Global Governance and Financial Crises
eBook - ePub

Global Governance and Financial Crises

Meghnad Desai, Yahia Said, Meghnad Desai, Yahia Said

Share book
  1. 176 pages
  2. English
  3. ePUB (mobile friendly)
  4. Available on iOS & Android
eBook - ePub

Global Governance and Financial Crises

Meghnad Desai, Yahia Said, Meghnad Desai, Yahia Said

Book details
Book preview
Table of contents
Citations

About This Book

The editors of this book have pulled together a collection of chapters that review the spate of financial crises that have occurred in recent years starting with Mexico in 1994 and moving on to more recent crises in Turkey and Argentina. With impressive contributors such as Douglas Gale, Gabriel Palma and Andrew Gamble, the book is a timely and aut

Frequently asked questions

How do I cancel my subscription?
Simply head over to the account section in settings and click on “Cancel Subscription” - it’s as simple as that. After you cancel, your membership will stay active for the remainder of the time you’ve paid for. Learn more here.
Can/how do I download books?
At the moment all of our mobile-responsive ePub books are available to download via the app. Most of our PDFs are also available to download and we're working on making the final remaining ones downloadable now. Learn more here.
What is the difference between the pricing plans?
Both plans give you full access to the library and all of Perlego’s features. The only differences are the price and subscription period: With the annual plan you’ll save around 30% compared to 12 months on the monthly plan.
What is Perlego?
We are an online textbook subscription service, where you can get access to an entire online library for less than the price of a single book per month. With over 1 million books across 1000+ topics, we’ve got you covered! Learn more here.
Do you support text-to-speech?
Look out for the read-aloud symbol on your next book to see if you can listen to it. The read-aloud tool reads text aloud for you, highlighting the text as it is being read. You can pause it, speed it up and slow it down. Learn more here.
Is Global Governance and Financial Crises an online PDF/ePUB?
Yes, you can access Global Governance and Financial Crises by Meghnad Desai, Yahia Said, Meghnad Desai, Yahia Said in PDF and/or ePUB format, as well as other popular books in Negocios y empresa & Negocios en general. We have over one million books available in our catalogue for you to explore.

Information

Publisher
Routledge
Year
2003
ISBN
9781134405688

1 Introduction

Meghnad Desai and Yahia Said

The new century is barely three years old and many of the certainties of the last century are being re-examined. During the last decade of the last century, there was an overwhelming confidence about the economy. A ‘New Paradigm’ was hailed; the business cycle had been abolished we were told. It seemed that the knowledge economy did not obey the old laws of economics. There would be no longer boom and bust as a new generation of central bankers and prudent Finance Ministers had fashioned the perfect combination of monetary and fiscal policies for us.
There was a warning in 1997 with the Asian crisis and the triple bypass for Long-Term Capital Management. The 1997 crisis was the first crisis of the new phase of globalisation. But while it sloshed about in Russia and Brazil, it failed to reach the shores of the New York or London financial markets. Smugness returned until in early 2001, the Dow Jones and Footsie began their journey southwards. We were soon hearing of a double-dip recession, retrenchment in the financial services sector and large budget deficits in the USA, Germany, France with no upturn in sight for Japan after ten years of stagnation.
The business cycle is back with us; indeed, it never went away. While a financial meltdown is a rare occurrence in developed country markets, the frequency of such events in periphery is worrisome. In the last ten years, we have had crises in Mexico, Indonesia, Thailand, Malaysia, South Korea, Brazil, Argentina and Turkey. There is financial fragility in India and China. The uneasy marriage of moral hazard of lenders lending to sovereign governments in the knowledge of a certain bailout and the inability of sovereign borrowers to follow time-consistent strategies in shaping their debt profile is becoming a major problem. The questions are many but the answers are few.
This volume attempts to address some of the questions raised by the string of financial crises over the past ten years. As Desai puts it – are global financial markets rational or are manias possible? Should crises which follow manias be allowed to run their course and purge the system or should a lender of last resort intervene to dampen their impact on the real economy? Who can play this role at the global level?
In Chapter 2, Desai explores the term ‘crisis’ and finds parallels between the medical and financial use of the words. Crises in both areas indicate (a) a turning point (b) a sudden and (c) precipitous drop in most indicators. It also may have benevolent characteristics by purging the system of previous excess and marking the end of the ailment.
Desai briefly reviews the state of academic inquiry into the subject. He finds that while various researchers can provide useful insights into individual aspects of crises there is no coherent and empirically supported theory that brings all these aspects together. He likens the state of research in this area to the joke about the elephant being described by several blind men who are holding on to different parts of his body and trying to extrapolate an understanding of the whole, each from his own limited perspective.
Marx who had in mind ten-year long Juglar type cycles viewed crises as endogenous, natural and an endemic phenomena of capitalism. He therefore concluded that nothing could be done to prevent them or manage their impact. Hayek believed that cycles should not occur in a healthy capitalist economy. They are likely to occur, however, as a result of overindulgence, such as excessive credit expansion. In this case, crises have the benevolent property of purging the system. They should be left to run their course, which may take a long time. Government intervention is only liable to exacerbate matters. Schumpeter analysing long Kondratieff type cycles believed that they are the only way to technical innovation. Crises are part of the process and indicated realignment to the steady state. Keynes’s analysis of short-term Kitchin type cycles has a similar perspective to that of Hayek although he disagrees with him about their causes, which he attributes to the market’s propensity to turn into a casino on occasion. Keynes believed that crises are predictable, pathological and warrant drastic remedies. Minsky in a follow-up to Keynes’s ISLM framework viewed cycles as Walrasian, non-endogenous events triggered by external shocks and caused by the market’s propensity to overshoot.
Desai proceeds to review the history of financial crises over the past 170 years. He agrees with Kindelberger on the pattern of manias, panics and crashes, which seem to feed into each other to produce them. He also points out to the effectiveness at various junctions of lender-of-last-resort intervention whether in the form of the Bank of England during the gold standard years in the nineteenth century or the Federal Reserve in the most recent crises. He attributes the severity of the Great Depression and the failure to address it over a long period to the absence of a lender of last resort at that moment in history – the Bank of England was no longer in the position to play that role and the Federal Reserve was not yet ready. In this context, he also blames the lack of awareness of the global nature of the Great Depression and the failure to coordinate actions between the US and European financial authorities.
During the Bretton Woods years, according to Desai, crises became mild recessions due to the Keynesian system of effective financial separation and fixed exchange rates. Indeed, the 1970s stagflation and the failure to mitigate it is a consequence of the system’s collapse in 1970.
In the new era of globalisation, according to Desai, it is the US Federal Reserve which assumed the mantle of the lender of last resort and not the IMF. He views the IMF as a lender of first resort charged with maintaining the exchange rate pegs with US support, conducting structural adjustment programmes and coordinating rescue packages. The problem with IMF intervention in crises is that it uses economic models that do not allow for cycles or crises. As such it views cycles as disequilibria, which can be remedied by drastic cuts.
Desai concludes that crises are likely to recur with varying reach, timing and magnitude. They are endogenous to capitalism and spread with it. With globalisation, crises have become intertwined. Desai believes that lender of last resort ‘tweaking’ should be sufficient to mitigate most crises. This role is not played by an international institution but rather by the central bank of the hegemonic power at the time.
In Chapter 3, Alan and Gale provide a quantitative analysis of the recent spate of financial crises. They find confirmation for Kindelberger’s identification of credit expansion as a determining factor behind asset price bubbles. They point out that historically asset price bubbles followed reforms, which led to credit expansion such as financial liberalisation, fiscal expansion and relaxation of reserve requirements. They cite Japan in the 1980s as an example of this phenomenon.
The mechanism through which financial deregulation feeds into asset price bubbles according to Alan and Gale is by exacerbating the agency problem. Speculative investors with improved access to credit shift the risk to financial intermediaries. This encourages them to bid prices even higher. Uncertainty over monetary policy further exacerbates this dynamic. On the down side, banks liquidate assets to meet demands, which further accelerates the negative bubble. Alan and Gale conclude that financial authorities can mitigate asset price collapse by expanding liquidity.
In Chapter 4, Aglietta provides an analysis of the IMF and proposals for its reform. He views crises as endogenous to financial markets and attributes them to a vicious cycle of credit expansion and asset price appreciation.
Aglietta attributes the Fund’s failure to adequately react to the recent spate of financial crises to the disjuncture between the changing environment, within which it operates and its structural and doctrinal rigidities. He argues that not only technical but also political measures are needed if IMF reforms are to succeed.
Aglietta argues that the IMF emerged in a world dominated by government intervention and international cooperation. As market dominance spread, the Fund reacted by accumulating and layering new functions, which are sometimes mutually exclusive. Thus, the Fund is simultaneously acting as an assuror of mutual assistance, an issuer of world currency (albeit discontinued), a financial intermediary and a crises manager. In particular, Aglietta sees a conflict of interest in the Fund acting both as a financial intermediary through its structural adjustment facilities and as a crises manager.
Aglietta recommends that the Fund should (a) focus on prudential issues both in terms of prevention and crises management. This should entail streamlining its portfolio of financial products and working closely with the private sector to share risks and strengthen international supervision. The IMF should work through national central banks or directly as a crises manager/lender of last resort. Aglietta is not proposing the IMF as a replacement to the Bank of International Settlements but as a more democratic complement to it since the latter is more dominated by the USA and the G7.
In Chapter 5, Gamble who believes that crises are a result of thirty years of deregulation, describes three models of globalisation and analyses their implications for financial crises theory and practice.
At one extreme are the hyper-globalists who proclaim the end of the nation state. They could be Marxists arguing that the state’s loss of discretion over markets is what causes crises or Neoliberals who argue that crises are caused by the remnants of state regulation. Both believe that markets are all powerful and reforms are either useless or unnecessary.
The sceptics, on the other hand, believe that states still have leverage over markets and that deregulation was voluntary rather than imposed by globalisation. They see state action – either unilateral (i.e. capital controls) or coordinated through international organisations – as the key to preventing crises and managing their consequences.
The transformationists believe that the state is still an important player but that globalisation has changed the constraints under which governments and the economies operate. They see crises as a result of a mismatch between an emerging global economy and national politics. Transformationists believe in the imperative to address crises because of their high cost. Some see the answer in global governance solutions, which are more than international arrangements. Others, whom Gamble calls hegemonists, see a role for the USA and its financial authorities in addressing crises.
Globalisation can also, according to Gamble, be viewed as a change in the model of capitalism from a nationalist model marked by a compromise between national capital and national labour to a transnational one where no compromise is necessary. Thus, both hyper-globalists and sceptics believe that a convergence is taking place on the Anglo-Saxon model of capitalism which leaves no space for reform while transformationalists see a possibility of maintaining local and regional institutional diversity in combination with global governance, be it democratic or hegemonic.
In Chapters 6 and 7, Jomo and Palma explore the crises in East Asia and Latin America, respectively.
Jomo, analysing the causes of the Asian crises, identifies a coalition of foreign capital and domestic constituencies including business leaders and politicians as the main culprits. This coalition, according to Jomo, pushed through a financial liberalisation process which was fitful and uneven due to conflicting interests of the various parties.
Jomo points out that the East Asian countries, regardless of the differences between them, used short-term foreign financial flows to finance the service side of their current account deficit. As a consequence these flows did not end up feeding economic growth but rather an asset price bubble. The ensuing collapse according to Jomo was not the result of fiscal profligacy but of the reversal of those short-term flows. The main causes of the crises were investor sentiment, herding behaviour and contagion. The IMF remedies of conditionality and corporate governance reform were therefore misdirected, they only exacerbated the problem. What these countries needed was a Keynesian stimulus package.
Jomo proceeds to propose a set of recommendations for international finance reforms. He suggests that the international financial community should not merely tolerate the imposition of selective and temporary financial controls but explicitly endorse them. In the case of crises, Jomo suggests that countries should have access to quick and unconditional liquidity. In general, sovereign debtors should be offered fairer terms for debt workout including a standstill. Jomo believes that developed countries should coordinate actions to ensure currency stability. He recommends the development of a prudential controls system which recognises diversity. Finally, Jomo believes that countries should have discretion over the exchange regime they choose.
Gabriel Palma, analysing financial crises in Latin America and Asia, posits that they were a result of lenders and borrowers accumulating excessive amounts of risk. He then asks the question whether this was due to exogenous market interference which distorted their otherwise rational behaviour or whether they did so because specific market failures within the financial market led them to be unable to assess and price their risk properly.
The surge in capital flows, according to Palma, rendered any policy aimed at their absorption inefficient. These flows were caused by excess liquidity in international markets and domestic policy aimed at attracting them. Emerging economies acted as a market of last resort – excess liquidity combined with slow growth in developed markets fed into excessive expectations and created artificial incentives.
After analysing the various routes which led countries into crises, Palma evaluates their exit strategies focusing on capital controls. Price-based capital controls employed by Chile had little effect on the volume of capital flows but had some effect on their composition. They also had some positive effect on the macro-economic environment. Quantitative controls such as those employed by Malaysia had, on the other hand, a stronger and more lasting effect on the volume of capital flows.
Palma concludes that economic dogma is preventing proper reaction to crises. Capital controls are of some help but not sufficient. Instead he suggests that diverse strategies should be targeted at expanding domestic lending for consumption and investment, sterilisating inbound financial flows and changing their composition.

2 Financial crises and global governance

Meghnad Desai

Introduction

There have been financial crises for 175 years, at least. At first they had national origin and reach but even in the nineteenth century their shocks were transmitted across countries. By the end of that century, the TransAtlantic cable had been laid and as a result, Britain, France, Holland, Germany and the USA had interlinked financial markets, which moved in parallel, especially at times of crises. At the end of the twentieth century, the Asian crisis of the summer of 1997 brought us back to that world. That crisis originated in Thailand and after spreading across Indonesia, Malaysia, South Korea, leapt across to Russia, threatened to hit Brazil and caused the spectacular troubles1 at Long-Term Capital Management (LTCM) in the summer of 1998. That was the first crisis of the recent phase of globalisation. It led in its turn to demands for ‘new financial architecture’ and much activity by the IMF/World Bank and G7 leaders in the summer of 1998 was directed towards coping with the global crisis.2 As it happened (and this is my reading of the events of October 1998), a small number of interest rate cuts by the Federal Reserve (Fed) calmed the markets and resolved the crisis. While some new institutions such as the Forum on Financial Stability were introduced, the global financial system has escaped any drastic structural adjustment or reform.
In the new century, stock markets in G7 countries again witnessed a prolonged decline with widespread failures in the dot.com sector. Events of September 11, 2001 had less impact than the news of accounting malpractice at Enron and World.com. While during the 1990s there was talk of a new paradigm and abolition of the business cycle (as indeed happens in every long boom), by 2002 there was a widespread fear of a double-dip recession in the USA or even a depression. The business cycle was back with us, alive and well.
The questions raised during the Asian crisis in those fifteen months between June 1997 and October 1998 and indeed since then in the most recent recession show that the issue of crises and cycles will not go away. After the euphoria of the first phase of explosive growth in financial markets during the 1990s, questions are being raised about the tendency of markets towards excess volatility and persistent bubbles, which take too long to burst.3 Thus, the political economy of financial markets, of their tendency towards crises and cycles, still requires some coherent consideration. Starkly put the main questions are:

  1. Is the global financial system an autonomously self-equilibrating, selfregulatory system requiring no policy intervention: either because the financial markets are efficient in the sense of Fama4 or because their cycles are self-reversing endogenously without the need of any exogenous shock/ intervention; or
  2. Is it a system that mostly works in a self-regulating way but does need occasional coordinated policy intervention to prevent escalation of local difficulties into a global meltdown; or
  3. Is it riddled with pervasive market failure, which leads to excess volatility and/or inequitable outcomes so that it is neither desirable nor efficient to leave it unregulated or even partially/occasionally tweaked but needs supranational or global government?
These questions are germane to the interpretation of the recent crises and the understanding of the next few as well. But the same set of questions has been put much better, perhaps in an earlier context by Kindleberger in his classic Manias, Panics and Crashes (MPC hereafter) (Kindleberger 1989). His argument can be summarised as follows:
Are markets so rational that manias – irrational by definition – cannot occur? If, on the other hand, such manias do occur, should they be allowed to run their course without government or other authoritative interference – at the risk of financial crisis and panic that may spread through propagation by one means or another to other financial markets at home and possibly abroad? Or is there a salutary role to be played by a ‘lender of last resort,’ who comes to the rescue and provides the public good of stability that the private market is unable to produce for itself?5 And, if the services of a lender of last resort are provided nationally, by governments or by such official institutions as a central bank, what agency or agencies can furnish stability to the international system, for which no government exists? (Kindleberger 1989, p. 4).
Thus, not only do financial crises recur, the ways of studying them also do so. In this chapter, I want to briefly and quickly survey the history of financial crises as well as the small amount of theoretical literature that is available (see Allen and Gale Chapter 3 in this volume for other references). Then I want to pose the issues about the policy choices. These choices very much hinge on the theories we have about the nature and causes of financial crises.

Defining crises and explaining cycles

Before getting into the history of financial crises, it is worthwhile to define them. To begin with, we need to define the much abused word ‘crisis’. The term originates in medicine and relates to a turning point in the s...

Table of contents