Interest rates had declined across the board since the confirmation of easier monetary policy in October 1982, with the overnight funds rate below 9 percent and the ten-year bond rate dipping to nearly 10 percent in early May 1983.
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In 1975 the drop in short-term rates had been accompanied by an increase in long-term rates because of a surge in inflationary expectations, an early warning that had been ignored.
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Interest rates had behaved thus far, since the FOMC meeting last October,
but he worried about remaining too easy for too long.
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America's suffering had been too great to squander.
Volcker thought this would be his last chance to make a difference. He was fifty-five years old and knew that Barbara was right: They had nothing except this huge apartment they had bought in 1975, when no one wanted to live in Manhattan except multimillionaires and junkies. They fit neither category. He did not mind living like a graduate student in D.C., but he was embarrassed that Barbara, suffering from crippling arthritis and diabetes, had to take in a boarder to help pay the monthly bills.
Volcker had always thought that by age sixty he would have enough to retire, perhaps to teach those who were similarly foolish enough to devote their lives to public service. He did not have much more time to complete his professional goals or to meet his personal responsibilities. But he could not step aside. Instead, he proposed a compromise, one that he expected would provide time to put inflation to bed and then to repay his debt to Barbara. “I will tell the president that if he chooses to reappoint me I will leave midway throughâafter two years.”
It did not happen that way.
The battle over Volcker's reappointment as Fed chairman had begun even before Ronald Reagan took office. In November 1980, soon after the election, the press reported that Edwin Meese III, head of Reagan's transition team, who would be named counselor to the president with cabinet rank, had said that “Mr. Reagan was committed to keeping William Webster as Director of the Federal Bureau of Investigation in his job but he would not make the same commitment to asking Paul Volcker to remain in his.”
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Meese added for good measure that it would be “difficult” to conceive of a Democrat as part of Reagan's cabinet, since a Democrat would not be “committed” to all the president-elect's beliefs.
Volcker certainly had lived up to Meese's suspicions. Even after his détente with the president in February 1982, Volcker continued to rail against the structural budget deficits that stretched well into the future. At the outset, Ronald Reagan had no choice but to accept Volcker until his four-year term as Federal Reserve chairman expired in August 1983.
Congress had installed this misalignment with the presidency as a speed bump when it created the Fed, to slow the executive branch's influence over the central bank. But now the president could chose his own chairman, someone less outspoken, someone more committed to his program.
Not all Republicans agreed with the strategy. Reagan had campaigned on two economic principles, eliminating inflation and balancing the budget. Neither objective seemed feasible at the time, especially price stability. Keynesians had labeled inflation intractable, and monetarists distrusted Volcker's pragmatism. And yet, two years after Reagan's election, Volcker had reduced inflation by two-thirds. Moreover, he served the higher purpose of absorbing complaints like a giant lightning rod.
Reagan's support for the “Kemp-Roth Tax Cut” in 1981 and his buildup of military spending doomed his promise to balance the budget. But Volcker's refusal to monetize the deficits by buying up government bonds shielded Americans from the most extreme consequences. High real interest rates sanctioned by monetary restraint had forced Reagan to increase taxes during the summer of 1982 and to return to greater fiscal discipline than would otherwise have prevailed. The renewed credibility had gained stature for the U.S. dollar in world markets. The greenback bought 2.5 German marks at the end of May 1983, a jump in value of 25 percent since Reagan took office.
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The high-flying dollar delivered more than just a boost to national pride. Reagan could now finance his unprecedented $200 billion deficits in Europe and Asia, softening the impact of the deficit on U.S. interest rates.
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Real rates remained high by historical standards, but would have been even higher without the huge foreign appetite for American securities. Conservative columnist George Will teased French president François Mitterrand over the “flight of French capital to America.”
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The French franc had declined by a staggering 60 percent against the dollar since the end of 1980.
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Will, brimming with Republican genes, supported Volcker's reappointment. “For their finest accomplishment, reduced inflation, [the Republicans] are deeply indebted to a Democrat appointed by Jimmy Carter. The DemocratâPaul Volckerâmay be more important than
Ronald Reagan this summer [of 1983] when the recovery hangs by a thread of confidence worn thin by congressional paralysis and exploding deficits.”
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Will blamed the Dump Volcker campaign on the “West Wing (of the White House) ⦠trying to wring every imaginable political advantage ⦠out of every decision.” The influential Ed Meese occupied a corner office in the West Wing.
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Reagan apologized to Volcker for leaks about successors to the chairmanship. The press advertised the leading candidates, including Alan Greenspan, who ran his full-time economic consulting firm in New York, and Preston Martin, who served with Volcker at the Federal Reserve, having been appointed vice-chairman of the board by Reagan in 1981.
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Milton Friedman was mentioned as a dark horse candidateâ probably just to irritate Volcker.
Friedman had belittled Volcker's record during a meeting of the President's Economic Policy Advisory Board, a group of mostly outside consultants, in April 1983. According to the
New York Times
, Friedman “laced into the Fed Chairman for steering the country towards the rocks,” while the other attendees listened, including Arthur Burns, who took a few extra puffs on his pipe during the harangue.
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Newsweek
reported that Friedman had “leveled a finger at Volcker” and told the president that “because of the policies of the Fed under that man we have had an inflationary surge in the money supply that is going to have to be corrected.”
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Volcker, who usually attended these advisory sessions as a guest, remained silent through “the savaging.”
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At the end of the meeting, the president sidestepped the verbal bullying and said to Volcker, “I'm sorry about this spate of stories. I want you to know that I have simply not addressed [the chairmanship] issue yet.”
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Friedman's attack certainly did not improve Volcker's prospects.
Volcker had requested a meeting with the president scheduled for Monday, June 6, 1983, after his discussion with Barbara and after he had nearly lost a vote at the FOMC meeting a week earlier. He had favored a slight “snugging up” of interest rates to signal an end to the easy-money period, but after a lengthy discussion within the FOMC, the vote was tied.
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He was not pleased, recalling how William Miller had
lost control of his committee after voting with the minority on a discount decision in 1978. He would not make that mistake, and said to his colleagues, “Well, someone's going to have to change [their] vote ⦠we will sit here until somebody has a better idea.” Theodore Roberts, who had just succeeded Lawrence Roos as president of the Federal Reserve Bank of St. Louis, finally said, “Okay, Mr. Chairman, I give in.” Volcker then rewarded everyone: “Now we can go eat, if we don't have any other business.”
Volcker knew he had to end the speculation over the chairmanship. He was pleased that the appointment on June 6 was late in the afternoon in the White House residence, where he had met privately with Reagan before. He waited for the president in the West Sitting Hall, which serves as an informal living room for the first family, but was caught by surprise when Nancy Reagan entered wearing an elegant red evening dress. Volcker said, “Madam First Lady, you look quite beautiful.”
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The president, out of sight but right behind her, responded to the uncharacteristic flirt. “Congratulations on your good taste, Mr. Chairman.”
After an exchange of pleasantries, Nancy Reagan left, and Volcker turned to business: “Mr. President, we are in a sensitive period, both domestically and internationally, and you do not need a lame duck as Fed chairman right now. But there is something I should tell you before you announce a decision, whatever it is. I think I've been here long enough, so if you choose to reappoint me, I would expect to stay for only the next eighteen months to two years. I thought you should know this before you decide.”
“Paul, I will be in touch shortly.”
Reagan's shorthand entry in his diary at the end of the day confirms that he had still not decided. “I met with Paul VolckerâDo I reappoint him as Chmn. of the Fed Aug. 1 or change? The financial mkt. seems set on having him. I don't want to shake their confidence in recovery.”
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Reagan's budget director, David Stockman, and Martin Feldstein, the well-known Harvard economist who had replaced Murray Weidenbaum as chairman of the president's Council of Economic Advisers, had been early supporters of Volcker within the White House. They shared
Volcker's concern with the federal deficit and valued his inflation-fighting credentials. Treasury Secretary Donald Regan had become a more recent convert, saying the “financial markets seem to favor him ⦠by an overwhelming majority.”
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Senator Paul Laxalt, Reagan's first friend on Capitol Hill, had called the president during his meeting with Volcker and urged him to reappoint the Fed chairman.
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And so did Senate Majority Leader Howard Baker. “It's tough to argue against the success,” said an unnamed White House staffer.
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On Tuesday, June 7, 1983, the day after Reagan met with Volcker, the president wrote in his diary, “I think we'll re-appoint Paul Volcker for about a year & a half. He doesn't want a full term.”
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Reagan had no choiceâon two counts. He had no real alternative to compete with Volcker's stature and respect. And he would have to make the congressionally mandated four-year appointmentânothing shorterâand hope for the best.
Alan Greenspan wrote to Volcker afterward. “The President's indecision was unfortunate. But in the endâas he seems usually to doâhe came out on the right side.”
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Reagan certainly decided correctly, but he added insult by waiting almost two weeks to make the announcement, and even then it sounded like an afterthought.
At noon on June 18, 1983, during Reagan's regular Saturday radio address, the president deviated from his prepared remarks and inserted a “news flash,” like an old-time reporter calling in a story to the newsroom.
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He told his listeners, “Well, I'm not wearing a hat or clutching a phone [like you see in the movies]. But before getting into today's broadcast, I'd like to make an important announcement ⦔
Reagan had surprised many of his staff with the impromptu release of such an important appointment. He had delivered his radio address live from the presidential retreat at Camp David, Maryland, and had written the announcement in longhand on the paper containing his prepared remarks. Volcker knew an hour before, when the president called him in New York to confirm the offer as chairman for a second term.
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The informality of the proceedings did not bother Volcker. He knew that such announcements were normally made by the president in the White House, with the appointee at his side. But he had achieved his goal, so he swallowed his pride. Besides, there was some precedent for
doing it this way. Lyndon Johnson, miffed at the Federal Reserve's tight monetary policy, had reappointed William McChesney Martin with a simple press release.
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Volcker felt that he was in good company, and that he could finish what he had started. It would not go smoothly.
An obsession as thick as harbor fog smothered Volcker's confirmation hearings on Thursday, July 14, 1983. Republican Jake Garn of Utah, chairman of the Senate Banking Committee, welcomed Volcker to the Caucus Room of the Russell Senate Office Building, a formal space with crystal chandeliers that had hosted the Watergate hearings a decade earlier, and began with a peculiar compliment: “Under your leadership the Federal Reserve certainly has acted more responsibly in redirecting monetary policy than the Congress has acted in redirecting fiscal policy ⦠I'm amazed at how well Congress has been able to get away with placing a majority of the blame [for our economic difficulties] on the Federal Reserve Board ⦠Congress ⦠has not worked very closely ⦠to match fiscal policy with monetary policy. The proof of that is the ever-increasing deficits that we face, and Congress['s] unwillingness to significantly cut those deficits.”
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Garn alternated chairmanship of the Senate Banking Committee with William Proxmire of Wisconsin, depending on whether the Republicans or Democrats controlled the Senate. He urged Congress to “face up realistically to those budget deficits and send the proper signals to the financial markets of this country.”
Garn's rant against the deficit during Volcker's confirmation seems misplaced, considering that neither the Senate Banking Committee
nor Volcker had any direct control over federal expenditures and taxation, but Proxmire followed Garn's opening remarks with the same obsession. The Wisconsin Democrat greeted Volcker like an old friend. “I think we owe you ⦠a rousing vote of thanks for your great job in bringing inflation down ⦠Meanwhile between the Congress and the administration, two administrations, we sharply increased spending [and] reduced Federal revenues ⦠and created ⦠the assurance that we will ⦠explode the national debt to more than two trillion dollars ⦠We have created a mammoth, ponderous, and fire-eating dragon ⦠And all this is just another way of saying that ⦠the time is coming ⦠when inflation or high interest rates or both will choke off this recovery ⦠So, good luck, Paul, you poor devil.”
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