Volcker (23 page)

“Well, I blew it,” Volcker began after they had sat down.
¹²⁰

“What do you mean?” Ritter asked. He had learned the art of listening while recording the stories of players from the early days of baseball. He had turned the oral history into a bestselling book,
The Glory of Their Times
, sharing the royalties with the old-timers because he thought it was the right thing to do.

“I was sitting alongside the president, who sat in a wing chair,”
Volcker growled. “I said that I attached great importance to the independence of the Federal Reserve and that I also favored a more restrictive monetary policy. And just for emphasis I pointed at Miller, who was sitting in a chair next to me, and added that I wanted a tighter policy than him.”

“The Volcker charm at work,” Kavesh said. “What did Carter say?”

“Nothing. He just listened.”

Ritter lit a cigarette and tried some humor: “Were you smoking one of your El Cheapos?”

“He just said that Miller was there,” Kavesh interjected. “Of course he was smoking.”

They laughed together, and then Volcker continued. “You know it might be for the best. I would have to take a fifty percent cut in salary if I were offered the job. I don't know how we could mange … I don't know if I have the right to ask my family to make that kind of sacrifice.”

Volcker looked at both men for a response. Neither one spoke, until Ritter said, “If the president calls, you cannot turn him down.”

Kavesh asked, “What did Barbara say?”

“The same as him.” Volcker nodded toward Ritter.

Paul knew that they had given him the answer he wanted. This was the job he had trained for his entire professional life. This was the job that provided the opportunity to rescue his country from crisis. He wanted it more than he cared to admit.

“Did Barbara say anything else? Kavesh continued.

Volcker looked down at his plate. “Yes. She said we'd manage.”

At 7:30 the following morning, the sharp ring of the telephone woke Volcker. It was the White House.

Volcker sat at the oversize desk in the chairman's office at the Federal Reserve Board in Washington, D.C., inhaling the aroma of his favorite A&C Grenadier cigar. The smoke irritated his eyes. A cigar aficionado had once told him that Grenadiers were little more than “horse manure sprinkled with tobacco,” but Volcker did not care. Macanudos had never fit his pocketbook, so he had learned to like what he could afford. Now that he would be earning $57,500 a year rather than the $110,000 salary as president of the Federal Reserve Bank of New York, the Grenadiers tasted even better.

Volcker waved away the fumes and stared at the postcards, letters, and telegrams piled neatly in front of him. There must be at least two hundred, he thought, and it was only August 7, 1979, a day after he was sworn in as chairman of America's central bank in the East Room of the White House. He had read a few of the messages and they made him nervous.

Not all of them, of course.
¹
Some made him smile, such as the one from Dave McGrath, which read, “I felt like a big shot just telling people I was once your college roommate. I was also happy to hear that you refused to pay $5 for a lousy drink in Zurich.” Others raised a lump in his throat, like the one from Judge Waesche reminiscing, “Your father was highly respected for his honesty and ability … I know he would be
proud of your appointment.” And some gave sound advice, such as Doc Wolk's suggestion “To please keep the cigars under five a day, if not for your own sake then for the dollar.”

But too many old friends, including Tom Rees and Ed Hamilton, delivered the identical message: “I called my broker and sold short gold and went long dollars.” Volcker worried that lawyers and consultants, like Tom and Ed, expected immediate success in the battle to control inflation, as though he could say the magic words and erase a decade of futility. He knew the euphoria was premature, a recipe for disappointment. Volcker preferred skepticism.

And then he saw a glimmer of hope: an envelope sticking out of the pile with a Vermont postmark. This one, he thought, could deliver a pessimistic message that would buoy his spirits. He knew that Milton Friedman summered in Ely, Vermont.

Volcker's history with Friedman, the Nobel Prize–winning University of Chicago economist, went back more than twenty years, to Volcker's first job at the Federal Reserve Bank of New York. He recalled Friedman coming to the bank in 1957 to explain his research indicting the Federal Reserve for causing the Great Depression. Friedman had presented his case like a prosecutor, offering evidence that the central bank had allowed the money supply to decline by one third between 1929 and 1933, which in turn caused the economic collapse. “Milton was convinced he had found the gospel truth. I was skeptical of anyone so confident—whether from Chicago or Cambridge.”
²

Volcker slid the envelope from the middle of the pile and smiled. The accompanying letter was written in Friedman's barely legible longhand, covered a single page, and was dated July 31, 1912 (Friedman's birthday). It greeted him with “Dear Paul”:

My condolences to you on your “promotion.” I am delighted for the country at your accession to the chairmanship but sympathize with respect to the difficulties you are doomed to face. You have, however, a great advantage and consolation. Your predecessors have, most unfortunately on every other count, left records that it will not be difficult to improve on. The years 1930–1933 aside, and perhaps also 1920 and 1921, there has never been both a greater need and greater opportunity for the [Federal
Reserve] System to render service to the nation by courageous and steady policy of monetary restraint, experienced gradually and moderately. As you know, I do not believe that the System can rise to that challenge without major changes in its method of operation. My very best wishes to you for success in pushing those changes and those results.
³

Volcker wanted Friedman's message broadcast throughout the country. He thought about a discreet leak to a favored reporter but decided instead to write a letter that would accomplish the same result. It began with “Dear Milton”:

It's taken a little while to get out from under and to respond to those special letters of congratulations or condolences—and I recognize that the latter may be more apt than the former. I don't know whether I have simply been elected the fall guy in most difficult circumstances, but some of the broad directions of necessary change seem clear enough. And as you point out, the past record has not exactly been perfection. I am perfectly confident you will find plenty to criticize but I also suspect you know I will not be unhappy to have you preaching the doctrines of monetary rectitude as we move ahead … In any event, the test will come soon enough, and we will, as always, be following your comments with interest.
⁴

Milton Friedman had won the 1976 Nobel Prize in Economics as an agent provocateur, subverting the foundations of the establishment. Some contemporaries dismissed his ideas as though they were fundamentalist doctrines of a midwestern preacher. Friedman often sounded like a true believer, but he rarely lost a debate. His friend and former colleague at the University of Chicago, George Shultz, Nixon's treasury secretary, once quipped, “Everybody loves to argue with Milton, particularly when he isn't there.”
⁵
Friedman's advice to Richard Nixon, Margaret Thatcher, and Ronald Reagan gave prominence to his views.

Friedman argued throughout his career that the Federal Reserve should restrain inflation with steady and slow monetary growth. In an especially provocative article, he proposed that a modest rate of
deflation
, a decline in the price level, serve as the central bank's objective.
⁶
Volcker's obsession with inflation should have made Friedman a natural ally. Instead they went to war, like the biblical clash between David and Goliath, with the five-foot, three-inch Friedman battling the six-foot, seven-inch Volcker over how to conduct monetary policy. And it was not always cordial.

Milton Friedman is most famous for saying, “Inflation is always and everywhere a monetary phenomenon,” in the sense that inflation cannot occur without increases in the money supply that exceed the growth of output.
⁷
Months before Volcker took office, Friedman used his
Newsweek
magazine column to advertise the Federal Reserve's responsibility for the inflation of the 1970s.
⁸
“From April 1975 to September 1978, the quantity of money … grew at the rate of 10 percent per year. Since the end of World War II [the money supply] grew that fast during only one prior period of equal length—from February 1970 to July 1973.” Friedman predicted that “the current inflation is not likely to reach its peak until late 1979 or early 1980, by which time it may challenge the earlier record.”

Friedman should have held Arthur Burns accountable for the Federal Reserve's dismal performance. Burns governed the Federal Reserve System from January 1970 through March 1978. The chairman is the public face of the Federal Reserve in congressional hearings and he manages the secret deliberations of the FOMC. His final word on appointments within the system makes him more than just another vote at the table, just like the legendary King Arthur. And Burns knew as well as Friedman that inflation comes with excess growth in the money supply. Friedman, a former student of Burns, said, “Outside of my parents and my wife, there is nobody else who had as much influence on my life as Arthur Burns did. And that major source of influence started exerting itself during a course I took [from him].”
⁹

The
New York Times
identified Burns as the culprit in the recent inflationary surge: “Although Mr. Burns was critical of the economic policies of the Carter Administration, he permitted an uninterrupted expansion of the money supply in 1977 to finance the economic stimulus that many now hold at least partly responsible for current inflationary
woes.”
¹⁰
But Friedman turns his former teacher into a victim rather than a perpetrator.
¹¹
“Arthur Burns … [had] been informing Congress … that the Fed has reduced its target rates of growth of the monetary aggregates as a gradual step toward a steady reduction of inflation … In sharp contrast, the actual rates of monetary growth [had] risen rather than decreased … Duplicity? Not at all. Simply another example of how an individual may be unable to bend an institution, subject to many pressures and forces, to his will … It has occurred time and again in the Fed's sixty-four-year history.”

Friedman excused Burns, perhaps out of loyalty, but he knew that a strong personality at the central bank could make a difference. In his influential
A Monetary History of the United States
, written with Anna Jacobson Schwartz, he laments the death of Benjamin Strong, governor (president) of the Federal Reserve Bank of New York in 1928, and writes that Strong's guidance could have avoided the fatal mistakes of the Federal Reserve during the Great Depression. “If Benjamin Strong could have had twelve months more of vigorous health, we might have ended the depression in 1930.”
¹²

By the time Volcker occupied Strong's position at the New York bank, the locus of power had shifted to Washington. Volcker's dissents in March and April of 1979 failed to sway the FOMC majority, but he would be more persuasive as chairman.
¹³
The press expected Volcker's leadership to make a difference. “Paul A. Volcker isn't going to be another G. William Miller, or Arthur Burns, or William McChesney Martin Jr. in his new post as chairman of the Federal Reserve Board—even though on the surface, all Fed chairmen sound alike. They don't like inflation, big government spending, excessive regulation … Mr. Volcker, a skilled market technician … and monetary diplomat, … [will] be more rigorous in the application of orthodox monetary policies than … Mr. Miller.”
¹⁴

William Miller had been chairman for only eighteen months before Volcker's appointment, too short a time to measure his direct impact on inflation, but he undermined the Fed's role as guardian of the currency. He opposed a discount rate increase approved by a majority of the board in July 1978, registering a dissent that the
Washington Post
labeled “‘political'—an attempt to assuage the Carter administration fears that higher interest rates would be dangerous to the country.”
¹⁵
Richard Adams, executive vice president at Chemical Bank (now merged into JPMorgan Chase), said, “I think Mr. Miller's image has been tarnished … The economy is still operating at a strong level … We've got excessive money growth and excessive inflation … We feel better when we have a Federal Reserve chairman who is in command of the Board.”
¹⁶
And the
New York Times
complained, “How does [Miller] justify his vote in light of the acceleration of the growth of the money supply and the sharp rise in consumer prices?”
¹⁷

The press counted on Volcker's international stature to make an impact.

The remarkable speed and enthusiasm with which European governments have welcomed Mr. Volcker … testifies to the pivotal role they see him playing … The key is the long personal involvement Mr. Volcker has had with men who have become heads of state … The President of France, Valéry Giscard d'Estaing, and the Chancellor of West Germany, Helmut Schmidt … are both former finance ministers who dealt with Mr. Volcker … and who trust him. Volcker will stand out in an otherwise rather undistinguished Washington scene as the one man they already know and respect.
¹⁸

The newspaper references to Giscard d'Estaing and Helmut Schmidt reminded Volcker of his thirty-one-thousand-mile dollar-rescue trek in February 1973. Paul cringed when recalling that this final effort to maintain fixed exchange rates collapsed a month later, ushering in the era of floating exchange rates championed by Milton Friedman. He suspected that the years spent shoring up the doomed system had been a waste. The run on the dollar in October 1978 offered bittersweet comfort. It demonstrated American vulnerability but also negated Friedman's claim that a floating system would put an end to international currency crises. And that had been his main consolation—until now.