Volcker was quite proud of the design and sent it for comments and suggestions to select members of the Volcker Group. Robert Solomon, a senior staffer at the Fed and an expert in international trade, pointed out that it was a great ideaâso great, in fact, that John Maynard Keynes had proposed almost the same thing thirty years earlier, while planning for the Bretton Woods conference.
38
Volcker did not mind retracing the steps of the great British economist but worried how a monetarist sympathizer such as George Shultz would react to a Keynesian initiative.
On Tuesday, September 26, 1972, George Shultz began his address to a standing-room-only audience at the International Monetary Fund
conference with a message straight from the University of Chicago's free-market playbook. “We can now seek a firm consensus for new monetary arrangements that will serve us all in the decades ahead ⦠Our mutual interest is encouraging freer trade in goods and services and the flow of capital to the places where it can contribute most to economic growth.”
39
But when it came to outlining the details, Shultz laid out Volcker's Plan X, emphasizing that “a workable international agreement will ⦠take as a point of departure that most countries will want to operate within the framework of specified exchange rates.”
40
Volcker had thought that Shultz would adopt Milton Friedman's scheme for freely floating exchange rates. The treasury secretary had reviewed Volcker's draft with Friedman a few days before his talk.
41
Instead, Shultz put his Chicago colleague's proposal on the back burner, knowing that the finance ministers of the world were not ready for truly radical reform. The treasury secretary was not a monetarist ideologue like his former colleague. He was a consensus builder who had learned that patience paid dividends. Besides, he did not have to wait long to get what he truly wanted.
Willy Brandt, chancellor of West Germany, concerned over renewed speculation against the dollar in favor of the German mark, sent a classified cable to Richard Nixon on Friday, February 9, 1973.
42
“If we do not succeed in stabilizing the present situation on exchange markets by joint and rapid action, the future development would lead to dangerous political consequences. The cohesion of the Free World would be endangered economically, psychologically, and finally, also politically, at a moment when ⦠it is of utmost importance to negotiate on the basis of unity of the Western countries.”
43
Brandt makes it sound as though controlling foreign exchange ranked alongside nuclear nonproliferation in the survival kit of a democratic world. Perhaps he exaggerated, but the devaluation wars in Europe during the 1930s still haunted politicians. And the German chancellor knew firsthand about international crises, having been the mayor of West Berlin in 1961, when the Soviet Union sanctioned the construction of the wall separating East Berlin from West. Brandt had also hosted JFK's visit to the divided city on June 26, 1963, when Kennedy gave his “Ich
bin ein Berliner” speech, in defiance of the Communist regime. Now he wanted something narrower, more specific, but apparently worthy of his personal attention. “I would appreciate if the American monetary authorities would, in the future, do everything in their power to support the [dollar-mark] exchange rate.”
44
Nixon responded to Brandt within a dayâafter all, this was about the German mark and not the Italian liraâbut he sidestepped the technical details and emphasized a broad diplomatic effort he had already initiated. “I appreciate your constructive message on international monetary developments ⦠I had come to the same conclusion as you on the importance of our authorized representatives working together immediately to find solutions. It was for this reason that I dispatched Paul Volcker on his trip to Tokyo and Europe on Wednesday [February 7]. He is fully cognizant of my thinking on these matters.”
45
Nixon had been paying attention to foreign exchange, which at the time competed with the Watergate scandal for front-page news.
46
Speculators were shifting funds out of dollars and into the mark and the yen because Americans continued to spend too many greenbacks abroad. The president had sent Volcker to Japan after cabling Prime Minister Kakuei Tanaka, “Because the continued JapaneseâUnited States [trade] imbalance is so central to the problem [of disturbances in the currency markets] ⦠I have asked Mr. Paul Volcker, Under secretary of the U.S. Treasury for Monetary Affairs, to fly to Tokyo to relate the reasons for our conclusion that action must be taken immediately in the exchange rate field if we are to remain in command of the situation.”
47
Volcker had arrived in Tokyo on Thursday evening, February 8, the first leg of his secret globe-trotting mission to stabilize world financeâagain. He went directly to the home of Finance Minister Kiichi Aichi, a venue with less press surveillance than the ministry office, and outlined a U.S. proposal to make American products more competitive. Volcker suggested a 10 percent devaluation of the U.S. dollar against gold and a 10 percent upward valuation of the yen, for a combined 20 percent appreciation of the Japanese yen versus the dollar.
Aichi recoiled at the size of the proposed revaluation, which would exceed the Smithsonian adjustment. “That is a shock.”
48
Volcker asked, “Is that a big shock or a little shock?”
“It is a big shock ⦠a Volcker shock ⦠big like Mr. Volcker.”
Paul smiled. “There would be no purpose talking to the Europeans if it were anything less.”
Aichi suggested floating the yen, allowing the exchange rate to move freely with supply and demand without interference from the Bank of Tokyo, but the finance minister could not commit to a formal revaluation until he saw what Germany was prepared to do. “Fixing a new rate would be a highly political decision.”
Volcker had hoped for more but suspected that temporarily floating the yen would lead to a substantial appreciation versus the dollar. Paul thought he had enough leeway to continue his journey, and boarded a military transport taking him to Europe. The plane was a converted Boeing KC-135 tanker, outfitted with full accommodations for the overnight journey.
After Volcker was airborne, he received a final communiqué from Aichi through Roger Ingersoll, the U.S. ambassador to Japan. Ingersoll telephoned Jack Bennett, Volcker's deputy at the Treasury, with the following message: “The Japanese finance minister asked me to express his concern about the publicity of âour travelling friend's' visit to Tokyo, and of his strong hope that no word would leak out of his visit, especially since the finance minister was questioned about whether the United States had pressured Japan into closing the foreign exchange market ⦠If there were any publicity the finance minister would say it was a visit by âthe travelling friend' to his very old friend, the Japanese finance minister, on his way to Europe.”
49
Aichi's amateur cryptography, like a schoolboy slipping a concealed note to a classmate, amused Volcker. He did not mind the label “travelling friend” as an alias, but doubted it would jump-start a second career as a spy. The
New York Times
disparaged the weak undercover effort when Volcker arrived in West Germany. “At six feet seven inches and 240 pounds, Paul Adolph Volcker, the Under Secretary of the Treasury for Monetary Affairs, has certain obvious problems as a secret agent in foreign capitals.”
50
The
Times
headline encouraged Volcker not to give up his day job as a monetary diplomat. “Mr. Volcker has come to be thought of as the Henry Kissinger of monetary diplomacyâthe intellectual master of arcane international affairs ⦠who often speaks
abroad for the United States government ⦠The Nixon Administration confirmed his globe girdling search for means of resolving the new monetary crisis.”
51
Volcker made Bonn the first stop of his European tour, to consult with Helmut Schmidt, the German finance minister. Schmidt, who would soon succeed Willy Brandt as chancellor, was staunchly pro-American and spoke flawless English. He surprised Volcker with an opening harangue: “The United States does not understand how much damage the last ten days has done to European-American relations ⦠It seems as though the U.S welcomed the monetary crisis ⦠You believe this is a good development.”
52
“I can assure you that's not the case,” Volcker said, realizing that he could not have given that response prior to August 15, 1971. Back then, he had urged John Connally to exploit the foreign exchange crisis to justify suspending gold convertibility. “My trip here is in part a response to Chancellor Brandt's request to the President. The major problem is Japan, but Europe tooâ”
Schmidt interrupted, as though he was cross-examining a hostile witness. “How great is your basic deficit with Europe?”
“Four billion dollars with Japan and a half billion with Europe, but Japan has been shuffling out of the dollars it receives from us and they wind up in the Bundesbank. It is a multilateral problem.”
“The problem is a dollar problem ⦠And do not make the mistake of underestimating the political repercussions.”
“I came to Bonn to work things out.”
“We should have sat together a week ago ⦠It is late.”
“The time is ripe for resolving the crisis.”
Finally, Schmidt softened. “Okay, let us do it this weekend.”
Volcker paused before proceeding with a concrete proposal toward floating exchange rates. He suspected that unless they acted now, it would take years of international negotiations to implement. And he had already accepted the compromise. “One possibility would be a common European float against the dollar, and a separate float of the yen versus bothâ”
Schmidt interjected, “This would not be the worst solution, but it isn't feasible ⦠time is very short.”
Volcker knew that only another upheaval could precipitate the
change. “The difficulty is that no one is ever prepared to move except in a crisis.”
At a late night news conference on Monday, February 12, 1973, the day Volcker returned from the weekend of negotiations that concluded his global tour, Treasury Secretary George Shultz announced a 10 percent devaluation of the U.S. dollar against gold. Shultz said that the increase in the official gold price from $38.00 an ounce to $42.22 an ounce was “a technical change” with “no practical significance,” considering that this official price differed so much from the free-market price, now quoted at $68.95.
53
Shultz had a point, but this did not prevent the American devaluation from making front-page headlines in the
New York Times
and the
Washington Post
. Even the
Times
of London, the standard-bearer of British understatement, could not resist the temptation.
54
Newspapers need provocative headlines to entice readers, but they were right to feature the U.S. devaluation. It was the second time in fourteen months that the dollar had been devalued after remaining stable at thirty-five dollars since 1934. The devaluation advertised America's culpability in the crisis and served to lubricate the engine of international financial negotiations.
Volcker had spent the previous four days traveling thirty-one thousand miles from Washington to Tokyo (for his friendly chat with Aichi), to Bonn (for Schmidt's lecture), to London (for a conference with Chancellor of the Exchequer Anthony Barber), to Paris (where Valéry Giscard d'Estaing played host), to Rome's Leonardo da Vinci airport (Finance Minister Giovanni Malagodi was waiting for him), back to Paris (with Malagodi in tow), and finally home (to get a clean shirt and a cheap cigar).
55
Along the way, he engineered a depreciation of the dollar against the mark and the yen. A day after the announcement of the devaluation against gold, the dollar purchased only 2.96 marks and 270.0 yen compared with 3.15 marks and 308.0 yen prior to the talks.
56
Volcker succeeded by enabling foreign politicians to use the devaluation against gold as cover for dollar depreciation. Japanese prime minister Kakuei Tanaka denied any involvement. “We should appreciate that the United States ⦠felt its responsibility deeply and devalued
the dollar.” Tanaka avoided saying that the Bank of Japan would allow the yen to float up in value in the foreign exchange market. German finance minister Helmut Schmidt described the American devaluation as “vindicating” Bonn's policies because the mark would remain stable relative to its European trading partners.
57
The Italians disapproved of the entire process because Britain, Germany, and France had negotiated as an exclusive clique with the United States, rather than working through the European Common Market. The daily
Il Tempo
in Rome carried a front-page editorial with the headline “The Snubbed Lira.”
58
The Italians were right (even more than they knew at the time).
Dollar depreciation would defuse the crisis by making U.S. exports more competitive on world markets, with the resulting incentive to “buy American” reducing the glut of greenbacks abroad. Perhaps even the U.S. Treasury would switch allegiance from Sony to Motorola. Unfortunately, these shifts in consumption would take time, and no one knew this better than Volcker.
At a February 16, 1973, news conference, Volcker warned that the “full effects” of the devaluation would take more than two years.
59
“If there is anything we've learned it's that exchange rate changes ⦠can only work their way through the system and restore the flows in the balance of trade over a period of time ⦠And that period of time seems terribly long as you wait for it to happen.” More ominously, he added, “An exchange rate action almost inevitably has a perverse impact in the short run. It is going to make imports more costly in particular, and the trading pattern in the short run is set ⦠You may go backwards before you go forwards.”
60