At 12:00 midnight on Sunday, August 15, 1971, Volcker boarded a refitted military transport plane on the runway at Andrews Air Force Base headed for battle with European finance ministers. Nixon had lit the fuse three hours earlier with his address to the American people on network television outlining the administration’s New Economic Policy. The plan, hatched over the weekend at Camp David, invoked the Trading with the Enemy Act of 1917 to impose some of its emergency measures, and threatened global economic warfare.1
Most foreigners would not care about the most dramatic announcement, the three-month freeze on wages and prices imposed by the president, except to marvel that a California Republican had adopted a Social Democrat’s approach to controlling inflation. But America’s trading partners would resent the suspension of gold convertibility, which tarnished their dollar holdings, and the 10 percent surcharge on imports, which made their exports less welcome on American shores. Those measures were the equivalent of a declaration of economic hostilities.
The president had asked John Connally to lead a news conference the next day in Washington, a coveted spotlight for Nixon’s chief economic spokesman. Connally assigned Volcker the task of conducting a private meeting with foreign central bankers and finance ministers in London, launching Volcker’s transformation from monetary technician to international financial diplomat.
Paul could not wait to embark on his mission. He felt like a wartime emissary dispatched to cool a provocation. Volcker had always regretted missing the call to action during World War II, blaming himself for failing to convince the draft board that he was short enough to fight. Now he looked forward to defending his country, to maintaining the supremacy of the American dollar as the world’s premier currency, and to ensuring the stability of international trade within the framework of a revamped Bretton Woods System. It was the beginning of a new career.
Volcker replayed the whirlwind weekend in his head as he settled into the cavernous hull of the transport plane. The meeting at Camp David had been conducted in total secrecy: no reporters, no phone calls, and by order of the president, no representatives from the State Department. Nixon had been almost dismissive: “I want this kept secret … don’t bother with the foreign relations types.”2 Volcker thought the president’s distrust of the foreign affairs bureaucracy had deep roots, extending back to Nixon’s days as a congressman on the House Un-American Activities Committee, and his pursuit of Alger Hiss, a State Department official accused of espionage in 1948 and convicted of perjury in 1950.
Volcker noted the president’s attention to detail, especially when it bordered on the absurd. Nixon’s obsession began with instructions that every person sign the guest book as they entered Aspen Cottage on Friday afternoon, August 13, and ended on Sunday morning, with detailed directions during the final picture-taking ceremony.3 Volcker smiled, recalling how Nixon exhorted his valet, “Manolo, quick, Manolo, bring in more chairs, we need more chairs for the picture.”4 The president understood the historic significance of the unfolding events, and participated in every substantive decision.
The joust with Arthur Burns over the wisdom of gold suspension, with the president as referee, dominated Volcker’s thoughts. Burns had not minced words.5
“Volcker and Connolly may be right about closing the gold window, but I think they are wrong. We are taking dramatic steps … the wage-price freeze, the border tax, and the government spending cuts. They will electrify the world. On the other hand, there are grave risks in closing the gold window. First, political … Pravda [the Communist Party newspaper] will headline this as a sign of the collapse of capitalism. The second risk is economic … world trade will suffer. Foreign exporters will clamor for action—”
Connally interjected, “So the other countries don’t like it, so what … We’ll go broke getting their goodwill.”
Burns protested, “They’ll retaliate.”
“Let ’em. What can they do?”
Volcker cringed, having spent the better part of his professional career nurturing America’s international relationships, but said, “I hate to do this. All my life I have defended Bretton Woods, but I think it’s needed … we cannot continue this way. But let’s not just close the gold window and sit. We need to negotiate a new set of exchange rates. This is an opportunity to repair a system that needs fixing.”
Paul McCracken offered some balance: “People’s reaction to closing the gold window could be negative. On the other hand, they could see it as part of a program of strong action on wages and prices.”
Volcker tried some historical perspective, “There is a certain public sentiment about a ‘cross of gold.’”
Paul realized his error too late—a misplaced reference to the denunciation of gold by presidential candidate William Jennings Bryan at the 1896 Democratic convention.
Nixon put Volcker in his place: “Bryan ran four times and lost.”6
Arthur Burns’s special relationship with Richard Nixon, extending back to the Eisenhower administration, might have carried the day. His warnings about the dire consequences of suspension worried the president. But Connally’s tongue and Volcker’s expertise won Nixon over. Volcker had lugged a fat briefing book to every meeting, just in case he needed to consult the black loose-leaf binder containing the plans. His preparation paid off. No one else could muster an answer when the president asked how much revenue the import tax would generate.7
Volcker grounded all his calculations in economic analysis, despite the skepticism he had learned from Morgenstern at Princeton.8 He knew this precision gave him the credibility of a surgeon, but he also recognized the downside. His numerical skills left him vulnerable to being branded an idiot savant.
Not after his mission abroad.
The roar of the engines buzzed in Volcker’s ears as the military transport plane, without windows, lumbered into the air. He could hardly believe that he had returned by helicopter from Camp David just a few hours earlier, had stopped at the Treasury to prepare the press release describing the new program, and was now off on a transatlantic journey. He worried about delivering the proper message, considering that the draft apology for abandoning gold he had given to William Safire, the president’s speechwriter, had disappeared entirely from Nixon’s televised talk. The president had written much of the speech himself and turned over detailed notes to Safire with explicit instructions to avoid “the gobbly gook about crisis of international monetary affairs … which seemed to be the thrust of Volcker.”9
Nixon told H. R. Haldeman, his chief of staff, “Don’t circulate the drafts of the speech. Show the other people only the sections that concern them. I want it to be a surprise.” It was.
Volcker marveled at what a master politician could engineer with the proper turn of phrase, like the sweep of a magician’s wand. During the first minute of his talk, Nixon had transformed three days of anxiety into victory. “The time has come for a new economic policy for the United States … We must create more and better jobs. We must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.”10
Volcker knew that Americans would respond well to thwarting unprincipled speculators. He wondered how that would play in London.
The New York Stock Exchange greeted the president’s plan with thunderous approval, jumping more than 3 percent on Monday, August 16, the first day of trading after the president’s talk.11 The surcharge on imports, raising the cost of Volkswagens and Toyotas, buoyed domestic automakers. Eager buyers pushed up the shares of Chrysler by more than 15 percent, while the larger companies, General Motors and Ford, rose 10 percent each.12 Gold mining stocks declined, suffering from Nixon’s edict, which diminished America’s need to replenish its stock of the precious metal.13
Nixon won new friends among investors. Clarence Netherland, a petroleum engineer watching stock prices flash across an electronic screen in a Merrill Lynch brokerage office in Dallas, said, “There’s a hell of [a] lot more confidence in the economy now. We have begun to face up to realities.”14 Frederick Papolos, a retired Florida businessman, added, “Mr. Nixon has proved himself to be a real statesman. I’ll vote for him in 1972, although I didn’t in 1968.”
Consumers went on a buying spree as well.15 Martin Spenser, a personnel consultant in New York City, visited Sherry-Lehman, a fine wine and liquor store on the Upper East Side of Manhattan and bought a case of Château Lafite-Rothschild. “A wise decision,” said the store owner, Sam Aaron. “I assume retailers and restaurants will be buying madly … until present supplies … run out.” Louis Evans, the president of Evans Motor Company in the Forest Park suburb of Atlanta, reported that several people had shown up early Monday morning to buy Toyotas, and he suggested that “the surcharge announcement was the reason.”
The Wall Street Journal delivered a lecture from its editorial page pulpit, preaching against the inflationary consequences of the wage-price freeze and the foreign exchange uncertainty triggered by gold suspension.
President Nixon has revealed in his two and a half years in office a predilection for the grandstand play … So it should not come as a surprise that he responded to his growing problems with the U.S. economy as he did in his speech Sunday night … [But] grandstanding is … more likely than not to fail in meeting the popular hopes that it raises … A wage and price freeze could result in rather panicky return to price inflation after it is lifted … The import surcharge and a floating dollar will initially produce confusion; what comes out of it could be better or worse.16
Both were valid concerns.
The suspension of gold convertibility brought foreign exchange markets to a standstill, except for small retail transactions. In London on the day after Nixon’s speech, the press reported a “bewildering variety of exchange rates for tourists … The London Hilton would change up to $50 for a person at $2.60 [per pound sterling] during the morning, but it switched to $2.80 a pound during the afternoon.”17 In Milan, Dr. and Mrs. Lawrence Gould from New York City “were just shocked” when their dollars could not buy them even an ice-cream cone. “Fortunately our trip was ending,” they said, “and we had enough foreign currency to see us home.”18
Confusion reigned in foreign exchange because Nixon had upended a key pillar of the Bretton Woods edifice: the link between the U.S. dollar and gold. Until Sunday night, August 15, 1971, the U.S. Treasury permitted foreign central banks, such as the Bank of England or the Bank of Japan, to exchange dollars for gold at the official rate of thirty-five dollars per ounce. And because they could exchange dollars for gold, these central banks felt comfortable using dollars as reserves to establish fixed exchange rates for world travelers.
The Bank of England, for example, would intervene in the market by buying and selling pounds versus dollars, as necessary, to maintain the exchange rate at $2.60 per pound. And the Bank of Italy would intervene in the market by buying and selling lira versus dollars, as necessary, to maintain the exchange rate at 600 lira per dollar. The fixed exchange rate between the dollar and the pound meant that American tourists knew how much they needed to pay their bill at the London Hilton. The fixed exchange rate between the lira and the dollar meant that Dr. and Mrs. Lawrence Gould could enjoy gelato for about fifty cents while on their way to the Milan airport.
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 his 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 financial 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.
John Connally played the role of chairman in Rome as though he wanted an Oscar. He spoke of the historical significance of their discussions, the appropriate setting in the birthplace of Western civilization, and urged everyone to renew their efforts to move toward a viable system of international cooperation. He then asked if there were new items of business, cuing Volcker with an imperceptible wink that left no doubt about what should come next.54
Volcker cleared his throat. “Well, suppose, just hypothetically, we were willing to discuss the price of gold. How would you respond if we increased the price by ten or fifteen percent?”
Connally interrupted. “All right, the issue has been raised. Let’s assume ten percent. What will you people do?”
Volcker had purposely overreached with his 15 percent proposal, knowing that Giscard d’Estaing had suggested France would accept 5 percent. America needed a bigger move to adjust exchange rates. Now Paul worried that his exaggeration, combined with Connally’s correction, advertised dissension within the U.S. Treasury. Unsure of how to set the record straight, Volcker said nothing, recalling a favorite quote attributed to Mark Twain: “Better to remain silent and be thought a fool than to speak out and remove all doubt.”
For the next hour, no one spoke. Most of the central bankers smoked, while the finance ministers looked at their shoes, probably checking whether they needed a shine.
Germany had always been the most flexible of America’s trading partners, so it was no surprise when Finance Minister Karl Schiller spoke first. The export powerhouse could afford to be generous because of its balance-of-payments surpluses. Moreover, preserving America’s commitment to defending Western Europe against Communist aggression carried great weight in West Germany. In March 1967, Karl Blessing, the then president of the Bundesbank, had written to Fed chairman William McChesney Martin pledging that Germany would refrain from demanding gold from the U.S. Treasury in consideration of American defense commitments in Europe.55
Schiller said Germany could live with a 10 percent U.S. devaluation “and would probably add some percentage to it.”56
One of the bankers asked, “What do you mean by ‘some’?”
Professor Schiller, a former academic at the University of Hamburg, responded with a brief linguistics lesson. “In the German language, ‘some’ does not mean ‘one.’ It means ‘two.’ ”
Volcker knew that Schiller’s proposed 12 percent appreciation of the mark had put Germany’s European partners on the spot. Everyone wanted the United States to remove the import surcharge and recognized that the price for that relief was a major realignment of exchange rates. But France could not afford anything close to a 12 percent appreciation of its currency. Most Americans loved the Volkswagen, but probably thought Peugeot, the pride of the French automobile industry, was a miniature poodle.
Nevertheless, Giscard d’Estaing remained silent. Nixon and Pompidou were scheduled to meet the following week. The French finance minister knew the final negotiations would take place then. And so did everyone else.57 The press anticipated “The Coming Devaluation of the Dollar.”58
The Azores Islands, a Portuguese archipelago in the mid-Atlantic, home to a U.S. air base and less than a thousand miles from continental Europe, served as the neutral meeting point for the American and French presidents on Monday, December 13, 1971. Georges Pompidou arrived prepared with a lecture on the centrality of gold to a stable international monetary system. He knew far more finance than Richard Nixon, having been an investment banker at Rothschild, and he recognized an opportunity to capitalize on France’s position in European economic affairs. French intransigence had paid dividends ever since de Gaulle withdrew from NATO in 1966.
Nixon, for his part, wanted to skip the economics and talk politics, in preparation for his scheduled visits to Peking in February 1972, and to Moscow the following May.59 He delegated the monetary discussions to Connally and Volcker. Pompidou, after his pitch to bury the dollar as the premier reserve currency, assigned the task of planning the greenback’s funeral to finance minister Valéry Giscard d’Estaing.
Two days of negotiations produced a compromise “Framework for Monetary and Trade Settlement,” signed by both presidents.60 Among the key items, the United States agreed to remove the import surcharge and to devalue the dollar by raising the price of gold from thirty-five dollars to thirty-eight dollars per ounce. France agreed to allow the franc to appreciate against the dollar by roughly the same 8 percent as the jump in the price of gold and, as an interim step toward monetary reform, would permit some flexibility around the newly established exchange rate.61
The presidents agreed to defer discussions of longer-term issues to a broader forum. The items on this “too hot to handle” list included the division of responsibilities among countries for defending stable exchange rates, the proper role of gold, and a timetable for resuming dollar convertibility into gold. However, Nixon committed the United States “to assist in the stability of the … newly fixed structure of exchange rates … by vigorous implementation of its efforts to restore price stability.”62 This benign pledge that every Boy Scout could support would become a source of conflict between the two presidents.
John Connally viewed the Azores agreement as a blueprint for the meeting of the G-10 scheduled for the following week in Washington. He chose the precise venue with purpose: the Commons Room of the Smithsonian Institution Castle, a 116-year-old red sandstone structure designed by James Renwick, architect of St. Patrick’s Cathedral in New York City. A crypt just inside the castle contains the remains of James Smithson, the illegitimate son of an English duke who left his fortune to the U.S. government and bestowed his name on the complex of museums and research centers now known as the Smithsonian.63 The Gothic architecture and forty-foot-high vaulted ceiling of the cathedral-like Commons Room conferred an aura of high purpose on the assembled ministers of finance and central bankers.
After two days of deliberations, on Saturday, December 18, 1971, the conclave unveiled a new structure of prices and arrangements in international finance. The dollar would be worth less against everything. An ounce of gold would now cost $38 rather than $35. A dollar would buy 3.22 German marks rather than 3.66 and would exchange for 308 yen rather than 360. Even the lowly Italian lira became more expensive: a dollar would buy only 581.5 lira rather than 625.0.64
Central banks would still intervene to maintain fixed exchange rates, but those rates could vary by 2¼ percent around their central values rather than the 1 percent leeway permitted under Bretton Woods.65 Dollar convertibility into gold remained suspended, meaning central banks could not exchange greenbacks for gold even at the higher price of $38. The international financial system had become a de facto dollar standard despite France’s success at embarrassing the United States.
Volcker should have been happy. He had engineered the depreciation of the dollar against all the major currencies, making American goods more competitive in world markets. He had shored up the Bretton Woods framework of fixed exchange rates by adding a built-in safety net of modest fluctuations around central values. He had avoided the freely floating exchange rate system advocated by Milton Friedman, George Shultz, and the Council of Economic Advisers. And he had had to swallow only a small devaluation of the dollar against gold.
President Nixon surprised the gathering of financiers by appearing at the Smithsonian to celebrate the accomplishment. The president hailed the agreement as inaugurating a new era of international finance. “It is my great privilege to announce on behalf of the finance ministers and the other representatives of the ten countries involved, the conclusion of the most significant monetary agreement in the history of the world.”66
Volcker, standing off to the side, muttered under his breath, “I hope it lasts three months.”67
Paul made a living as a professional skeptic, but his doubts about the newly minted Smithsonian Agreement were well founded. The realignment of exchange rates fell far short of the 15 percent adjustment needed for a new sustainable system.68 The dollar would remain under pressure.