Volcker urges global financial system overhaul after crisis

Former Federal Reserve Chairman Paul Volcker Former Federal Reserve Chairman Paul Volcker

May 31 (Bloomberg) -- Former Federal Reserve Chairman Paul Volcker, the namesake of U.S. rules designed to rein in banks’ proprietary trading, proposed another regulatory overhaul: This time, regarding supervision of global capital flows.

“This is a subject that has been basically ignored for 20 or 30 years now, ever since the breakdown of the Bretton Woods system,” Volcker said in an interview with Bloomberg Television in Hong Kong today. “Behind this immediate crisis of the financial system, the weaknesses in the international monetary system have left these huge imbalances going on and on.”

A new framework is needed to apply “discipline” against the types of imbalances that swelled between the U.S. and China in recent years, with excess American consumption financed by surplus Chinese saving, Volcker said. In a speech later, he proposed a system revolving around “equilibrium exchange- rates” and trading bands that would still allow markets to help determine currency levels.

The world’s most-traded currencies have been set mainly by markets since the postwar Bretton Woods system of fixed currencies broke down in the early 1970s. Volcker, 84, witnessed the collapse when he was at the U.S. Treasury Department in 1973. He later went on to helm the Fed from 1979 to 1987.

“The central idea is that individual nations would direct their interventions and if necessary their economic policies to defending the ‘equilibrium rate,’” Volcker said in his speech at a conference organized by the Fung Global Institute. “One more radical suggestion is that aggressive intervention by trading partners might be authorized by an international authority to promote consistency.”

Dimon’s Position

Volcker also said in the interview that JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon’s membership on the Federal Reserve Bank of New York’s board of directors created “an appearance of a problem.” He said European policy makers should be more decisive and must safeguard the stability of Spain and Italy. The Fed will need to “pull more rabbits out of the hat” if the euro crisis affects U.S. activity, he said.

Since the 2007-2009 global credit crunch, world financial regulators have focused on capital adequacy and risk management at banks. The global monetary and financial system hasn’t maintained financial stability as well as the Bretton Woods system and needs to be reformed, according to a Bank of England research paper published in December.

‘A Little Discipline’

“We need some system to employ a little discipline so that you don’t have China running trillion-dollar surpluses or the U.S. is running a $5-trillion deficit,” Volcker said. “They are both happy doing it. They both thought it was in their individual interest but until it breaks down and when it breaks down, you have a big problem.”

China’s foreign-exchange reserves have almost doubled over the past four years, reaching a world record $3.3 trillion at the end of March, central bank data show. The increase stems from trade surpluses and China’s efforts to stem appreciation in the yuan, a policy that’s prompted the European Union and countries including the U.S. to accuse it of giving exporters an unfair advantage.

Possibilities for forcing countries to correct imbalances may include stronger surveillance by the International Monetary Fund or financial penalties and incentives, Volcker said. He also urged the study of a multiple-currency reserve system.

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