How Paul Volcker Saved the Dollar: A Rule

Originally posted on Tuesday, April 9th, 2013

“It is fair to say that my style… is to search out a rule or indicator to supply discipline.”  — Paul Volcker

Journalist Steven Solomon provided the world with an intense close up of monetary policy in action in his The Confidence Game: How Unelected Central Bankers Are Governing the Changed World Economy(Simon & Schuster, 1995).  The story of the monetary and financial disorders — and how Volcker formulated and initiated the “Great Moderation” — which, as this writer has observed elsewhere, emulated the gold standard and brought a generation of reasonable stability and ushered in a generation of reasonable equitable prosperity — is a dramatic one.  At the heart of it was the use reliance of rules rather than discretion:

“Many have debated whether Volcker’s use of the monetarist technique was ‘an act of skillful hypocrisy’ to get higher interest rates, as one admiring European central banker thinks, or whether, as Solomon says, ‘Volcker had a semi-converted attitude toward practical monetarism.’  Yet the distinction tended to blur when looked at from Volcker’s pragmatic viewpoint.  ‘We’ve got a market that will seize upon markers of one kind or another.  It is fair to say that my style — more than most others — is to search for a rule or indicator to supply discipline.” (p. 140)

The story of how Volcker executed the politically delicate task of rescuing the dollar from collapse in an era of double digit inflation inaugurated by the reckless policies of presidents Johnson and Nixon, who, respectively, de facto and de jure abandoned the gold standard which had been a “rule … to supply discipline” is a dramatic one.  At the heart of the matter, however, was this key:  “to search for a rule or indicator to supply discipline.”  Which is, of course, precisely what the classical gold standard had so successfully furnished during its era, and, notwithstanding its inherent flaw, the gold-exchange standard provided on a day-to-day basis until its inherent inability to extinguish excess liquidity balances (an intrinsic moral hazard rather than a technical flaw) ultimately manifested, as is inevitable.

To be continued….