The Golden Revolution, Revisited: Chapter 7

This Insight is the tenth in the serial publication of the new, Revisited edition of my book, The Golden Revolution (John Wiley and Sons, 2012). (The first instalment can be found here.) The book is being published by Goldmoney and will also appear as a special series of Goldmoney Insights over the coming months. This instalment comprises the second chapter of Section II.

View the Entire Research Piece as a PDF here.

Stagnation, Stagflation, and the Rise of 'Darth' Volcker

“When I look at the past year or two I am impressed myself by an intangible: the degree to which inflationary psychology has really changed. It's not that we didn't have it before, but I think people are acting on that expectation [of continued high inflation] much more firmly than they used to. That's important to us because it does produce, potentially and actually, paradoxical reactions to policy.”


1979 was not an easy year in which to be the president of the United States. On the domestic front, although economic growth had been relatively weak on average for years, inflation seemed to trend steadily upward nonetheless. The OPEC member nations had, for the second time in a decade, demanded higher prices, contributing to that unfortunate (and, to Neo-Keynesian economists, perplexing) set of conditions now termed stagflation. New economic indicators were invented to help measure the malaise, most notably the Misery Index which simply added up the headline unemployment rate and the consumer price inflation (CPI) rate.1 Having risen into middouble digits by the mid-1970s, it was now rapidly approaching the 20s.2

On the foreign front, fifty-three Americans were taken hostage at the former US Embassy in Tehran in November 1979, following the successful revolution of Ayatollah Khomeini and his clerical associates against the Shah, Reza Pahlavi (and the foreign powers thought to be behind him), in February. In Asia, there were occasional reports of sightings of American prisoners of war (POWs) in Vietnam, yet there seemed little the United States could do about it. Following its withdrawal some years earlier, the US army had returned home, demoralized and, in the view of some, disgraced.

It must have seemed so unfair. Jimmy Carter, the 39th president, had inherited an economic mess. Exactly who was to blame was unclear, although as discussed in Chapter 1, the United States spent and borrowed its way into an economic crisis in the late 1960s and early 1970s, and, taking the easy way out, President Nixon famously closed the gold window at the Federal Reserve in August 1971. Without the protection of the Bretton Woods system of fixed exchange rates, the dollar was now in full free float, and occasionally free fall, versus other major currencies.

Yet the dollar’s weakness was not limited to currencies. Oil producers, previously selling oil at fixed prices in dollars, revolted against this devaluation in the denominator of the oil price by organizing supply and pricing conventions and forcing the nominator (i.e. the price) dramatically higher in the process. When Nixon told the American people on August 15, 1971, that allowing the dollar to devalue versus other currencies and gold would not be inflationary, he neglected to mention the obvious but unpleasant fact that US trading partners in general, including the oil producers, would almost certainly raise their selling prices in response.

Almost overnight, OPEC became nearly as big a villain in American eyes as the Soviet Union. In was mooted in certain circles how the US military, home from Vietnam, might be redeployed to deal with those Arabs—in so doing displaying traditional American geographical ignorance. Among major OPEC members, Iran is a Persian and Libya a North African country; both are Muslim but neither is Arab. And Venezuela and Indonesia are neither in the Middle East nor North Africa, as those few Americans who did bother to look at a map might have noticed.

The demise of the gold-backed dollar and subsequent policy actions and reactions both at home and abroad all contributed to the harshest set of economic conditions the United States had faced since the 1930s. Sure, the United States was now an immensely wealthier country, with interstate highways striping the landscape from coast to coast and (to paraphrase Herbert Hoover) not just one, but two or more automobiles in every garage.

Indeed, America was now so wealthy that a majority of young Americans were not merely graduating from high school but receiving some form of further education. Americans celebrated their wealth by consuming all sorts of goods and gadgets that had not even existed in any form but a generation earlier, such as televisions and all manner of home appliances. Leisure activities once reserved for the upper classes were now thoroughly middle-class pastimes, such as golf, tennis, sailing, and skiing. Although the dollar had weakened since being allowed to float in 1971, it was still strong in purchasing power terms versus the rest of the world. Combined with the arrival of long-range, relatively cost-efficient jet travel, middle-class families could now contemplate foreign vacations, and those who did were amazed that they could eat fine French cuisine for the cost of an ordinary restaurant meal at home or stay in a grand hotel in many Old World cities for the cost of the local Holiday Inn.

The problem, however, as psychologists have learned, is that it is not the level but rather the change in our standard of living that matters when people consider whether they are satisfied with the economic state of affairs. We are wired to expect either stability or improvement—any sense of outright economic decline, even from a lofty level, can raise dissatisfaction quickly, with obvious consequences for politicians. Boldly optimistic on assuming office in 1977, Carter believed that he could use his saltof- the-earth charm—he had been a successful peanut farmer before entering politics— to reach out to ordinary (voting) Americans and not just palliate their concerns but reinvigorate their spirit and shake America out of its national funk. In the epitome of this style, he began broadcasting regular fireside chats, in which he would wear a cardigan sweater in front of a modest, slow-burning fire, implicit signals to Americans that there were simple, commonsense ways to deal with higher energy prices. Once seated comfortably, he would inform his audience of what was going well, what could be improved, and how lucky they were to be citizens of such a fine country.

But perhaps like all peoples, Americans might enjoy listening to promises and platitudes, but what they really want are results. They were promised victory in Vietnam. They got defeat. They were promised a Great Society. They got civil strife and deficits. They were promised wage-and-price controls. They got a weaker dollar and inflation. They were promised the American dream. And they felt they were slipping into a nightmare. It might not have been Carter’s fault, but the consequences were showing up on his watch.

As the economy continued to get worse, Carter found that he had an unusually short honeymoon period with the electorate. But optimism gave way not to pessimism but to determination. He seized the opportunity to mediate peace talks between Egypt and Israel, eventually presiding over the Camp David accords, which would contribute to the decision to award him the Nobel Peace Prize in 2002. He embraced efforts to deregulate certain industries, such as railroads, airlines, and communications. He even made a push to provide comprehensive health care for all Americans but failed to convince Congress to go along.

Perhaps most important of all, Carter faced down the financial markets and set about repairing the economic damage unleashed in the aftermath of the breakdown of the Bretton Woods system.


In the summer of 1979, as he approached the end of his first term and began campaigning for his second, Carter had a choice to make, certainly one of the most difficult decisions he would ever make. Inflation was rising. The dollar was falling. Unemployment was high, and it looked like the economy was beginning to weaken. The choice in question was whom Carter was going to appoint to be the new chairman of the Federal Reserve when the seat was abruptly vacated by Bill Miller, who left to head up the Treasury. The candidates included David Rockefeller, arguably the most powerful banker on Wall Street. But he declined, citing his prominent position and the public image problems it might create for the president. In his place, he recommended his onetime colleague and friend, Paul Volcker, who, incidentally, had been a key player in President Nixon’s economic policy team and in the policy debates that culminated in the August 1971 Camp David meeting at which it was decided to end the dollar’s convertibility into gold.

Notwithstanding Volcker’s long tenure in various economic policy roles, the problem with Volcker, according to some of Carter’s senior advisers, was that he was perhaps too independent; in other words, he was a noted hard money advocate who would not cave to pressure from the president or anyone else. He might not be enough of a team player. But Carter overrode his advisers, sensing that the best way to deal with an economic crisis was to bring in a tough guy with market credibility who, hopefully, would shore up White House economic credentials generally.

Carter could have done like some presidents before him, including Nixon, and deliberately given the economy a jolt of stimulus heading into the reelection campaign, boosting job prospects and carrying him through to a second term, but instead he did what he thought was best for the country, which was to tackle the problems before him right there and then, although he knew it could cost him the election. He overruled his advisors and appointed Volcker. And he lost to Reagan in a landslide.3

Paul Volcker was not just known as perhaps the tallest man on Wall Street. He had a solid reputation both as a banker and as a public servant. Notwithstanding a stellar career at the Chase Manhattan Bank, at the Treasury, and at the Federal Reserve Bank of New York, he was not particularly wealthy by Wall Street standards. He eschewed luxury. As one example, he commuted on foot, briefcase in hand, from a relatively modest apartment to his New York Fed office in Maiden Lane. Yet his legendary support for tight monetary policy would soon earn him the nickname “Darth” Volcker. Following his appointment, Volcker didn’t waste any time. At his first Federal Reserve Board meeting as chairman in August 1979, Volcker asked around the room for comments on the current state of the economy, what the Fed should be watching, and whether a change in policy was appropriate.

His Fed Board of Governors, other colleagues, and a handful of senior staff subsequently chimed in with a great deal of comment on the state of industrial production, inventories, employment, exports and imports, and all manner of economic activity. The general message was that the economy appeared to have entered a recession, although to what extent and for what duration was, naturally, unclear. But in keeping with the conundrum of those times, there was also reference to stubbornly high inflation regardless of economic weakness.

Once the discussion had completed an initial circuit around the room in this fashion, Volcker weighed in, invoking a dramatic change in subject and tone. Rather than talk about economic activity in any detail or anything remotely quantifiable, he focused on the more basic, qualitative issues of confidence, credibility, psychology, and symbolism:

This is a meeting that is perhaps of more than usual symbolic importance if nothing else. And sometimes symbols are important. In general, I don’t think I have to go into all the dilemmas and difficulties we face for economic policy. It looks as though we’re in a recession; I suppose we have to consider that the recession could be worse than the staff’s projections suggest at this time…
When I look at the past year or two I am impressed myself by an intangible: the degree to which inflationary psychology has really changed. It’s not that we didn’t have it before, but I think people are acting on that expectation [of continued high inflation] much more firmly than they used to. That’s important to us because it does produce, potentially and actually, paradoxical reactions to policy.

Put those two things together and I think we are in something of a box—a box that says that the ordinary response one expects to easing actions may not work, although there would be differences of judgment on that. They won’t work if they’re interpreted as inflationary; and much of the stimulus will come out in prices rather than activity…

I think there is some evidence, for instance—if a tightening action is interpreted as a responsible action and if one thinks long-term interest rates are important— that long-term rates tend to move favorably. The dollar externally obviously adds to the dilemma and makes it kind of a “trilemma.” Nobody knows what is going to happen to the dollar but I do think it’s fair to say that the psychology is extremely tender… I’m not terrified over the idea of some decline in the average weighted exchange rate of the dollar or some similar measure. The danger is, however, that once the market begins moving, it tends to move in a cumulative way and feeds back on psychology and we will get a kind of cascading decline, which I don’t think is helpful. In fact, it’s decidedly unhelpful to both our inflation prospects and business prospects…

In terms of our own policy and our approach, I do have the feeling—I don’t know whether other people share it or not—that economic policy in general has a kind of crisis of credibility, and we’re not entirely exempt from that. There is a similar question or a feeling of uncertainty about our own credentials. So when I think of strategy, I do believe that we have to give some attention to whether we have the capability, within the narrow limits perhaps in which we can operate, of turning expectations and sentiment…

Specifically, that suggests that we may have to be particularly sensitive to some of the things that are looked at in the short run, such as the [monetary] aggregates and the external value of the dollar. When we’re sensitive to those things, there’s certainly a perceived risk of aggravating the recession… it would be very nice if in some sense we could restore our own credentials and [the credibility] of economic policy in general on the inflation issue.

To the extent we can achieve that, I do think we will buy some flexibility in the future… If we’re going to be in a recession, by all traditional standards the money supply does tend to be a little weak and interest rates go down. I suspect that’s a pretty manageable proposition for us if long-term expectations are not upset at the time by any decline in interest rates—an action we might actually have to take to or want to take to support the money supply. But I don’t think that approach will be a very happy one unless people are pretty confident about our long-term intentions. That’s the credibility problem…

I don’t know what the chances are of changing these perceptions in a limited period of time. But as I look at it, I don’t know that we have any alternative other than to try…

In saying all that, I don’t think that monetary policy is the only instrument we have either. I might say that my own bias is, while I certainly think in the particular situation we find ourselves it’s premature to be arguing for a big fiscal policy move, that such a move might be necessary. If it is necessary, it ought to be through the tax side and it ought to be through a tax program that not only deals with the short-run situation but fits into the long-term objectives… Ordinarily I tend to think that we ought to keep our ammunition reserved as much as possible for more of a crisis situation where we have a rather clear public backing for whatever drastic action we take. But I’m also fairly persuaded at the moment that some gesture, in a framework in which we don’t have a lot of room, might be a very useful prophylactic—if I can put it that way—and would save us a lot of grief later. If we can achieve a little credibility both in the exchange markets and with respect to the [monetary] aggregates now, we can buy the flexibility later.

So, in a tactical sense, that leads me to the feeling that some small move now… together with a relatively restrained [monetary] aggregate specification might be desirable…

I might only say that I’m somewhat allergic to the use of the discount [rate] as pure symbol—in other words move the discount rate and do nothing else because I think there’s already some flavor of that in market thinking. We do that about once and that means the symbol is pretty much destroyed for the future.4

This meeting represents a turning point in US monetary policy. In subsequent meetings, Volcker worked toward building a consensus around the idea, initially laid out in these remarks, that the Fed needed to communicate in a fundamentally different way with the financial markets. Given that the stagflationary 1970s had seriously undermined the Keynesian economic concept of the Phillips curve, in which there was a quantifiable and manageable trade-off between unemployment and inflation, Volcker aimed for a clean break, and in short order he got it. To anchor inflation expectations, Fed policy itself needed an anchor. In October 1979, the Fed announced that, going forward, it would target growth rates in monetary aggregates believed to be consistent with low and stable inflation. The Phillips curve was out. Unemployment had been relegated de facto to a second-order priority. But the financial markets were not convinced. They would first have to test the Fed’s new regime to see just how credible it was.

Their opportunity was not long in coming. In early 1980, notwithstanding a weakening economy, money growth remained surprisingly strong. The Fed, in line with its new policy, pushed interest rates higher and higher. The economy now began to weaken dramatically. Unemployment soared. But Volcker was relentless. His priority, to restore credibility in the Fed and the dollar specifically and, by implication, in the US economy generally, remained unchanged. The money supply continued to grow above target and so the Volcker Fed continued to raise interest rates. Recession be damned; the Fed kept on tightening. At the peak, interest rates reached over 20 percent (Figure 7.1).

US Money Growth Fed Funds

The reaction on Capitol Hill was predictable. In one instance in the summer of 1981, when Volcker was answering questions before a Congressional committee, he explained that, notwithstanding the recession, rates were going to remain high as long as money growth failed to slow. Vitriol followed:

The Congressmen literally shrieked. Frank Annunzio, a Democrat from Illinois, shouted and pounded his desk. “Your course of action is wrong,” he yelled, his voice breaking with emotion. “It must be wrong. There isn’t anybody who says you’re right.” Volcker’s high interest rates were “destroying the small businessman,” decried George Hansen, a Republican from Idaho. “We’re destroying Middle America,” Representative Hansen said. “We’re destroying the American Dream.” Representative Henry B. Gonzalez, a Democrat from Texas, called for Volcker’s impeachment, saying he had permitted big banks to be “predatory dinosaurs that suck up billions of dollars in resources” to support mergers while doing little to help neighborhood stores and workshops and the average American consumer.5

Volcker, however, refused to back down. The Fed’s credibility was at greater stake than at any time since the 1930s. Unemployment continued to rise. Several large banks were distressed. Auto manufacturer Chrysler was on the verge of bankruptcy. It was at this time of greatest stress that Volcker hosted his former colleague and friend, John Exter, for a visit at his office at the Federal Reserve Board in Washington.

Exter was regarded by Volcker and his counterparts around the world as the central banker’s central banker. Part retired since the early 1970s, he had been active in banking in the US and abroad since the 1940s, and had served as vice president of the New York Federal Reserve, senior vice president of the First National City Bank (Citibank) and the first governor of the Central Bank of Sri Lanka (Ceylon), founded in 1950 following the independence of Ceylon from India a few years earlier. He was also an active investor. In the 1960s, he not only warned against the policies that he believed would lead to a dramatic devaluation of the dollar and rise in the price of gold but, witnessing that his advice was going unheeded by those in greatest power and influence, positioned his investments so as to profit from them. And he did so, handsomely.

Following his retirement from Citibank in 1971, he went into private consulting work and managed his by-then substantial fortune. He specialized in gold and gold mining investments and sat on the board of ASA Ltd. His clients included wealthy investors in the US and around the world.

No other US banker of the time had such extensive domestic and international private and public banking experience. None had had his degree of foresight to invest their savings as John had, accumulating a large holding of gold and gold mining shares. He had literally seen it all, and had predicted much of what he eventually saw, including what was unfolding in the US in the spring of 1981.

That day, Exter was astonished to discover that against the walls of Volcker’s office were stacked piles of one-foot planks of lumber, sent by unemployed construction workers in protest at the many building projects cancelled because of record high interest rates. Some of the 2x4s were even personalized. On one was written, “Because of your high interest rates, Mr. Volcker, I’ve lost my job, my wife has divorced me, and I’m losing my teeth and hair, you no good SOB.” Volcker was clearly in need of some reassuring advice from those he respected most, and Exter was as high on that list as anyone.

Retired or not, Exter never shied away from offering helpful if potentially harsh advice when asked. So when a desperate friend asked for John’s help, he was only too pleased to provide it. That said, John could have responded with an entirely justified degree of schadenfreude. After all, Volcker had been active in US policy circles since the 1960s and was among those who had not always heeded John’s advice. But schadenfreude was not in John’s character. Rather, he went straight to offering his friend his best, honest economic advice. He suggested to Volcker that, in his view, he had already restored the Fed’s credibility as an inflation fighter; that money supply growth would soon begin to trend lower; that the battle, as it were, had now been won; and that it was time for the Fed to start easing interest rates to stabilize the economy.

Volcker found it hard to believe what he was hearing. He had expected Exter to recommend more of the same, to stay the course. Even higher interest rates perhaps, or tighter bank reserve requirements, some form of tough economic love, whatever was required to break the back of the rampant inflation. Yet Exter argued that this had now been accomplished, that Volcker could begin to ease off the monetary brakes. How could he know that?

Perhaps it takes a true monetary hawk to know when policy is convincing and credible and when it is not. John was a highly accomplished and experienced economist, and had an extensive analytical toolbox from which he could draw. In any case, Volcker appears to have followed Exter’s advice and began to ease interest rates within weeks of their meeting. Not long thereafter, money supply growth indeed began to slow, as did the rate of price inflation. By 1982, the inflation rate had fallen to under 3 percent, yet the economy was beginning to recover sharply. The stock market rallied. Growth soon picked up. Unemployment declined. And yet inflation remained low. The dollar grew stronger. Not only was the recession over but the battle against the dreaded “stagflation” had been won. John Exter had been proven right. Volcker’s credibility grew. The dollar reemerged as a strong, stable currency.

In 1984, basking in this pronounced economic success, President Reagan was reelected in a landslide. In that same year, he publicly gave Volcker tremendous credit for his achievements and reappointed him to a second term at the helm of the Federal Reserve. Yet little did Reagan know how things could have turned out differently. Had the Fed continued pressing on the monetary brakes for too long the economy would have failed to recover meaningfully prior to 1984, and Reagan might well have lost his bid for a second term. Volcker might not have received a reappointment. The economy might have spiraled downward into a deep financial crisis. The US dollar might have lost global investors’ confidence and continued to lose value, leading right back into the stagflation Volcker had long sought to end.

US economic and monetary policy might be made by institutions such as the Federal Reserve and the Treasury but all policies are the product of real decisions by real people, receiving real advice that they can either heed or ignore. John Exter’s advice was at times heeded, at times not during his long career and retirement. In 1981, it was heeded, Volcker succeeded, Reagan celebrated, and the country experienced what was rightly described during Reagan’s reelection campaign as “Morning in America.” That the dawn came as it did, as soon as it did, was quite possibly due to the sage advice of John Exter.

There was another interesting topic of discussion late that spring afternoon: gold. Volcker knew that Exter was an expert in gold and gold investments, and he asked him what he thought of the outlook. John explained why he believed that gold served as an insurance policy against financial calamity. But then he went further. He predicted how someday, perhaps when it was least expected, there would be a sudden debt crisis, investors would rush into gold, and the entire banking system would be at risk of collapse. Volcker removed his glasses, rubbed his eyes, and said, “John, I hope you are wrong, but I respect you too much to rule out your predictions.”

John Exter died in 2006, aged ninety-five. He may not have lived to see the global financial crisis of 2008 unfold, but as with most major economic developments of his time, he predicted it. He was more than just an ordinary banker. He was a banker for all seasons, and a monetary theorist of the first order.6


Although Volcker’s policies no doubt contributed directly to the most severe recession since World War II, he achieved his goals. Inflation plummeted from double digits to less than 3 percent by the mid-1980s. The dollar not only stabilized but also, by 1984, had recovered its entire 1970s decline (as measured in trade-weighted terms versus other major currencies). The United States reemerged as a productive, dynamic economy. Yet when the going got tough again in the late 1980s and the dollar was once again in sharp decline, Volcker had left the stage, replaced by Alan Greenspan. The rest is an instructive episode of economic and monetary policy history, a history of asset bubbles and financial bailouts. It is to that we now turn.

1 Economist Arthur Okun created the Misery Index—originally using wage growth rather than consumer price inflation—as a simple means to measure overall economic performance from the perspective of the average worker. It peaked at just under 22 percent in mid-1980, as Carter was running for reelection.

2The calculation basis for the Misery Index has necessarily changed through the years as the methodologies for calculating the CPI and the unemployment rate have both changed substantially. Were one to calculate the CPI and unemployment rate today as they were in the 1970s, the Misery Index today would be far higher. For more detail on how this adjustment could be made, see economist John Williams’s Internet site, Shadow Government Statistics,

3It has been claimed, based on Carter’s initial press conference following Volcker’s appointment, that the president was not particularly aware of what Volcker planned to do at the Fed and appointed him in the expectation that he would provide continuity rather than an abrupt change in policy. While this is possible, it seems not plausible that a president clearly in the midst of an economic crisis, who has just announced a major cabinet reshuffle, would prefer continuity over change, rhetoric notwithstanding. In Volcker’s own account, he stressed the need for tighter policy and strict Fed independence in his meetings with Carter prior to his appointment. For a thorough account of how Carter came to appoint Volcker to the chairmanship, see Joseph B. Treaster, Paul Volcker: The Making of a Financial Legend (Hoboken, NJ: John Wiley & Sons, 2004).

4FOMC meeting transcript, August 1979, pp. 20–23.

5Joseph B. Treaster, Paul Volcker: The Making of a Financial Legend (Hoboken, NJ: Wiley & Sons, 2004), p. 5.

6This account of John Exter’s meeting with Volcker in spring 1981 is based on a series of the author’s interviews with Exter’s son-in-law, Barry Downs, who retains custody over John Exter’s personal papers.

The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information purposes only and does not constitute either Goldmoney or the author(s) providing you with legal, financial, tax, investment, or accounting advice. You should not act or rely on any information contained in the article without first seeking independent professional advice. Care has been taken to ensure that the information in the article is reliable; however, Goldmoney does not represent that it is accurate, complete, up-to-date and/or to be taken as an indication of future results and it should not be relied upon as such. Goldmoney will not be held responsible for any claim, loss, damage, or inconvenience caused as a result of any information or opinion contained in this article and any action taken as a result of the opinions and information contained in this article is at your own risk.


















































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