Calls for more government regulation and intervention are common in times of crisis. But as soon as the crises subside, the pressure to reform quickly dissipates and the government is asked to withdraw. Instead of long-needed reforms, new financial fads and opportunities are touted.
Global Financial Crisis
The 2007-2009 Global Financial Crisis (GFC) started in the US housing market. Collateralised Debt Obligations (CDOs), Credit Default Swaps (CDSs) and other related contracts, many of which are quite ‘novel’, spread risk globally, well beyond US mortgage markets.
Transnational financial “neural” networks ensured that vulnerabilities spread quickly to other economies and sectors, despite government efforts to contain contagion. Since these were only partially successful, deleveraging – the reduction of debt levels through the hasty sale of assets – with all its dire consequences, became inevitable.
The GFC also uncovered massive misallocations of resources due to financial liberalization with minimal regulation of supposedly efficient markets. As arbitrage of interest rate differentials increased, it had become impossible to achieve balanced equilibria except in current economic models.
Financialization has meant much greater indebtedness and risk exposure for many households and businesses, as well as vulnerabilities such as those due to ‘maturity’ (duration) and ‘currency mismatches’, resulting in greater overall vulnerability of the financial system.
This worsened global imbalances, reflected in larger trade and current account deficits and surpluses. Under adverse circumstances, corporate and household exposure to risky assets and liabilities had been sufficient to trigger defaults.
Bold fiscal efforts successfully led to a modest economic recovery before being nipped in the bud shortly after the ‘green shoots of recovery’ appeared. Instead, the US Federal Reserve launched “unconventional” monetary policy, offering easy credit with “quantitative easing”.
currencies in transition
The seemingly coordinated rise in various, seemingly unrelated asset prices cannot be explained by conventional economics. Speculations in the commodity, currency and stock markets were therefore grudgingly recognized as a deterioration in the GFC.
Exchange rates for many currencies have also come under more pressure as residents borrow in low-interest currencies like the yen. In return, they have usually bought financial assets that promise higher returns.
So higher interest rates attract capital inflows and push up most domestic asset prices. Exchange rate movements are meant to reflect comparative national economic strengths, but rarely do. Traditional monetary responses exacerbate rather than mitigate contraction tendencies.
The globalization of trade and finance has created conflicting pressures. All countries are under pressure to run trade or current account surpluses. But of course this is impossible, since not all economies can run surpluses at the same time.
Many try to do this by devaluing their currencies or otherwise cutting costs. But only the US can use its “exorbitant privilege” to maintain both fiscal and current account deficits simply by issuing government bonds.
Currency markets can also undermine such efforts by allowing arbitrage on interest rate differentials. International imbalances have worsened, reflected in larger current account deficits and surpluses.
Unlike mainstream economics, currency speculation does not balance the domestic, let alone the international, market. It does not reflect economic fundamentals that ensure exchange rate volatility with detrimental effects.
commodity speculation
Because of currency mismatches, many businesses and households are at greater risk. Exchange rate fluctuations, in turn, exacerbate price volatility and its damaging consequences, which may vary depending on the circumstances.
Changes in the “fundamentals” no longer explain the volatility of commodity prices. Meanwhile, more commodity speculation has led to greater price volatility and higher prices for food, oil, metals and other commodities.
These prices were driven by much more speculation, which often involved index fund trading in real assets. The resulting price volatility primarily affects all food consumers and agricultural producers in developing countries.
Much of the surge in commodity prices since mid-2007 has been fueled by speculation, mostly affecting index funds. With the Great Recession that followed the global financial crisis, most commodity producers in the developing world faced difficulties.
Since then, almost all commodity prices have fallen from the mid-2010s as the global economic slowdown showed no sign of abating until 2022 when economic sanctions again pushed up food, energy, fertilizer and other prices.
In addition to export earnings, lower commodity prices and even greater volatility have accelerated the depreciation of past investments in equipment and infrastructure after commodity price spikes.
Integrated solutions required
The uneven collapse of the financial system after the GFC raised expectations that finance as usual would never return. But lasting solutions to threats like currency and commodity speculation require international cooperation and regulation.
Commodity and financial markets are now more closely linked. Therefore, a truly multilateral and cooperative approach must be found in the complex interdependencies of international trade and finance.
In this asymmetrically interdependent world, political reforms are urgently needed. All countries must be able to pursue appropriate counter-cyclical macroeconomic policies. Also, small economies should be able to achieve exchange rate stability at an affordable low cost.
Despite immediate action being taken in response to the global financial crisis, the world economy experienced a prolonged slowdown, the Great Recession. Myopic policymakers in most developed economies focus on perceived national risks and ignore international risks, especially those affecting developing countries.
Contrary to popular belief, the Bretton Woods multilateral monetary and financial arrangements did not include a regulatory regime. No such regime has emerged since then, even after then-US President Richard Nixon unilaterally ended the Bretton Woods system in 1971.
With developing countries’ voice gagged in international financial institutions and markets, the United Nations must take the lead, as it did in the mid-1940s. It is the only global body that could legitimately develop a better alternative. Fortunately, the UN Charter gives her the responsibility to guide efforts in this regard.
Jomo Kwame Sundaram, a former economics professor, was the United Nations Deputy Secretary-General for Economic Development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.
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