Paul Volcker: Monetary Hero?

Each week, I often discuss central bank policies.  As long-time readers of this blog know, I am not a fan of the central banking system.

That said, I would be remiss if I didn’t acknowledge the passing of former Federal Reserve Chair Paul Volker on December 8 at the age of 92.

“The New York Times” reported Mr. Volcker’s death calling him the Fed Chairman who waged war on inflation.

Mr. Volcker was the Federal Reserve Chairman from 1979 to 1987.  While in that position, he nearly doubled interest rates in order to curb inflation.

In our fractional reserve banking system, when interest rates are lower, more money is loaned into existence.  When interest rates are higher, borrowing declines and the money supply contracts.

Since inflation technically defined is an expansion of the money supply, Mr. Volker’s actions led to the contraction of the money supply which got inflation under control.

Dr.  Joseph Salerno, a past guest on my radio program, wrote a piece about Mr. Volcker last week titled, “Paul Volcker:  The Man Who Vanquished Gold”.

In his piece, Dr. Salerno states that while Mr. Volcker deserves credit for stopping rampant inflation, he also ought to take some of the blame for the massive inflation of the 1970’s.  Here is a bit from Dr. Salerno’s piece:

It was Mr. Volcker who masterminded the program that President Nixon announced on August 15, 1971, which unilaterally suspended gold convertibility of U.S. dollars held by foreign governments and central banks, imposed a fascist wage-price freeze on the U.S. economy, and slapped a 10 percent surcharge on foreign imports.

Tragically, by severing the last link between the dollar and gold, Volcker’s program scuttled the last chance of restoring a genuine gold standard. 

More than two years before Nixon slammed down the “gold window,” Volcker, the recently appointed undersecretary of the Treasury for monetary affairs, gave an oral presentation to Nixon and his closest advisors on US balance-of-payments problems. The presentation was based on a memo that the secret “Volcker group,” initiated by Henry Kissinger, spent five months preparing.  

Among other things, Volcker recommended a continuation of capital controls to prop up the inflated dollar’s overvalued exchange rate and a massive appreciation or “revaluation” of the currencies of less inflationary countries such as West Germany, placing the burden of adjustment to unrestrained US inflation on these countries.  Volcker then planted the time bomb that would eventually detonate and seal the fate of the gold standard.  He suggested to Nixon that if these measures did not work to sustain the pseudo–gold standard of the Bretton Woods System, a run on the US gold stock could only be avoided by unilaterally repudiating the postwar US pledge to convert foreign official dollar holdings into gold. Unfortunately, the Volcker Group report summarily dismissed the alternative of raising — possibly doubling — the dollar price of gold, i.e., “devaluing the dollar,” which would have increased the value of the US gold stock and facilitated the restoration of a genuine gold standard. 

As Dr. Salerno states, it was in 1971 that then-President Nixon closed the gold window.  Up until that time, foreign investors holding US Dollars had the right to exchange them for gold at the rate of $35 per ounce.

It was at that point, that there would have been another choice as Dr. Salerno states, the gold price could have been increased.  For example, instead of redeeming US Dollars for gold at a rate of $35 per ounce, the exchange rate could have been increased to $70 per ounce.

That would have maintained a gold standard and made the US Dollar more competitive relative to other currencies simultaneously.

But, that’s not what Mr. Volcker advised Mr. Nixon to do.

If you’re reading this and wondering why eliminating the gold exchange was necessary in the first place, it’s a very good question.

The answer to the question is simple.

The United States had printed more paper currency than she had gold to back.

As Dr. Salerno’s article states:  “He (Volcker) suggested to Nixon that if these measures did not work to sustain the pseudo-gold standard of the Bretton Woods system, a run on the US gold stock could only be avoided by unilaterally repudiating the postwar US pledge to convert foreign official dollar holdings into gold.”

Given all the paper currency that the US had created, much more paper currency than there was gold to back, Mr. Volcker was concerned that foreign investors would prefer to hold gold rather than dollars.

When foreign investors came to that conclusion en masse, the run on the gold would initiate and quickly intensify.

The run on the gold supply stopped when Nixon closed the gold window.  That made the US Dollar a fiat currency and eliminated what little discipline and restraint that was imposed on the Fed as far as money creation was concerned.  The Fed was now able to create as much new currency as it deemed appropriate and necessary.

The Fed did continue to create currency and massive inflation was the result.  The official, annual inflation rate as measured by the Consumer Price Index (the most commonly used measure of inflation) in December of 1979 reached more than 13%.

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Within a short time, Mr. Volker nearly doubled the Fed Funds rate which did eventually get inflation under control.

In essence, Mr. Volcker temporarily slayed the monster that he’d helped to create.

But the inflation monster has come back to life.  Because of the level of money creation that is once again occurring.

To quell inflation fears among the populace, clever, politically-savvy, career bureaucrats hanged the way the inflation rate is calculated.

Past RLA Radio guest, John Williams of tracks inflation using the methodologies that the government used to use.

While the official inflation rate is hovering at about 2%, using the inflation rate calculation methods used in 1990, the official inflation rate would be about 6%.

If one were to revert to the inflation rate calculation methodologies used in 1980, the current official inflation rate would be about 10% which is not far from the level at which Mr. Volcker spectacularly increased interest rates.  (See charts courtesy of

The monster Mr. Volcker helped create and then slay is once again alive and well.

As I stated last week, money creation will continue until it doesn’t.

No one knows precisely WHEN that will be, but if we can all agree that the current path is unsustainable, the WHAT is certain. 

And whenever the WHAT hits, if you’re not yet holding tangible assets with at least part of your portfolio, you could find yourself unprotected.

My 2020 forecast issue of the “You May Not Know Report” is now available.  It will be mailed to the regular recipients. 

If you don’t regularly get the newsletter, but would like the forecast issue, feel free to request a complimentary copy by calling my office at 1-866-921-3613.

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