Global Finance

Robert Holton, Robert J. Holton

• Publisher: Routledge
• Year: 2012
• eBook ISBN: 9781136808081
• Edition: 1
• Topic: Social Sciences
• Subtopic: Finance
• Index: Social Sciences

Written under the shadow of the global financial crisis, this book charts the current shape of global finance and tries to explain why the crisis arose – and what can be done about it. Economics alone cannot fully explain how global finance operates, and why it is so crisis prone. Global Finance offers a wider approach in three key ways, by:

• setting markets and financial market failure in a historical context
• bringing politics and culture back into the analysis of global finance
• drawing on the latest thinking by sociologists of economic life.

With a convincing argument for better regulation of markets, Robert Holton provides a fascinating insight into the volatile and often misunderstood world of global finance. This is a key text for undergraduate students of sociology, economics, business, and politics, as well as being an incisive, informative read for anyone with an interest in this topical issue.

1

GLOBAL FINANCE

This book is intended to make sense of global finance. There can be few topics of such immediate importance, whether to citizens, businesses, or governments. The recent global financial crisis (GFC), which began in 2007, is still playing out in the sovereign debt crisis of a number of European countries and the USA, while many global banks remain subject to stress tests to determine whether they would withstand further financial shocks if conditions deteriorate. Citizens find they are paying many of the costs of financial breakdown whether through unemployment, cuts to public services or increased taxation, while many businesses are finding credit hard to obtain. So how is it that this situation has arisen and what can be done about it?

Global finance has an enormous dynamic potential, yet its economic power and global scope raise fundamental challenges to national sovereignty, democratic politics, and international co-operation. These challenges are magnified by the problems of risk and severe economic instability to which the sector is prone, posing further challenges for global as well as national public policy as to how global finance is best regulated.

Many discussions of global finance are written by economists and management specialists, and others by financial regulators or journalists. The distinctiveness of the present study, written by a sociologist and economic historian, is that it takes a rather different and far broader approach. This has two main features. First, it places global finance within society and subject to political and cultural as well as economic processes. Second, it is historical and as such not limited to the present or to immediate financial concerns.

Economics does not provide all the answers to an understanding of how global finance works, while a focus exclusively on the present does not engage with the historical fact that global finance and globalization itself has a long history. Financial crises are not new but endemic to market-based economic systems. Much of the rhythm of global finance over the last 300 years has been cyclical in nature, as Charles Kindleberger famously pointed out in Manias, Panics and Crashes (1978). Such cycles followed a pattern of credit expansion–speculation–bubble–distress–bust. Many look to economists for answers to these questions, but there is equally a strong sense that economics failed to predict crisis and may only have limited purchase on its causes. The alternative sociological approach outlined in this book includes greater emphasis both on historical trends and instabilities in global finance, and gives close attention to the cultural worlds of finance, to the traders and bankers at the heart of the system. The idea that markets work simply through the rational pursuit of self-interest is too simplistic and needs to be replaced by a broader sense of the culture, social psychology, emotions, and discursive contours of financial market players. These shed light on how markets work, and why participants fundamentally underestimated risks and uncertainties, leading eventually to crisis.

Markets and financial institutions, together with investors, borrowers and savers, are then part of wider social arrangements, rather than operating in an entirely separate economic domain. This does not mean economic thought is not helpful or productive. Indeed, economic theory acts not simply as a commentary on economic life, but also helps to shape the way economic activity is organized. The problem is rather that economics, as we shall see, is not enough if we want to understand how markets work. There is, after all, a two-way flow of influences between the economy, on the one hand, and political, legal, and cultural processes on the other. Such processes include public regulation of markets, legislation and legal norms concerning economic property rights, and acceptable forms of economic transaction, as well as cultural expectations and conventions concerning the purposes, functioning, and limits to the scope of economic activity. Markets have, in other words, social, political, and cultural preconditions as well as consequences. They are acted out or performed by individuals and groups according to ways of understanding economic life, that arise within the broader social infrastructures that markets inhabit. This is true both within nations and in cross-border activities where differences in political arrangements, legal requirements, and cultural practices affect how business is done. Research in areas such as management styles, modes of negotiation, and preferred forms of legal regulation show this to be the case.

So while the ideal of ‘free’ markets is widespread, it would be misleading to assume that this amounts to a complete description of how markets actually work. Finance markets may appear impersonal, a characteristic enhanced both by the extensive use of computer-based transactions and by the secretive nature of confidential business practice. Yet they are performed by individuals operating within organizations and networks. Market participants must make judgements not simply about price signals and what they mean for investment, saving, employment, and consumption, but also about who they trust, what operating methods are legitimate, how they interpret risk, what legal and political obligations are required of them, and whether ethical considerations should enter into market behaviour. This does not mean that market participants necessarily comply with external norms and obligations – tax evasion and insider share dealing being two obvious areas where they do not. But it does mean that there is a wider social setting to be reckoned with. Even if self-interest or greed are the norm, there are circumstances – such as repeated financial crises over the last 300 years – where they are inadequate as guides to behaviour, and where the location of markets within society can no longer be ignored.

This is evident in the emergence of criticism over the legitimacy of high salaries and bonuses paid to financiers who have presided over banking failure. It is also connected with arguments that businesses that receive massive public bail-outs in order to survive financial collapse should not simply carry on as before, but should have a greater public responsibility for their actions. The wider social and political context is also reflected in adverse commentary on the widespread tendency of banks to raise their own interest rates in excess of central bank interest rate rises. Legislators and regulators, as well as citizens, take these matters seriously and often seek redress. Whereas conventional economic thought brackets out much of this wider array of concerns and influences, in this book they are brought back in to the analysis.

The development of global finance is part and parcel of wider social arrangements, but it is equally connected with that much-hyped and omnipresent phenomenon of globalization. This involves a growth and intensification in cross-border transactions and relationships, such that the world becomes increasingly interdependent. This interdependence is seen within an international division of labour which sees raw materials, manufactured goods, and financial services exported and imported. But it also applies to finance, where money markets for investment capital, foreign exchange, government debt, real estate, and household consumption depend on global linkages between borrowers and investors, conducted through financial intermediaries. Nations may have particular profiles in terms of the types and scale of financial institutions located within them, levels of domestic savings, and levels of public expenditure and debt. Yet their room for manoeuvre in financial matters is circumscribed by the integration of national finance within global arrangements. Such limits apply even to the world’s largest and most powerful nation, the USA, whose deficits both in international trade and in government expenditure depend on huge inflows of global capital, including massive purchase by China of US government bonds. Without these global inflows, US consumers would have to curtail their consumption, corporations would have to limit capital expenditure, and governments would have to slash public spending.

Global interdependence also means that events or crises in one region spill over to many others. This happened in the Wall Street crash of 1929 and subsequent Great Depression. It has also happened in the recent financial crisis. The reverberations of this renewed episode of global financial dislocation have been felt not only in the USA where banking collapse and the sub-prime mortgage crisis bit deepest, or in Europe where banking crisis has been combined with sovereign debt crises and political instability in smaller countries such as Greece and Ireland. The crisis also has ramifications for Latin America, Africa, and Asia, as the upward trajectory in the growth in world trade faltered, while global capital markets reduced the supply of credit and largely abandoned poorer indebted nations.

Economic globalization involves cross-border trade, investment, migration, and technology transfer. These are associated not simply with cross-border flows of economic activity and interdependence, but also with evolving power structures that contain within them significant global inequalities, as well as challenging older understandings of national sovereignty. Nation-states, as recent events in Europe indicate, have to deal with the global financial system, because they typically need to borrow money internationally to finance budget deficits. The sovereign debts involved arise from the sale of government bonds to investors, but the prices which investors are prepared to pay to hold bonds reflect private calculations and perceptions of the creditworthiness of nations. The more risky, the higher the interest rate investors demand, posing further challenges to the finances of the states involved, and to their freedom of manoeuvre in setting levels and deciding types of government spending. These in turn challenge the idea that nation-states should be self-governing according to democratic principles. So while the operations of multi-national companies were the focus of earlier debates over the challenges of the global economy to nations and democracy, this focus has recently shifted to a new preoccupation with bond markets and the fiscal challenges facing ostensibly self-governing nations. National sovereignty and global bond markets seem to be incompatible with each other, with democracy a further casualty in the process.

The place of global finance within economic globalization has also been growing. Thus the massive upswing in economic globalization that has taken place over the last two decades saw an increase in the relative importance of finance within the global economy, as compared with manufacturing and primary production. This change has been associated both with a massive increase in the global scale and outreach of banks and other financial institutions and with the volume and complexity of financial transactions within the global economy. Major players in global finance now include hedge funds and private equity funds as well as banks and insurance companies, while new instruments such as derivatives have grown up alongside bonds, shares, loans, and mortgages.

Global finance, then, is not simply a matter of institutions and products, but also of the people and occupational groups that constitute financial markets, together with the ideas and forms of knowledge that guide and influence their actions. Its operation depends both on this internal set of activities and on a wider set of social and political influences. These are the guiding perspectives of this study, which is organized as follows.

Plan of the book

In Chapter 2, attention is focused on what exactly global finance is and how it operates. This provides an account of the underlying principles of finance and credit, as well as an account of the leading institutions and products involved in the global financial arena. These include the growth of securitization and derivatives, together with new developments in investment banking around arbitrage. These important technical terms are explained in non-technical language. The chapter also identifies the paradox that global finance is simultaneously very creative and at the same time so destructive. These are characteristics that the Austrian economic historian Joseph Schumpeter saw as fundamental to capitalism itself.

Attention turns in Chapter 3 to the history and social geography of global finance, including questions as to the origins of global finance, and its evolving spatial location within the global economy. This identifies the historical origins and key moments in the evolution of global finance, whose history goes back millennia, and the spatial locations in which global finance has operated. Attention is also given to structures of financial power, referred to by many recent commentators as financialization, and what they mean for the place of finance within the economy as a whole. Finally, the evidence for historical patterns of boom, bust, upswing, and crisis, is reviewed, breaking down the general idea of financial crisis into distinct types and considering how far the GFC has taken on new dimensions.

Chapter 4 looks at a neglected feature of global finance, namely the cultural worlds of global finance and the key players involved. This examines the importance of new information technology and electronic trading, while being equally concerned with the social dynamics of trading rooms and deliberations by central bankers. The emotions and social psychology of global finance are discussed as a means of enriching accounts of economic life beyond the impoverished assumptions of rational self-interest.

Chapter 5 brings together the case for grounding the study of finance markets within a broad sociological approach. While there have been many criticisms of the narrow focus of conventional economics in the past, these have not displaced economics as the place analysts go to find answers to economic challenges and to the reasons for GFC. In this chapter, the values underlying support for markets are discussed, and in particular the attractions of utopian projections of markets as systems of natural liberty. This market utopianism, rather than any superior analytical capacity, is argued to be the main obstacle to a shift toward a sociological approach to economic life, embracing culture and politics.

Chapter 6 turns to more practical issues to do with public policy and whether global finance can be made to work better. This examines attempts to address the instabilities and risks associated with global finance through a re-structuring of global financial architecture, and whether these are likely to be successful. Attention is also given to problems of a democracy deficit in the area of global finance and how this might be addressed. Global finance has an enormous dynamic potential, yet its economic power and global scope raise fundamental challenges to national sovereignty, democratic politics, and international co-operation. These challenges are magnified by the problems of risk and severe economic instability to which the sector is prone, posing further challenges for global as well as national public policy as to how global finance is best regulated.

2

GLOBAL FINANCE

What it is and how it operates

This chapter is organized around the following questions. What exactly does global finance entail? What are the key institutions involved, and how do they operate?

Introduction

Global finance, as we have seen, stands at the intersection of two broad long-term processes. One is the development of specialist financial institutions serving households, businesses, and states. The other is globalization: a complex set of processes involving cross-border flows and dependencies arising from not only the mobility of capital, commodities, technology, and people, but also political ideas and institutions, and cultural ways of life. Without global finance it is unlikely that economic globalization would be sustainable. However, it is equally the case that repeated global financial crises are evident across history, raising questions about why it is that global finance bears with it a high level of risk, and whether such crises can be avoided in the future.

Global finance is a familiar feature of contemporary life that may be identified with a range of businesses, markets, and public institutions. These span banking, insurance, and investment, products such as shares, bonds, loans of various kinds including mortgages, and more complex financial instruments such as derivatives including futures – all of which will be explored further below. They involve well-known banking giants such as Goldman Sachs and Barclays, insurance businesses such as Lloyds, hedge funds such as JP Morgan Chase or Soros Fund Management, less well-known bond dealers such as Pimco, debt ratings agencies such as Moodys and Standard and Poors, and a range of trading markets. These include face-to-face ‘open outcry’ markets such as the New York Stock Exchange and the Chicago Board of Trade (which trades commodities and bonds), and electronic screen-based markets such as the Nasdaq – US share dealing markets specializing in high-tech companies – or the vast electronic global foreign exchange markets. These markets are centred in global cities, not only New York, London, and Chicago, but also Tokyo, Sydney, and Zurich.

Recent economic globalization in combination with new communications and information technologies has meant that global finance never sleeps. Trading is spread across a global twenty-four-hour period, meaning that a succession of market centres open and close across a range of different timezones. Electronic communication involves special trading and information screens displaying a constant stream of market information delivered by specialist terminals from news providers such as Bloomberg and Reuters.

And beyond this rather breathless world of global dealing based on constantly changing market prices and commercial news is the slower but equally globally connected world of central banks and regulators. Some of these are organized internationally such as the Bank for International Settlements, some regionally such as the European Central Bank, some nationally such as the US Federal Reserve or Bank of England, and some on a sub-national basis, such as regulatory agencies in the various US states. Making the picture even more complicated are private organizations that are charged with regulating specific industry sectors within global finance, such as the International Swaps and Derivatives Association, or the International Association of Investment Bankers.

Some general preconditions of global finance

Before we look in detail at financial processes and institutions, it is important to place finance markets in a broader social and political setting. Such markets may seem, at first, to more or less organize themselves, balancing supply and demand through price mechanisms. On this view one would expect that analysis of the functioning of markets can be left to economics. Yet to assume this view of finance begs many important questions. How is it, for example, that various markets arise in the first place, especially those involving highly mobile and highly risky kinds of transactions? Why and how, in particular, have cross-border markets for capital and credit arisen, when there is no absolute guarantee that loans will be repaid to banks, that share prices will remain buoyant, and that bond-holders will continue to receive regular interest payments from corporations or governments? And why is it that public confidence in finance in general and global finance in particular is so volatile, including periods of extreme suspicion and criticism such as the present? In following through these kinds of questions, a broader enquiry drawing on wider resources in social science is required.

Sociology, in particular, has developed a suitably broad way of understanding markets and economic globalization, which examines the ways in which social and economic activities and institutions interact and influence each other. The theoretical basis for this strand of thinking is explored in more depth in Chapter 5. For the moment we note the particular language in which much of this approach proceeds. This speaks both of the embedding of the economy in society and of the periodic dis-embedding of markets from wider social regulation. An alternative, more familiar, way of describing dis-embedding is to speak of de-regulation. But underlying these analytical questions is one of the central public policy questions of our t...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Series editor’s preface
• Preface: Global finance: the argument
• 1. Global Finance
• 2. Global Finance: What it is and how it operates
• 3. The History and Social Geography of Global Finance
• 4. The Social Actors in Global Finance: Market culture and financial knowledge
• 5. Society and Finance: An alternative theoretical approach
• 6. Global Finance and Public Policy
• Glossary
• Further Reading
• Web Resources
• Index