25 Dec 2011

We are all caught in a higher debt trap. That’s the problem with Greece, Spain, Italy, Portugal and Ireland. It’s not a very happy situation.

We are all caught in a higher debt trap. That's the problem with Greece, Spain,Italy, Portugal and Ireland. It's not a very happy situation.

The recent collapse of U.S. brokerage MF Global serves as a warning against excessive risk-taking, former Federal Reserve Chairman Paul Volcker said, referring to the U.S. firm that filed for bankruptcy after risky bets on debt from the euro zone scared away clients and investors.

Dr Volcker, who in January stepped down as Chairman of U.S. President Barack Obama’s Economic Recovery Advisory Board, was in Singapore in November for a dialogue session organised by the Lee Kuan Yew School of Public Policy.

He said MF Global’s bankruptcy supported the case for more financial regulation in the U.S. and suggested that Singapore authorities do the same.

“In my view, (banks) should not take part in speculative activity … I would like to see that rule adopted in Singapore and right around the world,” Dr Volcker said, adding that such speculative activity had played a key role in the 2008 financial crisis.

Dr Volcker said he would like to see the Volcker Rule — which is due to come into force next year in the U.S. as part of the Dodd- Frank financial reform bill — implemented all over the world.

But the Volcker rule, which aims to prevent American banks from making big bets on markets with their own money or from backing private equity and hedge funds, was criticised by the man whose name backs the new regulation as being “much more complicated than I would like to see”.

He blamed financial industry lobbyists for making the proposed regulation much more complex than it needed to be. “There is no set of lobbyists in the United States bigger, more important, and more rewarded than the financial lobbyists,” he said.

The most important issue in banking reform is how to deal with failures or incipient failures of large financial institutions, Dr Volcker said, adding that it was better to liquidate failed financial institutions so that they could continue to meet their obligations and not upset the market. What was in question, he said, was the political will of governments to enforce such action when “push came to shove”.

On other banking reforms, Dr Volcker said he believed there was still unfinished business with the U.S. mortgage market, the role and structure of credit rating agencies, and U.S. money market mutual funds regulation.

Asked by the dialogue session’s moderator, Professor Kishore Mahbubani, Dean of the LKY School, what was the way out of the euro zone debt crisis, Dr Volcker said: “I think it’s a soluble problem, but they are solving it inch-by-inch instead of a general dramatic solution.”

The recent ousters of the Greek and Italian prime ministers have not eased pressures as bond yields in Italy and other euro zone countries continue to rise, threatening the ability of some states to repay their debt.

Dr Volcker praised measures taken by European leaders to reduce debt, such as the recapitalisation of banks, providing funds to insure Spanish and Italian financing, and debt relief for Greece.

“But whether they are enough and being implemented forcefully enough is the question, and, in the long run they are going to have to find some means for maintaining better discipline within Europe which requires more integration and policy making. I don’t think they can escape that, and they understand that, but you can’t do that overnight.”

Asked if Europe had the resources to solve its problems, Dr Volcker said: “They have the resources in Europe to get it done. Or they go to the rest of the world for funds. The rest of the world has a big stake in this. Europe as a whole can manage it, but can it manage it? They all have their own political problems.”

Turning to the United States, Dr Volcker lamented that although policymakers knew that raising taxes would produce positive results for the economy, this was not happening because of the unprecedented “deep ideological divisions” between the current administration and the rightwing Republican opposition.

When asked if the United States had fallen into a liquidity trap as Japan did in the 1990s, Dr Volcker said: “We are all caught in a higher debt trap. That’s the problem with Greece, Spain, Italy, Portugal and Ireland. It’s not a very happy situation.” He added the Japanese experience, which saw a bust in the real-estate and stock markets at the same time, provided a valuable lesson to U.S. policymakers as it showed that restoring growth too slowly could result in prolonged unemployment and hardship.

Turning to China, Dr. Volcker noted that it has become a force in the world economy, and at no point in history had a country of its size grown at a rate of 10 per cent a year.

He said: “The emerging world is now as big as the developed world and that is the phenomenon of the last decade and requires a change in thinking. China is out there and wants to have a say in the affairs of the world. In 12 to 15 years, its economy will be as big as the U.S., and it will be a different world politically and a different world economically.”

In this new world, Dr Volcker believed China will be more preoccupied with its own internal affairs but will be called upon to shoulder more responsibilities as a rising power. In light of this, China cannot continue to run big current account surpluses at the expense of other nations. In line with other advanced economies, China will in future need to raise consumption as a percentage of GDP to 50 or 60 per cent, from 35 per cent currently, Dr Volcker said.

Dr Volcker had a few words to say about his profession, too. Economists, he felt, had become overly wound up in creating highly sophisticated Mathematical models so much so that some of their work in forecasting was unwarranted. “An economic system is not a physical system”, and unlike the physical world, human behaviour does not comply with distribution curves, he said, lauding the use of psychology in the work of this year’s winners of the Nobel Prize for Economics.

Asked by a member of the floor if he had any advice for the Singapore civil service, Dr Volcker gave a surprising reply that drew laughter from the audience: “My understanding is that civil servants in this city-state are extremely well paid. I approve of that. It’s unusual. You have a reputation of running a clean, efficient civil service. That is an advantage. It doesn’t exist in the U.S.”

Emphasising the importance of quality public policy education, Dr Volcker said great policies that are not well administered will ultimately come to naught, and hence there will always be demand for an institution like the LKY School, which has made “remarkable progress” in understanding the problems and complexities of public administration.

by Benjamin Tan () is Editor of Global-is-Asian.