A massive dollar-rescue operation launched on Wednesday, November 1, 1978, delayed Volcker's first substantive FOMC dissent for five months. Treasury Secretary Michael Blumenthal, the former president of Bendix Corporation, a company that made home washing machines and antilock braking systems for cars, convinced President Jimmy Carter of the need for drastic measures, including a significant increase in U.S. interest rates.
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Anthony Solomon, who held Volcker's old position as undersecretary of the treasury for monetary affairs, then orchestrated a $30 billion intervention in the foreign exchange market, the equivalent of total warfare on anti-dollar speculators.
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Solomon implied that the Treasury would abandon the policy of benign neglect toward the dollar that had ruled since floating exchange rates had replaced Bretton Woods. “The point has come where Adam Smith had to be curbed.”
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Adam Smith was not a speculator, of course, but he took the blame as the founder of modern economics.
Volcker participated in the dollar rescue by requesting an increase from 8½ percent to 9½ percent in the discount rate charged by the Federal Reserve Bank of New York for lending reserves to its member banks. Unlike most changes in the discount rate that occur after a fundamental shift in policy by the FOMC, the November 1 increase signaled a new initiative. Establishing the discount rate is one of the few prerogatives left to the regional Federal Reserve banks, but the Board of Governors in Washington must approve all changes. Volcker recalls, “I was only too happy to conduct a special telephone meeting of my directors to vote for an increase once I knew Washington would approve.”
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Foreign exchange markets painted a new outlook. On the day the rescue package was announced, the dollar rose by 6 percent against the German currency, and a month later it had jumped to 1.93 marks.
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Had the Frankfurt cabbie not spurned the greenback, he would have earned a profit of more than 10 percent during November.
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The program also punished gold speculators. An ounce of the precious metal declined from its peak of $243.65 on October 31, 1978, to $193.40 at the end of November, a decline of more than 20 percent.
The rise in U.S. interest rates restored a shine to the tarnished dollar, but Volcker expected the gains to fade without follow-through, especially if inflation accelerated. He had good reason for concern. Corporate
borrowing showed no signs of tapering off with the increased cost of funds. The controller of R.H. Macy, Mortimer Leavitt, said that the department store's “aggressive capital spending program hasn't changed in light of any recent events. The company ⦠will just go along with interest rate increases. If you want to eat ⦠you pay the price. You don't stop eating.”
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A spokesman for St. Joe Minerals Corporation, the largest producer of lead and zinc in the United States, added, “Much of our spending is on a long lead-time basis and we certainly wouldn't leave things sitting there half or three-quarters finished.”
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By the March 20, 1979, meeting of the FOMC, almost five months had elapsed since the Treasury's rescue of the dollar, and the annual rate of inflation had moved into double digits.
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Volcker sounded the alarm.
I think we're in retreat on the inflation side; if there's not a complete rout, it's close to it. And in my view that poses the major danger to the stability of the economy ⦠It's an obvious danger for international stability [especially] ⦠if the dollar ⦠should [return to] the panicky situation we had earlier ⦠There's no doubt in my mind that ⦠this is the time for some firming rather than the reverse. I think we are at a critical point in the inflation program, with the tide against us.
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Volcker faced a battle.
Frank Morris, a friend of Paul's ever since they shared an office at the Treasury when JFK was president, served on the FOMC in his capacity as president of the Federal Reserve Bank of Boston. Morris had been on the committee for over ten years, more than twice as long as Volcker. He had been appointed president of the Boston Fed in 1968 from a select list of candidates that included one six-foot, seven-inch financial economist from Chase Manhattan Bank. Volcker recalls: “They chose well. Frank is a first-rate economist and a devoted central banker ⦠but it did rankle at the time. It is the only job I was ever turned down for, unless I count when the Federal Reserve Board refused to hire me right after I finished Princeton in January 1949.”
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On Tuesday, March 20, 1979, Morris staked out a position diametrically opposed to Volcker's. “I think we're facing an emerging conflict between the domestic and international requirements of monetary
policy ⦠I think we're approaching a cyclical peak in the economy sometime around midyear ⦠If it's our objective to avoid a recession, I think we have to [ease] today; I don't think we can wait for another month ⦠I think the issue is whether we seriously are concerned about avoiding a recession or not.”
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Frank Morris knew from his long experience on the FOMC that members responded more to the domestic economy than to international finance, in keeping with its congressional mandate to “promote full employment ⦠and reasonable price stability.”
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In 1913, Congress conferred its constitutional right “to coin money and regulate the value thereof” on the Federal Reserve System. The central bank's obligations have changed over the years, in response to economic circumstance and political pressure, but the Full Employment and Balanced Growth Act of 1978, also known as the Humphrey-Hawkins Act, formalized the goals of full employment and price stability. Foreign exchange remained in the Senate cloakroom.
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Morris argued that Volcker's recommendation to tighten credit was inconsistent with those priorities. “Paul, I think, is resigned to a recession; I think the international constraint may be more of a factor in his thinking than he let on.”
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Volcker felt cornered. He had gone on record with an incriminating message a few months earlier, in a speech at the University of Warwick in Coventry, England, that received considerable attention.
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“It has been a difficult matter to bring ⦠exchange market stability to bear on a Congress ⦠preoccupied with the domestic economy ⦠In retrospect the case can be made that ⦠more forceful response to pressures on the dollar would have ultimately been helpful in promoting domestic as well as international stability ⦠Today, a stronger and stable dollar is plainly in the interest of the United States and the rest of the world.”
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Volcker tried to navigate a response to Morris that would salvage the case for tighter credit while avoiding perjury. “Inflation is a factor in my thinking.”
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He told the truth, but Morris's speech carried the day.
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The FOMC refused to tighten, and Volcker, with three others, voted against the decision. The press labeled the FOMC dissenters “the Volcker minority.”
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In the three months ending June 1979, prices increased at nearly 13 percent per annum, a relentless acceleration in the rate of inflation that caused both resignation and resentment across the country.
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Terry Grantham, a college student and painter's helper in Lubbock, Texas, said, “Every day that goes by it seems like the money I have doesn't buy as much ⦠I was raised as a steak and potatoes boy, but now it ain't that way no more. Forget the steaks and go with hamburger or bologna.”
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But Ron Gordon, a baseball fan in San Francisco, rebelled. He refused to accept the nickel increase in the price of hot dogs and beer at Candlestick Park, where the Giants played their home games.
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Gordon assembled an inch-thick folder of statistics and protested before the San Francisco Recreation and Park Commission, which had approved the five-cent price increases. His effort attracted the attention of Alfred E. Kahn, President Carter's chairman of the Council on Wage and Price Stability, who praised his “heroic and unflagging campaign.”
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Ron Gordon prevailed on hot dogsâthe price increase was rescindedâbut he lost on beer. His batting average, a respectable .500, exceeded Jimmy Carter's by a wide margin. The president's approval ratings declined to 30 percent in June 1979.
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At a meeting of the National Association of Broadcasters in Dallas, he had been asked whether the federal government was not the main cause of inflation.
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It was the same question he had gotten earlier, in Elk City, Oklahoma. The president smiled and said, “That seems to be the most popular question.” Wayne Hardrow, of the North Carolina Association of Broadcasters, summed up the mood with “Where do we go from here?” as if inflation were a mysterious fourteenth-century plague.
On Sunday evening, July 15, 1979, President Jimmy Carter delivered his diagnosis to the American people in a televised speech from the Oval Office. The president had spent the previous ten days at Camp David discussing the country's problems with industrialists, labor leaders, economists, pastors, and ordinary Americans (not necessarily in that order). His thirty-three-minute talk addressed the details of the country's dependence on foreign oil, but his broader message focused on “the crisis of confidence” that he considered “a fundamental threat to American democracy.”
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Carter lamented that “for the first time in our history a majority of our people believe that the next five years will be
worse than the past five years.” He recognized that “the phrase âsound as a dollar' was an expression of absolute dependability until ten years of inflation began to shrink our dollar and our savings.”
Two days after his speech, Carter requested the resignation of his entire senior staff, a housecleaning to signify a fresh start. Instead, it created confusion. The president removed five of his cabinet members, including Treasury Secretary Michael Blumenthal, who had run afoul of the so-called Georgia Mafia in the White House.
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In November 1978, Blumenthal had convinced Carter to support the discount rate increase that had accompanied the dollar rescue package. He compounded his offense in April 1979, by publicly calling for an increase in interest rates soon after the “Volcker minority” had urged a tightening of credit conditions.
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When asked at his final news conference whether he had jumped or was pushed, Blumenthal answered, “I took advantage of an opportunity to get paroled with time off for good behavior.”
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Blumenthal's firing provided fodder for talk show hosts such as Johnny Carson on
The Tonight Show
. “Treasury secretary Blumenthal did not handle his job too well. He asked for his severance pay in Krugerrands.”
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No one had to tell the late-night television audience that the Krugerrand was South Africa's gold coin. Carter's cabinet shakeup had triggered an overnight jump in gold to over $300 an ounce, a new record.
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The
New York Times
commented that the resignations “significantly intensified European worries” and quoted a specialist at Samuel Montagu & Company, a leading London gold trading firm: “Seen from over here this looks pretty awful.”
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The president replaced Blumenthal with Fed chairman William Miller, considered by Carter's political advisers more of a team player. The switch delighted Miller, who was pleased to bequeath his egg timers to the next Fed chairman, whoever that might be. The vacancy at the central bank worried America's trading partners.
Gilbert de Botton, general manager of Zurich's Bank Rothschild, said, “My feeling is one of gloom. Washington is becoming more politically organized.”
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A European finance minister who preferred to remain anonymous said, “I hope that whoever now becomes dominant will pursue a conservative monetary policy and not delude themselves into thinking that they can float the United States ⦠by adopting an
inflationary policy.” The press reported, “Several European officials and bankers suggested that Paul A. Volcker ⦠would be an ideal choice” for Federal Reserve chairman.
Volcker met with the president on Tuesday, July 24, 1979, in the Oval Office. They were joined by William Miller, the new treasury secretary, who had called Volcker at the New York Fed the day before to set up the meeting. The discussion lasted less than an hour, and Volcker knew it had not gone well. He returned to New York that same afternoon.
On the flight back, he thought about the other names appearing publicly on the short list to succeed Miller.
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He knew them all well. Bruce McLaury, Volcker's former deputy at Treasury and now president of the Brookings Institution, the liberal Washington think tank, had been mentioned as a possible candidate. David Rockefeller, the chairman of Chase Manhattan Bank, had also been listed. Volcker had worked for Rockefeller during his two stints at the bank. And A. W. (Tom) Clausen, the CEO of Bank of America, a third name in the hopper, had offered Volcker the number-two job there when he left the Treasury. It was an impressive group, and Volcker wondered whom the president would pick, now that he had talked himself out of the job.
After landing at LaGuardia Airport, Volcker called his two best friends, Larry Ritter and Bob Kavesh, and asked them to dinner for a postmortem. They met at Parma, a neighborhood Italian restaurant around the corner from Volcker's Seventy-ninth Street apartment on the East Side of Manhattan. Ritter and Kavesh, about the same age as Volcker, were professors at NYU's Graduate School of Business. Volcker had gone to Harvard with Kavesh and had overlapped with Ritter at the New York Fed. “They would not bullshit me about anything,” Volcker says. “Barbara liked them for the same reason.”
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