‘Financial Globalisation’ and the ‘Crisis’: A Critical Assessment and ‘What is to be Done’?

Abstract

Do we have a genuine global financial system? This article challenges the strong notion that the recent financial crisis was global in scope. It argues the international financial system is quite differentiated, being made up of domestic-national, supranational regional and international aspects. The system is characterised by contagion, however, and the article goes on to consider the role of this in generating spill-overs into the wider economic mechanism. Given this characterisation of the financial system the implications for how to organise a regulatory response are pursued. Here the argument is that the principle of ‘distributed preparedness for resilience’ should guide this response not a new set of top-down global rules and norms organised once again by the institutions of global economic governance.

Keywords:

• financial crisis
• financial globalisation
• contagion
• regulation
• money supply
• events
• distributed preparedness for resilience

Notes

Many of the themes developed here were first outlined in Thompson (2004). In addition the basis of the detailed arguments advanced about the recent crisis derive from my contributions to the Open Democracy web magazine in 2008 (http://www.opendemocracy.net/article/some-contrarian-views-on-the-current-financial-crisis; and http://www.opendemocracy.net/article/international-contagion-under-national-leadership).

For particular application of this technique by the World Bank see Essama-Nssah (2006).

For a thorough analysis of the use of gravity equations in modelling international trade see Rauch (1999).

In the equations for investment flows (FDI, equity) the distance variable (D) is a highly significant one (see Hirst et al. 2009: 175, Table 6.8).

This is referred to as the ‘home bias’ effect. In the case of trade see Disdier and Head (2008) and for financial markets see Bong-Chan et al. (2006) and Cai and Warnock (2004).

As of December 2008 the Financial Times estimated that the total costs of the ‘global’ bailout had already risen to US$8,000bn, but other estimates suggested this might be as high as US$30,000bn for the US alone (http://www.usnews.com/blogs/capital-commerce/2008/9/22/bailout-prevents-great-depression-20.html). All of this must remain somewhat speculative of course. But what is more certain is that the vast bulk of these losses were incurred in a very few countries.

For instance, after an initial shock China emerged more or less unscathed (Wolf 2009).

On the first ‘global financial bubble’ (of 1720) see Frehen et al. (2009).

Brunnermeier suggests an interesting measure to cope with contagion in these settings designed to indicate to the 'value at risk' of any organisation's balance sheet which is co-varied with other organisations in the network (‘CoVaR’). This is designed as part of a better assessment of systemic network stress (Adrian and Brunnermeier 2009). Haldane (2009) constructs various measures of network characteristics based upon the extent of foreign assets and liabilities between the main financial centres.

A clear case of this was Gordon Brown (the UK Prime Minister) who, in an interview for the BBC Radio 4 ‘Today’ programme on 23 January 2009, argued that the financial crisis was solely the result of irresponsible lending in the US. He also reiterated 14 times that this was a ‘global financial crisis’, presumably something being faced in the same way by everyone. We are all, as a result, shared victims of a common unexpected process.

Thus, echoing a point made above, the media loves them; it chases them, helps construct them, and revels in them: ‘breaking news’, ‘global tremors’, ‘the worst day on Wall Street since…’, etc. Crises are enthusiastically embraced by the media when they erupt.

An additional – and related – aspect of ‘events’ would be to stress their specific political character. According to Badiou (2001) and Rancière (1999) genuinely political events are those that declare a radical equality. They announce an equality where there had previously been a deep inequality. They right a wrong (Thompson 2007). In the context of the financial crisis being discussed here, this would manifest itself in the way such events seem to demonstrate a unity in the diversity they display, and the way they open up an opportunity to put right things that had, up until then, been going very much awry.

In the contemporary crisis the emphasis on the private control of the money supply was signalled by the call from several leading UK monetarists for the government to once again borrow from the commercial banks to create money (to prevent a potential deflationary spiral from emerging): ‘Money being destroyed by the collapse in bank lending to the private sector must be made good by bank lending to the public sector. … If banks’ claims on the private sector fall, the initial effect on the other side of the balance sheet is a matching decline in their deposit liabilities (ie, the quantity of money). In these circumstances there is a risk of a debt-deflationary spiral. If so, the right policy response is for the government itself to borrow from the banks. … If the government borrows from the banks on an appropriate scale … we believe that a wider recovery can be reconciled with reductions in the private sector's indebtedness to the banks' (Financial Times 2008). This approach is an indirect challenge to the idea of ‘helicopter money’ – as explained by Martin Wolf (Financial Times, 17 December 2008: 11) and in Willem Buiter (2008). The creation of helicopter money would involve the government selling Treasury Bills (TBs) to the Bank of England (not the private commercial banking sector), which would then become assets of the Bank. The Bank could then create liabilities to match these assets in the form of expanding the monetary base (‘printing money’). That cash could be used to purchase the TBs, so the government would have money directly to hand to use as it wished (substitute for tax cuts, give away, use to purchase resources, etc.). This would locate the creation of an addition to the money supply firmly with the public authorities in the first instance (because the Bank of England is a joint stock company whose shares are all owned by the Treasury). But the ‘success’ of the quantitative easing arranged by the Bank and the commercial banks in the UK was celebrated by the same monetarists who proposed it earlier as the crises eased in mid-2009 (Congdon 2009).

Thus the authorities in effect conducted a 'Keynesian' monetary policy, not a 'monetarist' monetary policy. Indeed, in the 2009 crisis interest rates have been forced down to almost zero, where monetary policy stops. In principle this enables the government to purchase anything at zero cost to itself (since it can borrow at zero cost) and to spend as much as it likes. But, as indicated in note 13, the authorities chose not to exercise this option. Instead they went for a conventional route of borrowing from the private sector, hence encumbering the public sector with significant amounts of debt which could have been avoided.

However, one of the problems more generally has been whether the nationalised banks – let alone the non-nationalised ones – have acted to pass on any easing of credit conditions to their customers. Generally they failed to do this – a consequence of having ownership but not full control in the case of the nationalised banks, which may be an emergent pattern in the financial system. Further nationalisation plus the exercise of control (or ‘governance’) may be an answer.

Thus Gordon Brown almost became a ‘Schmittian sovereign’ for a while (‘He who decides in the exception’ (Schmitt 1998) – in his New York Times column on 12 October 2008 Paul Krugman described Brown's decisive action in the UK as the potential saviour of the world financial system!). This is somewhat of an exaggeration, of course, since the very existence of the UK state was not in question (though it might have been more the case of Iceland's Geri Haarde).

In part this ‘irrationality’ can be illustrated by the way that options contracts (which are important in the derivatives markets) are priced – in fact necessarily ‘mis-priced’. Two key assumptions for valuing options are that the volatility of returns is constant and their distribution is log-normal (Black and Scholes 1973; Merton 1973; Brooks et al. 1994). In practice neither of these assumptions is likely other than by pure chance: usually returns are volatile and unexpected combinations of events disrupt their distribution. This means that strictly speaking options can only be ‘correctly’ priced ex post; when the contract has matured (because then the actual volatility and distribution would be known). These problems have given rise to a complex debate about options pricing (e.g. Mehrling 2005; MacKenzie 2006, also Thompson 2010).

See Reinhart (2008) and Reinhart and Rogoff (2008) for the way the ‘financial crisis cycle’ has reproduced itself over many centuries, and the failure of the regulatory authorities to come to terms with this.

An existential moment in this context would be a crisis that lacks purpose, meaning or authentication, leading to anxiety, disorientation and confusion in the face of the seeming randomness, absurdity and volatility of events.

Here the lessons from natural disaster planning are introduced. And although in its own terms this has been problematic (e.g. in the case of the flooding in New Orleans in 2007) in principle it provides an important alternative conceptual apparatus for thinking about crisis management (Grossi and Kunreuther 2005).

This problem is almost recognised by Martin Wolf when he laments the failure of conventional economic analysis to spot the oncoming crisis: ‘The difficulty was that we all tend to look at just one bit of the clichéd elephant in the room. Monetary economists looked at monetary policy. Financial economists looked at risk management. International macroeconomists looked at global imbalances. Central bankers focussed on inflation. Regulators looked at Basel capital ratios and then only inside the banking system. Politicians enjoyed the good times and did not ask too many questions. What of commentators? They tended to indulge the fantasy that the above knew what they were talking about. … One big lesson of this experience is that economics is too compartmentalised and so, too, are official institutions. To get a full sense of the risks, we need to combine the worst scenarios of each set of experts’ (Wolf 2008).