HONG KONG – Nowadays there is ample evidence that financial systems, whether in Asia in the 1990’s or a decade later in the United States and Europe, are vulnerable to breakdowns. The cost in interrupted growth and unemployment has been intolerably large.
But, in the absence of international consensus on some key points, reform will be greatly weakened, if not aborted. The freedom of money, financial markets, and people to move – and thus to escape regulation and taxation – might be an acceptable, even constructive, brake on excessive official intervention, but not if a deregulatory race to the bottom prevents adoption of needed ethical and prudential standards.
By law in the US, new approaches superseding established bankruptcy procedures dictate the demise rather than the rescue of failing firms, whether by sale, merger, or liquidation. But such efforts’ success will depend on complementary approaches elsewhere, most importantly in the United Kingdom and other key financial centres.
Strict uniformity of regulatory practices may not be necessary. For example, the UK and the US may be adopting approaches that differ with respect to protecting commercial banks from more speculative, proprietary trading, but the policy concerns are broadly similar – and may not be so pressing elsewhere, where banking traditions are different and trading is more restrained. But other jurisdictions should not act to undercut the restrictions imposed by home authorities.
Closely related to these reforms is reform of the international monetary system. Indeed, one might legitimately question whether we have a “system” at all, at least compared to the Bretton Woods arrangements and, before that, the seeming simplicity of the gold standard. No one today has been able to exert authority systematically and consistently, and there is no officially sanctified and controlled international currency.
But what is too often overlooked is that international monetary disorder lay at the root of the successive financial crises of the 1990’s, and played an even more striking role in the crisis that erupted in 2008. The sustained and, in a sense, complementary imbalances in the US and Asia stand out.
From 2000 to 2007, the US ran a cumulative current-account deficit of roughly $5.5 trillion, with nearly symmetrical offsetting increases in reserves in China and Japan. China found it useful to run a large trade surplus, using a very high rate of internal savings and inward foreign investment to support its industrialization and rapid growth.
By contrast, the US, in the face of slow growth, was content to sustain exceptionally high levels of consumption at the expense of personal savings, inflating a massive housing bubble that burst with a very large and deeply disturbing bang.
Not so long ago, we were comforted by theorizing that floating exchange rates would mediate international adjustments in a timely and orderly way. But, in the real world, many countries, particularly but not limited to small, open economies, simply find it impractical or undesirable to permit their currency to float.
We are left with the certainty, however awkward, that active participation in an open world economy requires some surrender of economic sovereignty. Or, to put the point more positively, it requires a willingness to coordinate policies more effectively. The possibilities include:
- Stronger surveillance by the International Monetary Fund and a firmer commitment by countries to abide by “best practices” and agreed norms.
- Direct and public recommendations by the IMF, the G-20, or others, following mandatory consultation.
- Qualification or disqualification with respect to the use of IMF or other credit facilities (for example, central banks’ swap lines).
- Interest or other financial penalties or incentives along the lines under consideration in Europe.
But, if approaches that build on past failure do not seem sufficiently effective, perhaps a new approach toward currency fluctuations would be more promising. That would require some agreement about appropriate “equilibrium” exchange rates, with a fairly wide band that would allow for uncertainty and permit the market to exert its own discipline. But individual countries would orient intervention and economic policies toward defending the equilibrium rate, or, more radically, an international authority might authorize aggressive intervention by trading partners to promote consistency.
An appropriate reserve currency and adequate international liquidity represent another central concern. For years, the pragmatic answer has been the dollar, and to some extent other national currencies, giving rise to complaints of an “inordinate privilege” for the US. But it is not in America’s interest to accentuate and extend its payment deficits at the expense of an internationally competitive economy with strong industry and restrained consumption. And the rest of the world wants the flexibility afforded by the currency of the largest, strongest, and most stable economy.
By Paul Volcker
Paul Volcker is a former chairman of the US Federal Reserve Board and the honorary co-chairman for the World Justice Project.
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