Volcker's anxiety subsided after he recognized that the crisis provided cover for a policy change America needed. He urged Connally to permit the upheaval “to develop without action or strong intervention by the U.S. ⦠[and to use] as negotiating leverage ⦠suspension of gold convertibility ⦠to achieve a significant revaluation of the currencies of the major European countries and Japan”
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The loss of $400 million in gold during the second week of Mayâto Belgium, Netherlands, and (of course) Franceâhad brought U.S. gold stocks to the lowest level since the years before World War II, and made the suspension of convertibility even more urgent.
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The burgeoning crisis would legitimize the “cold blooded suspension” Volcker had proposed two months earlier, deflecting the resentments and justifying an otherwise unpalatable economic decision.
John Connally prepared for a public performance as though he had studied drama at the Actors Studio, and Volcker took notes: “At the annual meeting of the International Monetary Conference in Munich [at the end of May 1971], which brought together the leading commercial
and central bankers, ⦠[Connally] sat through all the meetings and the elaborate lunches and dinners, quietly sizing up his audience and their thinking before delivering the traditional closing address.”
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Connally showed Volcker that preparation includes more than just knowing what to say; how to say it is equally important. Unlike other finance ministers, Connally took his own measure of the assemblage, and planned his words and cadence accordingly. “He taught me a lot,” says Volcker.
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Paul had, in fact, drafted his boss's remarks, but when Connally showed him the final version, it had a very different ending than the ambiguous conclusion Volcker had written. “It was pure Connally in tone,” says Paul, “and I could never do it, no matter how much I practiced.”
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Connally planned to end his speech with dramatic flair: “I want without any arrogance or defiance to make abundantly clear that we are not going to devalue, we are not going to change the price of gold, [and] we are going to control inflation.”
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Volcker swallowed his disbelief and asked Connally if he wanted to say that so strongly. “After all, we might have to end up devaluing before too long.”
Connally did not hesitate. “That's my unalterable position today. I don't know what it will be this summer.”
The response stunned Volcker into silence.
Paul admired John Connally's social skills and had learned much from the master politician. He had stopped wearing socks that slid down below his ankles and switched to a dry cleaner who impressed a sharp crease in his trousers. But there were limitations. Volcker could never wear blinders like a carriage horseâthey simply did not fit around his large head. He preferred to equivocate, qualify, and risk being branded a poor communicator, rather than feign certainty. His reluctance to skate near the boundary may have prevented him from ever becoming treasury secretary, but it would eventually turn him into the most trusted man in America.
Although Connally ignored Volcker's suggestion that he scale back his rhetoric, he clung to Volcker's battle plan. Not only did Connally allow the crisis to proceed unchecked, but he attacked those in the White House who questioned the strategy.
Paul McCracken, the soft-spoken former University of Michigan
economist who headed Nixon's Council of Economic Advisers, lamented the dollar crisis in an early June memo to the president: “We have just muddled through another international monetary crisis ⦠[but] we cannot be sure of having escaped entirely or permanently.”
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Connally's response to Nixon sent a direct shot at McCracken. “Given our present international economic and financial position, some monetary disturbances ⦠are virtually inevitable ⦠[But] I must take vigorous personal exception to [McCracken's] premises and conclusions ⦠Far from âmuddling through' the recent disturbance ⦠[we] quite deliberately avoided a strong reaction.”
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McCracken's memo to the president also included an argument for floating exchange rates. “A system that combines rigidly fixed exchange rates with free trade and capital movements appears to be unworkable ⦠You recognized this two years ago ⦠when you decided that the U.S. would ⦠support a study of greater [exchange rate] flexibility ⦠but it has not so far led to concrete results because ⦠the attitude of some our own representatives has been lukewarm at best.”
Connally recognized Volcker's image painted in lukewarm strokes, so he concluded his rebuttal with the following observation: “In view of recent developments it is hard for me to see how informed observers could think the flexibility issue is dead. But its specifics do involve difficult tactical as well as substantive questions ⦠[which] are under active review within the Treasury and in the Volcker group.”
The president weighed the exchange and issued a ruling, like the judge and jury he was. He sealed the fate of events to come by appointing Connally “the lead man” in making a recommendation about dealing with the crisis, with instructions that Connally “consult with Paul McCracken, Arthur Burns, George Shultz ⦠and your own experts.”
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Volcker smiled.
Paul created a briefing book about the size of a New York City telephone directory, detailing all aspects of the New Economic Policy.
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He divided the black loose-leaf binder into two parts. Section A contained an extensive set of bogus plans in case subversives (such as a
Washington Post
reporter) managed to procure a copy. Section C contained the real plans and was divided into twelve tabs, starting with
“Suspension” and extending through “Balance of Payments Controls.” Volcker had purposely omitted a section B, as another confusing diversion should the plans fall into enemy hands.
Connally had supplemented Volcker's recommendations on gold convertibility and the wage-price freeze with a proposal for a 10 percent import surcharge. Volcker had warned that the surcharge could spark a protectionist war with U.S. trading partners, but Connally insistedâprecisely because it would disturb the Germans and Japanese, forcing them to bargain in good faith.
On August 2, 1971, John Connally used the briefing book's details and his considerable personal charm to convince Richard Nixon to act.
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The 4 percent drop in the dollar against the German mark since the Bundesbank allowed the rate to float in May, and the spike in gold to over forty-two dollars an ounce, had brought matters to a head. But the president wanted to wait until Congress returned after Labor Day before implementing the plan. He had heard about the risks of suspension from Federal Reserve chairman Arthur Burns, and worried that closing the gold window “could cause a panic.”
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Nixon told Connally to bring Paul McCracken and George Shultz up to speed, but to warn them both about leaks. “And that means tell Shultz that he cannot talk with Milton Friedman.”
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Shultz had been relaying to the president Friedman's arguments for floating exchange rates.
Volcker liked the presidential embargo on discussions with Friedman but worried about the delay. “I did not want us to wind up implementing the package out of desperation.”
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On Thursday morning, August 12, after reports from Frankfurt, London, Tokyo, and Milan that speculation had pushed the German mark to its highest level against the dollar in more than twenty years, forcing massive intervention by all the world's central banks, Volcker turned desperate.
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He telephoned Connally at his Texas ranch, where the treasury secretary had gone for a brief vacation. The conversation made it briefer:
“I think you'd better get back here quick.”
“Thanks. I'm on my way.”
George Shultz had met with Nixon a number of times on August 12 and, in keeping with his training as a labor negotiator, had counseled patience. The president did not need much convincing to stick with the original timetable.
Nixon said, “We're not really ready. To get everyone ready we have to go to Camp David. September 7 seems like the right time ⦠The decision should be made by you, Connally, Burns, and me. I know Connally will want to bring Volcker ⦠but he's so obsessed by things international ⦠I don't know.”
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Shultz saw an opening to push his agenda. “Volcker also thinks we should solve the international problem by restricting the domestic economy ⦠but I don't think you want to do that.”
“Never ⦠Unfortunately, I don't have a hell of a lot of confidence in Volcker.”
Connally went directly from the airport to the White House at 5:30 on the afternoon of August 12, joining the president and George Shultz in the president's office in the Old Executive Office Building. Nixon was pleased to see him, greeting Connally with a loud “I'm glad you're here,” but the president seemed determined to avoid being stampeded.
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“I don't think we should do the whole program right now, especially the freeze and the import surcharge ⦠but if you think shutting the gold window must be done immediately then you can announce it yourself ⦠making it sound like a temporary measure, as a prelude to a complete package.”
Connally had no intention of getting out in front on this and appealed to Nixon's addiction to grand gestures. “The problem with doing this piecemeal is that people will keep worrying about what is coming next ⦠especially if we just close the gold window. It will seem clear that we were forced into it. Doing the whole package at once means that you have thought this through carefully ⦠You will seize the initiative.”
Nixon circled back to his concerns about the gold window. “Actually, Arthur [Burns] wants just the freeze. He thinks the risks of suspension are too great.”
“Arthur is talking like a central banker. You have the best man in the country down here. Why don't you talk to Volcker about this yourself.”
Connally had relied on Volcker's technical expertise and thought the president should as well, but Nixon had other ideas, courtesy of Shultz. “Volcker thinks we ought to sacrifice the domestic economy to save the dollar. I'm not in favor of that.”
Connally sounded surprised to hear this. “Well, I certainly don't think like that and I'm pretty sure Volcker doesn't either.”
“Good. That is why we are going to continue with an expansionary policy.”
“I agree ⦠but the public will believe that you are serious about controlling inflation if you announce the freeze.”
George Shultz had been listening to the interchange and began discussing the details needed to implement the wage-price freeze. The president interrupted him, in a clear and authoritative voice:
“What I think we should do, after hearing all of the possibilities, is this ⦠We ought to do the entire program at once, announcing it this coming Monday. We'll have a meeting at Camp David starting tomorrow afternoon. I'll have it all set up. But we need total security. The fewer people the better. The three of us will be there, make sure we have McCracken, and of course, Arthur must be involved.” Nixon paused, and then did a graceful pirouette. “And John, you bring Volcker.”
The meeting began on Friday afternoon, August 13, 1971, at the presidential retreat at Camp David in Maryland's Catoctin Mountains.
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It ended three days later, on Sunday morning, August 15, 1971. The president's message to the country that evening lasted a total of twenty minutes.
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Those twenty minutes changed Paul Volcker's life.
At 12:00 midnight on Sunday, August 15, 1971, Volcker boarded a refitted military transport plane on the runway at Andrews Air Force Base headed for battle with European finance ministers. Nixon had lit the fuse three hours earlier with his address to the American people on network television outlining the administration's New Economic Policy. The plan, hatched over the weekend at Camp David, invoked the Trading with the Enemy Act of 1917 to impose some of its emergency measures, and threatened global economic warfare.
1
Most foreigners would not care about the most dramatic announcement, the three-month freeze on wages and prices imposed by the president, except to marvel that a California Republican had adopted a Social Democrat's approach to controlling inflation. But America's trading partners would resent the suspension of gold convertibility, which tarnished their dollar holdings, and the 10 percent surcharge on imports, which made their exports less welcome on American shores. Those measures were the equivalent of a declaration of economic hostilities.
The president had asked John Connally to lead a news conference the next day in Washington, a coveted spotlight for Nixon's chief economic spokesman. Connally assigned Volcker the task of conducting a private meeting with foreign central bankers and finance ministers in
London, launching Volcker's transformation from monetary technician to international financial diplomat.
Paul could not wait to embark on his mission. He felt like a wartime emissary dispatched to cool a provocation. Volcker had always regretted missing the call to action during World War II, blaming himself for failing to convince the draft board that he was short enough to fight. Now he looked forward to defending his country, to maintaining the supremacy of the American dollar as the world's premier currency, and to ensuring the stability of international trade within the framework of a revamped Bretton Woods System. It was the beginning of a new career.
Volcker replayed the whirlwind weekend in his head as he settled into the cavernous hull of the transport plane. The meeting at Camp David had been conducted in total secrecy: no reporters, no phone calls, and by order of the president, no representatives from the State Department. Nixon had been almost dismissive: “I want this kept secret ⦠don't bother with the foreign relations types.”
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Volcker thought the president's distrust of the foreign affairs bureaucracy had deep roots, extending back to Nixon's days as a congressman on the House Un-American Activities Committee, and his pursuit of Alger Hiss, a State Department official accused of espionage in 1948 and convicted of perjury in 1950.