October 11, 2011
An NYT piece on the Volcker rule raised the possibility that if the rules are too tight then some trading may go overseas. It would have been worth reminding readers that rule would only limit the activity of banks that hold government insured deposits. Independent investment banks, which do not have government insured deposits, would be entirely free to do whatever trading activity they liked.
If the rules are drawn in a way that are too restrictive then we would expect that trading activity would migrate from banks that hold insured deposits to financial institutions that do not and therefore are not subject to the restrictions. If instead the trading goes to countries where banks are allowed effectively to gamble with money from government insured deposits this would imply that foreign governments are subsidizing their banks.
As every trade economist knows, if other countries want to subsidize an industry it is best for the United States to take advantage of this subsidy and shift resources to sectors where they can be more productivity employed. The fact that foreign governments want to be foolish and create large risks for taxpayers by subsidizing banks (e.g. Iceland) is not an argument for the U.S. government to be equally foolish.
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