Verballing Paul Volcker

I was interested to learn of this publication, written by two of the lecturers under whom I studied at university (plus a third who is unknown to me). While occupying a place on the n-dimensional political spectrum which is the polar opposite of theirs, I have long respected their work and their intellectual integrity.

So it was with great sadness and disappointment that, this afternoon, I had to revise my opinion of their integrity and their work.

Very briefly, the book posits that:

  • all economic theories are fundamentally flawed, and therefore are of little direct use in understanding the world as it is, however a study of them is of use in sharpening the mind and providing useful concepts for an analysis of the world as it is;
  • that world is the result of policy choices made by the United States since World War II, first to integrate the global economy for the advantage of the United States, and then, when this was unsustainable, to disintegrate it, again for the advantage of the United States.

The choice to move from integrative policies and institutions to disintegrative policies and institutions is said to have occurred in the 1970s, as a result of the breaking down of the previous international financial and trade system. The pivot is said to be a change in US thinking, with the authors declaring that a statement made in 1979 by the then chairman of the Federal Reserve Bank of New York, Paul Volcker, summarises the US position perfectly.

Here is the story in the book, starting from page 320: 

320: When Richard Nixon won the US Presidency in 1970, he appointed Paul Volcker as Undersecretary of the Treasury for International Monetary Affairs. His brief was to report to the National Security Council, headed by Henry Kissinger, who was to become a most influential Secretary of State in 1973. In May of 1971, the taskforce headed by Volcker at the Treasury presented Kissinger with a contingency plan which toyed with the idea of ‘suspension of gold convertibility’. It is now clear that, on both sides of the Atlantic, policymakers were jostling for position, anticipating a major change in the Global Plan …

338: The basis of the Plan was the idea of creating a stable international monetary system in which the dollar would play the role of the effective world currency, with the Deutschmark and the Yen in a supporting role (primarily the role of shock absorbers in case of a dom estic US downturn). To shore up these two currencies, and support its own export sector, the United States extended credit to Western Europe and Japan (on occasion through war financing) and used its geopolitical might to guarantee them both cheap raw materials and sizeable markets for their industries’ output. In return, its protégés absorbed substantial imports from the United States (increasingly of the high tech, aeronautical and military technology type) and afforded the dollar the privilege of being the only currency whose value transcended the demand and supply of American goods, services and assets.
The second phase was nowhere near as neat and tidy. Having emerged from the catastrophic collapse of the Global Plan (caused largely by the explosive costs of the Vietnam War and the need to spend large sums of money within the United States in order to minimise dangerous social tensions), the second phase was, at least to the naked eye, anarchic, traumatic and precarious. Indeed, the tumult was such that, even though the new phase was largely designed in Washington, it would be wrong to call it a ‘design’.
Its main feature was that, in contrast to the Global Plan’s express intention of balancing trade flows, capital flows, exchange rates, interest rates, energy prices, etc., the new phase was designed to defend American hegemony by doing exactly the opposite; that is, by causing energy prices to go through the roof, closely followed by interest rates, commodities prices, average prices, etc. Systematic asymmetries were the order of the day. Moreover, these asymmetries, on which the new global architecture was erected, could only be maintained if they kept deepening, accelerating, growing. In this sense, the second phase required a kind of negative engineering; an attempt by its architects (strategists like Henry Kissinger and Paul Volcker) to unbalance and rule; to destabilise and reign; to unhinge and stay ahead …

341-42: It is perhaps fitting to end this chapter with the words of Paul Volcker, the man whom we first ‘met’ earlier (see Section 11.4) when, during 1970-1, from the position of Under Secretary of the Treasury for International Monetary Affairs, he advised Henry Kissinger that the time had come to confine the Global Plan to history’s dustbin.
By the end of the decade, in 1979, Volcker had been elevated to the Chair of the Federal Reserve, the Fed. One of the first things he did, as Fed Chairman, was to give a disarmingly honest lecture at Warwick University in 1978, which was published in the Quarterly Review of the Federal Reserve Bank of New York (Volcker 1978-9). In it he tells anyone who was interested to listen that;

It is tempting to look at the market as an impartial arbiter … But balancing the requirements of a stable international system against the desirability of retaining freedom of action for national policy, a number of countries, including the US, opted for the latter…

And as if this were not loud and clear enough, Volcker added the following for good measure:

[A] controlled disintegration in the world economy is a legitimate objective for the 1980s.

We have the story: Paul Volcker as both architect and messenger of the planned disintegration of the world economy.

Below I present actual quotations, given with context, from Volcker’s November 1978 Fred Hirsch lecture at Warwick University. I must tell you that, as a professional economist who spent a decade working in economic policy and analysis in my nation’s public service, that, even with the constraints which necessarily restrict the commentary that a civil servant can offer in public, I believe that Volcker’s speech is outstanding, and a first-rate primary source for historical research into this turbulent and difficult period.

The context for the first quotation:

The contrast between the troublesome performance of present arrangements – at least as measured by the extreme volatility of exchange rates and the slowness of current account adjustment – and rather passive acceptance is striking. It seems to me to reveal much about the problems and preferences of governments in operating a monetary system. Management of an international system requires that certain rules and decisions be agreed among a number of countries, and those participating must have a sense of obligation to conduct their affairs within that framework.

The most sensitive of the rules and decisions involved the exchange rate itself. There is a becoming professional modesty among economists about their ability to approximate equilibrium exchange rates. The views of different countries, looking at the same exchange rates from different perspectives, usually differ. There is no objective way to settle the question. Yet no country today can feel indifferent to the decision. There are direct effects on industrial activity and structure. Support of an exchange rate structure may entail financial costs and impinge upon domestic policy whether as a result of intervention or because explicit adjustments in monetary or other policies will become necessary. And when financial markets are so open and fluid as in today’s world, the potential costs and pressures seem even greater than in the past.

In these circumstances, it is tempting to look to the market itself as an impartial arbiter. If the result is instability, then the potential costs in terms of integration may become relatively high. But balancing the requirements of a stable international system against the desirability of retaining freedom of action for national policy, a number of countries, including the United States, opted for the latter.

Others – mostly particularly smaller countries with open economies – may and do feel differently. To a considerable extent, their choices are limited by those of others, and they have a clear interest in binding these larger trading partners to codes of conduct. But they have not generally wanted to be bound by rules restricting their own options still further.

The nice question to which I want to return is whether these choices and compromises have, in fact, been appropriately struck – and whether the promise of autonomy, even for the United States, is not more than present arrangements can deliver.

What Volcker is saying here is that, even with the instability created by the new system, participants in the system are reluctant to go back to the old system, given the onerous requirements that it imposed on participants in the interests of stability. The cost-benefit analysis favours retaining some autonomy, even in the face of instability, over giving up that autonomy in favour of gaining stability. He then asks, have the compromises made under the new system been made in a way that optimises the functioning of that system?

None of this seems controversial to me. Exchange-rate policy is always a matter of second-best, and requires a realisation of the inevitability of problems arising abroad which adversely affect one’s domestic economy, regardless of the nature of the exchange-rate one has chosen. There is no ideal standard, no silver bullet. Volcker is saying (in his speech) that: we had a policy of stability; the stability it engendered created the conditions for the instability we have recently experienced; and, as a result, we have moved to a new system which yes is unstable but which was inevitable and which most participants, on balance, seem happy with and do not want to move away from.

There is nothing nefarious or controversial here. The United States is acting in its own interests, but so is everybody else, just as they have always done, and making the best of a situation which had to arise as a result of the failure of the old situation. But note that, even then, Volcker raises the question of whether the US’ seeking autonomy is the best way forward for it.

Now, the context for the second quotation:

In view of this occasion, I spent some time in recent weeks reading and rereading Fred Hirsch, and of course came away with a renewed feeling for the strength and breadth of his thinking …

For a good many years, the world of international monetary affairs was Fred’s particular speciality. In an area where much commentary written only a few years ago seems stale and naive, his continue to stimulate.

Indeed, I was tempted to take as my text today one of Fred Hirsch’s last dicta: ‘A controlled disintegration in the world economy is a legitimate objective for the 1980s. …’ The phrase captures what seems to me the prevailing attitudes and practices of most governments in this decade, as they struggle with two central issues that bedevil so much of our negotiations and our actions, not just with respect to money, but over the full range of international economics.

We live in a world in which individuals and businessmen, as never before, have the capacity and incentives to buy and sell, invest and travel, where they want and when they want – and they want to do so unencumbered by national boundaries. At the same time, modern democracies, at least as much as other forms of government, long for autonomy; they want to control their own destinies in ways responsive to the needs of an electorate often concerned less with national than with local or sectorial interests. Yet, theory and experience indicate we can’t have it both ways, full integration and full autonomy.

A compromise needs to be struck, and the way we strike that compromise seems to me conditioned and vastly complicated by needed adjustments to another set of circumstances. The United States no longer stands astride the world as a kind of economic colossus as it did in the 1940’s, nor quite obviously, is its currency any longer unchallenged. Now, other centers of strength and power have arisen in the industrialized world, and they will need to share in the leadership. Developing countries have a new economic importance and political consciousness of their own.

A world of more widely dispersed power may have some advantages. But ease of achieving consistent and coherent leadership in the collective international interest is not among them. Intellectually, it is easy to recognize our interdependence. But in practice the instinct is to exert our independence.

Perhaps in the circumstance, the objective of “controlled disintegration”  – modest as it may seem to be – is indeed a legitimate goal. Yet the phrase leaves me uneasy …

… [L]et us be aware of the difficulty of controlling disintegration, once fairly started.

Volcker then goes on to describe these difficulties.

It is very clear, from this context – absolutely crystal clear – that Volcker:

  1. is quoting Fred Hirsch when he mentions that controlled disintegration is a legitimate objective for the 1980s – these words are not his own; and
  2. he does not endorse them.

What are Volcker’s views? Here they are.

First from the following paragraph:

I do not suggest that we stand on a knife’s edge, forced to choose between integration and autarchy. But I would much rather take as my rallying cry, as a focus for necessary negotiations, as an ideal from which to measure progress, the challenge of “managing integration” rather than disintegration.

And from the final page of the speech:

Today, a stronger and stable dollar is plainly in the interests of the United States and the world. These recent months have, if nothing else, been instructive to all – a sliding dollar undercutting our own anti-inflationary effort, generating uncertainty at home and abroad, hurting growth. There has been a sense of drift, a lack of control or direction in the monetary system infecting and reinforcing other sources of economic instability.

Now, we can see the beginnings of a new base. It cannot rest on the actions of the United States alone – for we are no longer the dominant power of Bretton Woods. But our strength can be joined with others to provide fresh impetus and a renewed sense of commitment to a stable international order. And as we do, an objective of “managing integration” may not sound so utopian at all.

As soon as I read the quotations, as they appeared in the Varoufakis-Halevi-Theocarakis book, I was suspicious. Public servants tend to be careful in their public statements, and Volcker has always struck me as being one of the more conscientious and public-spirited of those to have held high public office in the United States. For him to have made such a blunt statement was uncharacteristic, and to have made such a provocative statement so freely was highly unusual. So I went searching for the source documents.

It took me just two minutes to find them using Google. Why couldn’t any of the three authors – all of whom are academics and thus trained, professional researchers – have done the same?

And how is it possible to have misquoted Volcker so egregiously? Did they not get the quotations from the original source but form a secondary source, and then never checked the quotations against the original, trusting instead the author of the secondary document/s on which they relied?

I suspect this is an example of what Heuer calls, on p.8 of his classic text,

‘one of the most fundamental principles concerning perception: We tend to perceive what we expect to perceive.’

And, later, on p.11:

New information is assimilated to existing images.

Because of their political position, which expects to see the United States behave in a way which allows it to exert its power to its benefit and the detriment of others, the authors expected Volcker to have said something which was consistent with that behaviour. Confirmation bias was at work.

I am deeply disappointed. I had great respect for these academics. Now, I see, my respect was misplaced. And, just as sadly, everything else that they write – their quotations and conclusions – I now must treat with suspicion. They have lost the trust of their audience.

And, having ‘verballed’ Paul Volcker, they’d better hope, if they ever meet him, that he doesn’t take it personally.

Lastly: what did Hirsch mean by ‘controlled disintegration’? Here, a quotation from a more responsible interpretation – including a more responsible interpretation of Volcker’s position, by Mark Mazower:

Some American observers believed that the age in which a hegemonic United States was able to impose economic rules and institutions on the world was past. “The quest for global rules is bound to be futile,” declared Robert Rothstein, a scholar of UNCTAD, at the end of the 1970s. He foresaw the emergence of a “system with the great potential for conflict and disintegration into hostile fragments.”  Others welcomed the prospect of a “loosening” of the system. In 1977, the brilliant young British economist Fred Hirsch had mused about whether what he called a “controlled disintegration of the world economy” might not be “a legitimate objective for the 1980s”. He was thinking about how a looser set of international monetary arrangements that allowed currencies to float would have the benefit of allowing national governments, following the collapse of fixed exchange rates, much more room to choose their own policies.

But what would the consequences of a “controlled disintegration” be for American world leadership? Hirsch’s dramatic phrase caught the attention of the American banker Paul Volcker. Already a man of considerable influence, Volcker was heading the Federal Reserve Bank of New York when he delivered a lecture in Hirsch’s memory in November 1978. (Hirsch had died prematurely that year). “A crisis can be therapeutic,” he told the audience. “It demands a response.” But it did not, he argued, need Hirsch’s. Volcker understood the conflict between the desire for greater global integration, on the one hand, and the goal of modern democracies, on the other, to shape their own destiny – the very conflict that would erupt with even greater force some three decades later. But he approached the problem, as he admitted, as an American, and as a member of the policy elite of the country searching for a new way of bringing stability to the world economy. From that perspective, increasing the autonomy of national governments as Hirsch (and the UK Labour government) wanted looked like a way to stop trade and financial liberalization and turning back the clock. The great fear was of a return to the 1930s. The “fabric of discipline is fraying,” warned Volcker; it was important to resist “the pressures to turn inward.” To protect an open world economy in an era of floating exchange rates would require greater coordination among bankers and treasury ministers. Stability would come in the long run not from intervening in the currency markets but from pursuing the right kind of policies at home. Thus Volcker reached the opposite conclusion from Hirsch: there was no substitute for international fiscal discipline.

[“… there was no substitute for international fiscal discipline.” Pssst … there never is. But good luck finding any – and don’t expect any in the future, either.]


About Stebbing Heuer

A person interested in exploring human perception, reasoning, judgement and deciding, and in promoting clear, effective thinking and the making of good decisions.
This entry was posted in Moral Hazard, Motivated Reasoning, Principal-Agent Problems. Bookmark the permalink.

One Response to Verballing Paul Volcker

  1. Pingback: ‘Fake News’: moral rhetoric in the face of strategic weakness | The Stebbing-Heuer Project

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