The Squeeze of '79

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In Volcker's approach, however, finance men and bankers now saw not just another quick fix but a direct assault on inflation itself. Said West German Finance Minister Hans Matthöfer: "The package goes straight to the heart of the problem." Brussels Banker Roland Leuschel expressed a conviction shared by almost all European moneymen: "Throttling back on the money supply itself will be much more effective than raising interest rates in the fight against inflation. Paul Volcker is attacking inflation at its source."

As if to underscore their approval, investors in London promptly chopped a sharp $13 off the price of gold; during the preceding weeks it had climbed by more than $100 to hit a momentary alltime high of $447 an ounce before settling back to about $385 at the beginning of October. Not only did the yellow metal on Monday droop to $372, but the dollar rebounded smartly on international exchanges, suggesting that its latest round of being bullied was coming to an end.

On Wall Street, however, about all that nervous traders could make of the Fed's complex announcement was that interest rates would be rising. That is especially bad news for investors who hold shares of stock bought on margin with money borrowed from brokers at floating rates of interest. Wary of just how high those rates might climb, margin holders along with smaller investors began selling in earnest on Monday, pushing the Dow down 13.57 points, to 884.

But the big market break came on Tuesday. That was when the naition's banks reopened after the Columbus Day holiday, and made their response to the Fed's discount-rate rise. Led by Chase Manhattan, the nation's third largest bank, several institutions immediately raised the prime rate (the interest charged the most credit-worthy corporate customers) from 13.5%, already a record, to a new peak of 14.5%. Since quarter-point raises are the norm, the effect of the full-point boost in the prime was electric. Not only did it push the interest charged to margin investors up close to 16%, making stock ownership on borrowed money extremely expensive, but it had a sharp psychological effect on the market. That was quickly compounded when Chase Manhattan President Willard Butcher, told a New Orleans press conference that the money markets were in such turmoil that banks might soon wind up having to recalculate their prime rates, "from 9 in the morning to 3 in the afternoon."

The sheer scariness of it all was what set off the really huge midweek selling spree on the Big Board. The dumping spread, irrationally, not only to the commodities and futures markets but also to the international currency centers. Out of fear and uncertainty, traders who had been buying dollars on Monday on the logical theory that the Fed's moves would strengthen the greenback abruptly began selling them again.

On the Big Board, sanity began to return late Wednesday, when large institutions like insurance companies and pension funds moved into the market heavily to buy up stocks that other less cool-headed investors had been selling off at unrealistically low prices.