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Steve Forbes, 08.23.10, 07:00 PM EDT
The giant of a man who once headed the Fed says the central bank needs to be careful with excess liquidity.
Head of President Obama's Economic Recovery Advisory Board Paul Volcker says the Federal Reserve worried needlessly about deflation in the 1970s when there was excess liquidity.
Head of President Obama's Economic Recovery Advisory Board Paul Volcker says the Federal Reserve worried needlessly about deflation in the 1970s when there was excess liquidity.
Steve Forbes: And let me ask you about your old institution, the Federal Reserve.
Paul Volcker: I never talk about the Federal Reserve.
Forbes: OK, I'll ask it anyway. Do you think their excess liquidity in the early part of the decade was much of a contributing factor in the financial crisis?
Volcker: That's a very controversial area. There's a lot of liquidity early in the decade. I'd trace this whole episode back importantly to the imbalance in the world economy, and that's what we are suffering from now. This was not an ordinary recession we went through. It was a basic structural problem where we became very consumer-oriented, very import-oriented. That matched consistent desires, not just to China, but other countries and Asia that were willing to produce to satisfy all our consumption. They were willing to hold our dollars. Everything was very comfortable for a while. They held our dollars. They exported, we imported. We consumed, they produced. Trouble was, it couldn't last. Now that that façade has been cracked, so to speak, and we're in a big recession, we've got to make some kind of an adjustment to get a better balance back in our economy.
That is very tough. We have to have more investment. I think more manufacturing. We're never going to become a major manufacturing nation, relatively speaking. It doesn't have to be as weak as it was. We've got to do more. We've got to be more competitive in exports and do less consumption. At some point, we've got a problem with government spending as well, as you well know.
Forbes: Have you told the president that?
Volcker: No, I think he understands it.
Forbes: But on the excess liquidity, it seemed in the 1970s, before you came, we had a bad bout of excess liquidity, that brings about excesses. I mean, certainly was an impetus, for example, on money market funds, was in reaction to that. And wasn't this excess liquidity a contributor too to the disaster we had?
Volcker: All right. You say excess liquidity. I think in retrospect, there's certainly excess liquidity. How much of that was, in some sense, a direct reflection of Federal Reserve policy and how much of it is a reflection of this willingness of our suppliers to hold dollars at very cheap, very low levels of interest was very comfortable while it lasted. How much the Federal Reserve could have done about that is a question.
I guess you can say they didn't try very hard to counter it. But I think the mistake the Federal Reserve made is they are unduly worried about the prospects of deflation at that particular period of time. So they were pretty slow to --
Forbes: Respond?
Volcker: To respond, yeah.
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