Americans did not care that President Nixon had suspended the convertibility of dollars into gold, having been barred from holding the precious metal since 1933. They cared only about fixed exchange rates and what the dollar would be worth in terms of the pound, yen, and lira. But suspension flustered foreign central bankers because many held dollars as reserves, assuming they could exchange their greenbacks for gold.19 Now that the dollar was no longer convertible, at least some members of the exclusive club might stop intervening in the foreign exchange markets, allowing the dollar to float with supply and demand. The financiers worried that the ensuing chaos would immobilize international trade.
Treasury Secretary John Connally tailored his press conference on Monday morning, August 16, to the domestic side of the president’s speech. He understood that the upcoming presidential election, less than fifteen months away, began at the supermarket checkout counter. He promised that the new Nixon policies would fill the shopping cart. “The programs are designed to create more jobs and reduce unemployment … to stimulate car sales … to bring inflation under control … [and] to give the American worker a chance to increase his productivity.”20
Connally knew that George McGovern, at the time the only declared candidate for the Democratic presidential nomination, had disparaged Nixon’s international program immediately after the president’s speech: “It is a disgrace for a great nation like ours to end in this way the convertibility of the dollar.”21 Connally deflected the criticism with a humorous aside: “I am not prepared to say what is going to happen in the international money markets … [but] there is no question that we shook them up.”22
Connally then withdrew from the fray by publicly designating Paul Volcker as the point man for all matters international. “I want to say to those of you who do not know, that about midnight last night, Undersecretary Paul Volcker left with Dewey Daane of the Federal Reserve Board to go to London. A meeting will be held this afternoon at the American embassy at four o’clock with representatives of our principal trading partners … So our people are there. They are already talking. But so far as the reaction of the central bankers in Europe, frankly I am unable to tell you.”23
It was past four o’clock in London when Connally made the announcement, and Volcker had already engaged a pride of financiers at Wychwood House, residence of the American ambassador to London. He knew most of these veterans of earlier crises, including Otmar Emminger of the Bundesbank, Jeremy Morse of the Bank of England, Rinaldo Ossola of the Bank of Italy, and Claude Pierre-Brossolette of the French Ministry of Finance. Two representatives from the Bank of Japan who happened to be vacationing in London at the time were pressed into service. They should have known that summer in the British capital rarely lasted more than a day.
Volcker summarized the proceedings at a press conference after the meeting, offering few details while remaining faithful to the substance.24 “I came for consultations, not negotiations, but we want to return to a stable system as soon as possible.” When asked whether he still dismissed floating exchange rates as ivory tower scribbling, he smiled. “I don’t think we can object to anything as an interim solution … and we do not have a blueprint going forward. But long-term monetary reform will be a slow process.”
Behind the closed doors of the meeting, Volcker had already embraced floating exchange rates as a means to accomplish a noble cause: a revitalized Bretton Woods System. “Letting the markets determine a credible set of exchange rates might not be entirely bad … We do not want to jump from one crisis to another.”25 His flexibility elicited concern from the Bank of England’s Jeremy Morse; “It might be difficult to get back to a fixed parity system.”26 Volcker seemed prepared to take a calculated risk, a characteristic that would serve him well in the future. The press commented favorably: “Mr. Volcker, despite his reputation for conservatism, is open to persuasion.”27
Volcker invoked a higher authority during the news conference when it came to gold. “The President would like to see a further diminution of the role of gold in international finance.” He had been even more explicit about Nixon’s preferences during the meeting with the central bankers, saying that the president did not want to raise the price of gold, even though that would be “a quick and easy solution” to the excess supply of dollars abroad.28
America’s stock of gold would cover twice as many dollars if the Treasury set the official gold price at seventy dollars an ounce rather than thirty-five. But raising the dollar price of gold, technically called a devaluation of the dollar, required congressional approval. Nixon did not want to suffer the embarrassment of devaluation, an indignity last perpetrated on the American people in 1934, at the urging of Franklin Delano Roosevelt.
Volcker dismissed devaluation because it would reward speculators and countries such as France, which had spurned dollars in favor of the precious metal. He wanted to restore a fundamental balance in U.S. imports and exports by depreciating the dollar against other currencies, the yen and the mark in particular. Central banks could allow the dollar to depreciate without a formal U.S. devaluation against gold simply by refraining from propping up the dollar in the foreign exchange market.
The dollar had already dropped by more than 6 percent against the mark since the Bundesbank stopped intervening in May.29 But Volcker calculated the dollar would have to decline by an average of 15 percent to restore the competitiveness of U.S. exports in world markets.30 Fifteen percent would make Volcker as unpopular among America’s trading partners as the tax collector.
Four months of negotiations would be needed to produce a new set of exchange rates under a revamped Bretton Woods System. Japan and France were the major bottlenecks: France, because President Georges Pompidou, a protégé of de Gaulle, wanted to embarrass the United States by forcing a devaluation of the dollar against gold; Japan, because companies such as Sony and Toyota wanted the yen to remain cheap relative to the dollar to encourage their exports to America. An embarrassing press report showed the extent of Japanese inroads: “Secretary of the Treasury, Mr. John Connally decided … that all senior members of his staff should have television sets in their offices so that they could keep in touch with the developing world monetary crisis. A Treasury purchasing agent was sent out and he returned with several portable sets—all products of the Japanese Sony Company.”31
Volcker dominated the negotiations from the outset, touring the major European financial centers to explain the American position.32 A communiqué from the Paris correspondent of the New York Times labeled Paul Adolph Volcker “the President’s Monetary Envoy” and quoted him as saying, “Mr. Nixon is facing the facts.”33
The Paris news story carried a picture of Volcker alongside French finance minister Valéry Giscard d’Estaing, Connally’s counterpart in Pompidou’s cabinet. The snapshot elevated Volcker in the international hierarchy as surely as a presidential promotion. Going forward, he received royal treatment at the famed Hotel de Crillon, located on the Place de la Concorde, a few steps from the Champs-Elysées. Management at the five-star hotel, built in the eighteenth century, would reserve the same bed for Volcker as had been used by the six-foot, five-inch general Charles de Gaulle.34
London’s Financial Times featured Volcker in their “Man of the Week” column with the headline “Big Man in a Big Job,” and offered historical perspective. “Paul Volcker has held his present job since the Republicans came to power two and a half years ago. That he got the job at all is noteworthy since he is widely believed to be a Democrat. But the fact that he has kept his post despite the dollar’s vicissitudes … underlines both his professional competence and his growing personal authority in Washington.”35
The Financial Times elaborated on key details: “No one could miss Paul Volcker in a crowd. President Nixon’s international monetary trouble shooter stands all of six feet seven inches high in his sober black socks, weighs 240 pounds and tops off his impressive frame with a pair of steely eyes, a slack jaw, and a near bald crown to h
is head.” Volcker clearly owed John Connally more than just an opportunity to represent America in world finance. His “sober black socks” came directly from the boss’s example of sartorial footwear.
The Sunday edition of the New York Times on August 22, 1971, confirmed Volcker’s transformation from technocrat to diplomat. The front page of the business section carried a black-bordered rectangular box that ran the entire length of the page, as though it were designed for the Volcker family scrapbook.36 The caption at the top read “Nixon Did It,” with a picture of the president immediately below. At the bottom of the frame the title read, “The World Reacted,” followed by a picture of Karl Klasen, head of the German central bank. In the center appeared the heading “Volcker Explained It,” bordering a picture of Paul, with eyes peering out from behind a microphone.
Alma Volcker, Paul’s mother, could not have done a better job.
The price reaction in gold to the suspension of convertibility surprised Volcker, teaching him a lesson in market psychology he would never forget. Arthur Burns had asked him during the Camp David meeting, “What will happen to the price of gold?” Volcker had answered, “Everybody who speculates in gold will seize on this to make a mint. We have to come up with a proposal to demonstrate that gold is not that important.”37 He added that “fortunes could be made” with the information on suspension, and joked to budget director George Shultz that, given “a free hand,” he could make up the government’s $23 billion budget deficit.38
Luckily for Volcker, and the U.S. Treasury, he never got the chance to put the speculation to work. The free-market price of gold in London had closed at forty-three dollars an ounce on Friday, August 13. The market remained closed on Monday, August 16, to let everyone digest the president’s bombshell, and then reopened on Tuesday with a giant yawn. The gold price remained virtually unchanged for the entire week after suspension and declined to below forty-one dollars an ounce by the end of August.39
Volcker’s forecasting record while treasury undersecretary had earned him the reputation of foreign exchange Nostradamus, having anticipated the French devaluation in August 1969 and the dollar crisis in May 1971. But his “fortunes could be made” observation sits on the shelf of miscalculations alongside business statistician and educator Roger Babson’s 1928 prediction, “The election of Hoover … should result in continued prosperity for 1929.”40 The only consolation is that Volcker himself might have contributed to gold’s lackluster per formance.
Speculators had pushed up the free-market price of gold to forty-three dollars an ounce prior to Nixon’s announcement, eight dollars above the official thirty-five-dollar price posted by the U.S. Treasury, anticipating an American devaluation. Under the bizarre two-tier market operating since March 1968, dealings among central banks took place at the official price and private transactions at the free-market price. The spread between the two reflected the ancient and honorable forces of supply and demand. Speculative demand had focused on gold as the government’s key monetary asset, a legacy of a century under the gold standard and of the dwindling stock of U.S. gold relative to dollar obligations abroad.41
Volcker thought that Nixon’s suspension of convertibility on August 15 confirmed a crisis that would inflate renewed speculation. He had not considered that his dismissal of devaluation during his London consultations the following day would puncture the balloon. He had underestimated the power of his own words because he knew that both Nixon and Connally cared more about politics than economics, and would sacrifice finance for political gain. He was right to expect devaluation to make a comeback but wrong in his assessment of market psychology.
Volcker had forgotten what he had learned on the government bond desk of the Federal Reserve Bank of New York. Traders bought and sold based on their expectations of the future, transacting at prices that reflected their best predictions of what was likely to happen. Prices respond only to surprises, and speculators had already built an expected devaluation into the price of gold. Volcker had disappointed the speculators, and they drowned their sorrows by selling their gold.
Volcker slipped into his role as international financial diplomat as though it were a custom-made suit. He wanted to negotiate a new set of exchange rates quickly, before foreign governments retaliated with their own trade barriers. He spent as much time in London, Paris, and Rome immediately following August 15, 1971, as he did in Washington, D.C. Perhaps that is why he encountered trouble on the domestic front on the morning of September 11, 1971.
Barbara called his office at eleven o’clock.42 “Have you forgotten something?”
Paul looked at his jacket to make sure it matched his pants. “Not that I know of … but I assume you are going to tell me.”
“Well, today we should be celebrating our trip to Maine.”
He had not only forgotten their wedding anniversary but had given Barbara the opportunity to remind him of a colossal error. His planning of their honeymoon trip to Pocomoonshine Lake in Maine ranked as the low point in almost twenty years of marriage. Paul had thought that sharing his love for the Volcker family passion with Barbara would get them off to a great start. He overlooked the possibility that fly-fishing would not necessarily arouse the same romantic interest in his new bride as it had in his father and grandfather.43 Barbara made her point by ending their trip two days early, right after they had spent an evening watching bears rummage through the garbage in the nearby village of Grand Lake Stream.
He responded with a weak attempt at humor. “Well, my only defense is that I’m not sure what day it is because I’m not sure what city I’m in.”
Barbara waited, to let him squirm, and then said, “At least you have an excuse. The only reason I remembered is because the mail just arrived and your mother sent us an anniversary card.”
Volcker’s international financial diplomacy during the fall of 1971, as the dollar depreciated, went about as well as his conversation with his wife on September 11. The Italian Socialist Party, a key member of Prime Minister Emilio Colombo’s coalition government, extended the resentment beyond simple economics. The Italians denounced the dollar’s weakness as a consequence of American spending on the Vietnam War, and echoed the French position, urging “the abandonment of the dollar as an international standard and reserve currency.”44
John Connally counseled patience from the beginning. He felt that time was on America’s side as the mark and yen appreciated, and the dollar declined, under the temporary float that began with the May crisis.45 He knew that the import surcharge irritated all America’s trading partners, especially the Japanese, and the suspension of dollar convertibility bothered the French most of all. Connally was determined to exploit these irritants until the United States achieved the 15 percent depreciation of the dollar that it needed to be competitive in world markets.
Volcker had been taught restraint by his father, but John Connally added that strategic element to the art of negotiation, turning it almost into science. Volcker recalls that “while the French were buying dollars to prevent the franc from appreciating during the fall, Connally took a trip to Indonesia for no other reason than to make French finance minister Giscard d’Estaing think we did not care. I learned a lot from him, but sometimes he played his cards so close to the vest that I did not know what he really wanted.”46
Arthur Burns, still resentful over Volcker’s victory in suspending gold convertibility, memorialized Volcker’s vulnerability with the following entry in his diary: “Poor and wretched Volcker—never knowing where he stood on any issue—had succeeded in instilling an irrational fear of gold in his tyrannical master [Connolly], whom he tried constantly to please by catering to his fear of foreigners (particularly the French) instead of his capacity (not inconsiderable) for straight reasoning.”47
The meeting on Monday, November 29, 1971, of the ten richest non-communist countries, known as the Group of Ten (G-10), took place in the Palazzo Corsini in Rome, a princely setting for a breakthrough in the ongoing fi
nancial drama.48 The palazzo, built in the eighteenth century along the Tiber River, had served as the Roman town house of the Corsinis, a Renaissance banking family from Florence, and was now home to the Italian Academy of Arts and Sciences. Masterpieces by Rubens, de Hooch, and Brueghel decorated the walls of the makeshift press room, installed on the first floor.49
The rotating chairmanship of the G-10 meetings put John Connally at the head of the forum, with the remaining ministers of finance and their central bankers arrayed comfortably at the ornate rectangular table. Volcker sat immediately to the right of Connally, as the chief U.S. representative, and Federal Reserve chairman Arthur Burns sat next to Volcker. Burns’s presence reminded Volcker that he was about to lose the battle on devaluation, courtesy of the French.
Arthur Burns had relayed a message from Giscard d’Estaing to Richard Nixon, saying they would accept a “five or six percent” appreciation of the franc versus the dollar if the U.S. devalued the dollar against gold by the same amount. This would maintain a constant price of gold in terms of francs, precisely the stability that gold-loving Frenchmen wanted. According to Burns, there was a “widespread and long-standing custom of the French population to hold gold as a hedge against inflation and political uncertainty.”50
Prior to the G-10 meeting, Connally had told Volcker that Nixon had authorized a modest U.S. devaluation, despite all their denials, if that was necessary to move negotiations forward.51 The French surely wanted to embarrass the United States, and the large holdings of gold at the Banque de France, courtesy of General de Gaulle, strengthened their enthusiasm and intransigence.52 France’s gold would gain in dollar value if they forced America to take its medicine, confirming the wisdom of Gaullist policy.
Volcker accepted devaluation against gold as the price in prestige America had to pay for accomplishing the desired appreciation of the major currencies against the dollar. He felt better knowing that his recommendation to continue the suspension of convertibility had prevailed.53 French gold would be worth more dollars after devaluation, but the French would not be able to capitalize on their gain—a typical French victory, putting appearance over substance.
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