I.O.U.S.A. (44 page)

Q:
In the fi lm, 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 defi cit. What is a fi at currency and what is the
importance of gold in the monetary system?

Paul Volcker:
Throughout my career, I have worked in fi nance, 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, which IMF created. The basic fulcrum of the Bretton Woods system was the stability of the dollar and its 161

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conversion into gold. It was assumed that exchange rates would be fi xed 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 infl ation.

At that time, this small infl ation 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 defi cits. 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 fi at 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 c12.indd 162

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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 infl ation. Were you surprised at the
high rate of infl ation? What do you think were the root causes
of the ’ 70s infl ation 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 diffi cult to sustain the domestic price stability. But there was a combination of problems that led up to this high level of infl ation. The 1970s was also a period of great instability in exchange rates, which led to some diffi culties for the economy and for relations with other countries. People had become rather inured to a small amount of infl ation. 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 infl ationary 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 infl ationary pressure has encouraged OPEC to increase the oil price, and the increase in oil prices led to infl ation, or more infl ation. So we got into a discouraging passivity and cycle of poor economic performance and infl ation. 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 infl ation. I even
noticed you have the famous painting out in the hallway of
you with a shield, fi ghting off infl ation. Can you just tell us
how it felt to be in that position, and also describe what was
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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 infl ation 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 fl uctuate 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 - infl ationary 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 c12.indd 164

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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 infl ation get started, because once it gets some momentum it ’ s very diffi cult 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 infl ation 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 fl avor of it — we will all fi nd ourselves back in the days of stagfl ation 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 diffi cult circumstance. We are in a fi nancial 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 fi nancial world. But now we have reached a point of excess, maladjustments, and tensions. Correcting them is going to be a little bit painful.

Q:
When we spoke to Dr. Laffer yesterday, he credited you and
the policies that he was involved with during the Reagan years
as laying the groundwork for those 20 years of economic
expansion. Do you agree? He also credits Clinton and then
even George Bush with responding to crises in the 1990s
and early 2000s. Since you believe we may be heading down
that path again, how do you feel about this comment?

Paul Volcker:
The period beginning in the mid - early 1990s has been one of remarkable succession and leadership in the world economy by the United States. But a lot of things have contributed to it. As mentioned earlier, price stability, which has been characterized with higher stock prices or lower interest rates, is one factor that has contributed to that success. Following a period c12.indd 165

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of low - productivity growth in the United States, the explosion of high - tech industries and high productivity in the 1990s also led to broader economic policies. One crucial occurrence was during the Clinton administration. The movement toward a balanced budget was something that this country had not seen for a long time, and there was this worry that we would be so successful in running budget surpluses that the national debt would disappear in a few years. I thought the political system would make sure that that didn ’ t happen, but it was an indication of a sense of fi nancial discipline that hadn ’ t existed earlier.

Now that has been eroded. In recent years, we had a small recession, which grew out of the excesses of the high - tech era and the extremely high stock prices for Silicon Valley – type fi rms. I ’ m afraid budget defi cits, which to some degree are certainly tolerable and manageable in the light of the economic situation, will get us back in the habit of running defi cits as a matter of course. And of course the big problem for this country fi scally is a need for more spending — an inherent need for more spending in Social Security, Medicare, and other areas. That spending presents a very large fi scal challenge in coming years. It ’ s not here right now, but we ’ ll see whether a democracy can deal with an obvious problem that ’ s going to be present in not too many years; and the earlier we take action to deal with it, the better. But are we going to take action or not? That ’ s the crucial issue.

Q:
I know that you ’ re a part of the Concord Coalition. Can you
please comment on the work that they ’ re doing? Also, can
you comment on the work that David Walker is doing as the
comptroller general?

Paul Volcker:
With respect to the fi scal crisis looming out there in the future, the Paul Revere of America these days is David Walker, the comptroller general. He is absolutely dedicated to bringing the idea of the looming fi scal crisis to the attention of Congress and the American people. Maybe we have two Paul Reveres. We also have Pete Peterson pushing the Concord Coalition with a group of private individuals. This group was c12.indd 166

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started by Paul Tsongas, Pete Peterson, and Warren Rudman, a Republican. Paul was a Democratic senator who once ran for president some years ago. Unfortunately, he died some years after he started the Concord Coalition. So I look at these men as the two minutemen in alerting the American public to the threat that ’ s out there.

Q:
Why is it important for Americans or people who are not
involved in the fi nancial industry and/or economics to
understand these issues?

Paul Volcker:
It is always diffi cult 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 fi scal 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 infl ation 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 fi scal 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.