Paul Volcker’s long and torturous battle with inflation began when he was a teenager, preparing for his departure to Princeton in 1945. His mother offered twenty-five dollars a month for living expenses, just like his sisters, but he protested, “Mother, when they went to school, twenty-five dollars was really worth something. Prices have gone up a lot since then. And besides, I’m a boy and have higher expenses.”1
Alma Volcker looked at her son. “Really?” She had gone to Vassar and graduated as valedictorian of her class with a degree in chemistry, at a time when most women had thought about neither college nor chemistry. “Well, it was good enough for them, so it’ll be good enough for you.”
Paul turned to his siblings for support, but it would not be easy. They had always worried about everyone spoiling him, as the youngest in the family and the only son to carry on the Volcker name. Ruth and Louise, more than ten years older than Paul, had gone to college during the Depression. And Virginia, three years older, was nearly finished. Much to his delight, however, they all agreed, so he confronted his mother again.
“My sisters say that I should get more because of inflation.”
But Alma Volcker would not budge. “I don’t care about that. You’ll still get twenty-five dollars.”
At first Paul thought his mother wanted to teach him lesson in frugality, a family trait he himself still practices today with the dedication of a monk. He had seen his father wear suits long after they had frayed at the cuffs and knew that his sisters sewed their own clothes. Perhaps his mother was worried about the spendthrift ways of the prep school boys he would befriend at Princeton. Years later, he learned the truth. His father had tried to enlist in the army but was too old. In a burst of patriotic thrift, he refused a salary increase throughout the war, despite the inflation. “That didn’t change the facts, but it explained it all, and made a lasting impression.”2
Keynesians often dismiss the inequities of inflation as a nuisance, an irritant that can be ignored for the common good. A little inflation is certainly an acceptable price for running the economy at full throttle. But Volcker’s favorite author as an undergraduate, Friedrich Hayek, fueled his suspicion that it was not quite so simple. The Austrian émigré’s ode to free enterprise warned against the alleged virtues of inflation: “It should be specially noted that monetary policy cannot provide a real cure for [unemployment] except by a general and considerable inflation … and that even this would bring about the desired result only … in a concealed and underhand fashion.”3
Hayek meant that inflation worked by subterfuge, tricking people into thinking they are better off as their wages rise, only to disappoint them when they are confronted later with higher prices to match. According to Volcker, “Hayek’s words forever linked inflation and deception deep inside my head. And that connection, which undermines trust in government, is the greatest evil of inflation.”4
Hayek also denied the claim by Keynesians that inflation could permanently stimulate the economy. When worker expectations catch up with reality, as they inevitably must, the illusion of higher real wages is exposed as a fraud, and inflation loses its power to promote more employment. The end result is simply higher inflation and increased resentment, because rising prices do not affect everyone the same way.
Hayek’s message made logical sense to Volcker, even though it clashed with the emerging Keynesian consensus. It was reinforced by his Princeton professors. “I don’t think I heard the name of John Maynard Keynes until I got to Harvard. At Princeton they taught the famous quantity theory of money as though they heard it directly from David Hume in 1750,” says Volcker.5 “Friedrich Lutz was about forty at the time, but from the perspective of an eighteen-year-old, he might as well have been two hundred and forty. He taught us that too much money created inflation.”6
Volcker had applied those lessons during the fall of 1948 in writing “The Problems of Federal Reserve Policy Since World War II,” his undergraduate thesis. Prices had surged in the United States immediately after the war, triggered by the pent-up demand for consumer goods, the removal of wartime controls, and an enlarged stock of money. Volcker wrote, “A swollen money supply presented a grave inflationary threat to the economy. There was a need to bring this money supply under control if the disastrous effects of a sharp price rise were to be avoided.”7
He concluded with an indictment of the Federal Reserve’s performance worthy of Milton Friedman, a lifelong critic of the central bank: “Although the inflation problem continually raised its head in a disconcerting manner … the counter-measures taken have not [been] … a realistic attempt to combat the danger … The Federal Reserve System had no definite criteria of policy to follow.”8 Volcker lamented the central bank’s failure to ensure price stability, its most important responsibility.
Paul Volcker’s anti-inflationary sentiments prepared him perfectly for the U.S. Treasury in January 1962. President Kennedy had enlisted Robert Roosa to offset the pro-inflation bias of his Council of Economic Advisers and to oversee international economic affairs. Roosa drafted Paul Volcker as his personal watchdog. “I could hardly wait to get to Washington,” Volcker recalls. “It’s hard to re-create the excitement of working for a young vibrant John F. Kennedy. My main concern was that they would solve all the problems before I got there to help.”9
He had nothing to worry about. The U.S. Treasury served as the guardian of American gold. And the dwindling reserves in Fort Knox threatened American finance.
Gold has served as a store of value ever since King Tut passed into the afterlife with a treasure chest of the metal, in addition to his famous mask. Gold developed into money, something useful for making payments, in part because it is a good store of value. But many things are valuable and are not used as money, such as the New York Yankees, Buckingham Palace, and French antiques. Gold serves as money because in addition to holding its value, it is easily divisible and standardized.
More than 2,500 years ago, King Croesus invented gold coins by dividing the precious metal into a fixed number of grains and then certifying its weight with his stamp of approval.10 Gold in the form of standardized coins facilitated all types of payments, to the tailor for a brand-new suit, to the local tavern for a neighborhood celebration, and of course to the king’s tax collector for waging war and building castles.
Before 1933, U.S. gold coins, such as the famous twenty-dollar double eagle and the less-well-known ten-dollar eagle and five-dollar half eagle, had circulated as American currency alongside the familiar Federal Reserve notes still used today. The U.S. Mint, a bureau within the Treasury Department, created these coins out of gold bullion brought in for minting. The Treasury would also exchange paper dollars into gold at the rate of $20.67 in currency per ounce of gold.11
People preferred dollar bills rather than gold for most payments because gold is physically dense, making it cumbersome to carry and costly to ship. A gold bar, worth about $8,000 in 1933, is slightly smaller than an ordinary brick and weighs about as much as two bowling balls.12 As long as people knew they could convert dollars into gold, as the U.S. Treasury promised, they chose not to bother. They would rather hold dollar bills for convenience, or better yet, put the money into their neighborhood bank, where it would earn interest. Gold coins served primarily as Christmas presents for children of privilege rather than as pocket change for everyday shoppers.
All this changed in March 1933. President Franklin Roosevelt wanted to allow banks to expand credit without the limitations of gold, to help rescue the economy from the ravages of the Great Depression. He pushed Congress to pass a law authorizing a Presidential Executive Order requiring American citizens to turn in all gold coins and receive paper currency in exchange.13
Now that people had to give up the precious metal, of course, they did not want to. FDR’s treasury secretary, William Woodin, ordered the president’s directive printed up like Wanted Dead or Alive posters, exhorting the public “To deliver … all gold coin” or face criminal penalties, including a “$10,000 fine or 10 years imprisonment, or both.”14 He then distributed the placards to post offices throughout the country for display along with other criminal notices from the postal inspection service.
U.S. citizens complained about the dictatorial decree and squirreled away their gold in safe-deposit boxes, while litigating (unsuccessfully) that Congress had abrogated their inalienable rights.15 Mary Meeker, a recently unemployed fifty-one-year-old single woman, sent a latter dated April 30, 1933, to the New York Times, summarizing the complaint:
I was frugal in the use of my earnings, and what I managed to save … amounted to about $31,000.00 … A few months ago I became very much disturbed over the financial situation in this country and decided to withdraw my money from savings banks, convert it into gold and place it in safe deposit boxes … Congress [then] adopted the banking emergency bill requiring all persons to convert into currency … all gold coin … under penalty of a heavy fine or long imprisonment … We were assured that the bills we received in exchange for gold … were just as good and just as valuable … Will you kindly explain to me where I will stand in the event President Roosevelt does revalue the dollar by reducing the gold content? I worked for many years to accumulate the $31,000.00 in gold that I turned over … under duress of the law enacted by Congress at the behest of President Roosevelt … The government now holds my gold and all I have to show for it is the Federal Reserve notes given me in exchange for it.16
Money is a social contrivance, worth something only because others will accept it in payment for real things. A dollar retains its value if prices remain stable, which is precisely what the gold standard accomplished by allowing people to convert paper dollars into gold. It prevented inflation by controlling the printing press, holding the creation of paper dollars in check, for better or worse. The restraint on prices made Mary Meeker happy, but it also prevented banks from expanding credit to jump-start the economy.
Loosening the link with gold provided some leeway for the central bank to expand credit during a crisis, such as the Great Depression. And as long as the Federal Reserve managed its mandate responsibly, so that price increases did not become a way of life, dollars provided a safe store of value. Of course, that is precisely what worried Mary Meeker—she trusted gold more than the Federal Reserve. And she was right to worry.
The Gold Reserve Act of January 1934 established the secretary of the treasury as the czar of American gold.17 It specified that “all gold coin … shall be formed into bars … as the Secretary of the Treasury may direct.” It gave the secretary the power to “prescribe the conditions under which gold may be … transported, imported, and exported … for industrial, professional, and artistic use.” And finally, to stabilize the international value of the dollar, it gave the treasury secretary the right to “deal in gold and foreign exchange.” As far as gold was concerned, the secretary of the treasury was like a grand pooh-bah, an exalted official in charge of all matters, and worthy of the title Lord High Everything Else.18
The 1934 legislation also devalued the dollar, reducing its gold content to 13.714 grains of pure gold, which translated into a price of $35.00 per ounce rather than $20.67, but it did not take the United States off the gold standard.19 It softened the link between money and the precious metal by preventing Americans from exchanging paper dollars into gold, but the Federal Reserve still had to hold a reserve of 40 percent in gold against its liabilities, such as the familiar Federal Reserve notes Americans use as currency. Without further legislation, this “gold cover” provided an upper limit on credit creation by the central bank. Moreover, foreign central banks retained the right to exchange paper dollars for gold. The United States had to manage its monetary affairs so that the U.S. Treasury could meet America’s international obligation to redeem dollars in gold.
President Kennedy put Undersecretary of the Treasury for Monetary Affairs Robert Roosa in charge of defending America’s gold reserves, which had declined to nearly $17 billion by the time Kennedy took office in 1961.20 Roosa’s assignment was more difficult than it appeared, because over $11 billion of that hoard was immobilized as gold cover for Federal Reserve liabilities.21 America’s immediate obligations to foreign central banks amounted to double the remaining $6 billion of free gold.22
Roosa assigned the job of helping him protect the gold stock to Paul Volcker when he arrived at the Treasury in 1962. At times the task bordered on the mundane. The 1934 prohibition against U.S. citizens investing in gold lasted forty years, until 1974, and Volcker had to prevent gold coins from entering the country without a proper visa.23 He responded to numerous requests for exemptions from regular people like Mary Meeker of thirty years earlier, efforts that tested his diplomatic skills.
Volcker felt bad about being unable to make exceptions for sentiment, including the letter he had to write to a Mr. Schubert in Oklahoma City:
I understand and sympathize with your feelings in connection with the fact that the Collector of Customs in Kansas City detained gold coins which you [received as a] bequest from your deceased brother. Unfortunately they cannot be allowed under present regulations governing the importation of gold coins … only genuine and lawfully issued gold coins of exceptional numismatic value may be acquired abroad and imported to the United States. The determination as to exceptional value is made with reference to the coin itself and not the individual wishing to import it.24
Volcker could not single out Schubert (or his brother) for special treatment, because the gold coin restriction did not play favorites. JFK’s brother-in-law Sargent Shriver had been honored in Germany for his work as director of the Peace Corps. When he returned to the United States with a solid-gold medallion presented by the German government, it was promptly seized by the Customs Bureau. Shriver appealed to Treasury Secretary Douglas Dillon (Roosa’s boss) for help, and Dillon turned the matter over to Volcker. Shriver made his case to Volcker like the good lawyer he was.25
“What if I had won an Olympic gold medal?”
“We make an exception for Olympic medals.”
“What about a 1729 King George Gold Guinea?”
“It gets the okay as a collector’s coin.”
“So what’s wrong with my medallion?”
“It doesn’t fit either category.”
“That’s ridiculous.”
“You’re probably right. Do you want me to ask Secretary Dillon to instruct the Customs Bureau to make an exception?”
“I’ll think about it.”
According to Volcker, “Shriver was sore as a boil at being denied his gold medallion, an award he had been given for exceptional public service. But Shriver knew it would have looked bad to fight the law, so he waited until after resigning as director of the Peace Corps before successfully reclaiming his medal.”
Roosa responded to President Kennedy’s challenge to protect America’s commitment to redeem dollars in gold with a blizzard of innovations. His first initiative was to organize an international consortium, called the “Gold Pool,” to help defend the fixed price.26 Germany, the United Kingdom, Italy, France, Switzerland, the Netherlands, and Belgium agreed to help the United States fix the thirty-five-dollar price of gold by jointly selling gold in the London market if excess demand pushed up the price and buying gold if excess supply pushed it down. This was good for the entire world, since it maintained international financial stability under the Bretton Woods System, but it was a bonanza for the United States, like living in the Magic Kingdom, since it solidified the dollar as the world’s reserve currency.
A reserve currency serves like a checking account, a vehicle for exchanging payments, for central banks and financial institutions. The Bank of Japan, for example, would use dollars to settle obligations with the Bank of France. Business firms with extensive exports and imports would do the same, making dollars the international medium of exchange. Not everyone understood the benefits to America of having a reserve currency, not even JFK, who had pledged allegiance to gold to help sustain the dollar’s supremacy as international money.
Kennedy knew that “if everybody wants gold, we’re all going to be ruined because there isn’t enough gold to go around,” and he believed that “gold really should be used for international payments.”27 But JFK also worried about the political repercussions, and invited Undersecretary of State George Ball to balance the views of his financial brain trust. Ball thought that the Treasury’s monetary objectives might compromise national security. “Should [we] become more heavily involved in Southeast Asia … there is a fair chance that our European friends would walk away from us … [and] it would be a real temptation to exploit our own balance of payments difficulties … for political purposes.” Ball then added, “We’re not persuaded that it is at all vital to the United States that we … be the principal reserve currency.”28
Kennedy interrupted and turned to his Treasury team: “What is the advantage to the United States of our being a reserve currency?”29
Volcker knew that if JFK had posed that question while working for Roosa at the Federal Reserve Bank of New York he would have been dispatched to the sub-basement, fifty feet below sea level, right next to the gold vault, for indoctrination under the care and guidance of Tomás de Torquemada. Roosa believed with the faith of a zealot that America had an obligation to “provide the principal reserve currency for the monetary system of the world—a duty which involves special responsibilities as well as conveying special opportunities.”30
In answering the president, however, Roosa skipped the responsibilities and focused on the opportunities, something tangible that JFK could take to the bank. “[A reserve currency] makes it possible for us … year in and year out … to finance any [balance-of-payments] deficit we may run very readily, because you have the world accustomed to holding dollars. When you run behind for a year you don’t have to negotiate a credit, they just hold dollars … This is a situation similar to that of any commercial bank. If it controls the rate at which it creates credit, it can go on creating credit and perform a general service as well and make a profit.”31
Roosa told the president that the dollar’s status as a reserve currency allowed America to import more goods and services than it exported, and to enjoy a higher standard of living than otherwise. The advantage did not go unnoticed, and would eventually destroy the Gold Pool.
Roosa asked Volcker to craft a second initiative to defend America’s commitment to redeem dollars in gold. He wanted a plan to remove the “gold cover” that immobilized the bulk of America’s gold stock. Recall that the Federal Reserve had been required to maintain a reserve of 40 percent in gold against its liabilities, such as the dollar bills Americans use as currency. In 1945, Congress lowered the required “gold cover” to 25 percent, but that still isolated $11 billion of America’s $17 billion hoard in solitary confinement in Fort Knox.32
Volcker responded with a ten-page memorandum for the president’s signature. He proposed creating a commission to examine the question of whether the gold cover should be abolished and suggested Allan Sproul as chairman of the committee.33 He knew Sproul’s view on gold.
Sproul had retired as president of the Federal Reserve Bank of New York in 1956, while Volcker toiled on the Fed’s trading desk. He had used his influential position to disparage the role of gold in promoting monetary restraint: “The integrity of our money does not depend on domestic gold convertibility. It depends upon the great productive power of the American economy and the competence with which we manage our fiscal and monetary affairs … Discipline is necessary in these matters but it should be the discipline of competent and responsible men; not the automatic discipline of [gold], a harsh and perverse mechanism.”34
Sproul denounced the inflexibility of gold, a rigidity that had hampered the Federal Reserve’s response to the Great Depression. His argument echoed British economist John Maynard Keynes’s famous denunciation of gold as a “barbarous relic,” and confirmed the Federal Reserve as watchdog over U.S. monetary affairs. He would have recommended abolishing the gold cover. Nevertheless, Roosa dispatched to cold storage Volcker’s recommendation for a presidential commission.
Roosa’s change of heart came from circumstance rather than substance. He wrote to Volcker that “After extensive consideration … all of us felt uneasy over calling attention to the [gold] reserve ratio matter at a time when our balance of payments figures about to be released were … showing so large a deficit … It also became clear that the appointment of such a commission in conjunction with … other measures would likely stir up unrest.”35 Roosa emphasized the delicacy of the topic by concluding with “I do not know how many people were involved with you in the preparation of this memorandum. I think the best procedure for you would be to tell each of them orally that the matter is dropped for the time being. You might also check with Mr. Daane [Volcker’s immediate boss] … so that he will know that the matter is being quietly put to one side for the time being.”
Roosa’s detailed instructions to sequester the topic surprised Volcker, as though he were a child who could not keep a secret. A simple CONFIDENTIAL stamp would have been sufficient. But Volcker also knew that the link between money and gold evoked deep feelings, like the emotions in a crime of passion. Treasury Secretary Douglas Dillon had told the president of the sharp “division in the banking fraternity, with people who know something about foreign markets, like [the] New York banks, generally in favor of removing [the gold cover] and the people from the Middle West violently opposed because they think it means we’re going to have printing press money.”36
Volcker fully expected these emotions to surface again when the Treasury revisited the gold cover, but he was surprised by who led the charge.
Charles de Gaulle pursued gold the way Henry VIII did wives. On February 4, 1965, he called a news conference to denounce the dollar as the world’s reserve currency, pleading for the resurrection of gold as king of international finance. Instead, he sparked a revolution that turned the yellow metal into just another speculative asset.
President de Gaulle gathered seven hundred journalists in the Grand Ballroom in the Elysée Palace, built for French royalty in the eighteenth century and now serving as home to the president of the Fifth Republic, no less regal to most of France than Louis XVI. Le General began with an ode to gold that qualifies as great financial poetry (there is almost no competition): “International trade should rest … on an undisputable monetary basis bearing the mark of no particular country … on no other standard than gold—gold that never changes, that can be shaped into ingots, bars, coins, that has no nationality and that is eternally and universally accepted as the inalterable fiduciary value par excellence.”37
Charles de Gaulle had an obsession with gold, but his proposal reflected a deep resentment of America’s favored status under the Bretton Woods System. He noted that the rationale for American dominance, rooted in the devastation of World War II, had passed. “Western European states have been restored to such an extent that the total of their gold reserves equals that of the Americans … [and therefore the] transcending value attributed to the dollar has lost its initial foundation.”38 The French president felt that the dollar’s role as a reserve currency gave the United States an “exorbitant privilege” that permitted America to finance an “invasion” of French industry.39
De Gaulle was only partly right. Americans did not want to invade France—that is what Germans did—but he was right about the “exorbitant privilege,” the same privilege that Roosa had explained to President Kennedy in the Oval Office. The dollar’s role as international money allows America to import French champagne without having to export anything tangible in return—other than greenbacks. Of course, De Gaulle ignored that the world uses dollars as a universal medium of exchange because the United States is a free and open economy, providing a safe haven currency that transcends international borders.
The president of France backed his dollar bashing with action. De Gaulle moved $400 million in French gold, consisting of 25,900 bars weighing a total of 350 tons, from the basement vault of the Federal Reserve Bank of New York in Lower Manhattan, where most countries of the world store their precious metal, to the Banque de France in Paris.40 The high density of gold creates a logistical nightmare, taxing the most experienced shipping executive. Bars are packed four to a wooden box, in a bed of sawdust to avoid damage to the soft metal. Each box is tied with steel strapping and distributed throughout an aircraft to balance the weight. De Gaulle thought the transfer made sense. He wanted the gold in Paris when the world returned to the gold standard. De Gaulle also withdrew French forces from NATO, the North Atlantic Treaty Organization, to complete his divorce from America’s influence.41
De Gaulle’s performance benefited from perfect timing. Four days before the French president’s tirade, on February 1, 1965, the U. S. Congress took up a bill to loosen the gold cover requirement in an effort to bolster America’s defense of the dollar.42 According to the New York Times, the Treasury’s free gold had declined to about $2 billion, which amounted to less than 15 percent of America’s obligations to foreign central banks.43 A Times editorial emphasized American vulnerability by linking the gold cover to “France’s reported decision to exchange … dollars for gold.”44
Congress took the easy way out. It removed the gold cover against Federal Reserve liabilities to commercial banks but left intact the required backing against Federal Reserve notes, the currency used for day-to-day transactions.45 The compromise bought time, postponing a confrontation with conservatives who wanted gold to remain the permanent bulwark of American finance. A speculative frenzy would soon provide midwestern zealots the opportunity to do battle.
Volcker left the Treasury in December 1965 and returned to Chase Manhattan Bank as director of forward planning. During the last year in Washington, he began to have impure thoughts: that De Gaulle had a point. Productivity in Western Europe had caught up with American ingenuity, leaving the dollar overvalued. The German currency, in particular, was too cheap, encouraging American citizens to import anything with a price tag in deutsche marks. This meant that America’s balance-of-payments deficit would persist and the gold outflow would not disappear by anyone’s tinkering with the gold cover. “I could not help thinking that a more fundamental revaluation of currencies was required. Back then, such ideas were considered heresy at the Treasury, worthy of a Siberian exile. And besides, I had a family to support. It was time to leave.”46
Paul Volcker never did anything just for the money, but the jump in annual salary to $35,000 at Chase, compared with $18,000 at the Treasury, made a difference. He and Barbara had two children, ten-year-old Janice and seven-year-old Jimmy, and they had lived comfortably enough while he worked in Washington. But Jimmy had been born with cerebral palsy, and according to Paul, “Barbara insisted we treat him like an able-bodied person. The additional income at Chase would certainly help.”47
Jimmy had gone to a Catholic school, Mater Dei, in Bethesda, Maryland, simply because it was the only mainstream school that would accept him—after Barbara begged. Paul did what fathers do. He introduced his son to baseball at age five by tossing him balls to hit in the front yard of their home in Chevy Chase, Maryland, often until nightfall, using a four-legged homemade contraption to help Jimmy stand. After they moved to the New York bedroom community of Montclair, New Jersey, Paul turned Jimmy into a full-fledged baseball fan, unfortunately rooting for the New York Mets, now that the Dodgers had deserted to the West Coast. “The Mets were the laughingstock of the major leagues,” Jimmy says, “but I was hooked after my dad took me to more games than I was prepared for. I know he did it on purpose. It was good therapy. He would shuffle along beside me while I maneuvered with canes and on leg braces, except after my operations, when he pushed me in a wheelchair.”48
According to Paul, Jimmy’s progress exceeded expectations.
I remember how difficult it was getting him to walk … so much so that I worried about his entire future, whether he would be able to hold a job or get married. When Jimmy turned four, I did something that pained me more than anything I’ve ever done. He desperately wanted a Superman outfit, and I said, “I’ll get it for you after you walk.” Well, he tried and tried, falling down more times than I could count. And when he finally took two steps he looked at me and said, “See, I can do it. Now I want to look like Superman.” He brought tears to my eyes as I mumbled, “I knew you could do it.” And then I ran out to buy the outfit, cape and all … It’s hard to believe that in Montclair he walked to elementary school with Janice. Barbara and I were so proud.49
Paul swallows hard and then forces a smile. “Jimmy did much better than the Mets and far better than the American dollar … which barely survived 1968.”50
Volcker watched speculators attack the golden underpinnings of international finance in March 1968 from his office at Chase, the same vantage point he had during the October 1960 confrontation. But unlike the earlier flare-up, which fizzled like a shooting star, this one crippled the system.
The U.S. Treasury’s gold stock stood at $12 billion at the start of 1968, but only $1 billion of that total was available to meet America’s obligation to foreigners.51 The bulk of America’s gold still served as required backing for currency issued by the Federal Reserve, the “gold cover” against the tens and twenties Americans use for day-to-day transactions. Currency in circulation had expanded with growth in the economy, raising the gold requirement.
Foreign central banks held more than $15 billion in official dollar reserves at the beginning of 1968 and could exchange those dollars for gold at the U.S. Treasury at the rate of $35 per ounce under the Bretton Woods System.52 In addition, more than $25 billion in dollar-denominated deposits appeared on the books of European commercial banks.53 Every self-respecting Swiss schoolchild knew that these foreign holdings of dollars could overwhelm the Treasury’s $1 billion of free gold in the blink of a speculator’s eye. In case Americans failed to notice, however, a front-page headline in the Wall Street Journal spelled out the details: “Paper-Money … Tying Up Additional Gold … Cuts Supply Available to Meet Foreign Claims.”54
President Johnson asked Congress to eliminate the remaining gold cover for currency in his State of the Union address in January 1968.55 The United States would then have the entire gold stock at its disposal to defend the promise to redeem dollars in gold. Congressional testimony supporting the president’s proposal arrived from every corner of American finance, including the leading monetarist, Milton Friedman, from the University of Chicago; a respected Keynesian, Charles Kindleberger from MIT; and the quintessential millionaire David Rockefeller, from Chase Manhattan Bank.56 Nevertheless, the House of Representatives remained skeptical, voting to approve the administration’s bill by a slim majority, 199–190. The Senate prepared to take up the measure in early March.
Speculators responded to the confusing signals by draining gold in record amounts from the world’s central banks during the first two weeks of March 1968. The United States lost nearly 900 tons of gold valued at $1.0 billion, almost equaling the $1.2 billion decline for the entire year of 1967 (which had been a very bad year).57 Volume in the London gold market often hit 100 tons per day, ten or twenty times larger than normal.58 One of the bullion dealers said, “It can’t go on this way: something has to happen.”59
Real people joined the frenzy as well. Not in the United States, of course. Americans were still barred from investing in gold. But at the Bank of Nova Scotia in Toronto, on March 4, 1968, a thirty-two-year-old mechanical engineer bought fifty ounces of gold while claiming, “I’m not speculating, I’m protecting. I’ll give it a year. If nothing comes of it I’m selling out.”60 A line of unsatisfied speculative buyers stood at the teller’s window in the basement of the bank at closing time, some of them clutching envelopes stuffed with American dollars.
Deliberations in the Senate over the gold cover went poorly. The bill to eliminate the requirement caused an outbreak of insomnia among midwestern skeptics of central banking.61 Gordon Allott, the senior Republican senator from Colorado, complained that “the last vestige of restraint on money and currency … is removed by this bill. Money expansion decisions would be left … to the sole discretion of the Federal Reserve Board, which is answerable to no one.” Allott’s suspicion of central banking is as American as Andrew Jackson, but the senator was not nearly as tough as Old Hickory, who destroyed the Second Bank of the United States. He simply wanted Congress to continue as a central police station: “I am not suggesting that Congress carry out day-to-day management of our currency and money supply, but it certainly should not short-circuit the alarm system.”
Senator William Proxmire of Wisconsin, who knew more about banking and finance than just about anyone in the Senate, tried to persuade Allott that his opposition to the bill suffered from good intentions and bad execution. “What the Senator overlooks … is that the main part of our money supply is not in the form of currency, it is demand deposits … [and even] Dr. Milton Friedman … the one expert economist quoted by the distinguished Senator from Colorado … would be among the first to say that it would be hopeless to attempt to limit the money supply by limiting currency.”
Allott acknowledged Proxmire’s expertise by saying, “The Senator … is entirely correct—currency is just one part of the money supply,” and then launched a mixed metaphor straight from the American heartland to illustrate his point: “But … the tail is the only part of the dog I can get ahold of. I am going to hang on to it and try to keep it from wagging the dog clear out of the ball park.”
On March 14, 1968, the Senate voted 39–37 to repeal the 25 percent gold reserve requirement against currency, severing the final link between gold and the domestic money supply.62 The razor-thin majority reflected an undercurrent of distrust toward central bankers within the legislative branch of the U.S. government. It is not surprising that the favorable vote failed to mollify speculators throughout the world.
Speculators worried that even the entire stock of gold in the U.S. Treasury could not support the thirty-five-dollar price for very long. Americans were simply spending too much overseas, leaving too many dollars in foreign hands. President Johnson had sounded desperate during his State of the Union address, asking Americans to avoid trips abroad to keep dollars in the United States.63 But begging New Yorkers to visit the Grand Canyon instead of the Riviera could not solve America’s balance-of-payments problem; cutting Vietnam War expenditures to curtail inflation might have worked, but that was not part of the president’s plan.
On Friday, March 15, 1968, Queen Elizabeth shut down the London gold market in response to an emergency request from President Lyndon Johnson.64 A Zurich banker had summed up the consequence of the speculative frenzy: “Don’t they realize, these people who are buying gold, that they are destroying the whole monetary system of the world?”65
Representatives of the Gold Pool met at the Federal Reserve Board in Washington on Saturday, March 16, 1968, to determine their strategy.66 Central banks had been defending the thirty-five-dollar price by selling gold when there were too many buyers, including jewelry manufacturers and Arab sheikhs, and buying when there were too many sellers, usually gold producers such as Russia and South Africa. The Gold Pool worked within the law of supply and demand—and speculator demand had been outstripping supply.
After two days of deliberation the central bankers released a communiqué announcing the new rules: “The U.S. Government will continue to buy and sell gold at the existing price of $35 an ounce in transactions with monetary authorities … [but will] no longer supply gold to the London gold market or any other gold market.”67 The formal statement praised the U.S. legislation eliminating the gold cover but claimed that their new policy was needed to conserve the world’s stock of monetary gold.
The central bankers had built their own version of the Berlin Wall, separating the official monetary gold market from the private sector’s counterpart. They picked up what chips were still theirs and went off to play on their own, with all transactions in their fraternity taking place at the official price of thirty-five-dollars per ounce. As for the outsiders, speculators and real people, they could do as they wished and decide on whatever price they pleased. There would be a two-tier market for gold: one for central bankers at a fixed thirty-five-dollar price and another for everyone else at a freely determined price.
To most Americans the new rules for the gold market seemed as relevant as the rules about splitting aces at the blackjack tables in Las Vegas (probably less relevant). Some, such as Joseph Rokovich, working at a construction site on West Forty-Third Street in Manhattan, were mostly optimistic: “I figure our leaders know what they’re doing—I hope.”68 Others sounded confused, like John Wright, a bank security guard at the New York Bank for Savings in Times Square: “I’m not worried … But if this keeps on maybe the dollar won’t be worth anything.”69
John Wright should have been worried about the dollar’s value. Not so much because of the two-tier gold market, but because Congress had removed the gold cover from U.S. currency, short-circuiting Senator Allott’s alarm system. Federal Reserve chairman William McChesney Martin had helped to convince legislators that failure to eliminate the requirement would impair economic growth: “Federal Reserve notes in circulation [must] increase each year with the growth of the economy.” Milton Friedman invoked integrity to support removing the gold cover. “Twice before when gold reserve requirements came close to being a constraint the requirements were loosened. This is the third time … The legal requirement for a gold cover is therefore … a delusion … In the interest of plain honesty [it] … should be removed.”70 Chairman Martin concurred, emphasizing that the gold cover “discipline” does not control the money supply, but rather decisions of the Federal Reserve control it.71
Congress had good reason to trust Martin’s commitment to monetary stability. As an assistant secretary of the treasury in 1951, William McChesney Martin had incurred the displeasure of his boss, Treasury Secretary John Snyder, by taking a principled stand supporting Federal Reserve independence. He had negotiated the famous “accord” that freed the central bank to pursue an anti-inflationary policy.72 Martin then became chairman of the Federal Reserve Board and implemented a policy of price stability that would last almost a generation. But not every head of America’s central bank would follow his example.
Paul Volcker’s memo to Roosa back in 1962, proposing a presidential commission to remove the gold cover, had reflected his great faith in William McChesney Martin: “He was very nice to me when I first arrived at the Treasury and I never forgot that. He earned my respect by devoting himself to Federal Reserve independence, and then delivering on his promise to contain inflation. He is one of my heroes.”73 In 1968, after Congress removed the gold cover and the central bankers abandoned the Gold Pool, Volcker thought Martin could still maintain domestic stability, but he worried that the international monetary system “had fallen into jeopardy.”74 He thought that the two-tier gold market was a barometer of tension in the Bretton Woods System.
Speculators who had bought gold at thirty-five dollars per ounce before March 15, 1968, made a tidy profit. The withdrawal of central banker supply from the London gold market acted like the popping of a champagne cork. The free-market price of bullion jumped to thirty-eight dollars when the market reopened two weeks later, an increase of nearly 10 percent.75 And the twenty-dollar double eagle, which Americans (even Sargent Shriver) could buy from their favorite coin dealer, surged more than 25 percent.76 The price increase reflected expectations that the United States would eventually devalue the dollar.77
Volcker thought that, going forward, foreign central banks might purchase gold from the United States “to hedge against the possibility of an eventual American embargo on gold.”78 If the United States could change the rules in March 1968 and stop selling gold to the private market, it could amend them further by refusing to sell gold to other central banks. The specter of America suspending gold convertibility to other monetary authorities kept foreign central bankers awake at night. They had good reason to worry.