Talking with ex-Fed chairman Paul Volcker about debt, inflation, the Dollar and gold...
PAUL A.VOLCKER has had a long and successful career in monetary affairs, writes Addison Wiggin, co-author and producer of I.O.U.S.A. the book and movie, but he is best known as the chairman of the Federal Reserve from 1979 to 1987.
Dr.Volcker is lauded for battling inflation during a time of major economic imbalances in the United States. However, to do so, he had to raise interest rates to an all-time high...up to 19%.
Here's what he had to tell when we interviewed him for the film and now book of I.O.U.S.A.
Q: In the film, we talk a great deal about the dollar and its value. Since the dollar is the medium by which people save money and right now we're running out of it, our country is faced with a savings deficit. What is a fiat currency and what is the importance of gold in the monetary system?
Paul Volcker: Throughout my career, I have worked in finance, particularly in the Federal Reserve and the Treasury. I've also been concerned with the management and the stability of the dollar. Although the dollar had its ups and downs during my career, it has been an interesting period, to say the least. After World War II, we started out with a bright new monetary system, the so-called Bretton Woods system.
The basic fulcrum of the Bretton Woods system was the stability of the dollar and its conversion into Gold Bullion. It was assumed that exchange rates would be fixed and not change very much. And that's the way it was for about 20 years. In the 1960s, the system came under increasing pressure when the United States had a small amount of inflation.
At that time, this small inflation was actually considered rather large, particularly against the growth of other countries whose economies were becoming stronger. While other countries got more dollars and exchanged some for gold, we began running balance-of-payment deficits. That put pressure on the Bretton Woods system. In 1971, we broke away from it. At that time, I was the secretary of the Treasury for monetary affairs, so I was right in the middle of that decision-making.
Q: How did you feel about the decision at the time?
Paul Volcker: Well, I was in favor of the decision. I was one of the proponents of the decision, but I had very mixed feelings about it because I was brought up in defense of the system. I believed that the dollar should be supported at the center of that system and that a stable monetary system was important to the prosperity of the world. The system was set up in reaction to the turmoil in the 1930s – in the Great Depression of the 1930s – which had a lot of currency instability and antagonism between countries. So to see that system potentially undercut was a rather traumatic experience for me, especially since I was hoping for it to be restored at the time.
Q: Once the Bretton Woods exchange rate system was abandoned, did the Federal Reserve became the proponent of a sound currency?
Paul Volcker: Once we moved off gold, which was kind of the last vestige of a gold-based system, we entered a world of so-called fiat currencies. In that world, there's nothing behind money except the credibility of the government and of the central banks. They have the responsibility of maintaining the stability of the currency. Yet this country and other countries did not always honor this responsibility because of the ever-present tension between maintaining stability of the currency and maintaining full employment or economic growth.
I think maintaining full employment is a false economy. Most central bankers and most economists now understand that you shouldn't set up full employment in opposition to stable currency, but the stable currency domestically is important to building a base for prosperity over the long run.
Q: Following the end of the Bretton Woods era, the United States entered an era of rapid inflation. Were you surprised at the high rate of inflation? What do you think were the root causes of the '70s inflation that led to you taking over the Fed?
Paul Volcker: Well, I don't know whether it's fair to say I was surprised. I was disheartened, I suppose. It is difficult to sustain the domestic price stability. But there was a combination of problems that led up to this high level of inflation. The 1970s was also a period of great instability in exchange rates, which led to some difficulties for the economy and for relations with other countries. People had become rather inured to a small amount of inflation. And as I indicated earlier, there was this feeling of a trade-off between maintaining price stability or maintaining economic growth.
I think that this false trade-off made people more relaxed than they should have been. When these inflationary forces began getting stronger, it affected wage demands and pricing policies, and had a certain built-in momentum. And that whole process was aided and abetted by the big increases in oil prices and was something of a chicken-and-egg situation.
For instance, you can argue that the inflationary pressure has encouraged OPEC to increase the oil price, and the increase in oil prices led to inflation, or more inflation. So we got into a discouraging passivity and cycle of poor economic performance and inflation. And I think they were related.
Q: The popular press also tells the story of how you came in and raised interest rates in order to slay inflation. I even noticed you have the famous painting out in the hallway of you with a shield, fighting off inflation. Can you just tell us how it felt to be in that position, and also describe what was really happening rather than the popular portrayal expressed in that painting?
Paul Volcker: When I became chairman of the Federal Reserve, I think there was a general feeling in this country that economic affairs, and inflation in particular, had reached a kind of crisis point. Things were not going very well. There was a feeling of uncertainty.
There was a lot of speculation in commodities and the Gold Price, which was then free to fluctuate up to $800 an ounce. In an odd kind of way, that's a good time to step into a job because people thought that something needed to be done. I also think the mood of the country was willing to accept action, which 10 years earlier they wouldn't have been willing to accept. And once we got caught up and I got caught up – or the Federal Reserve Board got caught up, for that matter the country got caught up – in an anti-inflationary effort, there was a certain willingness to take very high interest rates and eventually a rather severe recession, with the hope and expectations – certainly, the expectation that I had – that things would get better.
And if we could restore any sense of stability in the currency, the country would be better off as long as we sustained that phase.
Q: Would it be fair to say that in that era the high interest rate was the tough medicine?
Paul Volcker: No. There was a lot of opposition and concern, understandably. It was a bad recession, but I think there was this underlying core that the country had not been on the right path economically and that it needed to be shaken up in order to restore stability. And that faith not only sustained me, it sustained the country.
Q: What do you feel were your proudest achievements? If you were able to restore stability, how did that come about?
Paul Volcker: Well, it's not a question, of course, of me achieving stability and sustaining stability. It was a situation in the country as a whole that a stronger approach was acceptable and that we have a Federal Reserve Board and a government who's all in. Although it was controversial – I don't want to minimize the controversy – there was a basic core of support and willingness to do it. And I think one of the lessons of the early ' 80s is don't let inflation get started, because once it gets some momentum it's very difficult to deal with, but it's also destructive for economic growth and prosperity. That lesson is also important today.
I repeat it all the time ad nauseam: Don't let inflation get out of control and build a kind of momentum that's inevitable. If that happens – and right now it seems like there is a little flavor of it – we will all find ourselves back in the days of stagflation and unacceptable economic performance.
Q: Do you feel like that the policies that are in place are reactive enough now?
Paul Volcker: Well, right now we are in a very difficult circumstance. We are in a financial world with lot of excess spending and lending, particularly in the infamous subprime mortgages. These many excesses put a lot of pressure on economic institutions.
The question becomes, how much pressure will they put on the economy as a whole? In the past 20 years, we have had a very good run of economic activity and a lot of success in the financial world. But now we have reached a point of excess, maladjustments, and tensions. Correcting them is going to be a little bit painful.
Q: Why is it important for Americans or people who are not involved in the financial industry and/or economics to understand these issues?
Paul Volcker: It is always difficult to answer that question because it seems that these issues are small and abstract in comparison to people's day-to-day problems of making a living and going to work. Well, they no longer seem abstract when it comes down to people maintaining fiscal discipline and paying for Social Security and Medicare. But the greatest challenge for democracy is to be able to effectively cope with problems that are pretty clearly out in the future but require some action, discipline, and restraint today.
That's the test we're going through. And, as people get a better understanding and education about some basic economic issues, the democracy will be better able to cope with those future challenges.
Q: What are the consequences of not being successful in this endeavor?
Paul Volcker: In the future, there will be all kinds of consequences and uncertainty if we don't deal with these problems. But when I look back on my lifetime, it is obvious that letting inflation get a little bit out of control and not dealing with economic problems effectively in the '70s led to a very uncomfortable crisis.
We don't want to have to go through big recessions again to teach people fiscal responsibility. Instead, we should anticipate what needs to be done while maintaining the growth of the economy. And the threat will always be an unstable economy and an unstable currency. And that's not just destructive to economic life, but it can be destructive to America's position in the world, which to me is the greatest concern.