Chapter 1

THE CHOICE OF WALL STREET

In the American system, citizens were taught that the transfer of political power accompanied elections, formal events when citizens made orderly choices about who shall govern. Very few Americans, therefore, understood that the transfer of power might also occur, more subtly, without elections. Even the President did not seem to grasp this possibility, until too late. He would remain in office, surrounded still by the aura of presidential authority, but he was no longer fully in control of his government.

The American system depended upon deeper transactions than elections. It provided another mechanism of government, beyond the reach of the popular vote, one that managed the continuing conflicts of democratic capitalism, the natural tension between those two words, "democracy" and "capitalism." It was part of the national government, yet deliberately set outside the electoral process, insulated from the control of mere politicians. Indeed, it had the power to resist the random passions of popular will and even to discipline the society at large. This other structure of American governance coexisted with the elected one, shared power with Congress and the President, and collaborated with them. In some circumstances, it opposed them and thwarted them.

Citizens were taught that its activities were mechanical and nonpolitical, unaffected by the self-interested pressures of competing economic groups, and its pervasive influence over American life was largely ignored by the continuing political debate. Its decisions and internal disputes and the large consequences that flowed from them remained remote and indistinct, submerged beneath the visible politics of the nation. The details of its actions were presumed to be too esoteric for ordinary citizens to understand.

The Federal Reserve System was the crucial anomaly at the very core of representative democracy, an uncomfortable contradiction with the civic mythology of self-government. Yet the American system accepted the inconsistency. The community of elected politicians acquiesced to its power. The private economy responded to its direction. Private capital depended on it for protection. The governors of the Federal Reserve decided the largest questions of the political economy, including who shall prosper and who shall fail, yet their role remained opaque and mysterious. The Federal Reserve was shielded from scrutiny partly by its own official secrecy, but also by the curious ignorance of the American public.

It was in midsummer of 1979 when this competing reality of the American system confronted the President of the United States and discreetly compelled him to yield. Jimmy Carter, in the third year of his Presidency, was engulfed by popular discontent and declining authority. The public that first embraced the simple virtues Carter expressed in his gentle Georgia accent -- earnest striving and honest, open government -- was by then overwhelmingly disenchanted with his management. Despite its accomplishments, the Carter Presidency had come to stand for confusion and inconsistency. His stature was diminished by a series of ill events, from failed legislation to revolution in Iran. A Gallup poll asked Democrats whom they would prefer as their party's nominee in 1980 and they chose Senator Edward M. Kennedy of Massachusetts over the incumbent President, 66 to 30 percent.

In early July, Jimmy Carter set out to restore his popular support. The political crisis had been developing for many months but was now dramatized by the President's own behavior. He scheduled an address to the nation on energy problems, then abruptly canceled it and, somewhat mysteriously, withdrew from the daily business of the White House. He and his closest advisers gathered in private at Camp David, the presidential retreat in the Maryland mountains. For ten days, the President remained there in isolation, conducting earnest seminars on what had gone wrong with the Carter Presidency and, indeed, what had gone wrong with America itself.

A stream of influential visitors was summoned to the President's lodge to offer advice. They were diverse opinion leaders from politics, education, religion and other realms, and their talk skipped across the landscape of American life. In his methodical manner, Carter filled a notebook with their comments. Each day, the press speculated extravagantly on what the President intended to do.

On Saturday, July 14, the isolation ended and Jimmy Carter returned to the White House. The next evening, more than two-thirds of the national audience gathered before their television sets to hear his report. After two and a half years, Carter's unusual mannerisms were familiar to the public, the rising and falling cadences that sounded like a Protestant preacher, the cheerful smile that sometimes oddly punctuated stern passages. This speech was different, more somber in tone, more desperate in content.

The President began with a startling ritual of confession -- revealing excerpts of the private criticism he had collected at the Camp David meetings. "Mr. President," a southern governor had told him, "you are not leading this nation -- you are just managing the government." Others' comments were equally critical. "You don't see the people enough anymore." "Don't talk to us about politics or the mechanics of government, but about an understanding of our common good." "Some of your Cabinet members don't seem loyal. There is not enough discipline among your disciples." "Mr. President, we are in trouble. Talk to us about blood and sweat and tears."

A religious leader had told him: "No material shortage can touch the important things like God's love for us or our love for one another." Carter said he especially liked the comment from a black woman who was mayor of a small town in Mississippi: "The big shots are not the only ones who are important. Remember, you can't sell anything on Wall Street unless someone digs it up somewhere else first." The President was candid about his own shortcomings as a political leader: "I have worked hard to put my campaign promises into law -- and I have to admit, with just mixed success."

The present crisis, however, was not really a matter of legislation, Carter declared. America faced a crisis of the soul, a testing of its moral and spiritual values. "The threat is nearly invisible in ordinary ways," the President warned. "It is a crisis of confidence. It is a crisis that strikes at the very heart and soul and spirit of our national will. We can see this crisis in the growing doubt about the meaning of our own lives and in the loss of a unity of purpose for our Nation."

Spiritual distress was an abstraction, but the source of America's political discontent was actually quite tangible. It was the lines at gas stations that made people angry and gasoline at $1.25 a gallon. It was the constantly rising prices on supermarket shelves, prices that seemed to change every week and always higher. In the spring of 1979, after the revolutionary upheaval in Iran had interrupted its oil production, the cartel of oil-producing nations, OPEC, had seized the opportunity of temporary shortages to raise world petroleum prices again. OPEC, which had roughly quadrupled oil prices during its embargo of 1973-1974, more than redoubled them through 1978 and 1979. This second "oil shock," as economists called it, automatically fed price increases into nearly every product, every marketplace where Americans bought and sold.

The latest oil-price shock, moreover, occurred at an especially bad time, when the inflation rate in the United States was already abnormally high. In the first three months of 1979, the government's index of consumer prices, covering everything from food to housing, had risen at an annual rate of nearly 11 percent. In a year's time, a dollar would buy only 89 cents' worth of goods. A $6,000 car would soon cost $660 more. And every wage earner would need a pay raise of more than 10 percent simply to stay even with prices. Through the second quarter of 1979, April to June, as the OPEC price increases took hold, the inflation rate had worsened, reaching 14 percent. By early summer, motorists in some regions were once again waiting in line at gas stations and Jimmy Carter's political popularity had reached a dangerously low point. In July, according to public-opinion polls, barely a fourth of the voters approved of his performance as President.

Carter and his advisers hoped that the dramatic speech, followed by swift and decisive actions, would turn things around. His message was daring. In similar circumstances, a different political leader might have blamed the economic distress on others -- on an easily recognized villain like the Arab nations of OPEC or the multinational oil companies -- and deflected Americans' resentment toward them. But polarizing politics, the technique of "us against them," was not Carter's style. Instead, he asked the people to blame themselves, just as he had done. The speech did outline an ambitious six-part energy program, designed to overcome the nation's dependency on imported oil. But the central message, the one most citizens would remember, was a critique of their own materialism:

In a nation that was proud of hard work, strong families, close-knit communities and our faith in God, too many of us now tend to worship self-indulgence and consumption. Human identity is no longer defined by what one does, but by what one owns. But we have discovered that owning things and consuming things does not satisfy our longing for meaning. We have learned that piling up material goods cannot fill the emptiness of lives which have no confidence or purpose.

The President called the country to sacrifice and spiritual renewal. He asked his audience for cooperative self-denial, to forgo the excesses of material pleasures in the national interest. Carter's speech did not even mention the Federal Reserve and its management of money, the government's handle on interest rates and credit expansion by which Washington ultimately influenced both prices and the pace of private economic activity. His stern message sounded especially strange coming from a Democratic President, leading the political party whose majority position was founded on the promise of prosperity for all. The news media quickly labeled it derisively the "malaise speech," a term that Caner himself never used.

But Carter's somber sermon was at first warmly received by the public and, in terms of popular reaction, was one of the most successful speeches of his Presidency. Contemporary Americans were devoted to the pursuit of their own affluence, but they still hearkened to spiritual themes. From the earliest days of the Republic, Americans had always been stirred by the jeremiads of puritan preachers warning of moral decay and calling them back to the old values. In this instance, the public quickly endorsed Jimmy Carter's diagnosis.

New public-opinion polls, taken right after his speech, reported that more than three-fourths of the voters agreed with the President's warnings of spiritual crisis. Carter's own popularity improved dramatically. One survey found that public approval for his Presidency increased overnight by 10 percent, an astonishing shift considering that it was generated by a single speech. At least 40 percent of the vast television audience said that Carter's address gave them greater confidence in his leadership.

This was a promising start, though White House advisers understood that more needed to be done. A Democratic political consultant in Washington remarked optimistically that the President's dramatic appeal to conscience "takes him from three touchdowns behind to one touchdown behind."

A jewelry manufacturer in Cedarhurst, New York, understood something about the American public that did not fit the President's message. Eugene Sussman had observed a new pattern of behavior among consumers which made it most unlikely that ordinary citizens however much they agreed with the President's sentiments would actually act upon them. Sussman kept raising the prices on his luxury jewelry to keep up with the rising costs of gold and diamonds as well as wages. Each time he raised prices, he worried that he would kill his sales. Each time, his sales increased. The higher he set prices on the pins and rings and brooches, the more people bought.

I'm talking about average working girls [Sussman said with wonder]. I see them on the street, wearing my jewelry. They're making $250 or $300 a week and they're spending it on jewelry. They have to have it. It's like food.

I'm paying 120 percent more for my diamonds than I did last year, my labor is up 35 to 40 percent. My product gets marked up again and again. Rings that sold for $170 four years ago are $350, maybe $400. I can sell all I can make.

The "working girls" who bought Sussman's fancy jewelry were on to something new in American life, the awareness that in this era of constant inflation it made sense to buy now and pay later -- to buy before prices went up again, even to borrow now and repay the debts in depreciated dollars. Most Americans could not pause for long to contemplate the President's warning about the emptiness of materialism. They were too busy buying things, buying them sooner rather than later.

In the Los Angeles suburb of Sun Valley, a union machinist named Roland Murphy and his wife borrowed $10,000 to redo their kitchen. They were still paying for the Dodge Aspen they bought the year before. When the price of hay got too high, the Murphys sold their horse. In Chicago, an English teacher named Derotha Rogers and her husband, Bev, a pipe fitter, bought a $19,000 Cadillac even though he was temporarily out of a job. Across town, Stephen C. Mitchell, an engineering executive, and his wife postponed remodeling their town house because of inflation, but they bought a $2,000 oil painting and were paying the gallery in installments. In Houston, a young computer analyst named Jack West and his wife, Roseann, used credit cards to take their daughter on a $1,500 vacation at Disneyland.

Mrs. West explained: "For our parents, everything went to the kids and nothing for themselves. But I think those of us who have grown up since World War II just don't want to live like that. We want to enjoy some of it too." Roland Murphy explained how easy it was for him to buy things on his $25,000-a-year income: "I have more credit than money. I could buy far more things than I could ever pay for. When I think about what Sears says I could buy on credit, it's frightening. We could cart away $7,000 of their stuff."

American consumers, having lived with constant inflation for more than a decade, had absorbed a new common wisdom, now shared by the rich and poor and middle class alike. Steadily rising prices were considered a permanent fixture of American life, a factor to be calculated in every transaction. For years, a succession of political leaders in Washington had promised to do something about inflation, and the public became quite cynical about those promises. Each government campaign against inflation had eventually failed and, each time, prices had resumed their steady escalation. Each time, the inflation rate ultimately reached an even higher peak.

By the late 1970s, most citizens had drawn their own practical lessons from the experience. It not only made sense to buy now rather than later; it also made sense to borrow money in order to buy things now. Even with higher interest rates, a loan made today to purchase an automobile or a television set or a house would be paid back tomorrow in inflated dollars that were worth less So long as wages continued to spiral upward in tandem with prices, one stayed ahead by borrowing. If inflation persisted, as everyone assumed, debtors would be rewarded and savers would be penalized. Jay Schmiedeskamp, research director of the Gallup Economic Service, saw the new behavior reflected in surveys of consumer attitudes. "The brake is off," he said. "Inflation doesn't slow people down the way it always has. That's a rather historic change. There used to be a brake -- inflation came along and people stopped buying. That isn't happening now."

The prudential wisdom inherited from the past -- a grandfather's old-fashioned warning to save for the future and avoid debt -- was turned upside down. Smart young consumers now did the opposite. The overall effect was neither irrational nor antisocial. What grandfather did not understand was that borrowing and buying drove the American economy.

While inflation unsettled economic assumptions in the marketplace, it was also destabilizing in the political arena. As consumers, people were compelled to focus more immediately on short-term decisions, rather than to plan for the distant future. Despite the spreading abundance generated during Carter's term, the rising prices produced anxieties for nearly everyone. Daily chores as routine as grocery shopping induced a sense of running on a treadmill that was moving faster and faster.

As voters, people expressed the same insecurities. Their daily lives might be prosperous, but they found themselves uncertain about the future, more skeptical of distant political promises. While Americans continued their borrowing and buying, they also assumed that the good times must soon end. A Gallup survey found that 62 percent of the public expected a recession sometime in 1979 -- all the more reason to buy now while prosperity continued. The political effect of inflation, like the economic effect, was to drive citizens toward a foreshortened time horizon in their thinking. A President who urged the nation to sacrifice for long-range goals was addressing an audience pushed in the opposite direction -- concentrating on today because it was unable to rely on tomorrow.

On Monday, amid the popular response to Carter's speech, the financial markets in New York expressed their own reaction to his message. It was negative. The interest rate on short-term borrowing among banks rose abruptly from 10.25 percent to 10.75 percent -- 50 basis points, in market talk, a very sharp swing for a single day. The rate subsided only after the Federal Reserve took action to supply more money to the banking system. The interest on three-month Treasury bills, the government's own short-term borrowing, also went up sharply. Such small fractional changes in the price of credit might appear insignificant to outsiders, but not to investors. A tenth of 1 percent in market rates would become the multiplier for tens of billions of dollars of other transactions.

The reaction of Wall Street was a troubling political signal -- an expressed nervousness about the future and skepticism about Carter's ability to regain control over inflation. The daily fluctuations of Wall Street were often read as implicit political messages, the numbers characterized as curbstone comments on the affairs of government. The day after Carter's speech, market specialists reported that the sudden increase in interest rates expressed "investor uncertainty over President Carter's energy proposals."

Assigning political interpretations to the results of financial markets was, of course, highly subjective. No one could claim to know exactly what combination of economic factors and political anxieties caused lenders and borrowers to bid up interest rates on a given day. Any market participant was free to assert his own analysis of what it meant, and these experts frequently disagreed among themselves. Still, over time, the collective opinions from Wall Street had real meaning to the government in Washington and could not easily be ignored. Pessimistic expectations in financial markets, both at home and abroad, might become self-fulfilling. Political reactions from Wall Street, whether they were right or wrong, could eventually influence the real economy, everything from the price of home mortgages to the pace of industrial expansion, in short, the economic well-being that every President seeks to achieve.

The markets, it was said, wanted reassurance from the President, a promise that he would act decisively to curb the inflationary pressures. For two weeks before Carter's speech, the financial numbers had sounded almost panicky, like nervous warnings to the White House. The American dollar, bought and sold daily in huge volumes on the currency exchanges, had been sliding in value, almost every day. This meant that the currency traders -- banks, multinational corporations, wealthy investors, perhaps even other governments -- expected the U.S. dollar to continue to lose its value in the coming weeks and months, and they, therefore, found it safer to hold their wealth in other currencies, Deutsche marks, yen, francs and pounds. Roughly translated, the dollar's steady decline amounted to an inflation forecast -- a prediction that, unless Carter acted swiftly and convincingly, U.S. price increases would grow even worse. After the "malaise speech," the dollar promptly fell further.

On Tuesday, Jimmy Carter took action to demonstrate his resolve -- he asked for resignations from his entire Cabinet and White House staff. Each top-level appointee would be reviewed, and the President would decide "expeditiously" which ones to keep and which ones to dismiss. It was meant to signal a new beginning for the Carter Presidency, a dramatic shake-up that would show he was in charge.

The financial markets drew the opposite conclusion. They were rattled further, both at home and abroad. On Wednesday, the dollar declined again and the price of gold reached a historic record in European markets -- moving above $300 an ounce. By comparison, a decade earlier, the official value of gold in American currency, then guaranteed by the United States government, had been $35 an ounce. Its dramatic increase in value was another surrogate measure of U.S. inflation. Gold was an ancient form of wealth, associated with the fabled kings of antiquity, and very few modern Americans ever thought of owning it, aside from jewelry. But the precious metal was bought and sold daily in global commodity markets, in part to serve wealthy investors who saw gold as another safe haven against U.S. inflation. Paper dollars might keep losing their value, but gold was forever. As more and more investors opted for the security of gold, the increased number of buyers naturally drove up the price, thus confirming the expectation that gold would become more valuable as the value of the dollar steadily declined.

Stuart Eizenstat, director of the White House Domestic Policy Staff and an intimate adviser on Carter's economic policies, thought the markets completely misunderstood the President's reorganization. "When the President asked for the resignations of his Cabinet unexpectedly, the financial markets became very jittery," Eizenstat said. "Interest rates were already high and the markets did not really know what was going on. They were thinking of the European model where governments fall."

Nevertheless, the White House was worried by the Wall Street reaction. The Secretary of the Treasury, who is usually a reassuring figure for financial markets, acknowledged that the "climate of uncertainty" in the government was contributing to the dollar's decline. W. Michael Blumenthal was regarded by Wall Street as one of its stronger advocates in the Carter Cabinet, but Blumenthal was himself unsure whether he would continue in office.

On Thursday, President Carter announced wholesale changes in his Cabinet. Blumenthal would be replaced, along with Attorney General Griffin Bell and the Secretary of Health, Education and Welfare, Joseph Califano. The next day, Energy Secretary James Schlesinger and Transportation Secretary Brock Adams were also dismissed. Each change was inspired by particular reasons, some of which were largely personal. Taken together, they provoked a storm of complaints from Congress. Democratic leaders and committee chairmen rushed to defend the Cabinet officers who had been fired and to express new doubts about Carter's direction. The swiftness of the startling shake-up convinced many political commentators in the press that the President had only aggravated his problems.

But neither the critics nor the White House staff itself focused on the most significant change -- the one that concerned Wall Street. It was the resignation of the chairman of the Federal Reserve Board. G. William Miller had served only seventeen months as chairman, since being appointed by President Carter early in 1978 to succeed Arthur Burns. Now, the White House announced, Miller would leave the Federal Reserve and replace Blumenthal as Secretary of the Treasury. But who would run the Fed? The White House did not have an answer.

Miller had been a corporate manager, not a banker or economist, before he became Fed chairman, and his stewardship at the central bank was widely criticized among Wall Street professionals. He was a former chief executive officer of Textron Inc., a mildly conservative Democrat who supported Jimmy Carter for President in 1976, and was warmly regarded by the President and his economic advisers. They thought of him as a "team player," a Fed chairman who cooperated closely with the President's economic goals, though the Federal Reserve was formally independent of the executive branch, not required by law to take orders from the Oval Office. Wall Street analysts complained that Miller was much too cooperative, too timid about raising interest rates high enough to suppress inflation.

Miller's loyalty was one reason why the White House selected him to replace Blumenthal, who was distrusted by the White House inner circle. But the choice of Miller for Treasury Secretary was more happenstance than deliberate, undertaken without much thought about its implications. Eizenstat explained the accidental sequence:

The President "accepts" the resignation of Blumenthal. Blumenthal is known as a voice against inflation and this adds to the confusion. So we were without a Treasury Secretary. So the President makes calls. Reg Jones of General Electric, Irv Shapiro of Du Pont, David Rockefeller of Chase Manhattan -- all are asked and turn it down.

This becomes a grave situation. The idea surfaces -- I'm not sure where -- that Bill Miller take the job. Bill takes it. That then creates a hole at the Fed. And that makes the financial markets even more nervous.

The daily financial numbers got worse. The President had started the week with a fresh glow of public approval and an intention to demonstrate renewed strength as the nation's leader. By Friday, he had created an entirely new problem for himself -- finding a new chairman for the Federal Reserve, one who would calm the financial markets.

An obscure banker from Florida, Frederick H. Schultz, meanwhile found himself caught in the middle of the great confusion. On Wednesday, July 18, after a nasty fight, the Senate had finally confirmed Schultz's nomination as vice chairman of the Federal Reserve Board, one of the seven governors who regulate the nation's money. The next day, with William Miller resigning, Schultz was theoretically left in charge -- a newcomer unknown to financial markets. This added an alarming new dimension to their nervousness.

Fred Schultz was an investment banker from Jacksonville, Florida, a tall man with a rumpled face and a southerner's amiable directness. He sounded less like a banker than an energetic entrepreneur. In fact, Schultz was one of those driven types who was born to wealth, then went out to make another fortune on his own. As a venture capitalist, he had picked several winners, among them Florida Wire & Cable, initially capitalized at $250,000, later sold for a little over $20 million. As a banker, he had run the investment management subsidiary of Barnett Banks, the largest chain in Florida.

When the President nominated him to be the Fed's vice chairman, the White House staff had told Schultz he was the wealthiest man Jimmy Carter had appointed to federal office. To avoid any conflict of interest, Schultz would have to sell his bank stocks, government bonds and other financial assets whose value might be directly affected by Federal Reserve decisions; the rest of his holdings would be placed in a blind trust. Despite his experience, some critics in Congress had thought he was too parochial for the job.

What bothered them was not Schultz's personal wealth or even that he was a banker, but that he was also a politician. He had served eight years in the Florida legislature, the last two as Speaker of the House, and run unsuccessfully for U.S. senator. Afterward, he was Florida chairman of the Democratic Party and in 1976 had helped raise money for Jimmy Carter's presidential campaign. Since the Federal Reserve's control of money was supposed to be above politics, protected from narrow partisan interests, Schultz's appointment aroused suspicions. On the surface, it looked as though Carter might be naming an old crony from southern politics to be second-in-command at the Fed -- just as the President would be heading into the 1980 re-election campaign.

"Some people went around saying, 'This guy is a political hack,'" Schultz acknowledged good-naturedly. He made no apologies for his political experience; he thought it would be an asset for the Fed.

Despite his background in Florida banking, Schultz was not well known in Wall Street. Nervous rumors spread through the financial districts of New York and London that Schultz would now be elevated to Federal Reserve chairman. To some in Wall Street, the Cabinet shuffle in Washington began to look like a clever plot intended to give President Carter political control over the independent central bank so it would pump up the economy for the campaign year.

Frederick Schultz assured the financial press that these rumors were untrue. "It was like asking a new swimmer to serve as lifeguard on his first day at the pool," Schultz said. "When the financial markets opened in Europe on Monday, the dollar dropped like a stone."

The President could not allow this to continue. "Things were beginning to get a little dicey," Schultz said. "They needed to find someone to settle things down. I don't think the White House had the vaguest idea of how bad things were going to get."

By the weekend, the White House was hearing from a wide array of political counselors and friendly business executives, all of whom amplified on the daily messages from the financial markets. The President would be gravely damaged if he did not quickly appoint a new chairman for the Fed, a chairman whom Wall Street trusted.

"It became obvious," Eizenstat said, "that we had to quell the nervousness of the markets."

Political tension existed inevitably between Wall Street and Washington. They were separate capitals, in a sense, representing two different sources of power in the American society. One spoke for capital, the accumulated financial wealth generated by private enterprise. The other spoke for popular democracy, the collective desires of the voting population, rich and poor, owners and workers. The two constituencies were overlapping, of course, and in harmony on many issues. But the two centers of power were often in conflict on the most fundamental questions, particularly in the one area where they both exercised authority, the management of the American economy. A strong President might choose to ignore Wall Street's demands and pursue his own agenda and

Excerpted from Secrets of the Temple: How the Federal Reserve Runs the Country by William Greider
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