Since his death last week, Paul Volcker has been heavily eulogized. That’s not the purpose here. In these trying times, Americans’ faith in our nation’s institutions is at historic lows. Once-vaunted organizations like the FBI now struggle to command a majority of Americans’ support.
The causes for this are legion. But there is a general sense that the vast federal appendages created in the last 100 years have little connection to the interests of the rest of America. There’s a sense that the bureaucrats who command this leviathan work for themselves, not for the country at large.
That couldn’t be said about Volcker. While jumping around between the Treasury Department, the private sector, academia, and the Federal Reserve Bank of New York, Volcker got a reputation for problem-solving, pragmatism, and being apolitical—all necessary ingredients of public service. Volcker also had a reputation for not buying into the latest academic fad or political expediency, and instead used history and evidence as his guides.
How Paul Volcker Stopped Runaway Inflation
In a way, history picked Volcker. In the late 1970s, inflation was running at around 10 percent and rising. In 1977, during the Carter presidency, the U.S. Treasury had to issue bonds denominated in Swiss francs, because nobody wanted dollars at the rate the Treasury was able to pay. They were called Carter bonds. By the time Ronald Reagan was elected president, inflation was nearing 15 percent.
Inflation of 5 percent can hurt working people, as the prices of the things they buy go up faster than wages and the businesses that hire them are unable to plan. But inflation above this level becomes disastrous. The expectation of price rises begets even higher prices, and inflation risks spinning out of control. The result throughout the 1970s was Americans waiting in lines at gas stations, while their real wages fell sharply.
Volcker was the natural choice to fight this inflation. Some would even say that President Carter had no choice but to nominate Volcker to be Fed chairman in 1979. So Volcker was pulled from his position as head of the New York Fed to be chairman of the Federal Reserve. He took a pay cut, moved into a small Foggy Bottom apartment, and his wife went back to work as a bookkeeper.
Volcker was a monetary conservative, and consistently advocated sound fiscal and monetary policy. When Nixon decided to close the gold window in 1971, ending the dollar’s international convertibility into gold, Volcker was in the room at Camp David. The decision was meant to be “temporary,” but Volcker and others lobbied for the dollar to be re-pegged to gold at a lower value, to no avail.
As Fed chair, Volcker said he would jack up short-term interest rates—directly set or influenced by the Fed—to fight inflation. Many at the time doubted this would work. As Fed chair, he did just that, bringing the fed funds rate all the way up to 20 percent in 1981 (the fed funds rate is the short-term rate the Fed sets, which influences all other interest rates in the economy).
Despite inflation’s dire effect on working people, those who depended on credit were outraged by Volcker’s scorched-earth effort to fight inflation by jacking up rates. The political pressure Volcker faced was immense, especially from the left. Farmers and other interest groups held protests outside the Federal Reserve’s Washington, D.C. Eccles building.
Sometimes, Temporary Pain Is Good for the Economy
Then-Treasury Secretary Donald Regan didn’t want President Reagan to re-appoint Volcker in 1983. Even though Reagan did, to his great credit, re-appoint Volcker in ’83, the Fed chair and the president didn’t always see eye-to-eye. At one time, Volcker declined Reagan’s invitation to visit the White House. In 1984, and with President Reagan in the room, White House Chief of Staff James Baker ordered Volcker not to raise rates ahead of the election.
Overall, however, Reagan’s faith in Volcker paid off. Because of Volcker’s high rates, the American economy was hit by a double-dip recession in 1980 and ’82. But Volcker tamed inflation, which dropped from nearly 15 percent in 1980 to 3 percent in 1983. Reagan won his 1984 election in a landslide.
Critics charged Volcker with doing the bidding of Wall Street. But these critics ignored or forget that while Wall Street doesn’t like high inflation, the market definitely doesn’t like high short-term interest rates and double-dip recessions. Yet Volcker didn’t mind shocking Wall Street with hikes they didn’t expect, which he did often.
All This Complication Is Bad for the Economy
Despite being a monetary and fiscal conservative, Volcker had little countenance for today’s establishment Republican dogma of financial deregulation. As Fed chair, Volcker opposed rules that would weaken Glass-Steagall, a law in place since the 1930s that kept investment banks and brokerages from merging with commercial banks, and was eventually repealed by Bill Clinton in the late 1990s.
Volcker was also highly critical of the financialization of America’s economy. In 2009, Mr. Volcker questioned whether any new financial innovation, beyond the ATM, had added to the real economy. “I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information. I am getting a bit wound up here,” said Volcker.
Following the greatest financial crash since the Great Depression, Volcker had an on-and-off relationship with the Obama administration. President Barack Obama was a bit friendlier to Volcker’s ideas, but Obama’s Treasury secretary—Wall Street insider Tim Geithner—was less keen. In the end, Volcker got a rule in Obama’s Dodd-Frank act named after him.
The Volcker Rule aimed to accomplish some of what Glass-Steagall had intended, and keep banks from using government-insured (FDIC-insured) deposits to “gamble” on the open market. Volcker lived to see his rule implemented, then watered down after many critics rightly noted that it hurt market making activity, and decreased liquidity in the bond market (which could exacerbate a crisis).
Working Americans Should Be Able to Save Profitably
But Volcker wasn’t a liberal Democrat. He strongly criticized the Fed’s 2 percent inflation target, adopted by Ben Bernanke during the Obama years. Volcker thought working Americans should be able to save their dollars, and get a positive real return on their savings, without the Fed eroding the purchasing power of their hard-earned money.
Volcker also stood steadfast against the monetary status-quo, where central bankers assume they need to pursue low rates to hit the arbitrary 2 percent target, or at the mere hint of declining stock prices—even though this stimulus boosts financial assets disproportionately held by the rich.
Volcker even pointed out that the Fed’s monetary interventions, which grew much larger in the last decade, could sow the seeds of the next crisis, by causing the excessive creation of debt. “While zero interest rates may be necessary at the moment, they lead to some dangerous possibilities in terms of breeding more speculative excesses,” Volcker said in 2009.
Volcker wrote in 2018 that, “Ironically, the ‘easy money,’ striving for a ‘little inflation’ as a means of forestalling deflation, could, in the end, be what brings [deflation and financial panic] about.” Yet since Volcker’s time at the Fed, Fed Chairs Alan Greenspan and Ben Bernanke flooded the system with money, and bailed out irresponsible actors, when panic hit.
Greenspan acted quickly to bail out the market in the October 1987 crash, and during the long-term capital management crisis. Bernanke did the same during the global financial crisis, and tried to massively devalue the dollar while juicing Wall Street as America was emerging from that recession. Later Fed Chair Janet Yellen kept rates ultra-low, long after the recession was over.
Volcker, on the other hand, wasn’t trying to be popular, support asset prices, or set himself up for a book tour. He was doing his job. It’s too bad that America’s so-called elite schools don’t generate more men and women like Volcker. And it’s too bad that America’s political system counts women and men like Volcker as the exception, not the rule.
Instead of a eulogy, think of this as a call to action. America desperately needs more public servants in Volcker’s mold. He wasn’t always right, just as none of us are, but he listened to his better angels and put his country first.