The following is an excellent excerpt from the book “THE MAN WHO KNEW: The Life and Times of Alan Greenspan” by Sebastian Mallaby from Chapter Eleven: “Republican Dreamers” on page 228 and I quote: “On the evening of September 30, 1979, the world’s financial statesmen gathered in Belgrade, Yugoslavia. The annual meetings of the IMF and World Bank were to open the following day with a speech from Josip Tito, the Yugoslav strongman, who would harangue his audience about inequality and then rapidly absent himself, lest shoulder rubbing with financiers diminish his revolutionary aura. But tonight the assembled dignitaries were to hear from one of their own. Arthur Burns, the former chairman of the Federal Reserve, was to deliver an address on “The Anguish of Central Banking.” Given the surge of inflation across the Western world, it seemed an appropriate topic.
“One of the time-honored functions of a central bank is to protect the integrity of its nation’s currency,” Burns began. “And yet, despite their antipathy to inflation and the powerful weapons they could wield against it, central bankers have failed so utterly in this mission.” The roots of this paradox lay in “philosophic and political trends” that had begun during the Great Depression, Burns continued; he looked as though he were puffing on his pipe, even when he wasn’t. Rehearsing the thumbnail history repeated so often by his student, Alan Greenspan, Burns noted that the 1930s had turned a nation of hardworking individualists into a people who looked to the government to battle unemployment; the postwar era had brought an extension of this attitude, so that by the 1960s Lyndon Johnson’s Great Society programs had committed the expanding state to placating multiple political constituencies. It was hardly surprising, Burns pleaded, that the central bank had been caught up in this profound change. As he put it,
“Viewed in the abstract, the Federal Reserve System had the power to abort the inflation at its incipient stage fifteen years ago or at any later point, and it has the power to end it today. At any time within that period, it could have restricted the money supply and created sufficient strains in financial and industrial markets to terminate inflation with little delay. It did not do so because the Federal Reserve was itself caught up in the philosophic and political currents that were transforming American life and culture.”
Burn’s pronouncement was doubly remarkable. For one thing, he was not arguing that the Fed lacked the tools to vanquish inflation: he was rejecting the widespread view that monetary policy was impotent. As recently as 1978, he had suggested that budget policy, not monetary policy, was the key driver of prices; and even when he was not blaming the budget deficit, he resisted the idea that the Fed was responsible, instead pointing the finger at cost-push factors: commodity-price shocks, over-mighty labor unions, rent-seeking monopolists, regulations that created bottlenecks and scarcities. On occasions when he acknowledged the power of interest rates, he nonetheless took refuge behind a version of Greenspan’s conundrum. In congressional testimony in July 1975, he noted that it was long-term interest rates that really influenced the economy, and that “all of us recognize that the influence the Federal Reserve has on long-term rates is negligible.” In declaring unambiguously that the Fed did have the power to control inflation, Burns was announcing the arrival of a new consensus.
But Burns’s speech in Belgrade was also striking for another reason. In blaming the political culture for the Fed’s lack of determination, he was invoking a truth that modern commentators forget: despite the aura of independence that has grown up around central banks, they do not exist in a vacuum. To the contrary, their mandates come from lawmakers; their legitimacy derives from the climate of expert opinion; and they ultimately depend on the sympathy of voters. If Burns had tried to extinguish inflation under Nixon, he would have suffered even more punishment from the president’s henchmen; and even under Ford and Carter, there were limits to his freedom. At a minimum, a Fed leader wanting to defy his political overlords would need the legitimizing support of the economics profession; but in the 1970s many economists argued that the cost of fighting inflation would exceed the benefit. Because there was neither a political nor an intellectual consensus in favor of higher interest rates, Burns had felt unable to act. Thanks to the constraints imposed by the zeitgeist, the Fed was omnipotent in principle but still impotent in practice.
Sometime after Burns had begun speaking, a huge, rumpled, egg-headed figure entered the auditorium. Not seeing a convenient chair free, he slouched down against the back wall like an overgrown schoolboy and crossed his legs in front of him. The strange impression he created–powerfully gigantic in stature, meekly childlike in posture–mirrored Burns’s message; for the six-foot, seven-inch latecomer was none other than Paul Volcker, the newly appointed Federal Reserve chairman. In principle, Volcker was the world’s most powerful economic policy maker, with the weaponry to eliminate inflation at will. But he was doing his best to impersonate a 240-pound kindergartner.
Burns continued. Not only did central bankers face political constraints; their task was intrinsically treacherous because the economy and the financial system were forever changing. Central bankers understood that an expanding money supply could herald inflationary pressure; but given the protean nature of finance, they were unsure whether time deposits, money-market funds, and such should be counted as money. They recognized that changes in monetary policy took effect gradually; but the duration of the lags was unpredictable. They knew that higher interest rates would restrain prices, but they had no clear sense of how large the effect might be. Because of these manifold uncertainties, monetary experts could not be expected to speak with one voice. Mustering the intellectual consensus necessary to defy political pressures was therefore all but impossible.
As Burns spoke, Paul Volcker listened at the other end of the huge hall. Anyone with a window into his thoughts would have been startled. Whatever the impression created by his schoolboyish posture, this giant was not mild. He was rebellious, possibly dangerous. Burns’s long lament came down to the claim that the political and intellectual assumptions of the age constrained the Fed’s actions. It was precisely the argument that Volcker rejected.
Burns was coming to the end of his lecture. “Fairly drastic therapy will be needed to turn inflationary psychology around,” he announced, stressing that the therapy could not be administered only or even mainly by constrained central bankers. In addition to tougher monetary policy, governments would have to play their part by disciplining their budgets, and they would have to unleash supply by deregulating industry and lowering business taxes. “I wish I could lose this long address by expressing confidence that a . . . forceful program for dealing with inflation will be undertaken in the near future,” the professor concluded. “That I cannot do today. I am not even sure that many of the central bankers of the world, having by now become accustomed to gradualism, would be willing to risk the painful economic adjustments that I fear are ultimately unavoidable.”
The day after the speech, Volcker suddenly left Belgrade. He did not care that the IMF/World Bank meetings had barely begun. He was heading back to Washington with a mission: to refute Arthur Burns’s message.
Paul Volcker is often held up as the model Federal Reserve chairman–the standard against which others must be judged, including Alan Greenspan. Everything about him seemed to radiate frugality and discipline; with his wearily stooped shoulders, lumpy features, and bald head, he looked like an Old Testament prophet. He was raised by a fiercely ethical town manager in a small New Jersey suburb: “Do not suffer your good nature. . . to say yes when you ought to say no,” ran a quotation from George Washington on the wall of his father’s office. As a student at Princeton, he imbibed the writings of the austere Austrian Friedrich Hayek, who taught him that inflation could reduce unemployment only by disguising real wage cuts. “Hayek’s words forever linked inflation and deception deep inside my head,” Volcker told his biographer William L. Silber. “And that connection, which undermines trust in government, is the greatest evil of inflation.”
Volcker’s legendary stature is built on what he did after listening to Burns in Belgrade. Arriving back in Washington, he convened a secret weekend meeting of the Federal Open Market Committee, which usually gathers every six weeks to decide the Fed’s monetary policy. Emerging from that confabulation on October 6, 1979, Volcker drew himself up to his full height and unleashed his Saturday Night Special, a sharp break in the way the Fed would conduct business. Rather than targeting a particular short-term interest rate, Volcker decreed that the Fed would henceforth target the supply of money in the banking system–he would switch from manipulating the price of credit to policing the quantity of it. Under the old system, the Fed might raise the official short-term borrowing rate by what felt like a hefty amount, but the economy might continue to surge if home-equity extraction or some other market change made long-term credit cheap and plentiful. Under the new system, by contrast, the Fed would impose a straitjacket on the quantity of money and credit. If that meant that interest rates went through the roof, so be it.
Volcker could have halted inflation simply by raising interest rates aggressively. If he had pulled that lever hard enough, the appetite for loans would have collapsed and the money supply would have been brought under control without being directly targeted. But Volcker understood that a fierce-sounding new policy would get the public’s attention: it would signal that the Fed really meant business. The more the giant could shock people, the likelier they were to stop expecting inflation. If workers pulled back from demanding pay raises and companies thought twice before hiking prices, inflation might subside without requiring drastic treatment.
The Saturday-night shock was the most impressive moment in the Fed’s history since the Fed-Treasury Accord of February 1951, when Chairman Thomas McCabe had defied President Truman by refusing to hold down the government, in October 1979, consumer price inflation was running at 12.1 percent; three years later, when Volcker ended his experiment with monetary targets, the rate had plummeted to 5.9 percent. To force inflation down, round upon round of tightening proved necessary; and in the summer of 1981 short-term interest rates breached the extraordinary height of 20 percent, prompting Representative Henry Gonzalez, a Democrat from Texas, to denounce Volcker for “legalized usury beyond any kind of conscionable limit.” The economy endured a double-dip recession, and unemployment hit double digits too. But the payoff was clear. Inflation not only halved during Volcker’s three-year monetarist experiment, it kept falling into 1983. By dint of iron-willed persistence, Volcker turned the inflationary 1970 into the disinflationary 1980s.
Nobody, least of all Alan Greenspan, likes to question this achievement. At the time of Volcker’s elevation to the top job at the Fed, Milton Friedman himself had predicted he would fail–like Burns, he believed that the political constraints on central banks were insuperable. But Volcker trampled those constraints under his large feet, and even the most hostile reactions could not stop him. Bankrupt home builders protested by mailing two-by-fours to his office; struggling carmakers sent him the keys of unsold vehicles; furious farmers drove their tractors to Washington and encircled the Fed’s headquarters. But unlike Ayn Rand’s Atlas, Volcker refused to shrug off his responsibility, patiently carrying the world on his shoulders even when lawmakers threatened to impeach him. Month after month, the giant sat stoically through furious congressional hearings in his cheap suits, blowing clouds of cigar smoke as if to hide himself from his critics, occasionally shaking his domed head as if to say that he pitied the simpletons who abused him. “I’ve always considered him the most important Chairman ever,” Greenspan said flatly, years later.
And yet despite his courage and achievement, the legend of Paul Volcker requires qualification, for if he is allowed to stand too tall, others will be left to shrink unfairly. The first thing to be noted is that Volcker’s victory against inflation owed much to timing. He assumed the Fed chairmanship in August 1979, at a moment when Americans craved bold leadership. Confidence in the dollar was evaporating fast: the moment favored a big man with a big sense of his own destiny. As one pollster put it, “For the public today, inflation has the kind of dominance that no other issue has had since World War II. . . . It would be necessary to go back to the 1930s and the Great Depression to find a peacetime issue that has had the country so concerned and distraught.” If ordinary people wanted Volcker to act forcefully, Wall Street was even more desperate for a firm hand. Around this time, Merrill Lynch dispatched a team to hyperinflationary Brazil to learn how to navigate a world in which prices might do anything.
Even though circumstances cried out for decisive monetary tightening, Volcker proceeded cautiously during his first weeks, contrary to the legend that has grown up around him. The first two meetings of the Federal Open Market Committee held under his guidance, in August and September 1979, raised interest rates only modestly. As a result, the inflationary fear in the markets continued to build, and investors fled the dollar in favor of gold. On Monday, October 1, perhaps reacting to Burns’s speech the previous evening, gold rose by fully 4 percent. The next day it spiked a further 6 percent–investors’ determination to dump dollars implied an expectation of hyperinflation. Now, with both the public and the markets clamoring for a dramatic move, the political constraints that Burns emphasized magically loosened: with the nation behind it, the Fed could clamp down on inflation and ride out any recriminations from the White House. Yet even with this strong wind behind him, Volcker coaxed the timid members of his Open Market Committee as gently as he could. He pleaded that the switch to monetary targets might bring down inflation expectations painlessly, sparing the economy a prolonged recession. He reassured his colleagues that they could always turn back. “If we adopt a new approach,” he said, “we are not locked into it indefinitely.”
Volcker did not so much lead his committee into battle as deliberately wait for the panic in the markets to do the leading for him. In this sense, he did not quite refute Burns’s Belgrade speech. In ordinary times, the Fed would indeed be hard-pressed to defy political currents, just as Burns argued; it was only when the times were out of the ordinary that the Fed acquired the latitude that Volcker was now exploiting. In 1951, the Fed had stood firm against President Truman because inflation had hit the terrifying rate of 20 percent. In 1979, the combination of 12 percent inflation and a crashing dollar gave Volcker the chance to show his greatness. Fed chairmen who preside over calmer periods, like American presidents who govern in peacetime, face an altogether different set of challenges and opportunities.”
(WHOEVER IS THE PRESIDENT SHOWS JUST HOW SMART HE IS CONCERNING THE ECONOMY IN THE PERSON HE PICKS FOR FED CHM. I BELIEVE IT’S THE MOST IMPORTANT POSITION THE PRESIDENT CAN CHOOSE FOR THE SAFETY OF THE BANKING INDUSTRY. THIS BOOK TELLS YOU JUST WHY THAT IS AND WHO WERE THE WISEST FED CHM AND WHO WAS NOT, WHICH CAUSED OUR ECONOMIC GROWTH TO DECLINE. THIS BOOK MAINLY FOCUSES ON ALAN GREENSPAN’S LIFE BUT IT DID TALK ABOUT OTHER FED CHAIRMEN. I BELIEVE THE BEST FED CHM WAS PAUL VOLCKER, WHO WAS PICKED BY DEMOCRATIC PRESIDENT JIMMY CARTER. I BELIEVE THAT ALAN GREENSPAN WAS NOT AS WELL QUALIFIED AS PAUL VOLCKER, EVEN THOUGH MR. GREENSPAN WAS APPOINTED BY REPUBLICAN PRESIDENT RONALD REAGAN. THE LAST SEGMENT THAT I’M GOING TO PUT ON FROM THIS BOOK IS HOW ALAN GREENSPAN HELPED THE GROWTH OF THE WILD, UNREGULATED DERIVATIVE MARKET AND HE THOUGH IT WOULDN’T HAVE ANY BAD EFFECTS ON OUR MARKETS. BUT HE WAS LATER PROVEN WRONG IN THE 2008 FINANCIAL CRISIS AND THE PASSAGE OF THE $700 BILLION TARP BANK BAILOUT BILL WHICH WAS PASSED JUST BEFORE REPUBLICAN PRESIDENT GEORGE W BUSH LEFT OFFICE.
LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran