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Paul Volcker

Volcker startade sedelpressarna, inte Greenspan
Rolf Englund blog 2014-04-08

Paul Volcker
FT April 11 2008

Henry Kaufman, legendary Wall Street economist, describes his friend of 50 years as “a classical person. I’m not saying that he studies philosophy, but he has deep feelings about responsibilities”. Another friend, hedge fund manager and philanthropist George Soros, calls him “the exemplary public servant – he embodies that old idea of civic virtue”.

This reputation, and Mr Volcker’s defining achievement as the banker who slayed the double-digit inflation of the late 1970s, lent a special weight to the speech he delivered this week about the country’s economic crisis. “The bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the marketplace,” he told the Economic Club of New York. Despite all the noise of the volatile markets, the world listened.

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Allan Meltzer warns that Bernanke is risking a disastrous replay of the 1970s, when high oil prices fueled double-digit inflation. Every time the Fed started to tighten and unemployment jumped, chairmen G. William Miller and Arthur Burns lost their nerve. They lowered rates to boost job growth, and inflation inevitably revived, causing a vicious price spiral.
The Fed let the disease rage for so long that it took draconian action by chairman Paul Volcker in the early 1980s to finally defeat inflation.
The price was a deep recession, with unemployment hitting 11% in 1982.

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Trillion Dollar Meltdown:
Easy Money, High Rollers, and the Great Credit Crash, by Charles R Morris
thought-provoking for experts and a readable primer for the layperson
Review by Gillian Tett, FT, September 23 2007

Finally, we must emphasize the fundamental importance of reform of the exchange rate system. Indifference to swings in the major exchange rates, ranging to 50 per cent or more over a year or two, cannot any longer be justified.
There is a clear possibility the introduction of the euro will complicate matters here.
Paul Volcker, Financial Times 1998-10-07

The author was chairman of the Federal Reserve Board from 1979 to 1987.

I do not want to be alarmist. The European and American economies still have forward momentum.

But we should not kid ourselves. The problems we see with such force today are systemic - they arise from within the ordinary workings of global financial capitalism.

The present crisis can be constructively resolved. But it is bound to take time, and it is going to involve a real willingness to re-examine the way we have organised (or failed to organise) the international financial system.

A year ago, to express that view was enough to question my allegiance to all that is holy and good: the sanctity of markets and their unfailing ability to adjust, the freedom of capital and trade, maybe even to democracy itself.

The then prevailing view was that the difficulties lay not in the system but in the policies and the practices of small countries. Thailand had mismanaged its exchange rate. Banks were not well capitalised. There was no Securities and Exchange Commission, no Chapter 11 bankruptcy code.

All those things were and are true. But it is totally unconvincing to say those shortcomings are uniquely or primarily responsible for the current global predicament.

Just suppose all those policies and practices were somehow changed to something closely in tune with the American or European model. There is no evidence that financial crises would be ended.

Consider the latest bit of evidence from the US itself; one unsupervised and unregulated financial institution - an institution boasting the most elaborate models of market behaviour and sophisticated advisors - carried the possibility, by testimony of the US Federal Reserve of pulling down the financial tent.

The basic story is as old as financial capitalism itself. Success breeds confidence and over-confidence. Greed overcomes prudence. Then something unexpected happens - perhaps at home, perhaps abroad - to raise doubts. Fear becomes contagious. Individual self-defence helps spread distress. And if the excesses are widespread enough, a financial crisis becomes an economic crisis, which is where much of the emerging world is today.

However, there are two large differences in financial markets now that add to the vulnerabilities of other nations. One is a difference of degree. Irreversible technological change means the amount of money ready, willing, and able to move around the world, whether out of greed or fear, has risen exponentially.

The second difference is of kind. In the space of 15 years or so, the ideology of free and open markets has swept over virtually the entire world. One consequence has been the number of countries emerging into the international market place. One common characteristic of those countries, some large in population and area, is the small size of their financial sector.

The aggregate size of the banks in the typical emerging country is now the size of a single regional bank in the US - precisely the kind of bank that is told that it is too small to survive in today's turbulent markets.

In short, there is a systemic problem: how should we deal with it?

The first recourse, naturally, has been to the established mechanisms for dealing with financial crises, essentially the International Monetary Fund, the US Treasury and the Group of Seven largest industrial countries. That seemed to work in Mexico by providing massive liquidity support with manageable macroeconomic conditionality.

But that approach was not easily adaptable to east Asia. For one thing, much less upfront money was available. At the same time, much stronger conditionality, extending into the established economic and social structure was deemed essential. When the terms were not met and money withheld, confidence collapsed.

As a result of those problems, we now see experiments with the opposite approach: sweeping exchange and capital controls in defence of the established order. This alternative cannot be workable today. The attempt to maintain comprehensive controls for any length of time will undercut growth and efficiency.

We still hear the siren song that somehow floating exchange rates will solve the problem. That seems to me a strange and sad refrain.

The wide swings in the exchange rate of the world's two largest economies, Japan and the US, has been a critically important factor contributing to the instability of east Asia generally. How can there be a "correct" rate, fixed or floating, for Thailand or Indonesia or the Philippines when the exchange rates of their major trading partners are diverging sharply? How can it be rational for some Asian countries to be advised to float their currencies while others are urged to stand firm in fixing their exchange rates, even while their competitive positions are deteriorating?

The fact of the matter is that small, open economies simply do not have the breadth of financial markets to withstand sharp fluctuations in exchange rates.

If those approaches have been inadequate, the question remains: what can be done?

The tendency will be to seek stability in regional arrangements, formal or informal. All of that is apparent within Europe, capped now with the ultimate of fixed exchange rates, a common currency.

It is promising, I think, that for the first time in decades, political leaders in Europe and America have begun to recognise the need for basic reform of the financial architecture. But they should not be misled. The kind of reform required will not come easily. There is not, so far as I can see, anything like a strong intellectual consensus. The technical problems are formidable. The issues will not be solved in a conference or two or by a reassuring communiqué emphasising the need for good behaviour.

Efforts of small emerging economies to retreat into a web of exchange controls will only breed evasion and corruption. But should we condemn countries that seek to discourage the inflow of hot money, particularly when that can help stabilise domestic financial institutions?

Going further, how should multinational financial conglomerates be regulated? Do we really want to extend the official safety net beyond banks? And if so how do we extend co-operation and co-ordination among regulators?

Finally, we must emphasize the fundamental importance of reform of the exchange rate system. Indifference to swings in the major exchange rates, ranging to 50 per cent or more over a year or two, cannot any longer be justified.

There is a clear possibility the introduction of the euro will complicate matters here.

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