Volcker Goes From Villain to Hero, but Will He Stay?
In October, 1980, when Federal Reserve Chairman Paul A. Volcker approached the podium of the American Bankers Assn. convention, the band broke into strains of “Mr. Wonderful.” To the rest of the country, however, Volcker was anything but.
Bankers loved him as the Fed’s tight money policy propelled the prime interest rate toward a record 21.5%, but the economy suffered back-to-back recessions that also pushed unemployment into double-digits.
Hostility to him was so strong that Volcker, viewed as tight money’s most ardent proponent, was given Secret Service protection.
Even as late as 1984, Congress was seriously considering efforts to rein in the vaunted independence of the Fed, the nation’s principal architect of monetary policy. Some lawmakers muttered about impeaching Volcker.
How times have changed. Today, Volcker’s stern visage, his gloomy lectures on the evils of deficit spending and the clouds of smoke from his ever-present cheap cigar have made him into something of a national folk hero, an American Crocodile Dundee--the man who slew the inflation dragon and stayed to preside over one of the longest economic expansions since World War II.
The resurrection of Volcker’s popularity gives President Reagan one of the most important decisions of his second term, one likely to affect the nation’s economic direction even after he leaves office: Should he ask Volcker to stay for a third four-year term when his present one expires in August?
The key players in the decision--Treasury Secretary James A. Baker III and newly installed White House chief of staff Howard H. Baker Jr.--aren’t talking. But the latest hints from other Administration officials and comments by analysts suggest that Volcker, 59, once considered a long shot, now has slightly better than a 50-50 chance of being reappointed.
If he is, part of the reason may be the change in Volcker himself. Faced with an overwhelming majority of five Reagan appointees on the Fed’s seven-member governing board (one seat is vacant) and holding only a tenuous sway over the 12 voting members of the crucial Open Market Committee, Volcker overcame a rocky period a year ago to work out a modus vivendi on monetary policy.
“The Reaganites have been Volckerized,” said A. Gary Shilling, a New York economic consultant with ties to several Fed members, “but Volcker has also been Reaganized as well.”
Within the Fed, most of Reagan’s appointees have taken pains since last summer to emphasize their strong commitment to Volcker’s top priority, fighting inflation. Vice Chairman Manuel H. Johnson took the lead in publicly hinting last September that the board should halt its steady reductions of the discount rate, which the Fed charges financial institutions to borrow money.
In turn, Volcker--on the losing end of a 4-3 vote last February in favor of cutting the discount rate--presided over a dramatic loosening of the monetary policy reins earlier last year. A compromise between Volcker and new Fed governor Wayne Angell that delayed the rate cut for several days to coordinate with a similar cut in Japan prevented the chairman’s resignation.
Ignores Rapid Growth
Volcker, who in the early 1980s was insisting that too much money in circulation breeds inflation, is ignoring a recent explosive growth of the money supply as meaningless because banking deregulation has revolutionized the way Americans hold money, particularly in such new instruments as interest-bearing checking accounts. He has also accepted the preference of several new Fed governors for using monetary policy to stabilize a basket of commodity prices such as wheat, copper and oil.
“We accomplished all that I ever wanted,” Angell said. “It was important to show that the Fed would move against commodity price deflation just as much as it would to stop inflation. Inflation and deflation are twin bedfellows that we have to pay equal attention to.”
Moreover, over the past two years, Volcker has established a cordial working relationship with Treasury Secretary Baker and has become a stalwart supporter of nearly all of Baker’s economic initiatives. “I’ve been able to work in close cooperation with Volcker,” the Treasury secretary said recently. That contrasts with Volcker’s prickly dealings with Baker’s predecessor, Donald T. Regan.
In fact, some analysts worry that Volcker has gone too far in accommodating Baker.
“Since 1985, when Baker took over Treasury, Volcker has given him everything that Administration policy ever wanted,” argued Larry Kudlow, chief economist at Bear, Stearns & Co. in New York. "(Baker) wanted a cheaper dollar as the Administration response to protectionist fevers in Congress. Volcker has given it to him with the creation of a huge new volume of money.”
Helped Trade Posture
Beyond dispute, the growth of the money supply has promoted lower interest rates, which helped drive down the attractiveness--and therefore the value--of the dollar. That in turn worked to the advantage of the U.S. trade posture by boosting the cost of foreign goods in the United States and reducing the cost of American products abroad.
What is no longer so clear is the relationship between the money supply and inflation. The dogma of monetarist economists--that the burst of growth in the money supply over the past couple of years should have triggered inflation by now--has been discredited.
“Conducting monetary policy is always a very messy business,” Washington economic analyst Michael Barker said, “and if we’ve learned anything in recent years, it’s that it is impossible to retreat into a fixed rule. It is a question of judgment, and there is nobody in Washington with better judgment on these issues and more enduring credibility with the financial markets than Volcker.”
It is just those qualities that have encouraged Administration officials to take a second look at Volcker, who has served for nearly eight years in a job that President Jimmy Carter and then Reagan gave him only reluctantly.
Carter, unable to control inflation or stem the decline in the dollar’s value in the late 1970s, had not even heard of Volcker--then president of the New York Federal Reserve Bank--shortly before appointing him in 1979 to help settle the financial markets.
“Volcker was known for his conservative, independent thinking,” Carter’s chief domestic adviser, Stuart Eizenstat, recalled later. “But no one in the Administration appreciated the degree of that independence.”
And Reagan, in deciding to reappoint Volcker in 1983 over the objections of most of his top advisers, feared that to do otherwise would trigger adverse market reactions that might abort the budding economic recovery.
Had Little Choice
“We didn’t really have a free hand in choosing Volcker then,” one Administration insider said. “The markets made the decision a fait accompli .”
Today, with the Reagan Administration trying to recover from the Iran- contra affair, there are growing signs that Volcker may once again have the upper hand. Regan, his arch-foe, has been drummed out of his latest job as White House chief of staff. Pressures from Congress, Wall Street and foreign leaders are pushing the Administration toward demonstrating its interest in continuity and economic stability.
“Nobody is irreplaceable, but Volcker is viewed as a sound leader in financial markets,” said Steven Axilrod, former staff director for monetary and financial policy at the Fed who recently left to become vice chairman of Nikko Securities Co. International in New York. “Anyone else would have to prove himself in some way, and that could take a long time.”
All the widely considered alternatives to Volcker carry their own drawbacks.
The top candidates to replace him, according to most analysts, include Alan Greenspan, who was chief economic adviser to former President Gerald R. Ford; Fed Vice Chairman Johnson, a former Treasury deputy in the Reagan Administration; New York Federal Reserve Bank President E. Gerald Corrigan, a Volcker protege, and Beryl W. Sprinkel, current chairman of the White House Council of Economic Advisers. Others, such as Secretary of State George P. Shultz and former Citicorp Chairman Walter R. Wriston, have also been mentioned but remain long shots.
While Greenspan and Sprinkel appear to be campaigning not so quietly for the job, Administration insiders suggest that their reputations as hard-line proponents of tight money could easily derail them. “Alan and Beryl will never be able to entirely dispose of their monetarist baggage,” one Reagan official said.
Even some of Volcker’s critics, after considering the alternatives, have discovered new virtues in the incumbent chairman.
“I wouldn’t feel bad about him staying on,” said Alan Reynolds, chief economist at Polyconomics in Morristown, N.J., and a leading advocate of supply-side economics. “Greenspan and Sprinkel would be much more dangerous.”
Johnson, 38, is popular inside the Administration but must overcome his relative youth and inexperience, particularly in international finance. To reassure those who thought he would try to overturn the central bank’s anti-inflation orthodoxy, Johnson has been working overtime to demonstrate his loyalty to the Fed.
Johnson has repeatedly contended that he and the four other Fed members appointed by Reagan will avoid promoting economic growth that would produce excessive inflation. In speeches and interviews, Johnson vows to be just as determined to stamp out inflationary pressures now as he was last year to spur the faltering economy.
Former Fed board member Lyle Gramley, who underwent a metamorphosis of his own from Carter-era liberal to anti-inflation hawk during his six-year tenure on the board, observed:
“Manley Johnson has demonstrated once again that you can’t characterize individuals by their background. There is a new group of people at the Fed, but the process of coming to a consensus about the best way to keep inflation in check remains much the same.”
Corrigan’s chief drawback is that he is widely considered Volcker’s choice as a successor. The Reagan Administration has studiously ignored Volcker’s past suggestions on appointments to the Fed.
Moreover, in the eyes of Washington policy makers, Corrigan has not emerged from Volcker’s shadow. “Why pick someone else when you can have the real thing?” an Administration official asked rhetorically.
But would Volcker take the job again, particularly considering the financial sacrifice he has made by remaining in his $89,500-a-year job? He could easily earn at least $1 million a year as a Wall Street executive. A sign on his desk reads: “My take-home pay won’t take me home.”
His wife, who suffers from arthritis and diabetes, maintains the family home in New York while Volcker rents a disheveled bachelor apartment near Fed headquarters.
When asked recently about his future by Chicago Tribune reporter William Neikirk, who is writing a book on him, Volcker replied: “What worries me is that I’m not getting any younger. It ain’t quite fair to leave a family sitting out there--well, you obviously have the possibility of assuring a little more comfort than I have done so far.”
Asked if it was time for him to make some real money, he replied with a laugh: “Yes. Yes.”
Despite that, few of Volcker’s associates believe that he would leap at the opportunity to cash in on his stature. “How boring,” he reportedly replied when told once about his potential value in the private sector.
And after nearly eight years at the helm of the nation’s central bank, sometimes called the second most powerful job in America, Volcker probably would find it difficult to do anything else.
“Paul Volcker was born to be chairman of the Fed,” Albert M. Wojnilower, chief economist at First Boston Corp., said a couple of years ago. “It was as though somebody had trained all his life to play the piano and now was finally allowed to play the best instrument in the world.”