Back in 1999, when Paul Volcker was lecturing at New York University’s business school, he asked students to raise their hands if they expected stock prices to rise at least 10 percent a year over the next decade. “Every hand shot up,” Volcker recalls. Not long afterward, naturally, the tech bubble burst: “The actual return for that period is zero!”
At this, the 6-foot-7 Volcker erupts in laughter. The words “I told you so” are unspoken. And one can forgive the former Federal Reserve chairman a little smugness. During his long career, Volcker has often been a lone voice arguing against Wall Street’s excesses. But his vision of stricter regulation has come back into vogue since the financial system imploded. This summer he watched from the audience as President Obama signed a reform bill that included a version of the “Volcker rule,” which curbs banks’ ability to take big risks with their own capital. Since then Volcker has stayed visible on the media circuit, warning regulators against growing lenient as they work out the fine print. “Obviously,” he deadpans, “they weren’t too diligent before the crisis.”
Of course, Volcker has been grappling with financial messes for more than four decades. Most famously, after becoming chairman of the Fed in 1979, he pursued policies that eventually tamed soaring inflation—even as he earned enemies by raising interest rates. He was unenthusiastic about the Reagan-era trend toward financial deregulation, and in 1987, Reagan replaced him with Alan Greenspan. Still, his ability to keep a seat at the table under Democratic and Republican administrations remains a rare talent. Volcker, who’s now chairing Obama’s economic-recovery advisory board, “has strong convictions but manages not to be wildly political,” notes William Donaldson, the former Securities and Exchange Commission chairman.
The question now is how he’ll use his influence to help rebuild the financial system—a job Volcker, 83, says has just begun. Unlike many economists (including Fed chief Ben Bernanke), he doesn’t see deflation as a looming threat to investors; he also thinks China won’t soon dethrone the U.S. as the world’s top economy. But he foresees plenty of other problems—including the effects of government deficits, which could crush bondholders. “We have to figure out how society deals with this,” he says.
When SmartMoney caught up with him at his office in New York’s Rockefeller Center, Volcker was in good spirits, looking forward to a fishing trip. But even a good mood for Volcker is grumpy by others’ standards. In feisty fashion, he offered his solutions for getting the economy back on track.
SmartMoney: You aren’t overly concerned by deflation.
Paul Volcker: No, I am not. It’s a difficult balancing question now. We are way below full employment. The immediate outlook is for extremely sluggish growth. It’s not the time to take strongly restrictive measures. But we do have to do so over time, or eventually we will be up to our necks in red ink. That’s the lesson, not just for the federal government but for state governments as well.
SM: And right now government agencies are expanding. The economist Friedrich Hayek warns of tyranny when the government controls economic decision making.
PV: Obviously, government should get more involved in the regulatory side than we have been in the last two decades. The government has a role in health care—we just had a big political fight about it. I don’t think people are ready to give up Social Security, Medicare or defense.
SM: Weigh in on the debate.
PV: I’m not in favor of big government by and large. I picked up Hayek’s The Road to Serfdom the other day, and it seemed less relevant than in 1945 [when it was published]. He wrote at a time when communism was a prime threat and socialism an existential ideal. We still have too much government interference, but we don’t have the communist bear looming down on us.
SM: But you do share the concern—that real growth does not usually come from social programs?
PV: Yes, growth comes from productivity and innovation, and hopefully, jobs will follow.
SM: And how do we get those?
PV: From the magic of the marketplace. What your Mr. Hayek writes about.
SM: How should we address the rising red ink?
PV: Spending restraint. If that doesn’t do it, a tax increase. Better to do it by spending restraint.
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