Paul Volcker (USA Former Chairman of the Federal Reserve) – Towards a New World of Finance | Fung Global Institute (Jun 2012)

Chapters

Abstract

Navigating the New Economic Terrain: Asia’s Rise and the Global Financial System’s Evolution

In a rapidly evolving global landscape, Asia’s ascent to economic prominence stands as a pivotal shift, challenging Western hegemony and necessitating substantial financial and monetary reforms. This transformation, led by China’s potential to eclipse North American and European economies, brings into focus the need for an effective international monetary system, addressing systemic risks, and recalibrating international consensus. As these developments unfold, entities like the Fung Global Institute and the International Monetary Fund (IMF) are poised to play crucial roles, underlining the urgency for international cooperation and innovative approaches to global financial stability.

Asia’s Economic Surge and Global Implications

Asia’s dramatic economic growth signifies a major transformation, positioning the region as a formidable global force. This shift underscores the need for Western nations to adapt to a world where Asia, especially China, holds significant economic and political influence. As Asia’s collective economic prowess approaches that of the United States and Europe, it brings new responsibilities, including leadership that is open and outward-looking.

Asia’s rapid transformation from a dependent region to a major force in the world economy and political system has been astonishing. China alone is projected to surpass North America and Europe economically within a generation, and the combined Asian economies could approach the size of the United States and Europe combined. This dramatic shift requires psychological adjustments, particularly for those accustomed to Western dominance, as Asia’s size and wealth imply new responsibilities, attitudes, and open, outward-looking leadership. The Asia Global Dialogue serves as a significant step in accepting and adjusting to these new economic and political realities.

The Imperative of Financial and Monetary Reforms

Financial instabilities experienced globally highlight the urgency for reforms to avert future crises. These include enhancing capital standards for banks, increasing regulatory authority over speculative forces, simplifying financial instruments, and improving understanding of financial market mechanisms.

International Consensus and Reform Areas

Achieving international consensus is critical for effective reform, especially in regulating financial markets and ethical behavior. Key areas of reform involve understanding derivatives, systemic risks, and the necessity of international cooperation to manage these risks. The potential contagion from failing large financial institutions necessitates new approaches beyond taxpayer bailouts.

The burgeoning world of derivatives poses significant implications for national borders, with an estimated $700 trillion of derivatives outstanding internationally. The interconnectedness of financial markets requires a coherent and consistent approach to addressing the imminent failure of systemically important institutions. New approaches in the United States prioritize the demise of failing financial firms through sale, merger, or liquidation rather than bailouts, but success in this effort depends on complementary approaches elsewhere. Strict uniformity of regulatory practices may not be necessary, but jurisdictions should not undercut restrictions imposed by home authorities.

Challenges and Prospects in the International Financial System

The international financial system faces challenges in managing systemic risks, addressing international imbalances, and creating a functional monetary framework. The contrasting economic behaviors of major economies like the United States and China, and the inadequacy of floating exchange rates in ensuring timely adjustments, call for new approaches to international monetary cooperation.

The current international monetary system lacks a well-defined and effective structure, leading to successive financial crises. Persistent imbalances, such as the United States’ trade deficit and China’s trade surplus, have contributed to financial instability. These imbalances were bridged by an inflow of capital from China and Asia to the United States, leading to low interest rates and a housing bubble in the United States. The unsustainable nature of these imbalances resulted in a massive financial crisis. Active participation in an open world economy requires some surrender of economic sovereignty for effective policy coordination. A willingness to find means of coordinating policies more effectively is essential for a well-functioning international monetary system.

The Role and Potential Reforms of the IMF

The IMF’s enhanced surveillance, commitment to best practices, and public recommendations to entities like the G20 underscore its evolving role. Proposals include financial incentives or penalties and measures to address chronic surplus countries through capital controls or trade restrictions.

IMF could have stronger surveillance, nations could abide by best practices, and the IMF could make public recommendations to the G20. IMF could use disqualification or qualification with respect to the use of credit facilities to encourage countries to follow best practices. Penalties such as interest rate adjustments could be used to encourage compliance. As a last resort, capital controls or temporary trade restrictions could be authorized against chronic surplus countries.

Exchange Rates and International Liquidity

Establishing equilibrium exchange rates and creating zones around them is pivotal for market discipline. The pragmatic use of the dollar and other national currencies, along with the limited usefulness of Special Drawing Rights (SDRs), highlights the complexities of international liquidity.

New approaches to exchange rate fluctuations could be considered, such as establishing equilibrium exchange rates and allowing market discipline within a band around those rates. The use of the dollar as an international reserve currency has practical advantages but can also lead to imbalances. Special Drawing Rights (SDRs) could be a potential substitute for the dollar, but their usefulness depends on their acceptance in private markets. Some Asian nations may seek reserve currency status for their own currencies, leading to a multi-regional monetary system.

Regional and Global Monetary Dynamics

Asian nations’ aspirations for reserve currency status and the implications for a global or regional monetary system are noteworthy. The IMF’s need for wider representation and legitimacy underscores the importance of inclusive governance in global finance.

Wider representation on the governing boards of international institutions is important for legitimacy but will not solve substantive issues. Hong Kong serves as a unique vantage point for understanding both China and the rest of the world, promoting transparency and openness. This position is crucial for global financial entities and think tanks like the Fung Global Institute.

The Fung Institute’s Role and Future Outlook

The Fung Institute, under Andrew Sheng’s leadership and backed by the Fung Foundation, is uniquely positioned to contribute to the global financial discourse. Its focus on practical measures for international adjustment and promoting a stable financial system is timely. Personal involvement and continued engagement by influential figures like Paul Volcker highlight the critical nature of these discussions and the global financial system’s future trajectory.

The Victor and William Fung Foundation and Andrew Shang’s leadership are essential to the success of the new Fung Institute, which aims to study and address these complex issues in the international monetary system.

Notes by: datagram