FAREED ZAKARIA GPS/CNN

Interview With Paul Volcker

Aired February 14, 2010 - 10:00   ET

THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.

FAREED ZAKARIA, HOST: This is GPS, the GLOBAL PUBLIC SQUARE. Welcome to our viewers in the United States and around the world. I'm Fareed Zakaria.

On the show today, a rare interview with the former chairman of the Federal Reserve, Paul Volcker. He's, of course, currently a key adviser to President Obama.

But he earned his place in history for something he did almost three decades ago. Paul Volcker killed inflation.

You will remember that in the 1970s, the United States was experiencing uncontrolled inflation, higher than at any time in its modern history. Savings were being wiped out. Wages were escalating every month.

Then, in 1979, Paul Volcker was appointed chairman of the Fed. And he began to raise interest rates to crush inflation. It succeeded. And it actually had a follow-on effect around the world, ushering in an era of low inflation, low interest rates and strong growth.

What impresses me most about Volcker was his willingness to do something that was deeply unpopular in the short term for the long- term good of the country. Today what he did is widely praised, but at the time, he was burned in effigy as a job destroyer.

Now, if you think about almost every problem we face in the United States -- and, in fact, in Europe, Japan and just about every advanced industrial country -- the solutions are readily identifiable. But they all involved trimming benefits, restricting credit, raising retirement ages, cutting pensions -- and, of course, raising taxes.

The effect of these reforms would be to place the country on much stronger economic foundations. But that benefit comes slowly over time, while the costs are sharply felt now, and by powerful, special interests.

That's why no one will propose any real cuts in spending or any real increases in taxation. Much easier to give everyone what they want and solve the problem by borrowing, borrowing and more borrowing.

So, the core problem facing rich democracies these days is that they cannot impose any short-term pain for long-term gain. And if we can't find the courage to do it, it is very difficult to be optimistic about the future for these countries, including the United States. Now, if we need a role model, Paul Volcker is still here.



ZAKARIA: And Paul Volcker joins me now.

Thank you for doing this, Mr. Volcker.

PAUL VOLCKER, FORMER CHAIRMAN OF THE FEDERAL RESERVE: Nice to be here.

ZAKARIA: Explain to the average viewer what is at stake here. Why is it important to get this financial reform passed?

VOLCKER: If a big, non-bank institution gets in trouble and threatens the whole system, there ought to be some authority that can step in, take over that organization and liquidate it or merge it -- not save it. It's what I call euthanasia, not a rescue.

And that has to be clear enough so that you avoid the so-called "moral hazard," that people think they're going to be rescued and, therefore, will take risks that they shouldn't be doing, in my view. This is what we pushed, what the president has accepted. They shouldn't be doing highly speculated activity. They shouldn't be doing so-called "proprietary" activity, where they're off there trading for their own interest. They're trading to make money.

And you get very aggressive traders, and they're out there. Millions of dollars are at stake, and personal bonuses, so they have a real incentive to take risks, which is fine, if you're not being protected by the government.

ZAKARIA: Are you surprised by the level of dysfunction on Capitol Hill in getting this reform done?

VOLCKER: Capitol Hill and the Senate is dysfunctional. I mean, I'm very disturbed about the trend in the government generally and its inability to get together and do things.

And I had some hopes. This is a relatively neutral subject politically. The need is so clear here. And it's not an ideological issue -- or it shouldn't be, anyway -- an ideological issue. It's a practical issue.

And, yes, I'm disturbed, because they can't get together on (ph) it (ph).

ZAKARIA: You've been around Washington, in and out, for 40, 45 years. Have you -- is this the worst...

VOLCKER: Yes.

ZAKARIA: ... you've seen it?

VOLCKER: Yes. Maybe I was child earlier, 40 years ago, 50 years ago and I was in my 30s. Maybe I was little more idealistic. But, no, I do think this is more dysfunctional than I've seen it.

Let me give you an example that resonates with me, and I can generalize it around the government.

But here we are, we had a new government come in last January, in the midst or the aftermath of this great financial crisis, and a clear need to consider reform. It's a complicated subject. It's going to take a lot of attention, a lot of expertise.

We are more than a year after the inauguration, and neither the undersecretary for international or the undersecretary for domestic finance -- you don't have them. It's not because people haven't been put forward. It took a long to get them nominated, and an impossible amount of time to get them confirmed.

I mean, why? What's going on here?

My memory is, when I became undersecretary of the Treasury in 1969, I was in office inauguration day. Now, I wasn't confirmed, but nobody questioned the legitimacy of being there. And I think I was confirmed within a week.

But how can the Treasury effectively function -- at least anything like maximum efficiency -- without the top officials in place that are needed to go up with the Congress, and negotiate with the Congress, and develop the plans, and meet with the people in the market?

And I pick on the Treasury. The same comment could be made about some other departments.

But what's the matter with this government that we can't even get together and get an administration installed?

ZAKARIA: You saw this crisis coming. You gave several speeches in which you outlined why you thought we were at a very dangerous point, in some cases, a year-and-a-half, two years before it hit.

What did you see that worried you?

VOLCKER: Well, this country, I'm afraid, went on a kind of consumption binge.

ZAKARIA: So, the core problem is that Americans started consuming too much...

VOLCKER: Right.

ZAKARIA: ... and consuming more than their historical averages. And that's perhaps what really got us the growth of the last 10 or 15 years.

VOLCKER: That certainly -- that gave a rosy complexion to the growth. That's correct. But it was built on a foundation that can't persist.

We need to do more manufacturing again. We're never going to be the major world manufacturer as we were some years ago, but we could do more than we're doing and be more competitive. And we've got to close that big gap.

You know, consumption is running about 5 percent above normal. That 5 percent is reflected just about equally to what we're importing in excess of what we're exporting. And we've got to bring that back into closer balance.

ZAKARIA: You feel that the longer term issue, the big issue is really this issue of how do we get real growth. How do we get exports, manufacturing -- not growth that's based on borrowing, not growth that's based on each of us selling each other our own houses in a kind of ascending spiral...

VOLCKER: Absolutely.

ZAKARIA: ... of asset inflation.

VOLCKER: We've got to produce something that somebody else wants to buy.

ZAKARIA: How do you do that? What should we be doing?

VOLCKER: Well, you really want to get -- fundamentally, I think we spent a -- more than a decade -- we spent 20 years inducing some of our brightest people, our most energetic people to go to Wall Street. And nobody wants to be a mechanical engineer or a chemical engineer or a civil engineer. They want to be a financial engineer.

If you go to a university graduation these days, and you get to the advanced degrees in mathematics, engineering, physics, you're rather hard pressed to find an American. There are Chinese, there are Indians, they're Taiwanese, they're from the Middle East.

Look, it's not easy to answer your question, because there's no easy answer.

ZAKARIA: When you look at American industry, making it more competitive again, do you think that when you compare it to industry in China, or in India or in South Korea, is part of the problem that there is -- our corporate tax rate is now the second-highest in the industrialized world?

We probably have more regulation. There's the issue of tort, you know, and the way in which the liability system...

VOLCKER: All of those things add up to some extent. And some of it is kind of a mystery, in a way. I hate to pick a particular industry, or whatever, and just anecdotally. But I understand that the cost of shipping a ton of steel from China to the United States, one ton, is about the same as the total labor cost to produce a ton of steel in the United States.

So, if, in effect, it's not all our labor costs, they're offset by the transport cost, why are we still importing so much steel?

The challenge is very substantial. I think we can do it. I mean, we used to be, not so long ago, the world's greatest manufacturer. And we haven't got any big cost disadvantage relative to Europe or other developed countries. But the emerging world certainly has a big competitive advantage.

ZAKARIA: When you look at this crisis, there are many regulatory problems. There are many issues that the bankers did wrong. There are many issues government regulators did wrong.

But many people argue that the one key issue, the biggest weapon the United States government has to slow down, to tamp down excesses, is to have raised the interest rate.

Do you believe, during this period, if interest rates had been higher, some of this would have been -- some of this froth would have subsided?

VOLCKER: Well, I have certain rule that ex-chairmen of the Federal Reserve don't comment on monetary policy of their successors. I'll tell you how good monetary policy was 30 years ago, but I don't want to comment on it now.

But I don't think there's any question that the Federal Reserve -- and the other regulators, it wasn't just the Federal Reserve -- were not on the top of this housing picture, or they weren't on top of the regulatory picture. And unfortunately, you know, when this was all going up, where was the SEC? And you ask, where was the Federal Reserve? Where was the comptroller of the currency?

There was a whole attitude, a kind of philosophic attitude that the market would take care of itself. And that became quite ingrained. The complexities, the so-called "financial engineering," a whole school of thought said you don't have to worry about a breakdown. These smart mathematicians are taking care of it. And all the risks have been dispersed to the point where they won't upset anything.

Well, when the screws became loose, we found out a lot of the risks were pretty concentrated.

ZAKARIA: All in AIG, for example... VOLCKER: And AIG was one case.

ZAKARIA: ... insuring almost all the risk.

VOLCKER: Part of the problem was that it got so complex, that a lot of the management, you know, couldn't understand it, and didn't understand it. But they were kind of reassured that somebody down in the bowels had it under control. But there was just a complexity which made it very opaque.

ZAKARIA: Is it true that you once said that the only financial innovation that you believe has added any real value in recent years is the ATM machine?

VOLCKER: I have said something like that to make the point, yes. And I guess I'll have to add the ATM machine was a mechanical innovation.

ZAKARIA: Not a financial...

VOLCKER: But I'll tell you, it is a very useful innovation. I don't think there's any doubt about that. Heavily used, efficient, saves you a lot of money.

ZAKARIA: Let me ask you a final question.

What is the crisis you're worried about now? Because one of the things people talk about is, does the United States still have the credibility to continue borrowing at the quantities we borrow? The people who -- you know, the rating agencies are now saying our AAA creditworthiness might be in doubt.

Is it something that we need to worry about? Larry Summers says...

VOLCKER: I hate to give you this answer...

ZAKARIA: ... can the world's greatest power be the world's greatest borrower?

VOLCKER: I hate to give you this answer, but the crisis I most worry about is the crisis in governance.

ZAKARIA: In government.

VOLCKER: In governance, yes. Have we got the capacity to develop programs, get them enacted and in a constructive way?

And that -- it's not just a political problem. That will underlie your question about the confidence in the United States, and confidence in American leadership.

ZAKARIA: And your basic concern is, can our democratic system make the hard choices that it needs to make...

VOLCKER: Yes. ZAKARIA: ... the reform -- to push these reforms forward?

VOLCKER: Yes. That's not a very happy note upon which to end. But, you know, there's no other country in the world that's going to lead. We can't lead the way we used to. And I think there's some guy named Fareed Zakaria who talks about the United States is no longer so dominant as it was. It's absolutely true.

But on the other hand, we may not be so dominant, but somebody out there has to be in the lead and show some sense of continuity and decision-making, and all the rest, as you well know. And I don't see that anybody else is going to do that.

ZAKARIA: Paul Volcker, a pleasure, sir. Thank you for doing this.

VOLCKER: OK.