Volcker urges exchange-rate reform

Speaking at the Asia-Global Dialogue 2012 Conference, Volcker, who was also chairman of the Economic Recovery Advisory Board under US President Barack Obama from 2009 until early last year, said countries should consider new approaches to the monetary system. 

He said there was evidence that financial systems are vulnerable to breakdowns such as the Asian financial crisis in the 1990s, the US sub-prime crisis and the subsequent crisis in Europe. The cost of the breakdowns, when they happen, is high. 

“We cannot accept failure in achieving sensible and needed reform,” the veteran economist added.

The ongoing euro crisis and its implications for Asia were widely discussed during the conference, organised by the Fung Global Institute. The concept of an alternate reserve currency to the US dollar was discussed. Volcker suggested that the institute do a study on whether one – or more than one – Asian nation may be tempted to seek or at least tolerate reserve-currency status for its own money. 

Many panellists shared the view that the dollar should not continue to be the sole international reserve currency. Yaga Venugopal Reddy, former governor of the Bank of India, said Asia should play a more active role in the monetary system. Asian currencies should become more internationalised, he said.

Volcker suggested one approach should be an appropriate equilibrium exchange rate, which is a fairly wide band or zone around the equilibrium rate to allow for uncertainty and permit the market to exert its own discipline. The central idea is that individual nations would direct their interventions and if necessary their economic policies to defend the equilibrium rate. Aggressive intervention by trading partners might be authorised by an international authority to promote consistency.

He added that an appropriate reserve currency and the provisions of international liquidity were another area of concern in the design of the international monetary system. For years, the dollar has been a pragmatic answer. There was a complaint that the international use of the US dollar provides inordinate privileges to the US. But Volcker said it was not in America’s interest to accentuate and extend US payment deficits at the expense of ever-larger holdings of the dollar by foreign governments and central banks. 

The idea of Special Drawing Rights (SDR), supplementary foreign-exchange reserve assets defined and maintained by the International Monetary Fund, was discussed as a substitute for gold and the dollar. But any future usefulness of the SDR as the main international currency will be dependent on its usefulness in private markets. “We are far from that today,” said Volcker.

On Europe, Sir Howard Davies, professor of practice at the Fondation Nationale des Sciences Politiques and deputy governor of the Bank of England from 1995 to 1997, forecast that the crisis might grow worse if Greece is unable to fulfil its austerity conditions. This would create a contagion. 

Eurobonds, backed by the European Central Bank, would be issued to pay debts from Spain and Italy. A depository guarantee scheme for the euro zone would be launched. One side effect of that, he said, would be that the countries that have chosen to stay out of the euro zone would be more distanced from the group, widening the gap within “two-speed” Europe.

The lesson for Asian economies is that a slowdown in the euro zone is inevitable, Davies added. And that will have a financial impact because European banks participate in the domestic credit sector in the Asian region. 

 

Regulatory change 

In addition, there may be regulatory change. The three crises have spelled the end for monetary management policy that focuses on inflation targets and capital controls. There will be more regulation of the financial system – at both the macro and micro levels. These will require a diverse set of tools to control the financial market. He said the degree of convergence between West and East would increase, since both sides can learn from each other.

Qi Bin, director-general of the Research Centre at the China Securities Regulatory Commission, shared the experiences of China’s stock market, which was set up only 22 years ago. The operation is typically top-down, according to the central planning system of China, unlike the United States, where the system is bottom-up. One derivative futures product in China’s market was launched only a few years ago.