Beware unintended Volcker consequences

G20 members must support global growth while dealing with indebtedness, and the Volcker reform is the wrong prescription for vulnerable debt markets.

FT.com

This week’s meeting of the Group of 20 leading economies confronts pressing challenges: tackling indebtedness; supporting growth, strengthening international and financial institutions to promote global stability; and reforming financial regulation. However, all countries need to be alert to the unintended consequences of financial reforms. Both our governments have expressed concerns about the 'Volcker rule'.

At the heart of the global crisis is the explosion of indebtedness in advanced economies. History tells us that recoveries after debt-fuelled crises tend to be slower than other recoveries. But the arguments for deficit reduction have become stronger over the past year.

The British government is taking the tough decisions needed to get a grip on its finances, tackling a budget deficit forecast to be the largest in the G20. Last year’s earthquake created an immense challenge for Japan’s economy. The Japanese budget for reconstruction spending is equivalent to 4 per cent of gross domestic product and is being financed without issuing deficit-financing bonds. The Japanese government is also determined to address the fiscal challenges of an ageing society, through reform of social security and tax.

Dealing with indebtedness is crucial but the global community must also support growth. Both our governments are undertaking pro-enterprise reforms and providing practical support to help companies take advantage of overseas markets. In Japan, substantial investment in reconstruction should help growth.

The IMF has said the biggest risk to global growth is the eurozone crisis. Eurozone countries have made progress but more needs to be done to reach a lasting solution. Japan and Britain are longstanding supporters of the IMF and stand ready to play our part in the global effort if certain conditions are met. There can be no new vehicles or funds specific to the eurozone. There must be full IMF conditionality. The additional resources should be drawn from a wide range of countries. Crucially, IMF resources cannot be a substitute for further steps by the eurozone to support its currency. The eurozone must increase the resources of its firewall so the markets can be reassured that it can respond to any eventuality.

Finally, we must not lose momentum on financial sector reform. We must implement our G20 commitments in an internationally consistent way, ensuring that the implicit taxpayer guarantee is eliminated. We need rigorous implementation of the agreement on minimum standards for bank capital, liquidity and leverage.

One important element is strengthening financial-market infrastructure regarding over-the-counter derivatives. Britain and Japan have already put in place appropriate macro-prudential frameworks. All countries should take steps to introduce frameworks that tackle systemic risks. Systemic risk could also arise from 'shadow banking', and its regulation is being explored at the Financial Stability Board.

All countries need to be alert to the unintended consequences of reforms. The "Volcker rule” is a prime example. These proposals aim to reduce risky behaviour within banks. However, there is an exemption for trading in US government securities but not other sovereigns, so it could reduce liquidity in non-US sovereign markets, making it more difficult, costlier and riskier for countries to issue and distribute debt.

At such a vulnerable time in the sovereign debt markets, it would be the wrong prescription. The rule could also disincentivise foreign companies from transacting with their US counterparties, reducing market liquidity and potentially increasing price volatility regarding financial transactions such as foreign exchange swaps. Japan’s and Britain’s governments are discussing with the US how we ensure reform supports international as well as domestic financial stability.

The barriers to action are political, not economic. Japan and the UK have shown willing to tackle debt, restore competitiveness and strengthen their financial centres. We are as committed to taking tough decisions at a global level.

George Osborne and Jun Azumi are finance ministers of Britain and Japan.

Copyright The Financial Times Limited 2012.

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