Volcker (19 page)

The press memorialized Volcker's globe-trotting by labeling the new structure of exchange rates the “Volcker Agreement.”
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The arrangement lasted less than three weeks, making Volcker wish they had ignored his exploits. By March 1, 1973, gold had jumped by more than 25 percent, to $86.00 per ounce, and the dollar had declined 5 percent against the mark, to 2.82 marks per dollar. The frenzied speculation confirmed Volcker's suspicion: a giant step backward.

The glut of dollars for sale forced central banks in Europe and Japan to suspend their dollar purchases to avoid domestic inflationary pressures
, referred to as “the dollar peril” by a European banker.
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The official closing of foreign exchange markets began on Friday, March 2, but this did not eliminate private transactions at commercial banks and at airport kiosks. It simply meant that currency values would be allowed to float with supply and demand, unfettered by central bank intervention.
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Volcker knew it was just the beginning.

French finance minister Valéry Giscard d'Estaing invited an American delegation, consisting of Treasury Secretary George Shultz, Federal Reserve chairman Arthur Burns, and Volcker, to Paris for an emergency conference on Friday, March 9, 1973, with representatives of the countries belonging to the European Common Market—Belgium, Denmark, France, Germany, Ireland, Italy, Luxembourg, Netherlands, and the United Kingdom.
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Volcker suspected a formal proposal by the Europeans for a joint float of their currencies versus the dollar, along the lines he had suggested to German finance minister Helmut Schmidt in February. With Britain floating since June 1972 and Japan floating since the February devaluation, a European float would represent a final break with fixed exchange rates.

The Friday morning meeting on March 9, 1973, amused Volcker. The Europeans had not seen George Shultz up close before and they knew relatively little about his views. Shultz did not help them. He listened more than he talked, true to his training as a labor negotiator.
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Right before the lunch break, Helmut Schmidt broached the possibility of a joint European float. “How would the United States respond?” he asked, as though he were handling a vial of nitroglycerin. Shultz answered even more delicately: “It is something we would consider sympathetically.”
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Volcker felt as though he were watching a scene from
Masterpiece Theatre
. Shultz had masked his support for floating exchange rates during his tenure as treasury secretary, and now, like a professional athlete on the brink of victory, he remained under perfect control. Volcker recognized the contrast with a John Connally performance and knew that each method had its place. As much as he admired his former mentor, however, his instincts placed him squarely in the Shultz School of the Performing Arts.

During the lunch break, Arthur Burns, who feared floating rates with
a passion, cornered Shultz and Volcker. He warned them that abandoning fixed exchange rates risked currency wars among nations, accompanied by political suspicion and the loss of domestic discipline. And he emphasized that “the exchange rates that emerge in a free market [are not] an infallible indication of what is the fundamental equilibrium.”
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Volcker had heard these arguments before—and had made some of them himself, while defending the Bretton Woods System. He, too, believed in the virtues of fixed exchange rates, but his pragmatism had taught him that time had expired on America's options. Only a permanent change in economic fundamentals could save the system he had worked so hard to sustain. And only Arthur Burns could do it. Volcker turned to the Federal Reserve chairman and said, “Arthur, if you want a par value [fixed exchange rate] system you had better go home right away and tighten money.”
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Burns sighed. “I would even do that.”

Volcker suspected that Burns would not deliver. A week later he knew it. At a press conference the following Friday, March 16, 1973, Shultz, flanked by Burns and Volcker, stood before a roomful of reporters at the American embassy in Paris to answer questions about the European initiative that had just been announced.
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Germany, France, Belgium, the Netherlands, Luxembourg, and Denmark had agreed to jointly float their currencies versus the dollar, like a miniature precursor to the euro. Britain, Ireland, and Italy had decided to sink or swim on their own.

A reporter asked Shultz, “Mr. Secretary, what does this all mean for American monetary policy?”
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It was a reasonable question that Shultz viewed as radioactive, knowing how sensitive Burns was (at least publicly) about Federal Reserve independence. He turned the microphone over to the Fed chairman, who delivered a clever response in his most authoritarian voice: “American monetary policy is not made in Paris; it is made in Washington.”
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Burns's answer made good press, but disappointed Volcker, more than anyone knew. He felt his shoulders sag while the consequences sank into his brain. “We were at a turning point in American economic history. Inflation was well under way in the United States, and the international monetary system was about to become less stable. Burns's
reluctance to factor international considerations into monetary policy was misplaced. We were ignoring our responsibility as custodian of the international medium of exchange, a responsibility that coincided with our obligation domestically to control money and credit. I was convinced that pursuing a monetary policy imprinted with the label ‘Made in Washington' was a mistake.”
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Volcker resigned as undersecretary of the treasury for monetary affairs on Monday, April 8, 1974, three weeks after George Shultz announced his resignation. Richard Nixon had chosen Deputy Treasury Secretary William Simon, a former partner at brokerage firm Salomon Brothers, to succeed Shultz. Simon's appointment had been delayed by a political power struggle, and Volcker had waited while he thought there was an outside chance he might be named secretary.
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Others in the administration had felt the same way. Donald Rumsfeld, at the time the U.S. ambassador to NATO and a future secretary of defense under Gerald Ford and under George W. Bush, sent a note to Volcker: “Given your unique experience, many years of service and your well known competence and skill, there was a good possibility that you would succeed George Shultz.”
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Volcker knew that foreign finance ministers would have supported his promotion by acclamation. He recalled with pride an incident during a Group of Ten meeting, chaired by French finance minister Valéry Giscard d'Estaing, who would become president of France in May 1974.
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Giscard d'Estaing, a favorite Volcker sparring partner during Franco-American negotiations, had announced a meeting of principals only, meaning that only finance ministers and central bankers themselves—no deputies—could participate. George Shultz turned to Giscard d'Estaing and asked, “How about Paul?” Giscard d'Estaing looked surprised and then said, “Of course, we never considered Paul a deputy.”
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A headline in the
International Herald Tribune
summed up Volcker's status abroad: “Volcker No. 4 at Treasury, No. 1 in European Capitals.”
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Volcker should have known that Richard Nixon would never appoint him secretary of the treasury. Despite his public status as the president's monetary diplomat, he was not part of the inner circle. Nixon had told
Prime Minister Tanaka of Japan and Chancellor Willy Brandt of West Germany in February 1973 that he had sent Volcker as his personal emissary. But during Volcker's news conference after his thirty-one-thousand-mile global trek, a reporter asked how often he had spoken with the president during his trip. Volcker did not hesitate to take himself down a peg by answering, “Not at all. I spoke with Secretary Shultz and he spoke with the President.”
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Nixon enjoyed surprises. He had stunned the establishment by appointing John Connally, a prominent Texas Democrat, as treasury secretary. And Connally had tutored Volcker, a conservative Democrat, in the art of Washington politics. But Volcker could never make a point without qualification, and Nixon could never trust him to toe the party line. Volcker accepted the consequences. He did not know any other way.

Arthur Burns exploited Paul Volcker's fixation with public service to persuade him to accept, as of August 1975, the presidency of the Federal Reserve Bank of New York, the second most important position in America's central bank. Burns occupied the most powerful slot, chairman of the Board of Governors of the Federal Reserve System, having been reappointed to a second four-year term by Richard Nixon in January 1974.

As Fed chairman, Burns was the final authority on appointments within the system and was its chief spokesperson. The New York Fed is the most important of the twelve regional Federal Reserve banks that serve as branches of the central bank. During the 1920s, Benjamin Strong, president (then called governor) of the Federal Reserve Bank of New York, dominated the system. Even more recently, during the 1950s, the president of the New York bank had challenged the authority of the Washington-based chairman. Volcker occupied a front-row seat in that battle.

To promote an independent central bank, congressional legislation mixed public and private authority in designing the Federal Reserve System, with built-in checks and balances to prevent any one person, including (especially) a sitting president, from gaining undue influence.
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There are seven members of the Board of Governors, who are appointed to fourteen-year terms by the president of the United States,
with the advice and consent of the Senate. The fourteen-year terms are staggered so that, absent resignations or deaths, the president gets to appoint only two new members. The president designates the chairman from among these seven members of the board, but the chairman's term of office does not coincide with the president's. Although each member of the board has the same vote in all deliberations, the chairman dominates by virtue of his role as the central bank's representative before Congress, with the president, and at international meetings.

There are twelve regional Federal Reserve banks dispersed geographically throughout the country, including the Federal Reserve Bank of New York, of San Francisco, of Philadelphia, and of Atlanta. These banks are technically owned by commercial banks, such as JPMorgan Chase and Bank of America, but they are supervised closely by the Board of Governors in Washington and amount to little more than branches of the central bank. The president of each Federal Reserve bank is selected from a slate of candidates approved by Washington.

The key policymaking arm of the system is the Federal Open Market Committee, often referred to as the FOMC. All seven members of the Board of Governors serve on the FOMC, along with five of the regional bank presidents, who rotate membership—except for the president of the Federal Reserve Bank of New York, who is a permanent member.

The special status of the New York bank stems from its location and from its role in executing the purchase and sale of securities for the entire system, called open market operations, the Fed's main weapon of monetary control. The chairman of the Board of Governors is the chairman of the FOMC, and the president of the New York bank is the vice-chairman. Meetings of the FOMC are held eight times a year and end in a formal vote (jacket and tie required) on a directive to chart the course of monetary policy until the next meeting, with concurrences and dissents recorded for posterity.

Volcker wonders to this day why Arthur Burns wanted him at the New York Fed. “I respected Arthur, especially his expertise in business cycle analysis, but we had battled throughout my years at Treasury.”
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Perhaps Burns wanted to neutralize an adversary by making him an
in-house critic.
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Volcker knew that antagonism between the board and New York defined earlier relationships. “I watched New York president Allan Sproul challenge the authority of Chairman William McChesney Martin in the early 1950s over who controlled open market operations. I was rooting for Sproul, of course, since I was working in New York.”
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Allan Sproul lost the argument and resigned as president of the Federal Reserve Bank of New York in 1956, but the antagonism continued to tug beneath the surface, like an ocean undertow.
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It erupted in 1970, when Burns became chairman of the Board of Governors. Alfred Hayes, who had replaced Sproul as president of the New York Fed, greeted Burns with a dissent in the formal vote at Burns's first meeting of the FOMC on February 10, 1970, wanting a tighter monetary policy to fight inflation.
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Philip Coldwell, president of the Federal Reserve Bank of Dallas, also dissented, for the same reason, and recalled, “For the next five meetings Al Hayes and I would be brought into Arthur's office [for] … a lecture from Arthur on the importance of consensus.”
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The reprimand did not end Hayes's dissents. The
New York Times
headlined the ongoing battle in 1972 with “Rift in Federal Reserve: Board Versus the Bank Here,” and compared the confrontation with Sproul's earlier insurrection.
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Burns had retaliated in many small ways, including questioning the New York bank's travel budget, and then began a very public search for a successor to Hayes more than a year before Hayes's scheduled retirement in August 1975.
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Headhunters had been chasing Volcker well before he left the Treasury, with offers that would have guaranteed a lifetime supply of Cuban cigars. A letter from recruiter Russell Reynolds in November 1973 proposed that Volcker consider a position at a leading investment banking firm with compensation in the low seven figures.
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A million-dollar investment banking salary package may sound pedestrian by twenty-first-century standards, but back then, when George Steinbrenner had just bought the New York Yankees for $10 million (yes, the entire team), and the highest-paid major leaguer was Cy Young Award–winner Jim “Catfish” Hunter, earning $750,000 a year, a million dollars was real money.
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“It certainly got my attention,”
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Volcker recalls.