Former Fed Chairman Paul Volcker said global monetary reforms implemented so far fall short of being able to fix the international banking system, and he worries what will happen when inflation picks up.

“Financial reform is still incomplete, in my judgment,” he said. “That’s not just a problem in the U.S., but it’s a problem elsewhere in the world, certainly Europe.”

In an exclusive interview with the Japanese newspaper The Asashi Shimbun, Volcker hammered anew at the operating practices of big banks. He also called for more international cooperation on managing fluctuations in currency rates.

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Volcker noted the full implementation in the United States of the Volcker Rule to separate banks’ proprietary trading from traditional lending and deposit business is not complete.

“[O]pposition comes from only a handful of big banks. Most banks in the United States are worried about how the regulation will be written, but basically it’s not important to them and many of them support the rule.”

Another area where reform still falls short is in the area of credit default swaps, Volcker said. “That’s one of the incomplete areas of reform, to bring ‘derivatives trading’ under more assured control and more protection when there are losses, so that the losses don’t ripple through the whole banking system.”

Volcker told the newspaper that when potential compensation for bankers becomes too lucrative, the temptation for them to “cut corners” to boost their pay likewise becomes too great.

“Are we dreaming when we think that years ago, decades ago, there was more sense of fiduciary responsibility, concern about the customer, a different kind of ethical instinct, and not just in banking but in lawyers and auditors and accountants and elsewhere?” he asked.

Volcker said the global financial crisis occurred because there was no force to counteract the excesses of banking systems.

“People talk about more surveillance by the [International Monetary Fund], but you need some capacity at some point, not just to ‘surveil,’ but to do something, to have some restraining influence.”

He called for international monetary cooperation to set “equilibrium” exchange rates to control currency movements within a fairly wide band.

Volcker predicted a full economic recovery in the United States and Europe is still years away. When that time comes, he said, central bank policies will be tested.

“Will they restore monetary discipline at the time when it becomes necessary? That’s what I worry about, because then, very rapidly, you could get excesses and speculation and new imbalances in the economy,” he said.

“History tells us that real problems cannot be solved by promoting inflation deliberately.”

Kaushik Basu, chief economist at the World Bank, told The Economic Times he believes the global economy will not recover until 2015.

Basu said the injection of liquidity into the eurozone in particular buys time for reform, but is not in itself real reform.

“The hope is that after this period, the global economy will steady up, with the emerging economies becoming the growth poles, while industrialized nations witness slower but steady growth,” he told the Indian newspaper.

Editor's Note: The Final Turning Predicted for America. See Proof.