* No inflation threat now but if "wait, it's too late"
* China unlikely to dump U.S. assets
* Says China partly influenced by lack of alternatives
(Adds foreign exchange trade reaction)
By Ros Krasny
CAMBRIDGE, Mass., Oct 15 The enormous amounts of
liquidity pumped into the U.S. financial system by the Federal
Reserve are not inflationary "at the moment" but will become so
at some point, Paul Volcker, the former Fed chairman and a
White House adviser, said on Thursday.
Volcker, now an economic adviser to President Barack Obama,
said it was difficult, but necessary, to start draining the
billions of dollars in liquidity even while unemployment rates
remained high as the U.S. battles out of recession.
"You have to act against what seems like common sense. If
you wait, it's too late," Volcker said while answering
questions after a speech on financial markets at Harvard
University's Kennedy School of Government.
Volcker is best known for bringing down raging inflation in
the United States after he was appointed Fed chairman in 1979
-- chiefly by pushing the federal funds rate, the central
bank's key policy tool, to a peak of 20 percent in 1981.
Volcker's hawkish rhetoric, urging a pro-active policy
shift by the Fed, helped push up the rate of the dollar against
the Japanese yen to a three-week high of 90.99 yen in Asian
trading, from the New York close of 90.55, according to
strategists at 4CAST Ltd.
In the meantime, Volcker said the recent sharp rally in the
U.S. stock market from recession lows and other signs of
revival in financial markets should not lead to complacency in
the push for financial reforms. Volcker chairs the Economic
Recovery Advisory Board set up at the start of the Obama
Financial markets have not yet fully healed, he said, and
the economy remains plagued by structural imbalances that
threaten to prevent a sustainable recovery taking hold from the
"We have to regain our ability to produce goods. Moving
money around does not necessarily provide dinner on the table,"
Volcker said. "You can't run an economy where the financial
sector is making 40 percent of the profits."
Answering a question from the audience, Volcker said he
doubted China would embark on a major reduction of its U.S.
dollar-denominated assets, partly because the alternatives to
the dollar, including the euro and the Japanese yen, do not
look that great either.
China has "a great interest in the stability of the
dollar," he said.
Volcker said moral hazard -- the concept that investors may
take greater risks if they believe the government will protect
them from suffering losses -- remained an issue in the wake of
the government's bailout of several major financial
institutions, by creating expectations for future bailouts.
"There is this kind of hovering concern about moral hazard
that could create another crisis down the road," Volcker said.
He urged a structure in which protections were offered to
commercial banks, the "backbone" of the financial system
because of their key role in providing credit to the economy,
but not to all classes of financial institutions.
(Editing by Leslie Adler)