14. His insistence is surprising. According to John Ehrlichman, Burns told the president in December 1970 that at some point he “might have to sever the link between the dollar and gold” (quoted in Wells, 1994, 66–67).
After the president announced the new program, labor union leaders and leading congressional Democrats protested exclusion of interest and dividends from the program.15 Burns did not want to put interest rates under the freeze because that would transfer authority for monetary policy to the new Cost of Living Council, in effect to John Connally, the council’s head. The Federal Reserve would be back in the position it had been in from 1942 to 1951, before the Accord.
To satisfy the critics, the administration decided on an informal program. In October, President Nixon asked Burns to chair the Committee on Interest and Dividends. Burns discussed the appointment with the Board of Governors on October 5. They agreed that Burns should serve. “The only questions raised were those of the powers of the committee related to those of the Board” (Maisel diary, October 20, 1971, 1). A main concern was that the committee would be heavily influenced by politics, since three members were cabinet officers. They expressed particular concern in this regard about Preston Martin of the Home Loan Bank Board, later vice-chairman of the Board of Governors. The Board concluded that the committee not have mandatory power to fix interest rates, and that it should avoid giving directions about open market operations and confine its attention to consumer credit and mortgage rates.
Thus, Burns became chairman of the Committee on Interest and Dividends.16 Market-determined rates remained unregulated; the committee’s responsibility applied only to dividends and so-called administered rates such as the prime rate or bank rates on consumer loans. Chairing the committee created a potential conflict of interest. If monetary policy actions raised market rates, banks expected prime rates (and others) to rise. The unions and Congressman Patman would oppose any increase in administered rates as a cost to consumers and business, so Burns might be reluctant to raise open market rates. This conflict is one explanation of expansive policy in 1972.17
15. At Secretary Connally’s briefing for reporters on Sunday evening, he answered a question about interest rates by saying, “[W]e did not do it because we didn’t know how effectively to do it” (Connally press conference, Nixon papers, Shultz Box 8, August 15, 1971, 8). In fact, the law that Congress had passed did not authorize control of interest and dividends, as he knew.
16. The other members were the Secretaries of Treasury, Commerce, and Housing and Urban Development, and the chairs of the Federal Home Loan Bank Board and the Federal Deposit Insurance Corporation. The Federal Reserve staff served as committee staff. As usual, Burns dominated the meetings so much that the others rarely attended.
17. Dewey Daane, a member of the Board of Governors at the time, objected to Burns taking the chairmanship of the Committee on Interest and Dividends. “I always thought it very, very inappropriate for him to wear that hat and be trying to hold down interest and interest payments, when to do the Fed’s job properly, you had to be pushing interest rates up” (Hargrove and Morley, 1984, 377). Burns accepted the chairmanship so that Connally wouldn’t get it (Brimmer, 2002, 20).
The group did not decide what came after the ninety-day wage and price freeze. It left that decision to a committee headed by Herbert Stein. Stein had experience with decontrol after World War II and Korea, and he wanted to end controls “promptly and in an orderly way” (Stein, 1988, 181). He shared the view that the president repeated several times at Camp David and emphasized in his speech: controls should not become permanent. When the press asked Secretary Connally about the inconsistency between earlier statements opposing price and wage controls as unworkable, he denied that the administration had adopted controls. Nixon “put on a wage price freeze for a limited period of time, 90 days, with the idea that this would be voluntarily adhered to by the American people” (Connally press conference, Nixon papers, Shultz Box 8, August 15, 1971, 9).18
The proposed fiscal program provided a small reduction in the deficit. The proposal reduced tax rates by $6.2 billion, about half from the new investment tax credit. The planned 10 percent surtax returned $2 billion, and proposed budget cuts reduced spending by $6.6 billion. The largest proposed reductions were made in general revenue sharing and by deferring a federal pay increase. These actions required congressional approval. Most spending reductions were not realized. This did not surprise President Nixon. Burns warned him in conversation that congressional Democrats would want to increase, not decrease, spending. The president responded: “That’s always their way—to increase government spending. Our way is to increase the private sector” (White House tapes, conversation 7-152, August 15, 1971).
In the next Economic Report of the President, the Council of Economic Advisers warned about the danger of relying on controls to stop inflation. The CEA and others in the administration and the Federal Reserve ignored the warning.
If monetary and fiscal policy keep the growth of demand moderate, the price and wage controls can bring about more quickly and surely the lower rate of inflation that competitive forces would cause in such circumstances. But if demand is allowed to grow excessively, the price and wage control system will lose its value. Correspondingly, if the presence of the price and wage control system becomes an excuse for laxity in monetary and fiscal policy, the system’s effect on controlling inflation will be negative. (Council of Economic Advisers, 1972, 96)
18. Stein later wrote, “As I look back to that weekend twenty years ago . . . I am amazed to recall how unconcerned and ignorant we were about what would happen next. . . . We did not foresee that the public would love the ninety-day freeze so much that we could not retreat from it very quickly” (Stein, 1994, 5).
There was little basis for the more optimistic possibility.
AFTER CAMP DAVID
The president drafted his own speech with revisions by his speechwriter, William Safire. On Sunday evening, he delivered the speech on television. The public accepted the new program enthusiastically. On Monday, the Dow Jones average rose 32.9 points, representing the largest one-day increase in dollar value to that time. The principal criticism came from economists,19 but labor union leaders grumbled also. George Meany, president of the AFL-CIO, wanted free collective bargaining, but he could do nothing, so he went along with the freeze at least initially (Shultz, 2003).20
The president’s address emphasized the role of speculators as the cause of dollar instability. He did not avoid the word “devaluation” but, reverting to populism, he reassured the public that the change in international policy affected only those who “want to buy a foreign car or take a trip abroad. . . . [For t]he overwhelming majority of Americans who buy American products in America, your dollar will be worth just as much tomorrow as it is today” (“The Challenge of Peace,” Nixon papers, August 15, 1971).
Connally went further. He denied devaluation. “I don’t know that it’s going to devalue at all. I think it is going to stabilize it. . . . With respect to some currencies it may go down, and with respect to others it may go up. I think it is going to change, but to say it is going to be devalued, I am not prepared to say that” (Connally press conference, Nixon papers, Shultz Box 8, August 15, 1971, 5). This was misleading. Connally also doubted that the gold price would change. He maintained this position in subsequent negotiations until he was forced to accept an increase. Since the United States did not buy or sell gold, the posted price had no economic significance.
19. Karl Brunner and I organized one group of about a dozen economists. We predicted that controls would not reduce inflation and published an op-ed in the Wall Street Journal. The public’s response differed. A public opinion poll asked, “‘Is the president doing a good job?’ Taken right after wage and price controls started, the poll showed that the percentage who thought the president was doing a good job had virtually doubled and held there” (Paul McCracken in Hargrove and Morley, 1984, 334).
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20. Shultz (2003) explained that the Business Council (representing major U.S. corporations) had a rare vote on price and wage controls. The vote for controls was overwhelming. Only two voted against.
International Negotiations
The government made a major change in policy without thought about its long-term consequences.21 No one at Camp David had a clear idea about what would happen when they closed the gold window and imposed a surtax on imports. At his August 2 meeting with the president, Connally said: “We may never go back to it [convertibility]. I suspect we never will” (White House tapes, conversations 268-6 to 269-1, August 2, 1971). But beyond this conjecture, he had no more than a loose plan to use the surtax as a bargaining chip to obtain trade concessions for exports, especially agricultural exports. And he expected to negotiate a new set of exchange rates without announcing a change in the gold price. The latter required congressional approval, which he and President Nixon wanted to avoid.
The Federal Reserve’s Board of Governors met on Sunday evening, August 15, to hear Chairman Burns’s report of the Camp David meeting, to watch the president’s speech, and to discuss the international policy change. Burns explained that Undersecretary Volcker and Governor Daane would leave that evening for London, where they would explain the president’s program to officials of principal European countries and get some preliminary views of the scope for currency realignment. Governor Daane added that he and Volcker would then travel to other European capitals to hold bilateral meetings.
Burns “said he agreed with Treasury officials who felt the dollar was overvalued, but he was not persuaded that the overvaluation was great” (Board Minutes, August 15, 1971, 4). Maisel mentioned devaluation of 10 percent. Unless that devaluation could be achieved and agreement reached on greater flexibility of exchange rates, the United States should not enter a new agreement. But Burns, Brimmer, and Robertson urged Daane to push for prompt agreement. And Robertson proposed to end the Voluntary Foreign Credit Restraint Program (ibid., 5).
Monday, August 16, was a holiday in Europe. Foreign exchange markets were closed, and they remained closed for the rest of the week. In Japan, markets remained open. The Bank of Japan purchased dollars to keep the existing exchange rate and to prevent large losses to Japanese banks that the government had urged to hold dollars (Toyoo Gyohten, in Volcker and Gyohten, 1992, 93). Also, “the Japanese were too naïve in believing President Johnson and President Nixon when they repeatedly pledged that the United States would not devalue the dollar. . . . So we thought that the real U.S. objective was not to devalue the dollar but to free it from gold and try to stabilize its value as quickly as possible. Supporting the dollar at the parity of 360 yen, we believed, would meet the interests of the United States and be taken as an act of cooperation” (ibid.). In two weeks Japan increased its reserves by 50 percent, from $8 to $12 billion. M1 balances rose 25 percent (ibid., 94). Critics blamed the subsequent inflation in 1973–74 on this decision.
21. Looking back long after the events, Paul Volcker was critical of the program. “The inflationary pressures that helped bring down the system did not abate for long; they got much worse as the controls came off and plagued the country for a decade or more” (Volcker and Gyohten, 1992, 80).
Representatives of France, Germany, Japan, and Italy joined the British at the London meeting. Volcker opened the meeting by explaining the president’s program and asking for initial reactions of the foreign participants.22 He insisted that he had not come to open negotiations and explained that one of the reasons for the international measures was to head off rising protectionist pressures. A main reason for using executive authority to impose the surtax was that legislation would be easy to adopt but hard to repeal. The United States wanted a long-term solution, he said, and it would not be satisfied with short-term measures. “The U.S., at this stage, had no program that it was going to spring on anyone. . . . [W]e would not be satisfied without a reform that would repair the erosion that had taken place in the U.S. position over the years” (memorandum of conversation 170, United States Department of State, August 16, 1971). However, the president had decided that the price of gold would not change.
The European reaction focused on the surcharge. Several complained that they could not negotiate new exchange rates until the U.S. removed the surcharge. They also expressed concern about problems of keeping exchange markets closed versus reopening them. They asked Volcker what objective the United States had in mind. “Mr. Volcker said the U.S. should have a period of surplus” (ibid.). He also mentioned removal or reduction of barriers to U.S. exports, especially agricultural exports, and greater contribution to the common defense and security. Later, he quantified the objective as a $13 billion change in the U.S. trade position—from a $4 billion deficit to a $9 billion sustained surplus. This shocked the Europeans. “Few of our trading partners really wanted to see any significant deterioration in their own trade positions” (ibid., 81). Although most recognized the benefits of a stable system, they were not disposed to provide or maintain a public good if it required them to bear a major cost.
22. One of the Japanese participants, Masaru Hayami, later became governor of the Bank of Japan. He described the European reaction as claiming that they could not reopen their exchange markets until the United States announced a new parity (Hayami, 2002, 2). They soon gave up that position. By the end of August all major countries had floated except France. France imposed exchange controls and adopted two-tier exchange rates. Volcker described the European response. “They were stunned and didn’t know how to react. . . . [T]heir idea of an appropriate exchange rate change was very small—certainly well under 10 percent—and then simply put the old system back together again. That didn’t make any sense, from our perspective” (Mehrling, 2007, 175).
Volcker and Daane went on to Paris, where they met the next day with the French finance minister, Valéry Giscard d’Estaing. The minister was most interested in the extent of U.S. intervention in the foreign exchange market. Volcker said that except in unusual circumstances, the United States would not intervene. “Basically, the U.S. had not changed the parity of the dollar. Others would make that decision; we could not. We did not assume that there would be no changes in parities. We simply didn’t know in which direction the dollar would move” (ibid.). Giscard questioned whether the United States expected to return to a fixed exchange rate system. Volcker gave a qualified yes; the system had to change in the direction of wider bands and fewer crises.
A few days later, Germany proposed a joint float of European currencies, but France opposed and, like Belgium, adopted a two-tier system bolstered by exchange controls. The Europeans made a formal complaint against the surcharge on exports. European irritation was out of proportion to its effect on them. The main effect was on Japan and Latin America (Solomon, 1982, 189; Nixon papers, Shultz Box 7, August 25, 1971).23
At a series of meetings, the developed countries gradually recognized the issues to be resolved and the positions that had to be negotiated. Early in these discussions, the Europeans rejected as too large both the proposed $13 billion swing in the United States’ trade balance and the argument that the United States should have a trade surplus to cover some of its development assistance and defense spending.24 But they accepted that a realignment of exchange rates was necessary. All but the United States agreed that realignment would require adjustment by the United States. Also, “there was nearly unanimous agreement among them that the surcharge was an obstacle to the achievement of an adequate realignment of exchange rates and should be removed as soon as possible” (FOMC Minutes, September25, 1971, 3).
At most of the meetings, the foreigners expressed concern about increased protection, dual exchange rates, capital controls, and a return to the “miseries of the 1930s” (ibid., 5). Secretary Connally continued to insist on the $13 billion swing, a U.S. trade surplus, no dollar devaluation, maintenance of the surtax, and agreements on trade barriers and sharing of defense costs.25
23. The Academic Consultants to the Treasury endorsed the basic program but preferred to eliminate the surcharge at an early date. Some favored floating; others preferred a large devaluation against principal foreign currencies and increased flexibility. None supported a return to the Bretton Woods arrangements or gold convertibility.
24. Volcker reported on a meeting at the OECD. He explained that the U.S. balance-ofpayments surplus had to increase to $9 billion from −$4 billion, a $13 billion swing. The representatives offered to provide $3 billion, $2 billion of it from Germany. The French, Dutch, and Belgians explained why they would not help. The Japanese remained silent (Volcker and Gyohten, 1992, 83).
Currency markets were thin for most currencies, and trading was limited to commercial transactions. Trading costs had increased, and there were “virtually no capital flows” (ibid., 15). Forward markets existed only in British pounds and German marks. Governor Brimmer pointed out that capital controls were a main reason for the absence of capital transfers.26
Connally was in charge of negotiations for the United States. He started with three objectives: exchange rate adjustment, reduced barriers to trade (especially to U.S. exports), and increased foreign contributions to the common defense and the cold war. “Somewhere along the way between August 15 and the Smithsonian meeting of December 17–18, the defense sharing objective was dropped and the request for reduced trade barriers abroad was watered down to a few trivial demands” (Solomon, 1982, 191).27 He was in no hurry to reach agreement. The surtax and appreciation of foreign currencies against the dollar helped U.S. exports and reduced imports. By early October, the yen had appreciated about 8 percent, the mark 9.5 percent, the Dutch guilder 7 percent, the British pound 3 percent, and the French financial franc about 2 percent.
A History of the Federal Reserve, Volume 2 Page 13
