The financial globalization echo emotive gains primarily because of the deemed connectivity between highly fluid capital flows and the financial crises, that have become more pronounced in the past three decades.
This connectivity is the controversy.
It will be quite useful to see beyond the narrow confine of economics, the temporal story behind the financial crises occurrence. The gained insight can help Asian countries to devise combating policies and strategies.
Treading the historical trail will provide apertures on temporal international politics, commerce and economics nexus. It will also help in understanding the underpinnings of financial crises in recent times, and will lead to unearthing the nexus that needs to be tamed.
In the middle of the 17th century, a strong urge for a central bank that could quench compelling liquidity thrust to finance economic development and expanding trade, imbued support in England.
The Dutch model of national banking became a backdrop of Bank of England construct, which was founded in 1694.
The Bank was backed by gold; the capital and loan came from a syndicate of private investors and lenders. The Bank of England managed the government's accounts and made loans to finance public spending.
Operating also as a commercial bank, it took deposits and issued notes.
The financial difficulties if occurred in those times were not merely an economic or monetary phenomena, it had a lot to do with the politics and sovereign aspirations of nations and the resultant difficulties they encountered in pursuit of their expanding geographical and economic sway.
In the ascent of Europe in past centuries, industrial progress was not allied to free market system, but natured and spurted by powerful European governments of the day, which provided investment capital through national banking.
Any nation that adopted any course other then government financed industrial policy, failed to expand as an economic or military power during the 17th, 18th and early part of the 19th centuries.
In early 17th century, The Dutch and East India Companies embarked on issuing shares to the public, essentially to fund enterprises, under the watch of Dutch and British governments. These shares being freely transferable impelled development of secondary financial markets.
The whole episode of shares issues had underlying imperialistic ambitions such as colonial expansion, wars and other administrative and colonies infrastructure development expenditures, to facilitate transfer of primary commodities and extracted minerals to home countries, and to market home countries industrial goods in the colonies.
In the eighteenth century, the New York Stock Exchange established in 1792 and the London Stock Exchange opened in 1802 channeled European savings to U.S railroads expansion.
Prior to the eruption of World War I, the bond markets of London, Paris, Berlin, and Amsterdam directed massive capital flows in pursuit of higher returns to the emerging markets of the U.S, Canada, Australia, Latin America and Russia.
Although, during that era the capital markets did experience swings and gave rise to financial crises, but these eruptions never left the confines of a few countries owing largely to somewhat disconnected global financial markets.
The global financial system of the 19th century is one of complete nexus of imperialistic sovereignty. On the one end an unstable balance between electorates’ demands on the European and North American governments to redress the growing income inequalities, and on the other end international capital flows that were flowing nomadically and were lurking for edifice that could ensure not only sound finance but also provide protection to home manufacturing sector; was the paradox.
This variance between globalization and domestic sovereignty re-emerged in the 1950s and remained unresolved till 1990s.
The global capital flows that mainly emerged from the European countries in 18th and 19th centuries were strongly directional towards emerging markets of the time. These flows had a strong underlying stability, primarily owing to stable exchange rates that were maintained by the European governments under the gold standard regime.
The newly developed tools of monetary policy led to the belief that central banks capability to stabilize the economy and eliminate the cycle of boom and slump is now in place.
To utter dismay, the Great Depression, which followed the stock market crash of 1929, led to the abandonment of the gold standard. The tariff barriers gained upsurge and trade increasingly confined to economic blocs.
After 1945, the radical thinking globally turned towards establishing a set of national and international institutions that would insulate world economy from depression and prevent insecurity allied with unregulated free markets.
The economic object of the system of international cooperation was to manage the capital flows in a way, which permit both fixed exchange rates and enough domestic freedom in economic policy to move towards the utopia of full employment.
At Bretton Woods in 1944, in the backdrop of spirit of international cooperation, two international institutions emerged; the International Monetary Fund (IMF) to provide short-term assistance to countries experiencing balance of payments problems and the International Bank for Reconstruction and Development (World Bank) to provide long-term finance for development projects.
The framework of these institutions thought to provide a mechanism for capital flows, which could capture benefits available from international borrowing and lending, with complete insulation from the instability allied with uncontrolled international financial markets.
The efficacy of these two institutions is now in question, primarily because of US dominance that made these institutions subservient to its foreign policy agenda.
From 1945 to the late 1960s, the Bretton Woods system in connivance with Keynesianism pushed mixed economy architecture to the forefront.
Then came the collapse of the Bretton Woods system, the roots can be traced back to upsurge of inflation, which rendered fixed exchange rates regime unsustainable, thereafter the exchange rate regime hung between floating and adjustable exchange rates; accompanied with gradual unrestrained international capital flows.
During 1970s the international financial deregulation crept in and led to eventual deregulation of global capital markets architecture. The era of monetarism thus dawned. However, monetarism was no more successful than Keynesianism as is quite apparent in recent times.
Viewing temporally, the global dominance by the powers at different times has continually manipulated the nexus of global financial architecture and the capital flows.
In fact a nexus whose links to the history of warfare, tussle for national autonomy and sway of strategic economic dominance are all too apparent.
These nexus tentacles have always been visible through strategic lending or through manipulation of integrated global financial markets.
In recent times, the level of the emerging markets sophistication and depth, determines the extent to which they can be tamed to keep the United Nations Western veto power’s interests intact.
The power dynamics since middle of the 20th century has undergone a dramatic change, owing to the suzerainty of the multinationals.
At this point in time the stakes of United Nations Western veto powers and the rest of the world incidentally have to an extent converged.
However, the deployment of financial resources internationally is consistently being manipulated by the multinational banks and financial institutions whose parentage rests in the advanced countries.
The important effect of financial globalization in the context of developing countries is the unhindered cross-border financial arrangements, stemming essentially from the lending, underwriting, fund management and e-commerce activities facilitated by the international banks, which at times distort host country’s macroeconomics dynamics, owing to inefficient or prevalent weak financial market infrastructures and lack of economy’s absorption capacity, thus at times putting the wayward financial flows at odd with sovereign security.
Another facet of the free market movement led by the liberalization of capital and current account across the globe has created a catalytic upsurge in capital flows, this phenomenon has the potential of continually generating fresh ways of financial crisis, with each new bout more voracious, swift and debilitating.
It was the speculative bubble that hastens the 1997 collapse of Asia’s financial markets and resultant deflationary economic depression. The bubble itself emerged out of almost unlimited access to international capital.
The main attraction of borrowing was the assumption that Asian currencies were pegged to US dollar and US dollar interest rates were lower when compared to local interest rates, notwithstanding the fact that this cheap financial resource generated speculative rather than justifiable economic investments in the regions.
In 1987, in the midst of a stock market crash that could have swiftly destabilized the world financial system, the Federal Reserve announced that US Federal Reserve would act as the world’s lender of last resort.
This pronouncement of the Fed gave the tinker of the new hub of global money supply.
The central banks of powerful Western countries thus created money to fulfill money demand of the world, this new dynamics has changed the entire scenario, but the danger is, the jinnee the powerful central banks have unleashed is difficult to control; the central banks can create money but they cannot control its flow and remain totally in dark as to its final parking.
In reality, to avert an international financial crisis, the powerful central banks alongside developing countries central banks create money, notwithstanding the fact that only a part of the liquidity created by central banks actually circulate in the distressed economies, while a large chunk of it leaks out to financial hubs known as “safe-havens”.
That leaked chunk flows to inflate the price of assets such as stocks and bonds. The vicious cycle thus fueled; create its own ripples that eventually lead to another bout of financial crisis.
In the wake of financial crisis the central banks time and again resort to swiftly pump new money, probably in the belief that it is still better to face over supply of money then money crunch, which in any case eventually leads to a much enlarged rescue effort and the allied costs.
Another facet of the new international finance scenario is that well established economic causation theories and economic models and well grounded economic indicators have now become not only weak in explaining the new dynamics but somewhat become irrelevant.
There are considerable hidden mechanisms in place that definitely interfere with the workings of so called free markets everywhere; some interference by design are owing to advanced countries vested interests, while others are straight unethical practices of vested interest of market players both domestically and internationally.
Summing up, the matrix (virtual reality) financial world the west has created using derivatives, futures and swaps etc has begun to haunt them.
Recently, the aggressive monetary easing policy being pursued by Fed and European central banks will lead them to deeper economic mess; one of the fallouts of this act is commencement of currency war, as pointed out and protested by Japan.
In the wake of present global financial and economic meltdown, there is a reversal phenomenon in financial flows from west to emerging markets of Asia in particular. These financial flows must not be construed as foreign direct investment, as by and large they will be parked as portfolio investment and can swiftly evaporate from any economy.
The Asian countries’ will do well to swiftly review their financial architecture, allied framework and policies, additionally they need to adopt economic policies that could enhance their respective economy’s absorption capacity, alongside strengthening regional economic cooperation; with the aim to capture the benefits of enhanced financial flows and at the same time neutralize the devastating effects of uncontrolled global financial flows that are nomadic by nature.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Asian Banking & Finance. The author was not remunerated for this article.
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Azam Ali is Ex.Senior Economist at State Bank of Pakistan. He is an Economist, Management, Organizational Capacity Building & Training and Organizational