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Is global financial reform possible?

RP’s Diary

Paul Volcker, one of the few universally-esteemed central bankers of the 20th century, has summed up in a few words the messages of The Money Trap. Maybe I should have saved myself the trouble of writing the 340 page book. At least, that was my immediate thought on reading his article. A colleague called to say – ‘Volcker seems to have read your book already!’. That is certainly not the case (although I had sent his office the press release about it a few days earlier). Volcker has been drumming these messages home for many years. I have been following in his large footsteps. At least he has made me feel I am in good company.

Volcker’s message is simply stated: we need fundamental reforms both of banking/finance and of international money. For that, we need to build a consensus on some key points.

On banking, these include ‘a coherent, consistent approach to dealing with the imminent failure of “systemically important” institutions’. The Dodd-Frank reform legislation in the US marks progress – US bankruptcy procedures ‘dictate the demise rather than the rescue of failing firms, whether by sale, merger or liquidation’. Other key financial centres should enact comparable practices. This is above all true in the UK, so that Volcker supports Vickers-type reforms. Here he is clearly encouraging George Osborne to press on rather than dilute Vickers reforms. Other jurisdictions ‘should not act to undercut the restrictions imposed by’ the US and UK.

Equally, ‘international monetary disorder lay at the root of the successive financial crises of the 1990s, and played an even more striking role in the crisis that erupted in 2008’.

This disorder permitted the US to run massive current account deficits for years, with symmetrical offsetting increase in the foreign reserves of China and Japan. In the US, this led to a housing boom that burst ‘with a very loud and disturbing bang’.

Left to their own devices, countries tend to follow bad policies. Yet sooner or later, adjustment is necessary. If it is not enforced in good time by a proper international monetary system, it will be brought about abruptly by crisis.

Floating is impractical for many countries:

“We are left with the certainty, however awkward, that active participation in an open world economy requires some surrender of economic sovereignty’.

That is a central message also of The Money Trap. Volcker suggests cooperation to maintain appropriate exchange rates.

RP comment

But are such reforms politically feasible? Don’t write off Volcker! Given his success in pushing through legislation changing banking regulation in the US, despite the millions of dollars spent fighting it by the banks, maybe he can reform international money too.

If The Money Trap can convince even one influential policy maker of the need to follow Volcker’s wise advice, writing it will have been worth while.

Admittedly, the omens do not look good. I cannot think of a single other well-known banker, central banker or politician who backs reform of the global financial system. They all want to go back, essentially, to business as usual (yes you do!). They benefit from being able to manipulate the present disorder. Central bankers brandish the new powers awarded to them by governments: it is not just commercial bankers who are rewarded for failure.

Politicians exploit paper money to offer goodies to the electorates, senior bankers to line their nests.

But Volcker has public opinion behind him. His appeal to higher ethical standards will find a responsive echo. Will any political leader rise to the challenge?