Deliberations in the Senate over the gold cover went poorly. The bill to eliminate the requirement caused an outbreak of insomnia among midwestern skeptics of central banking.
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Gordon Allott, the senior Republican senator from Colorado, complained that “the last vestige of restraint on money and currency ⦠is removed by this bill. Money expansion decisions would be left ⦠to the sole discretion of the Federal Reserve Board, which is answerable to no one.” Allott's suspicion of central banking is as American as Andrew Jackson, but the senator was not nearly as tough as Old Hickory, who destroyed the Second Bank of the United States. He simply wanted Congress to continue as a central police station: “I am not suggesting that Congress carry out day-to-day management of our currency and money supply, but it certainly should not short-circuit the alarm system.”
Senator William Proxmire of Wisconsin, who knew more about banking and finance than just about anyone in the Senate, tried to persuade Allott that his opposition to the bill suffered from good intentions and bad execution. “What the Senator overlooks ⦠is that the main part of our money supply is not in the form of currency, it is demand deposits ⦠[and even] Dr. Milton Friedman ⦠the one expert economist quoted by the distinguished Senator from Colorado ⦠would be among the first to say that it would be hopeless to attempt to limit the money supply by limiting currency.”
Allott acknowledged Proxmire's expertise by saying, “The Senator ⦠is entirely correctâcurrency is just one part of the money supply,” and then launched a mixed metaphor straight from the American heartland to illustrate his point: “But ⦠the tail is the only part of the dog I can get ahold of. I am going to hang on to it and try to keep it from wagging the dog clear out of the ball park.”
On March 14, 1968, the Senate voted 39â37 to repeal the 25 percent gold reserve requirement against currency, severing the final link between gold and the domestic money supply.
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The razor-thin majority reflected an undercurrent of distrust toward central bankers within
the legislative branch of the U.S. government. It is not surprising that the favorable vote failed to mollify speculators throughout the world.
Speculators worried that even the
entire
stock of gold in the U.S. Treasury could not support the thirty-five-dollar price for very long. Americans were simply spending too much overseas, leaving too many dollars in foreign hands. President Johnson had sounded desperate during his State of the Union address, asking Americans to avoid trips abroad to keep dollars in the United States.
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But begging New Yorkers to visit the Grand Canyon instead of the Riviera could not solve America's balance-of-payments problem; cutting Vietnam War expenditures to curtail inflation might have worked, but that was not part of the president's plan.
On Friday, March 15, 1968, Queen Elizabeth shut down the London gold market in response to an emergency request from President Lyndon Johnson.
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A Zurich banker had summed up the consequence of the speculative frenzy: “Don't they realize, these people who are buying gold, that they are destroying the whole monetary system of the world?”
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Representatives of the Gold Pool met at the Federal Reserve Board in Washington on Saturday, March 16, 1968, to determine their strategy.
66
Central banks had been defending the thirty-five-dollar price by selling gold when there were too many buyers, including jewelry manufacturers and Arab sheikhs, and buying when there were too many sellers, usually gold producers such as Russia and South Africa. The Gold Pool worked within the law of supply and demandâand speculator demand had been outstripping supply.
After two days of deliberation the central bankers released a communiqué announcing the new rules: “The U.S. Government will continue to buy and sell gold at the existing price of $35 an ounce in transactions with monetary authorities ⦠[but will] no longer supply gold to the London gold market or any other gold market.”
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The formal statement praised the U.S. legislation eliminating the gold cover but claimed that their new policy was needed to conserve the world's stock of monetary gold.
The central bankers had built their own version of the Berlin Wall, separating the official monetary gold market from the private sector's counterpart. They picked up what chips were still theirs and went off
to play on their own, with all transactions in their fraternity taking place at the official price of thirty-five-dollars per ounce. As for the outsiders, speculators and real people, they could do as they wished and decide on whatever price they pleased. There would be a two-tier market for gold: one for central bankers at a fixed thirty-five-dollar price and another for everyone else at a freely determined price.
To most Americans the new rules for the gold market seemed as relevant as the rules about splitting aces at the blackjack tables in Las Vegas (probably less relevant). Some, such as Joseph Rokovich, working at a construction site on West Forty-Third Street in Manhattan, were mostly optimistic: “I figure our leaders know what they're doingâI hope.”
68
Others sounded confused, like John Wright, a bank security guard at the New York Bank for Savings in Times Square: “I'm not worried ⦠But if this keeps on maybe the dollar won't be worth anything.”
69
John Wright should have been worried about the dollar's value. Not so much because of the two-tier gold market, but because Congress had removed the gold cover from U.S. currency, short-circuiting Senator Allott's alarm system. Federal Reserve chairman William McChesney Martin had helped to convince legislators that failure to eliminate the requirement would impair economic growth: “Federal Reserve notes in circulation [must] increase each year with the growth of the economy.” Milton Friedman invoked integrity to support removing the gold cover. “Twice before when gold reserve requirements came close to being a constraint the requirements were loosened. This is the third time ⦠The legal requirement for a gold cover is therefore ⦠a delusion ⦠In the interest of plain honesty [it] ⦠should be removed.”
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Chairman Martin concurred, emphasizing that the gold cover “discipline” does not control the money supply, but rather decisions of the Federal Reserve control it.
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Congress had good reason to trust Martin's commitment to monetary stability. As an assistant secretary of the treasury in 1951, William McChesney Martin had incurred the displeasure of his boss, Treasury Secretary John Snyder, by taking a principled stand supporting Federal Reserve independence. He had negotiated the famous “accord” that freed the central bank to pursue an anti-inflationary policy.
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Martin then became chairman of the Federal Reserve Board and implemented
a policy of price stability that would last almost a generation. But not every head of America's central bank would follow his example.
Paul Volcker's memo to Roosa back in 1962, proposing a presidential commission to remove the gold cover, had reflected his great faith in William McChesney Martin: “He was very nice to me when I first arrived at the Treasury and I never forgot that. He earned my respect by devoting himself to Federal Reserve independence, and then delivering on his promise to contain inflation. He is one of my heroes.”
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In 1968, after Congress removed the gold cover and the central bankers abandoned the Gold Pool, Volcker thought Martin could still maintain domestic stability, but he worried that the international monetary system “had fallen into jeopardy.”
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He thought that the two-tier gold market was a barometer of tension in the Bretton Woods System.
Speculators who had bought gold at thirty-five dollars per ounce before March 15, 1968, made a tidy profit. The withdrawal of central banker supply from the London gold market acted like the popping of a champagne cork. The free-market price of bullion jumped to thirty-eight dollars when the market reopened two weeks later, an increase of nearly 10 percent.
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And the twenty-dollar double eagle, which Americans (even Sargent Shriver) could buy from their favorite coin dealer, surged more than 25 percent.
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The price increase reflected expectations that the United States would eventually devalue the dollar.
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Volcker thought that, going forward, foreign central banks might purchase gold from the United States “to hedge against the possibility of an eventual American embargo on gold.”
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If the United States could change the rules in March 1968 and stop selling gold to the private market, it could amend them further by refusing to sell gold to other central banks. The specter of America suspending gold convertibility to other monetary authorities kept foreign central bankers awake at night. They had good reason to worry.
It was Monday, January 20, 1969, and Paul Volcker stood at the window of his corner office on the second floor of the Treasury Building, watching the motorcade advance at coronation speed along Pennsylvania Avenue. He had left his position as director of forward planning at Chase Manhattan Bank and had been appointed undersecretary of the treasury for monetary affairs in the new administration. It was the same job Robert Roosa had held under President Kennedy, and Volcker relished the challenge, knowing that America's problems had risen like a flood tide. He had watched Roosa seal cracks in the dikes with financial putty to preserve America's commitments. Now an inflationary upsurge threatened to overwhelm the levees and drown the dollar.
As Nixon's inaugural parade disappeared from view, Volcker thought about Kennedy's message to manage America's balance of payments because we were “the principal banker of the free world.” He believed JFK had understated our obligations: “Price stability belongs in the social contract. We give the government the right to print money because we trust our elected officials not to abuse that right, not to debase the currency by inflating. Foreigners hold our dollars because they trust our pledge that those dollars are equivalent to gold. Failure to maintain those promises undermines trust in America. And trust is everything.”
1
Volcker looked at the blank space on the wall behind the desk and
wanted to fill the void with his father's DO NOT SUFFER YOUR GOOD NATURE ⦠plaque.
2
It had disappeared after Paul Sr. died in 1959. Paul believed his father had accomplished much between 1930 and 1950, rescuing Teaneck from a financial crisis that began in 1929. On January 20, 1969, he wanted to follow in his father's path, to rescue the country from the financial setbacks that threatened to diminish America's stature in the world. He wanted to make his father proud, to show he understood the lesson: Public service is a sacred trust. He would miss his father at the formal swearing-in.
Volcker had nearly dismissed the idea of working for the new administration two months earlier, when Richard Nixon defeated Hubert Humphrey. He recalled how Nixon, as Dwight Eisenhower's vice-presidential running mate in 1952 and 1956, had smeared the Democratic presidential candidate Adlai Stevenson as being soft on communism. Nixon said Stevenson's “shocking lack of understanding” of the Communist fifth column was evidence of “exceedingly bad, perhaps dangerously bad judgment” that made him unfit for the presidency.
3
Volcker had campaigned for Adlai Stevenson, and like most Democrats, he never forgave Nixon for the slander.
Stevenson, whose bald pate and huge brain justified the egghead label, dazzled everyone with oratory. He poked fun at himself by saying, “A politician is a statesman who approaches every question with an open mouth.” He also delivered a message: “All progress has resulted from people who took unpopular positions.”
4
Volcker liked what Stevenson said and how he said it. He recalled how Stevenson described Nixon as “A man of many masks ⦠shifty ⦠rash and inexperienced.”
5
Richard Nixon was the enemy.
Volcker felt guilty knowing he would be working for Stevenson's executioner, but his passion for public service smothered his guilt. He wanted to make a difference and believed that Nixon's foreign policy experience, earned as Eisenhower's globe-trotting vice president, might help find a more permanent solution to the dollar crisis that had escalated along with the Vietnam War and inflation. He could not resist the opportunity.
Empathy arrived from several prominent Democrats. The former chairman of President Kennedy's Council of Economic Advisers, Walter Heller, wrote, “It is probably no secret to youâthough I tried to
keep it from highest authority, so as not to prejudice your chancesâthat you were my number one candidate as [undersecretary] in the Nixon Administration.”
6
Sargent Shriver, eventually the Democratic Party's vice-presidential candidate in 1972, understood Volcker's motivation. “My heartfelt congratulations on your nomination ⦠There is no question your new job is something of a hot seat, but I imagine that is one of the elements that attracts you to it.”
7
National Security Memorandum Number Seven from Henry Kissinger, labeled SECRET at the top and SECRET at the bottom, greeted Volcker on January 21, 1969, a day after the inauguration. “The President has directed the creation of a permanent Working Group to make recommendations on U.S. International Monetary Policy to the National Security Council (NSC) and to implement policy decisions.”
8
Kissinger's memo designated Volcker as the chairman of the working group and asked that a study on international monetary policy be delivered to the NSC by February 15, 1969.