Paul Volcker: Quantitative Easing (QE3) will not fix America's problems

According to a Telegraph article, in a speech at the Institute of Chartered Accountants in Scotland, Paul Volcker

warned that further quantitative easing will fail to repair economies in Europe and the US.

It is very nice to have an individual like Mr. Volcker confirm what your humble blogger has been telling readers since the beginning of the financial crisis.

I have been saying that we are dealing with a bank solvency led financial crisis and the only way to fix the problem is to deal with all of the excess debt in the financial system.

The way to do this is to adopt the Swedish model and force the banks to absorb the losses on the excess debt.  Iceland showed that this works.

Modern banks are designed to absorb losses on excess debt in the financial system and protect the real economy.  Banks can do this because they have deposit insurance and access to central bank funding that lets them continue to operate and support the real economy even when they have low or negative book capital levels.

Banks can continue to operate with low or negative book capital levels because with deposit insurance the taxpayers act as a silent equity partner.  This allows the banks to continue operating, retain earnings and rebuild their book capital levels.

For maximum effectiveness, the Swedish model must be combined with ultra transparency.  By requiring the banks to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, market participants can exert discipline on the banks to clean up the bad debt and to restrain future risk taking.

Mr Volcker, addressing a conference at Gleneagles in Scotland, said the decision by the Fed to begin a third round of asset buying — nicknamed QE3 — amounted to the “most extreme easing of monetary policy” he could recall. Mr Volcker’s comments came as the World Trade Organisation intensified the economic gloom by slashing its global growth forecasts. 

The organisation said it expected the world economy to grow 2.5pc this year, from a previous 3.7pc forecast, while growth in 2013 would slow from a previous estimate of 5.6pc to 4.5pc. 

Although not explicitly directed at Fed chairman Ben Bernanke, Mr Volcker’s words will be seen as a veiled criticism of the limitations of the current strategy being employed by the Federal Reserve. 

Mr Volcker, who has been a pivotal force in post-crisis regulation – as well as the architect behind the “Volcker Rule” that bares his name – addressed the Institute of Chartered Accountants in Scotland conference about how to revive the economic fortunes of the western world. 

“Monetary policy is about as easy as it can get,” said Mr Volcker, who built a reputation for quelling inflation through the unpopular decision of raising interest rates during his tenure at the US central bank. “Another round of QE is understandable – but it will fail to fix the problem. There is so much liquidity in the market that adding more is not going to change the economy.”