Volcker Is a Fascinating Choice for Obama’s Economic Advisor
President-elect Obama announced the formation of the "President's Economic Recovery Advisory Board". The board will be chaired by 81-year-old Paul Volker, who served as the chairman of the Federal Reserve under Presidents Carter and Reagan. Volcker is out-of-line with current government actions which are dramatically increasing the money supply. However, in the long-term, Volcker may be exactly the advisor Obama needs the most.
At the end of November, President-elect Obama announced the formation of the "President's Economic Recovery Advisory Board". The board will advise Obama on how to revive the ailing economy. The Board will have a two-year term, at which point Obama will determine whether to continue its existence based on economic circumstances that then exist.
The board will be chaired by 81-year-old Paul Volker. Volcker served as the chairman of the Federal Reserve from 1979 through 1987, under Presidents Carter and Reagan.
Volker received his Fed chairmanship at a time when inflation was a major problem, and the economy was headed for recession. Inflation (as measured by the CPI) was 13.3% for 1979, but decreased to 3.8% for 1982. Volker realized that inflation was caused by having the money supply grow faster than the real economy created value. Volcker dealt with inflation by increasing the federal discount rate to 15%. Although Volker’s tight money tactics dealt with inflation, it also increased unemployment, which reached 10% in some parts of the country. Volker was aware of the tradeoff, but concluded that inflation was the greater problem.
A Déjà-Vu for Inflation
Currently, the primary accepted means the government is using to stimulate the economy is a dramatic money supply increase. This creates liquidity beyond what is needed to finance the size of the economy. The money supply increase is intentionally being made available to churn assets and increase asset prices.
Many economic experts identify deflation as a current potential problem. While deflation could perhaps occur in the short-term, the long-term problem will instead be inflation. In the short-term, recent dramatic oil and commodity price drops show up as deflation in the PPI and CPI indices. But, the decline in oil and commodity is better described as a one-time price adjustment that reverses excessive increases occurring over the previous year. Previously, cheap foreign products restrained price increases, but this brake on overall inflation cannot continue once foreign workers obtain more affluence, and the foreign economies face their own high inflation in both wages and prices.
If this holds true, Volker is a fascinating choice for the job of Obama’s economic advisor. Absent (i) an interest rate policy similar to when Volker was Fed chairman, and (ii) a rapid unwinding of the U.S. investments in the capital markets and other bail-out activities, the U.S. will again reach double-digit inflation before Obama’s first term is over. At that point, facing a situation similar to when Volker was Fed chairman, Obama will need Volcker’s advice. The advice will not pertain to how to end the recession, but how to break the back of inflation that practically no one is currently even contemplating.
This prediction has plenty of ramifications, but here is the biggest as it pertains to investments. Avoid bonds, unless they are inflation adjusted (like TIPS). Investors who recently fled the stock market and invested in “safe” bonds will not only miss the coming stock market rally, but will also be devastated as inflation takes its toll on their bond investments.
Volker’s Accounting Connection
Volcker has other credentials that allow him to give advice in the accounting arena. Specifically:
1. In 1996, Volcker was chosen to chair the committee overseeing the restitution by Swiss banks to Holocaust victims. The far-reaching accounting investigation ultimately uncovered thousands of accounts that probably belonged to victims of Nazi Germany.
2. In 2000, Volcker chaired the oversight board that created the International Accounting Standards Board (IASB), and then served as head of the IASB's trustees for two years.
3. In 2002, Volker was brought in to assist Arthur Andersen in the aftermath of the Enron mess. The government’s indictment of Andersen prevented Volker from accomplishing much, but he demonstrated a disdain for those at Andersen who hired him. Volcker intended to throw out the existing management and establish a seven-member panel to select a new management team. Under Volker’s plan, the revamped Andersen would have focused almost exclusively on auditing, and would have eliminated its consulting business.
4. In late 2002, SEC-chairman Harvey Pitt to ask Volcker to head the newly created Public Company Accounting Oversight Board. Volcker declined the prestigious appointment, citing the time demands of the job.
The outspoken Volcker is likely to have the following additional advice for the Obama administration:
1. Accounting standards should be more principles-based accounting approach (meaning what the U.S. currently does not have). Volcker would support the movement to replace U.S. generally accepted accounting principles with International Financial Reporting Standards.
2. The large (Big Four) accounting firms should be further restricted from performing consulting services. These large firms are now more aggressively getting into non-audit projects to obtain growth that is no longer coming from projects associated with Sarbanes-Oxley. Volker objects to these additional services being offered by audit firms that help protect the capital markets.
3. If one of the large accounting firms faces a litigation problem that further restricts competition, Volker would probably support what would now be thought as harsh government restrictions on these firms. This government intervention could include the possibility of a forced breakup of one or more of these firms.
4. In the corporate governance area, companies should have nonexecutive chairman and more qualified independent audit committees. These are both consistent with Volker’s past comments. These corporate governance issues might arise because of U.S. investment in, or bailout of, American companies.
As long as Volker’s health allows him to remain active, Volcker could provide important economic and accounting advice to the new administration in areas that are not currently being contemplated.
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials: CPA, MBA, CMA and ASA.
Fulcrum Inquiry is a financial consulting firm that performs forensic accounting, business valuations and economic analysis.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.