This month I have enjoyed wonderful conversations with three elder statesman of international finance and economic policy – Paul Volcker, Jacques de Larosière and Allan Meltzer. They all agreed on one big thing – much of what has gone wrong is down to the absence of a proper international monetary system. This is a topic almost totally neglected by the current generation of economists and central bankers – doubtless because they see no political dividends from raising the topic and no prospect of anything being done about it. Yet if they had any guts they would at least raise the red flag. Modesty forbids me to say more, but all three interlocutors prasied The Money Trap (paperback edition here). Volcker even held the book aloft to the assembled company. I encouraged him to start a campaign for systemic reform – after all, he tends to win his campaigns. “Nobody is prepared to look at it” he said.
The “public conversation” with Volcker took place in front of an audience of 140 in London, including central bankers from 43 countries and executives of companies supplying asset management, technology and payments system services to central banks on the occasion of the first Central Banking Awards Ceremony. Paul Volcker honoured us by coming to receive the Lifetime Achievement Award, and sat down for a 40 minute conversation with me (video on the Central Banking website) while everybody strained to hear what the great man said. Among the items we touched on were:
1. The taper controversy: Volcker was perplexed by criticism of the Fed when it made a very small , even “tiny”, move. There were complaints that it should have “consulted”. But you can’t consult with countries round the world when you make a small move like that. “So what is going on here?” We have open financial markets and national borders are not relevant any longer in terms of capital flows – except you have different currencies with independent central banks. So you get volatile capital flows – flows that may not be large for large economies like the US but are very large indeed for small countries. We haven’t learnt to live with this system. Volatility in capital flows and currencies is built into the current monetary system.
2. Turning to large countries, again, a lesson of the crisis is that we have to look at the international monetary system. We need one that “makes sense”. Look at the behaviour of China and the US before the crisis. They both built up huge imbalances – surpluses in the case of China, deficits in the US. But “nobody wanted to do anything” about it. “There was nothing in the system that made anybody do anything”. Is that the system we want to live with? “I don’t think so” The system contributed to the blow-up of the financial system. Yet “nobody is prepared to look at it”.
3. The bloated balance sheets of major central banks can be run down without necessarily causing renewed market turbulence or a surge in inflation but there are two things to watch. First, since the collapse of the US mortgage market, the Fed has become the world’s biggest financial intermediary; secondly, a heavy load has been placed onto central banks. They are the last game in town; “and that is dangerous”. And they may need to act: “To take away the punchbowl in time is Mrs Yellen’s big test”. Central banks “are promising more than they can do”.
4. Macro-prudential tools: “I hate this macro-prudential….. I don’t know what it means. Do you?”
Jacques de Larosière
Vienna was the scene of my dialogue with Jacques de Larosière – first at the central bank and later in the salubrious environment of the Sacher Hotel. The paper he presented to the conference, run by the central bank and the Reinventing Bretton Woods Committee, was challenging. It is often said that we have a “non-system”. It is worse than that. The set of arrangements that emerged from the breakdown of Bretton Woods was an anti-system. It fails to provide the one key ingredient of a proper system, which is to harmonise national monetary policies. “When countries are free to peg their currency to another (or to peg partially), in order to preserve their competitive advantage, the system is bound to run into problems.”
“So we had an anti-system: central banks focused exclusively on a misleading yardstick (ex-post CPI targeting) while they turned a blind eye to the massive and artificial expansion of credit, to the formation of huge asset price bubbles and to the new mindset in which liquidity was understood as access to credit. And there was no interest in multilateral surveillance of macro economic policies. Imbalances were huge and structural, but as they were financed more and more smoothly with the help of innovative financial products, there was no pressure on governments to correct them: why bother? This eventually led to the 2007-2008 crisis that is threatening the very fabric of our societies.”
Indeed, in a financially globalized world, exchange rate volatility, currency misalignments and structural deficits are in no-one’s interest. But,being a realist, Mr de Larosière recognised that in the present circumstances, the probability of common macroeconomic governance with constraints on member countries’ policies seemed to be remote. Thus central banks and regulators around the globe must work together to identify and counter financial imbalances. The absence of an international monetary system can perhaps, to a certain extent, be mitigated by a serious macroeconomic oversight regime