President Carter

by Stuart E. Eizenstat

  CARTER BONDS

  What happened after that meeting would change the course of administration policy, and there would be no turning back. It had all the suspense of an Alfred Hitchcock film and was carried out with great stealth to shock the market. Blumenthal asked to see the president privately, told him that the dollar was sinking badly despite his speech, and then informed him for the first time that Solomon had been working on a rescue plan but had kept it secret in order to first gauge the market reaction to his speech—and now they could not wait.

  To avoid any suspicion that the markets would soon be socked by a major intervention, everyone maintained a normal Saturday schedule. Carter campaigned in New England. Miller went to a dinner party at the Georgetown home of Katherine Graham, the owner of the Washington Post, but excused himself early. He was sneaked into the White House, where Schultze met him in the room used by the White House chauffeurs.125 It was more difficult for Solomon, who was hosting a dinner party at his own home, and left early with a hardly credible plea that he had an appointment with an important European steel executive.

  I had a personal dilemma. Our synagogue had a long-planned family retreat in the small town of Orkney Springs, Virginia, and I did not want to leave Fran there with the boys, or to have my absence raise questions. But I wanted first to speak to Schultze and then to be plugged in to the afternoon discussion on the plan that would be presented to the president. So it was agreed that I would go through the White House operator and participate by telephone. The problem was that there was only one phone in the place, no desk, and telephone calls were frowned on during the Jewish Sabbath.

  What I heard was part of a four-hour discussion about a huge package Solomon had privately outlined to me, with a war chest of $30 billion from the Treasury and the International Monetary Fund to defend the dollar, and an unusually large 1 percent increase in the Fed’s discount rate to nudge interest rates higher and encourage foreigners to hold on to their dollars. Miller insisted on selling gold as a gesture, but the decisive American commitment was an offer to finance one-third of the war chest with $10 billion worth of bonds denominated in German marks and Japanese yen. They soon became known as “Carter bonds,” and were meant to show that the United States was willing to put its money where its mouth was: If the dollar did not rise, the bonds would cost more to repay in foreign currency.126 The president returned at 10:00 p.m. in a helicopter from Camp David on the White House South Lawn, shielded by the darkness, arrived at the Map Room unnoticed by reporters, and listened for two hours until just before midnight; then he approved the package.127

  On Sunday, German, Swiss, and Japanese officials arrived in Washington at Solomon’s invitation and went straight to his house. Since it was a weekend, Toyoo Gyohten of the Japanese Finance Ministry had to pay for his plane ticket from Tokyo with his personal credit card and worried that he might not be reimbursed if the negotiations failed.128

  * * *

  This “revolutionary” package—Miller’s term—was thrown at the markets as soon as they opened at 9:00 a.m. November 1, 1978, after a long European holiday weekend. It worked. Within minutes the dollar rose 7 percent against the mark, 5 percent against the yen, and 7.5 percent against the Swiss franc. The New York Stock Exchange soared to its largest single-day increase in years.129 Blumenthal called me twice, elated with the good news, and our ambassador to Switzerland, Marvin Warner, told me the president’s dollar-rescue program had been “met with ecstasy” throughout Europe.130

  While no one expected that all the money in the war chest would actually be spent, it cost the equivalent of $6.7 billion through the remainder of the year to support the currency. Solomon wondered aloud to Volcker at one point how long it was worth spending that kind of money, which eventually would have to be paid back.131 There were other bumps along the way. The Germans at first refused to do their part, but meanwhile medium and short-term interest rates fell and would not have to rise as much as feared.

  Solomon kept me apprised and gave me another message that stayed with me throughout my public service: “The Council of Economic Advisers does not understand the psychology of markets, which is critical and cannot be put into their models. Therefore, you need to stroke and pressure money markets. Now we may not need a recession.”132 I only wish he had been correct, and indeed he might have been had not the Iranian revolution intruded. Early in 1979 the dollar settled of its own accord as the trade balance improved—exactly as Solomon had predicted when he started putting the package together, and the dollar crisis ended. I only wish our anti-inflation program could have been as successful.

  The dollar rescue was important for other reasons. It ended the locomotive era of stimulating global growth through coordinated pump priming by our key allies. It also proved that the monetarists’ free-floating exchange rates did not adjust themselves without an occasional government thumb on the scales of the markets that were supposed to self-correct. It demonstrated how foreign markets can drive domestic decisions. It underscored that the dominance of the U.S. economy during the postwar period had been reduced. But it was also a fundamental turning point for the Carter administration. It showed that in dealing with stagflation, we could not have it both ways—we had to abandon the notion that we could stimulate the economy to lower unemployment without risking rising inflation.

  This also unsettled the dominant constituencies of the Democratic Party, which tended to believe that inflation was an issue for Republicans to worry about. What labor and liberals refused to understand was that their opposition to a progressive way of fighting inflation by wage and price guidelines and tighter budgets would inevitably leave brutal monetary policy as the only solution. Key elements of the Democratic Party base simply could not handle persistently high inflation, and were pretending it away, pushing the minimum wage increase and the Humphrey-Hawkins Full Employment Act. We now were on a perilous political course that would lead to a challenge from the left by Senator Kennedy to Carter’s renomination.

  But even while shifting the goal of his economic policy, Carter could not easily recalibrate the direction of his government to attain it. During the period we were spending billions to defend the dollar, no one was willing to pay the real price of stopping inflation by tightening money. The administration soldiered on with our tougher voluntary policy of anti-inflationary standards. Carter himself wondered why other nations had lower inflation rates, and Schultze explained that their labor markets were not as tight; our lower dollar imported more inflation; and their more disciplined unions were willing to heed their governments.133 Indeed, in other advanced nations there was a greater sense of social solidarity that eased the application of a voluntary policy—most notably in Germany with its social market economy (Sozialmarktwissenschaft), where even captains of industry refer to unions as their “social partners,” a model replicated in Scandinavia and to a lesser degree in some other European countries and Japan. All had long taxed petroleum products heavily to encourage conservation, so that when the Iranian revolution created a second worldwide inflationary oil price shock, they were less vulnerable, while we were still struggling to enact our national energy policy.

  * * *

  We hardly started 1979 with holiday cheer. Schultze reported at a January 2, briefing of the president, vice president, and top economic officials134 that most forecasters expected a recession in late 1979, with a snapback in 1980 that might be avoided if interest rates did not go much higher. All this was enough to leave one breathless and despondent. But it is worth pausing to dispel one myth about inflation, because a movement had arisen for a balanced-budget amendment to the Constitution, as part of the antitax revolt. Carter was in no way a big spender, and failed to achieve his goal of a balanced budget not because of excessive spending but because of inadequate growth and revenues. On the contrary, he followed his conservative instincts whenever possible.

  Between the fiscal years of 1976 and projecting into 1980, federal spending increased only by
1.1 percent, excluding defense spending and mandatory Social Security increases. When those figures were presented by Schultze and Budget Director McIntyre, Blumenthal commented that the president needed to tell the American people “the truth, that things are bad.” Schultze said that would only backfire because we were facing an inflation that was neither pushed by rising costs nor pulled by high demand—but by external factors like food and energy hikes that suck consumers into a psychological whirlpool where they tend to buy at any price to protect themselves from even higher prices in the future. If the president told the nation that things would only get worse, Americans might rush out to buy more and convert his sober warning into a self-fulfilling prophecy.135

  The fact is that neither Blumenthal nor any of Carter’s other economic advisers presented stronger anti-inflation options that the president himself could actually have adopted. And none focused on monetary policy until too late, because no one wanted to be identified with the increasingly high interest rates and unemployment that tight money would produce. As we moved into the spring of 1979, wholesale prices rose, a reliable harbinger of what consumers would soon be paying.136 The modest successes of the guidelines had been achieved largely with companies that did business with the government. Oil prices began a steady climb because of the Iranian revolution and would double within a year; food and housing were already growing more costly. Blumenthal could only present tougher and more unpalatable policies: Tighten the guidelines and enforce them by law; squeeze the budget further; and encourage the Fed to raise interest rates. We were near despair. As the cherry trees blossomed in Washington, Bosworth declared: “We’ve run out of options.”137

  The contemporaneous record, on which I have reflected over the years from my virtually verbatim notes, frequently showed Carter ahead of his advisers. He wanted to veto his own tax cut. He pushed for tough penalties against violations of the government’s wage and price guidelines. He ran a tight budget. In the end he had to rescue the sinking American dollar because foreigners and Wall Street lost confidence in our economic program. But no one had a clear answer for inflation, and Carter had the bad luck of governing at a time of deeply embedded inflationary expectations that we did not fully appreciate and could not be neatly modeled in the economists’ computers. They drew a statistical picture of dramatically lower growth in productivity, large increases in crude oil prices spiked by the Iran revolution, and a strongly expanding economy that simply did not jibe with their experience or economic equations. Fortunately they also could not account for Jimmy Carter’s resilience and his determination to keep trying until he found the answer. When he found it, he was reviled for it.

  VOLCKER

  On his return home from a successful Tokyo summit at the end of June 1979, in which he was able to coax the G7 nations to adopt import quotas on OPEC oil, he was nevertheless exhausted and dispirited. With lines of cars snaking around gasoline stations, inflation running at 11 percent, and his approval rating at a miserable 30 percent, Carter precipitously canceled a nationwide address on energy, mysteriously retreated to Camp David, rethought and restructured his government, and addressed the nation in what came to be known as the “malaise” speech, although he never uttered the word. The high drama of this extraordinary chapter in the American presidency is recounted later in this book, but suffice it to say here that Carter fired Blumenthal, who was viewed by financial markets as the key anti-inflation fighter, and reshuffled his cabinet without thinking about a replacement. This came just as Blumenthal felt he had at last reached a meeting of the minds with Carter, as they flew home from Tokyo together, but he was derided by Ham and Jody for not being a team player.138

  The search for successors during a time of high inflation and turmoil in financial markets, as well as in the government itself, was not the most attractive incentive for a quality candidate to succeed Blumenthal at Treasury. We canvassed the usual suspects in the corporate establishment: Reg Jones of General Electric, A. W. “Tom” Clausen, the respected CEO of Bank of America, David Rockefeller of Chase Manhattan, and Irving Shapiro of DuPont. All refused. Bereft of first-rate outsiders, the president turned to Bill Miller as the default replacement.139

  Miller had hardly distinguished himself as Fed chairman. He was neither an economist nor an expert in financial markets. He had committed an unprecedented error of leadership in his first months at the Fed by allowing himself to be outvoted on interest rates. His fellow board members begged him to reverse his vote for easier money but he refused.140 Fearful of creating a recession, Miller was so lax in his monetary policy that in the early weeks of 1979, Schultze and Blumenthal privately met with Miller to urge him to tighten it, an unprecedented appeal by any administration. The two economists started giving background interviews with the press urging higher interest rates until Carter, not yet ready to take this leap, issued Schultze and Blumenthal a written rebuke: “Cease immediately your campaign in the press to get Miller to raise interest rates.”141

  That left a hole to fill as Fed chairman. Dick Moe, the vice president’s savvy chief of staff, was quickly asked by Ham and the president to canvass labor, business, and political leaders and economists and compile a list of worthy candidates. In the course of a weekend, he came up with eight to ten names, which he delivered in a black notebook to Carter in the White House residence on Sunday. There were two names at the top of the list: Clausen and Paul Volcker. Volcker was favored by almost everyone he had called as the person most acceptable to nervous financial markets, but there were warnings as well: He would be tough as nails in attacking inflation and might not be a team player. Mondale, Moe’s boss, opposed Volcker’s appointment in the belief that such tough monetary medicine would lead to a recession as the president was campaigning for reelection. But as Carter went down the list of candidates Moe compiled during the weekend that Miller was asked to move to Treasury, Miller advised the president that Volcker should replace him at the Fed even though the two had clashed over policy.142 When Miller took Moe to meet Carter in his private study, while Moe did not make a recommendation from the short list, his warning about Volcker caught Carter’s attention. As a result, even with Miller’s advice, the president soon reached Clausen having breakfast with his wife in San Francisco to determine is he wanted to be considered for the Fed chairmanship. After putting the president on hold to check with his wife, Clausen demurred because, he said, it would “not be a good time to come.”143

  The concerns about Volcker’s tough views on fighting inflation were not mere speculation. As president of the New York Fed and vice chairman of the Fed’s Open Market Committee that sets interest rates, Volcker had long clashed with Fed chairman Arthur Burns during the Nixon and Ford administrations. “I was always pushing him to be tighter, tighter, tighter to get him to raise the discount rate a quarter of a percent, but he didn’t want to raise it at all.… Christ!” Volcker said later. As he bluntly put it to me, raising interest rates “isn’t fun,” so the Fed tended to move cautiously. It lagged the market because it lacked the backbone to get ahead of the traders and speculators, and they had lost confidence in its ability to fulfill its core function of managing America’s currency.144

  But if Volcker felt that Burns moved too little and too late, he felt it in spades about Miller. While he had not been prepared to challenge Burns as directly, Volcker felt that as chairman of a major corporation, Miller was “not a natural choice” to head the Fed: “I don’t think he fully appreciated all the sensitivities of central banking.” He even voted against Miller on the Open Market Committee, a highly unusual action for the vice chairman. Three other members of the committee joined him in several dissents, and at one point this “Volcker minority” (as the press called them) actually outvoted their own chairman and favored raising the Fed’s discount rate.

  Volcker remembered that Miller’s policy was so loose as inflation raged early in 1979 that Blumenthal and Schultze met with the seven members of the board and pointedly asked why they were
not running a tighter policy. “That is nothing that happens every day—when the Administration is concerned about the Federal Reserve being too easy!” Volcker remarked.145 Miller indirectly confirmed this years later by telling me: “There wasn’t a great deal of sentiment at the Fed to be tougher on inflation, because they did not have a desire to throw the economy into a big recession.”146

  Carter knew he needed someone in whom financial markets would have confidence, and Volcker was figuratively and literally head and shoulders above anyone else. Volcker was not simply a default candidate; there were a number of safer candidates to choose from on Moe’s list. But I believe that by this time Carter had lost confidence in the anti-inflation remedies his economic advisers had given him during the previous two and a half years and was ready to take a chance on someone committed to administer tough medicine even at his own short-term political peril. Gone was the effort to balance the attack on inflation and unemployment, and to calibrate his conservative instincts against his liberal Democratic constituencies. As he would do after the Soviet invasion of Afghanistan when he took a hard line against Moscow, Carter now was willing to throw in his lot with Volcker and recognize that at this stage there was no remedy for embedded inflation save allowing Volcker and the Fed to painfully squeeze it out of the economy with high interest rates and higher unemployment. He was now doing what he had hoped to avoid: fight inflation through a slowdown or even recession, to the dismay of the core Democrats. It is one reason he was not reelected.