Paul Volcker’s Guide to the Almighty Dollar

The former chairman of the Federal Reserve has three fundamental rules: stable prices, sound finance, and good government.

Jim Young / Reuters

Paul Volcker’s 6-foot-7-inch frame was draped over a chaise longue when I spoke with him recently in his Upper East Side apartment, in Manhattan. He is in his 91st year and very ill, and he tires easily. But his voice is still gruff, and his brain is still sharp.

We talked about his forthcoming memoir, Keeping at It: The Quest for Sound Money and Good Government—about why he wrote the book and the lessons he hopes to impart. Volcker is not a vain man, but he knows that his public life was consequential, and he wants posterity to get it right. He also does not mince words. In our conversation, he assailed the “greed and grasping” of the banks and corporate leadership, and the gross skewing of income distribution in America.

Keeping at It, written with Christine Harper, an editor at Bloomberg, is primarily the chronicle of Paul Volcker’s public life, which was spent in the thin air of global finance. After graduating from Princeton in 1949, he studied economics at Harvard and then in London, where he focused on the operations of the Bank of England. For the next 20 years, his career cycled between the U.S. Treasury and the Chase Manhattan Bank, with a particular focus on monetary affairs.

Few Americans had heard of Volcker until he was nominated, in 1979, to be chairman of the Federal Reserve Board by President Jimmy Carter, a post he held for the next eight years. During that time, he almost single-handedly pulled the nation back from a near-Weimar-scale financial collapse. If there were a Nobel Prize for government service, Paul Volcker’s name would surely be on the short list.

Volcker’s career spanned nearly the entire postwar era. World War II had ended with the United States effectively controlling the major part of the world’s wealth. In a supreme act of statesmanship, Washington offered to provide trade credits and other aid to allies and former enemies alike, so long as they adopted reasonably democratic values. The American dollar effectively became the world’s currency at its 1934 peg—$35 per ounce of gold. That worked splendidly while America’s allies were in recovery mode, but by the 1960s most industrialized countries were competitive with the United States. Swiss currency traders, the nefarious “gnomes of Zurich,” realized that America’s gold reserves could no longer support its dollar issuance. So they started testing the dollar with sudden spasms of dollar sales in the hope of forcing a devaluation.

The classic method of meeting an attack on a currency is to raise interest rates to increase the attractiveness of holding it. But this was the early 1960s, and John F. Kennedy had promised to “get this country moving again.” Higher interest rates would have scuttled that ambition. The Treasury Department hit on a temporizing solution: a tax on foreign security purchases to curb the foreign traders’ enthusiasm for holding dollars. Volcker, then a deputy undersecretary at Treasury, drafted the enabling legislation. It did not take long, however, for traders to engineer an end run around the new tax by simply keeping their dollars overseas. Thus was born the “Eurodollar,” which would proliferate wildly, quite out of the control of the Federal Reserve.

Volcker returned to Chase for several years before rejoining Treasury as undersecretary for monetary affairs in the Nixon administration. The war in Vietnam—paid for by deficit spending rather than new taxes—had triggered serious inflation. Oil imports were surging, and currency traders smelled blood. But Richard Nixon had a genius for the bold stroke. Along with John Connally, his outsize Treasury secretary, Nixon in August 1971 brought virtually his entire economics team to Camp David, where he announced that he would cut taxes, impose wage and price controls, levy a tax surcharge on all imports, and rescind the commitment to redeem dollars in gold. In his 1975 book, Before the Fall, Nixon’s über-speechwriter, William Safire, recalled, “Volcker was undergoing an especially searing experience; he was schooled in the international monetary system, almost bred to defend it.” Everyone he had worked with “trusted each other in crisis to respect the rules and cling to the few constants like the convertibility of gold.” Volcker was charged with drafting the announcement of Nixon’s new economic policies, but his moroseness showed through. Safire did the final draft, proclaiming “a triumph and a fresh start.” About Volcker himself, Safire wrote, “It was not a happy weekend for him.”

As the ’70s wound down, the dollar became a debased currency—but one that, for want of an alternative, still served as the world’s most important reserve currency. Nations might make other provisions, but that could take years. To make matters worse, an ideological cleavage between Milton Friedman’s “freshwater” Chicago monetarists and East and West Coast “saltwater” economists added an unusual testiness to the board’s discussions. Monetarists looked to the supply of money, which is the multiple of physical money—M1 in the jargon—times its velocity, or turnover rate. Friedman’s rigid version of monetarism assumed that the velocity of money was fairly stable over time, so policy makers could ignore it and steer solely by M1. (Indeed, Friedman also believed that you could eliminate the Federal Reserve Board.) Traditionalists, such as Volcker and most other saltwater economists, looked first to interest rates as a policy tool.

By the time Volcker was sworn in at the Fed, in 1979, inflation in the U.S. was running about 1 percent a month, and rising. In 1973, the OPEC countries had forsaken the hallowed $3 peg for a barrel of oil—tripling their prices and tripling them again six years later. By then, spot prices for gold were bouncing around from $235 to $578 per ounce. When the U.S. Treasury, in the early 1980s, needed to raise money, it would be forced to float bond issues in marks and yen, so far had the almighty dollar fallen.

Two months into his new job, Volcker attended a conference of central bankers in Belgrade and was shocked to find himself harangued by his peers. As he explains in his memoir, German Chancellor Helmut Schmidt, who was a friend, lectured Volcker for almost an hour “about waffling American policymakers who had let inflation run amok and undermined confidence in the dollar.” A shaken Volcker cut his trip short, got his fellow Fed members on board, and called an unusual evening press conference. Most dramatically, he stressed that he was shifting his key policy tool to monetarism. As a hedge, he also raised the Fed’s discount rate by a full point. The New York Times editorialized about the rate hike under the headline “Mr. Volcker’s Verdun,” noting that when it came to holding the line on inflation, the Fed chairman’s message echoed that of Marshal Pétain: “They shall not pass.”

At first, the experiment seemed to work. The objective was to reduce the money supply and thereby bring down prices. By January 1980, however, the numbers were going haywire. Perversely, inflation took off—it reached an annual rate of almost 15 percent. The Fed’s technical staff ruefully admitted that Friedman’s money-supply theory was not precise enough to form a basis for effective policy. The Fed board maintained its monetarist rhetoric, but Volcker shifted back to raising interest rates in order to wring inflation from the economy. This was language that all businesspeople understood. The bank prime rate eventually jumped to 21.5 percent, T-bills hit 17 percent, and prime mortgages were at 18 percent. Those rates were the highest the country had ever seen. Volcker went on a grueling speaking tour to bolster the case for what he was doing.

By the time Ronald Reagan was inaugurated, in 1981, the U.S. economy had slipped into a deep recession, one for which the Volcker Shock was largely blamed. Unemployment neared 11 percent. Volcker became a target of popular anger. One welcome ray of sunshine came from the White House, with Reagan giving full support to the continuation of Volcker’s program. (Volcker later said, “I don’t kiss men, but I was tempted.”) Another came from the American Home Builders Association, in early 1982. Its industry had been badly hit by the recession, but Volcker gave a tough speech to the association about staying the course against inflation, and was amazed to get a standing ovation.

Inflation—blessedly—broke in mid-1982. The second half of the year saw a flat consumer price index. Real GDP for 1983 was a very respectable 4.6 percent and  a blistering 7.2  in 1984. By 1986 annual inflation had come down to only 2 percent. The crisis was effectively over. After 1982, Americans enjoyed the lowest interest rates (with a blip here and there) among the major industrial countries, and interest rates are low to this day. The second half of the 1990s was one of the most prosperous periods in history—there was a twin boom in high technology and in housing. Volcker attributes the crash that came in both industries to the same “greed and grasping” he cited when we spoke.

Volcker served two terms as the chairman of the Fed, giving way to Alan Greenspan in 1987. By that time, the challenges confronting the Fed had moved to new arenas—like the reckless “oil lending” by the big American banks to Mexico, Brazil, Argentina, and a string of smaller countries. In Keeping at It, Volcker writes, “Looking back, I see Latin America today as a sad culmination of hard-fought, constructive efforts to deal with a debt crisis that, aided and abetted by reckless bank lending practices, grew out of a chronic absence of suitably disciplined economic policies.” Volcker will never escape a Fed-inflected prose style, but his assessment is spot-on.

Retirement has treated Volcker well. He did some teaching and loved it. He spent 10 contented years as the chief executive of Wolfensohn & Company, an old-fashioned investment bank, which mostly gave advice on mergers and acquisitions. When he retired, he had plenty of time for nonprofit activities and was much in demand. He chaired inquiries into the ownership of Jewish art sequestered in Swiss bank vaults; the massive theft from food and medical programs after the Iraq War; and corruption in the World Bank.

Volcker also played an important role in the cleanup after the 2008–2009 crash. His advice was widely solicited, if not always followed. In his memoir, he describes sitting at a conference and listening to bankers warn that new regulations must not inhibit trading and “innovation.” He finally exploded: “Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.” His lasting contribution from this period is the so-called Volcker Rule, which bars traders from taking risky positions with depositors’ funds, and which he summarizes as “Thou shall not gamble with the public’s money.”

Keeping at It is not a tell-all book. Volcker’s subject matter is economic policy, and his praise or criticism is almost entirely directed at specific ideas and actions. His first wife, Barbara Bahnson, died in 1998. In 2010, he married his longtime assistant, Anke Dening. There is not much of a personal nature in the book, and yet, unwittingly, it paints an accurate personal portrait. The picture that emerges is of a man of granitic integrity, committed to what he perceives as wise policies—committed, that is, to what he calls The Verities: stable prices, sound finance, and good government.

The secret of Paul Volcker was his father. Paul Adolph Volcker Sr. was almost as tall as his son. He was an engineer, with a degree from Rensselaer Polytechnic Institute, and he went on to become a city manager. The city he was most identified with was Teaneck, New Jersey, a municipality that had fallen prey to a corrupt political machine. It was the kind of challenge that Paul Sr. leaped at. In his son’s memoir, Paul Sr. is always working; even after a long day, he drove around his modest empire and made note of broken traffic lights, spilled garbage, and other petty violations. They were not petty to him. The city fathers once tried to can him for hiring a professional police chief. They couldn’t fire him, but they could stop paying him. Paul Sr. went to court and got his pay—and got his police chief. Exactly what his son would have done.

There are few people like Paul Volcker in the U.S. government today, or in business, for that matter—respected and trusted by everyone, whatever the disagreements, and motivated by public service. Volcker reveled in his middle-class status. He notes in his memoir that, in the 1960s and 1970s, Washington was “mostly populated by middle-class professionals, including families of civil servants and members of Congress,” and that “there wasn’t great wealth.” Now, he writes, Washington is “dominated by wealth” and by “lobbyists who are joined at the hip” with people in government, whether on the Hill or in the executive branch.

As a result, he says simply, “I stay away.”