Keeping At It: The Quest for Sound Money and Good Government

Paul A. Volcker, “Keeping At It: The Quest for Sound Money and Good Government,” C2018, 246 pp.

There are two institutions that remain somewhat out of the partisan peristaltic political-mess of recent times: the Supreme Court (except the nomination process), and the Federal Reserve, created in 1913.  This book covers the latter institution in some detail, especially during Paul Volcker’s tenure.

In August 1979, when Paul Volcker began an eight-year stint as chairman of the Federal Reserve, inflation was running at a rate of more than 11% a year. Soon Americans would see a 16% Treasury-bill yield and an 18% mortgage rate. How these things happened and what put a stop to them is covered in Volcker’s autobiographical book.  This is particularly interesting when viewed from today’s current 2.5% inflation and 5% mortgage rates along with the cavalier and isolationist attitudes of Congress and the White House and the consequences such incontinence may ignite.

Mr. Volcker came of age when the dollar was still defined as a weight of gold (foreign governments could exchange $35 for an ounce) and banks still were influenced by memories of the Great Depression. By the 1960s, bankers had stopped being influenced by disturbing memories. For instance, Walter Wriston, chairman and president of what is today Citigroup, went so far as to deny that any well-managed bank (his own, for instance) needed any capital, a claim that seemed brash when he made it and particularly distasteful following Citi’s near death in 2008-09.

In 1971, the dollar was cut loose from its gold anchor—henceforth, the U.S. could issue as many greenbacks, and run up as much debt, as the traffic would bear. Thus did an age of relatively restrained finance give way to the Age of Inflation and, its evil twin, the Age of Bailouts.  Against this tide, Volcker made a career of trying to replace the conservatism inherent in the gold-based system with the caution imposed by regulation.”

My Notes:

Pg. 24:  Coming out of WWII, peace and prosperity seemed to depend on maintaining the Bretton Woods newly formulated agreement.  Gold was set at $35 an ounce and all other currencies foreign exchange values were fixed against the dollar and the US Treasury promised to convert any nation’s dollars to gold at the $35 oz. price on demand.

Pg. 31:  William Martin, the chairman of the Fed (1951-1970), negotiated ‘the Accord’ that freed the Fed from the Treasury’s oversight.  Martin is credited with describing the role of the Fed as to take away the punch bowl just when the party was really warming up.

Pg. 41:  The 1933 Glass-Steagall Act forbids banks from underwriting and trading corporate stocks and bonds (effectively separating ‘deposit-taking’ banks from engaging in ‘investment banks’).  Branching across state lines was prohibited by federal law.

Pg. 64:  Underpinning currencies with the $35 oz. gold standard became visibly threatened by 1969 when only 25 percent of foreign-dollar liabilities were covered, down from almost 80 percent in 1960.

Pg. 86:  Sovereign nations typically want (1) full control of their own monetary and fiscal policies, (2) the benefits of a free flow of capital across national boundaries, and (3) stable, predictable foreign exchange rates.  Conceptually, they can achieve the first two objectives if they are willing to permit their exchange rate to float relatively freely.  (Countries that do this included the US, Canada, Japan, and the UK.) No country has had all three for any length of time.

They can have the last two—free capital flows and stable exchange rates—if they are willing to sacrifice control over monetary policy.  (The extreme example is the euro, in which national currencies are eliminated and a central bank sets monetary policy for the whole area.)

Or they can retain a fixed exchange rate and monetary policy independence if they are willing to close the economy to international flows of money and capital.  (The US itself moved in this direction in the 1960s.  Today China is struggling with this question.

Pg. 100:  In 1978, during the Carter administration, Congress passed the Full Employment and Balanced Growth Act, known as the ‘Humphrey-Hawkins Act”.  This act required the Fed chairman to report to the Congress twice a year on plans for monetary policy, setting out the board’s targets for the growth in money and credit.  It also went on to incorporate language about the goals of maximum employment, stable prices, and moderate long-term interest rates.

Pg. 102ff:  In 1979 price measures were rising 13 percent a year, driven in part by the oil crisis that followed the Iranian revolution.  The rate on three-month Treasury bills eventually exceeded 17 percent, the commercial bank prime lending rate peaked at 21.5 percent, and mortgage rates surpassed 18 percent.  (Pg. 108).

Pg. 113:  Reagan made one important but little recognized contribution to the fight against inflation when, in 1981, he fired thousands of striking air traffic controllers.   

Pg. 115:  In 1982 unemployment reached a postwar record.  Even though the inflation rate had dropped, the money supply remained well above target.  Interest rates were at 15 percent even though the money supply was still high.  Volcker stuck with his high-interest rate program and by summer inflation finally fell down into the single digits.  By years end, the inflation rate had dropped all the way to 4 percent and while the unemployment rate was still at close to 10 percent, a recovery had clearly begun. 

Pg. 118:  In the summer of 1984, Volcker was summoned to a meeting with President Reagan at the White House.  Strangely, it didn’t take place in the Oval Office, but in the more informal library.  The president was sitting there with Chief of Staff Jim Baker; Reagan didn’t say a word.  Instead, Baker delivered a message: “The president is ordering you not to raise interest rates before the election.”  Volcker was stunned and walked out without saying a word.  He hadn’t been planning on raising rates and didn’t but not because of this order. (Volcker believes this meeting was in the library because it probably had no taping device.)

Pg. 121:  By the end of the 1970s the financial world was beginning to break down.  The unique role of commercial banks was challenged by new rivals.  Proliferating money market funds, free of regulation, offered higher yields than bank deposits.  Investment banks increasingly began trading to generate revenue and competed to finance ambitious corporate takeovers and leveraged buyouts.   Savings and loans and mutual savings banks became more aggressive, taking advantage of lax regulation and higher interest rate ceilings than those enforced on commercial banks.  High inflation no doubt contributed to the uncertainties and speculative practices in financial markets.

Pg. 128:  The Dodd-Frank legislation under Obama in 2010 goes a long way toward dealing with the banks ‘too big to fail’ criticism. It requires removing the management of a failing bank and, if necessary, liquidating or reorganizing the bank at the expense of stockholders and creditors instead of taxpayers.  (Volcker thinks small banks should have been exempted).

Pg. 146f:  The question of how much capital banks should maintain is ongoing.  The US practice had been to assess capital adequacy by using a simple ‘leverage’ ratio—in other words, the bank’s total assets compared with the margin of capital available to absorb any losses on those assets.  (Historically, before the 1931 banking collapse, a 10 percent ratio was considered normal.). The Europeans, on the other hand, prefer a ‘risk-based’ approach which calculates assets based on how risky they seemed to be.   They felt that certain kinds of assets—including domestic government bonds, home mortgages, and other sovereign debt—shouldn’t require much if any capital.  Over time, the inherent problems with the risk-based approach became apparent.  The assets assigned the lowest risk were those that had the most political support: sovereign credits and home mortgages.   The very two assets that would fuel the 2008 crisis.  In the US a sensible middle approach has emerged, applying both a risk-based measurement and a simple leverage ratio, each helping to offset the weaknesses of the other. 

Pg. 178:  Volcker headed up a group investigating the 6.8 million Holocaust-era accounts held in Swiss banks; of these, there were still some records for 4.1 million of them in spite of Swiss law allowing records more than 10 years old to be destroyed.

Pg. 181:  Volcker strongly believes there is an indispensable role for international organizations in today’s world The simple fact is that much of the apparatus—the UN, the IMF, the World Trade Organization, the World Bank, and others—is the product of American leadership Taken together they are an essential link in maintaining the rule of law internationally, in peacekeeping, in dealing with natural disasters and refugee crises, in encouraging development, and in much else.

Pg. 190:  In 2006 it was discovered that Siemens AGH had been paying bribes to participate in international contracts over the course of years.  Hundreds of millions of dollars were involved. (Note: before 1999 bribes were a permitted tax-deductible expense in Germany).

Pg. 200:  The Enron-Anderson affair was the climax of a wave of corporate and accounting scandals around the start of the new millennium Tyco International and WorldCom were the largest and most publicized, but there were many others.  By mid-2002 Sarbanes-Oxley Act was passed.  The legislation did prohibit accounting firms from providing most consulting services to an audit client. 

Pg. 217:  The Volcker Rule, January 2010:  The rule was proposed by Paul Volcker, the former United States Federal Reserve Chairman.  It restricted United States banks from making certain kinds of speculative investments that do not benefit their customers. Volcker argued that such speculative activity played a key role in the financial crisis of 2007–2008. The rule is often referred to as a ban on proprietary trading by commercial banks, whereby FDIC insured deposits are used to trade on the bank's own accounts.

Pg. 225:  Alan Greenspan defined price stability as ‘that state in which expected changes in the general price level do not effectively alter business or household decisions.’

Pg. 237:  The US government—at the local, state, and federal levels—spends close to 40 percent of our total economic output.  Against that challenge the federal government today employs about the same number of civilians as they did during the Kennedy administration in 1962.  The US population meanwhile has nearly doubled.  GDP and federal spending have soared to more than thirty times their 1962 levels.