Paul Volcker: Do his views matter?

Owen Tan

JAN 2010 - President Barack Obama meets with Economic Recovery Advisory Board Chair Paul Volcker

US President Barack Obama meets Economic Recovery Advisory Board Chair Paul Volcker at the Oval Office

The drum-roll for Paul Volcker during the dialogue session organised by the Lee Kuan Yew School of Public Policy could hardly have gone any louder (and, perhaps, with a slight tinge of bias, given that Dr. Volcker also serves on the board of the school). “You are not going to find many Paul Volckers in America,” said Professor Kishore Mahbubani, the Dean of the school and also the moderator for the event, quoting a paragraph that appears in Lee Kuan Yew’s Hard Truths.

However, while the estimated 300-strong audience awaited the revered economist who served under the Carter and Reagan administrations as Federal Reserve chairman to provide some insights on the current economic crisis, he rarely provided any solutions. He spoke in a drawl that often descended into an unintelligible mumble, although in moments where he was comprehensible he was often humorous, and self-effacing at his age and difficulty in hearing. “I thought you said Lee Kuan Yew was a man of honesty!” Dr. Volcker replied to the praise lavished upon him, to much laughter in the audience.

The unprecedented growth rates all over the world in the first decade led the banks to give themselves credit where it was not due, for “helping us all along”, said Dr. Volcker. Yet the financial turmoil did eventually happen, at least in the two “pillars of the financial system” in Europe and the United States, said Professor Mahbubani – what was its root cause?

“People found that they were able at lower interest rates,” said Dr. Volcker. Those people, he said, were not as strong financially as the rest of the population, but the reduction in interest rates facilitated an increase in consumption that was eventually unsustainable. This happened in America, he said, but it is analogous to the situation also occurring in Europe.

Despite its monetary union, Europe remained a distinctly diverse set of countries that are in hugely varying stages of economic development and prudence. Some countries in the EU thought that the attractive interest rates offered by the banks of France and Germany offered a shortcut to their economic expansion. Countries like Greece, he said, financed its bureaucratic expansion through an unsustainable cycle of loans.

But like quicksand, it is not quite as easy to get out of economic trouble as it is to get into it. There would be no quick fix, he said. During the talk Silvio Berlusconi had yet to announce his resignation, but Dr. Volcker was also quick to play down the suggestion that the stepping down of the Italian Prime Minister would have any significant impact towards solving the crisis. Asked what he would suggest to solve the crisis if he were called by the European leaders for a meeting, Dr. Volcker quipped in dark humour, “I couldn’t imagine that. I would say, ‘Too late! Too late!’”.

Dr. Volcker also spent some time explaining the importance of the Volcker Rule, introduced along with the Dodd-Frank Bill by US President Barack Obama. The rule, in its purest form, is that any form of “proprietary trading activities” that were conducted by financial institutions were to be separated from commercial banking activities. In essence, Dr. Volcker said, the taxpayer should not be penalised from any losses incurred as a result of speculative activities by these institutions. But the Volcker Rule is now being diluted and strangled by a group of organisations – financial lobbies.

“The whole function of lobbyists,” Dr. Volcker said, “Is to complicate legislation.” He believes that the Volcker Rule is very clear, but the lobbyists attempt to define what proprietary trading is – and for the benefit of business interests, make exclusions to the rule that may destroy its original intentions.

China, of course, took up a significant portion of airtime. Asked if an exchange rate adjustment would be beneficial to the rest of the world (and the US in particular), Dr. Volcker remarked that there first have to be goods and services that could be exported to China in order for such a policy to work. He also believes that, along with India, the cooling measures adopted by these economies might be “entirely appropriate”, given that sustained rapid economic growth might result in dangerous levels of inflation.

Ironically, what seemed to be the best point that Dr. Volcker gave was a point that acknowledged the limitations of contemporary macroeconomics. Noting that a Nobel Prize in Economics was awarded to Daniel Kahneman – a psychologist – in 2002, Dr. Volcker believes that a lot of economists today are wrapped up in “esoteric mathematics” that not only complicates “simple” economics, but also produces inaccurate predictions.

“An economic system is not a physical system,” said Dr. Volcker. “It doesn’t follow a set of physical laws with certainty.” Ultimately, he added, economics is not a physical science, but a social science; the complexity of decision making cannot be ignored and does not necessarily follow a normal distribution curve. “If there’s any academic field that needs help, it’s economics,” he also added, in what seemed to be a pleading statement for a solution to the financial crisis that seems unlikely to come from within the discipline.

The views of Dr. Volcker, obviously, still matter – these views come from one of the most important economic minds of the twentieth century. But if Paul Volcker does not have a solution to the crisis that is engulfing Europe and the United States and threatening to envelope the rest of the world, to expect a solution to emerge from the rest of the economic field, or any other field, for that matter, might be asking for a miracle.

Photo courtesy of The White House.