer, as though he were attending a funeral rather than celebrating a victory.
Volcker had been appointed chairman of the President's Economic Recovery Advisory Board in November 2008, a newly created oversight panel reporting to Obama. Volcker was eighty-one, and his bald head fringed with white hair highlighted the generation gap with Geithner, Summers, and other members of the president's economic brain trust. “They are younger than my kids,” he observed later to anyone who would listen.
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Volcker's appointment had raised expectations in some quarters.
Newsweek
magazine commented, “Ah, finally an adult.”
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But with little staff and no policy responsibilities, he disappeared from view
soon after the election. When a reporter implied that Volcker had lost influence, Paul responded, “I did not have [any] to start with.”
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