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The 1st International Finance Forum (IFF) Leadership Dialogue: The Volcker Rule was held on February 22nd, 2014 in Beijing. Paul Volcker, IFF Honorary Chairman and former Chairman of U.S. Federal Reserve Board gave the keynote speech, and distinguished speakers as Jin Liqun, Executive Vice President of IFF and Secretary-General of Multilateral Interim Secretariat for Establishing Asian Infrastructure Investment Bank; Zhu Min, Deputy Managing Director of the IMF; and a few prominent experts from governmental policy-making bodies, financial regulation agencies, major financial institutions and leading academic institutions participated in the Dialogue.

Dialogue (I) The Rebuilding of Order: The Volcker Rule
Paul Volcker, IFF Honorary Chairman and former Chairman of U.S. Federal Reserve Board
ZHU Min, Deputy Managing Director of the IMF
JIN Liqun, Executive Vice President of IFF, Secretary-General of Multilateral Interim Secretariat for Establishing Asian Infrastructure Investment Bank
Dialogue (II) Re-initiate Reform: China's Next Step
Paul Volcker, IFF Honorary Chairman and former Chairman of U.S. Federal Reserve Board
ZHU Min, Deputy Managing Director of the IMF
JIN Liqun, Executive Vice President of IFF, Secretary-General of Multilateral Interim Secretariat for Establishing Asian Infrastructure Investment Bank


It is my pleasure to meet with people leading China's most important financial departments here at the IFF Leadership Dialogue. There is one thing I would like to clarify: it is true that Volcker Rule should be the main topic for today, but given the current backdrop, we will definitely need to cover more than that.
In the past few years, China's debts and high leverage have been the focus of the world. On one hand, China plays an important role in the rapidly growing economy in emerging markets; on the other hand, it may trigger quite some crises, impeding not only China's growth but also the world economy. Are we, in merely five years, seeding another recession? It requires our vision and cooperation to avoid the next crisis.
The core issue of the Volcker Rule is to control risks, which means to deal with the uncertainties in the financial market. Commercial banks, individuals, companies and government all require a safer way of capital-raising and settlements, which involves many concerns about risks and costs. Commercial banks can seek supports from the government when necessary, but they should not misuse the supports for speculative trading or proprietary trading. The Volcker Rule is intended to limit the speculations in Europe and America. Activities that involve high risks and high yields are not based on the interests of corporate clients or the interests of share prices, so we must find a way for orderly bankruptcy of financial institutions to address more problems arising afterwards.
We neither wish the government to protect the management of financial institutions, shareholders or grubstakes, nor want to see catastrophic events such as the sudden collapse of Lehman Brothers. It is no easy task for a country to achieve national balance, not to mention the international balance, since financial market is interdependent and circulation is transnational.
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Volcker's career

You took the position of the Chairman of the Federal Reserve Board when I was in college. Could you share with us your experience of making a series of decisions to deal with high inflation?

The U.S. was undergoing a period of the record-high inflation 35 years ago.  A term created for that time, "stagflation", reflected the coexistence of a weak economy and the high inflation. I was selected as the Chairman of U.S. Federal Reserve Board then, with the top priority to make a new policy to crack the hard nut. The public had not realized what a tough anti-inflation policy meant, and I didn't know how long it took to implement the policy, but I know it made sense politically and financially.

Five years ago, economists failed to forecast the breakout of the large-scale economic crisis. Do you think the economists should be blamed, and how to improve their work?

I don't think central banks or the Federal Reserve can do a better job than economists.  This is not the problem for only economists, as the economic system is far more complicated than they've learnt from years of education and research.
There is circulation in free market economy. People are becoming more confident with the development of the economy and thus willing to take more risks and using higher leverage for investment, which further triggers the economic crisis. Market confidence is likely to shatter after economic crisis, but it will be boosted after the recovery and high-risk investments will be popular again. The circulation is clear in the U.S., who suffered the most serious shock from the last economic crisis, and our financial market was hit badly, however, with the recovery of economy, financial derivatives sprouted. The transactions of financial derivatives were still limited in 1995, but the trading volume, CSD included, reached 60 million dollars in 2005.
Questions from the Audience
Do you think financial stability should be taken into consideration, besides price stabilization and employment, when making monetary policies?

The central bank has rights as well as responsibilities. First it has to maintain the stability of finance. I rarely talked about financial stability when I was in the Federal Reserve, while some recent laws and regulations in the U.S. not only take the price stabilization into consideration, but also list the financial stability as one of the topics. In terms of the relationship between price stabilization and employment stability, I think the price stabilization itself can bring about good conditions of employment.
Questions from the Audience
Do you think the inflation after 2000 sowed the seeds for the subprime mortgage crisis this time?

Talking about the inflation after 2000, the most difficult thing for central banks is to tighten the monetary policy. Usually the public cannot accept the decrease of money supply. It is hard to tighten the monetary policy in times of economic prosperity and rapid economic growth. But the U.S. government has now realized that some measures should be taken and put into effect step by step.
The Q&A of the Volcker Rule

Major financial institutions will not be allowed for proprietary-trading activities if the Volcker Rule is completely implemented. Will it cause the fluctuation of the market?

Proprietary-trading may generate speculations, however, the limit of proprietary-trading and speculations will affect the market liquidity. My answer is that the market liquidity is likely to be reduced. But when the financial crisis broke out, there was excessive market liquidity. So to decrease liquidity is beneficial for stabilizing the market.

How great resistance did you envision when you put forward the Volcker Rule? How can we facilitate the landing and implementation of the Volcker Rule over a short period?

Legislation is the main reason blocking the complete implementation of the Volcker Rule. Once the legislative issues are settled, banks will realize that it is the law by which they should abide naturally. The transition from rules or ideas into laws takes time and cannot be made without a lot of discussions. Moreover, each single organization has its own concerns. So the Volcker Rule has been in arduous debate for four years.
The social pressures on the Volcker Rule are not that heavy. American citizens and many bankers all welcome the Volcker Rule. In America, only few banks will be limited by the Volcker Rule. Overall, I think the Volcker Rule is beneficial and most banks will recognize it even though they were not satisfied at the very beginning.

Initially the Volcker Rule had only 30 pages, but later on it extended to specific regulations with more than 800 pages, which has become increasingly complicated. How can we properly set standards for financial supervision? Will a more responsible supervision system be effective?

The question is hard to answer. Whenever it comes to supervision, the issue complicates a lot. In fact, my rule is quite simple. There is only one page concerning the supervision issue, and actually I think rules of supervision should be shorter than an insurance agreement. But much work remains to be done in order to ensure the effective implementation of simple rules. The specific clauses are the major reason that complicates the entire rule. Banks will accept the major principle of supervision. It is the legislature purpose that complicates the supervision rules, turning them into thousands of pages. Everyone can make suggestions on the supervision rules and we will take every single question raised by citizens seriously.
Questions from the Audience
The Volcker Rule prohibits the proprietary trading, hedge funding and private equity between banks and other financial institutions. However, I doubt the definition of the term "bank entity". Some banks are not traditional banks so they can escape the limitation of the Volcker Rule. Besides, can some foreign financial institutions including some funds be regarded as the bank entity?

Our supervision aims at American banks wherever they were established. Meanwhile, it aims at the foreign banks opened in the U.S. as well. Foreign banks are required to regulate their behavior, which depends on the definition of banks.
Questions from the Audience
The definition of banks is any financial institutions that take banking business in the U.S., coupled with their subsidiaries and secondary organs. But some financial institutions are not the banks in traditional way. Besides, the term "control" also has a wide definition. Take China Investment Corporation as an example, it holds many shares of banks in China indirectly. Does it mean the China Investment Corporation falls into the category of the banks as you mentioned?

Your question reflects the reason why the implementation of the Volcker Rule has encountered so many complicated problems. I think the final version of the Volcker Rule should mention the issues of foreign banks. If the bank-holding corporations and their subsidiaries do business in the U.S., they have to obey the Volcker Rule. Because the nature of the China Investment Corporation is very complicated, we have to define its nature, whether it is a bank-holding corporation or a sovereign wealth fund, before it is allowed to invest in the U.S.
China's Debt Crisis

How to maintain China's sustainable development with its economy grows fast while debt grows even faster? Is that possible to mitigate the debt increase? What's worse, how to manage the boom of shadow banks which would probably become a huge challenge to China's economy in the future?

Debt increase and debt crisis are two definitions. To borrow or not is not the problem. What we need to consider are the following two aspects:
First, the usage of debt; China raised money for its infrastructure construction, technology upgrading and people's livelihood improvement,based on which China is brought to where it is today. However, debt doesn't mean growth. The debt-carrying capacity largely depends on the benefits created with previous borrowings. High returns mean more capacity, while low returns less capacity.
Second, debt monitoring; the US deregulation on debt has resulted in the financial crisis. I agree with Mr. Volcker on debt monitoring, but we need a simplified regulation system. As the reason why "Volcker Rule" cannot be implemented in the States is complexity. China needs to learn lessons from that and always keep in mind not to gamble with borrowed money.
Gold and Inflation
Questions from the Audience
Is gold the best way against inflation? Is the role of gold as important as it was 40 years ago?

When I was the Deputy Under-Secretary of the Treasury Department, gold which was worth 35 dollar per ounce, was the basis of world's currency exchange. We believed that the US would guard gold price by all means, but it failed. And my work was to disconnect the price of dollar with gold. So the fall of gold price is always good news for me.
Actually, gold price fluctuation reflects people's concerns towards American economy. Although reducing the pressure on gold market will facilitate financial stability, gold is not simply a financial concept at present, but one of bulk commodities as all the others.
China's Housing Bubble

How do you think about China's housing bubble?

I am not sure if there's bubble in China's housing market for the following several reasons: first, China's local governments largely rely on land sale to repay debt. The government manipulation in rising land price will result in wrong statistics when analyzing the housing market. Second, "location decides" is a golden rule in housing industry. Therefore it is reasonable to see the rise of housing price in major cities of China. Third, down-payment for Chinese households is much higher than that for the US household. So China's housing market is facing far less default risk.

I agree that housing market and government policies are related, and China and the US are facing different situations. I think, for me, debt problem is the top issue whether or not we are worrying about the housing bubble. U.S. housing loans are irresponsible, with almost 0 down-payment and no credit assess. A lack in prudent repayment capacity inspection leads to a series of problems. I am not sure if it will happen in China

Land sale is a major financing method for local government, but it is unsustainable. Once the land price fell, government will face problem of capital shortage and shadow bank. A lot of real estate and infrastructure programs are belonged to the local government, and consuming large proportion of money, therefore land price decides the immunity of financial system. Housing price fluctuation actually influence much more on the total financial system stability than China's household consumption which basically rely on deposit. Besides, trade of derivatives is acting as leverages for the housing market. So we need to pay more attention on the prices and fluctuation of the housing market.

The difference between American households and Chinese households lies in the housing transactions. Chinese family relies on deposit to purchase houses, while the U.S., on loans. However, since china's housing price is much higher than people's income, the gap between ordinary household's income and housing prices is getting wider. In addition, local governments' land sale took too much of its revenue. Good news is that the central government has started prudently thinking of policies to cool down the housing market and make it affordable. The governments need to be cautious when carrying out policies.

It is the regional difference that decides housing bubble. For example, housing prices in mega cities and major cities are believed to increase. China' families are paying much more down-payment than American family, therefore bearing more risks. This is the first difference. Secondly, it is for sure that china's irrational exuberance in housing market must be managed. Third, housing demands will decline if more investment opportunities shown in other places like the stock market. Last but not least, uncontrollable policy measures taken by the government for uncertainties in the housing market will trigger bigger turbulence in the market. Therefore, we'll need to have the market calm down by itself and take comprehensive measures to appropriately solve the problem with macroeconomic policies.
Questions from the Audience
China's total volume of trade in 2013 exceeded $4trillion, an eightfold increase of that in 2001. A major driver for this is China's joint in WTO in 2001. What do you believe will be the next major drive for China's trade growth in the next 10 years? Should China join the TPP?

It is the industrial structure upgrading that needs our attention in China's international competition instead of the growth rate each year. Technically, I am expecting to see an increase in hi-tech industries and a decline in traditional industries.
As for the drivers of China's trade in the next decade, I think there will be two of them: first, China should take the opportunities brought by WTO to have more engagement in the international market competition, so as to get the "ticket" of TPP negotiations; second, we should re-launch reform and opening up with more determination and at a higher level.
Questions from the Audience
Do you think China should join the TPP dominated by the US?

Of course. But the thing is, if all countries need to follow the same rules to join TPP, China will face the problems of trade subsidies, reform of its state-owned enterprises, etc. I am not very interested in trade agreement itself. It is very important for sure, but it remains open in practical operations, for example quota and tariff. What I care about more is political restrictions, as the US congress would block China from joining the TPP.

Mr. Volcker, do you think the establishment of TPP by the US is meant to discard WTO as a multinational institution, which is comparatively less efficient?

The US has paid great attention to WTO. I believe that TPP is made out of the will to drive economic growth. As we all know that bilateral trade agreements have been signed in many places of the world. TPP is actually integrating and expanding the agreement a bit more.
Questions from the Audience
As Mr. Jin has mentioned the TPP negotiation, China is working on the BIT with Europe and the US. Does this mean another chance to opening up? Are these opening measures contributing to the next structural reform? The US seems to be reluctant in TPP negotiation and active in BIT, how do you understand the difference? In the long run, what is the appropriate opening for China?

It is seen that China's reform has been forced forward after joining the WTO. Why don't we take some measures? I cannot deny the political factors in TPP and BIT. But we are not open enough to take proactive measures against political restrictions, and that's the problem needing reflection.

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