The future of financial globalisation

This post was written by Philip Lane

The revised versions of the papers presented at the BIS Annual Conference are now available:

The papers presented at the conference and the discussants’ comments are released as BIS Working Papers 397 to 400:
Financial Globalisation and the Crisis, BIS Working Papers No 397
by  Philip R. Lane
Comments by Dani Rodrik

The great leveraging, BIS Working Papers No 398
by  Alan M. Taylor
Comments by Barry Eichengreen and Dr. Y V Reddy

Global safe assets, BIS Working Papers No 399
by Pierre-Olivier Gourinchas and Olivier Jeanne
Comments by Peter R Fisher and Fabrizio Saccomanni

Capital Flows and the Risk-Taking Channel of Monetary Policy, BIS Working Papers No 400
by Valentina Bruno and Hyun Song Shin
Comments by Lars E O Svensson and John B Taylor

16 Responses to “The future of financial globalisation”

  1. DOCM Says:

    Very interesting papers (insofar as I could get a handle on them), notably those in relation to the creation of safe assets! However, I would venture to say that there is an element of cause and effect being mixed up. Changes in the world economic and political balances are driving financial globalisation, not the reverse.

    Hot of the presses!

    http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245345165314

  2. rf Says:

    This seems to support those who argue the causes of the crisis are systemic rather than domestic (honohan, most micro econs etc) ?

  3. DOCM Says:

    @ rf

    I would not be so sure!

    http://video.ft.com/v/2043651453001/The-French-exception

  4. rf Says:

    But if he’s (primarily) linking lower bond yields to ‘a revival of confidence in the eurozone’, doesn’t that reinforce the argument that it’s systemic? (btw Im not saying there were no domestic faults on our end.. just that I’ve never heard a convincing explanation of how we could have avoided the bubble/crash post Euro, and how we can get out of the downturn without Europe wide action - also larger countries will probably tend to be less at the mercy of systemic crises as they’re generally at the heart of the system and have more room to maneuver)

  5. rf Says:

    Although “at the heart of the system” isnt the most articulate/clear way of putting it..

  6. paul quigley Says:

    @ Philip

    Many thanks for posting these enlightening documents. If I may say so as a non-economist, your own paper threads its way through the complexities in a very cogent and readable fashion. That’s the level of expertise we need to be able to bring to bear on our national economic crisis.

    Dani Rodrik’s comments are particularly interesting:

    ‘Policy makers with a first-best mind-set put the emphasis on removing the pre-existing market imperfections that create the second-best complications. Their list of recommendations revolves around improving macroeconomic policies and financial regulations and erecting the requisite global regulations and institutions. The trouble with this approach is that it lacks realism in light of both the practical and substantive difficulties in fixing these problems. In particular, the experience of the eurozone should be a cautionary tale on the likelihood of building the transnational governance needed to run an integrated financial system’

    I read that as a broad endorsement of Dork’s view. He rejects the market state, as described by Philip Bobbit, to which destination we are being led by untrammelled financial interests:
    http://www.youtube.com/watch?v=ZhR1f3rdk1Y

    We don’t have to go there, as a nation, or as a region.

  7. David O'Donnell Says:

    Ta for links. Will get to them.

    IMHO the power of financial globalization will continue to expand; e.g. the big boys in the U.S. are still far too big to fail and well they know so.

    Financial Globalization also represents the greatest threat to what used to be known as Democracy.

  8. David O'Donnell Says:

    Note: THE Financial System Spinner is on the blog!

  9. OMF Says:

    The future of financial globalisation is that more criminal banks will get their hands on more and more of the public’s money, and the criminals who run them will increasingly raid the private holdings of others. We now live in a world where banks have been given an explicit licence to commit crime without fear of prosecution.

    And they will. And our society will rot because of it.

    This is not a crisis of economics, or of finance, or of sovereignty. This is a crisis of the rule of law. Financiers are criminals, and financial globalisation is nothing short of the greatest enemy of the law in history.

  10. DOCM Says:

    @ rf

    I do not think that there is any necessary contradiction. What is under discussion is cause and effect. If those running the process of financial globalisation have run amok - and there is considerable evidence to suggest that they have - it is time for governments - acting individually if there is no other basis - to recover control. They appear to be taking action to do so. (600 law officers raiding Deutsche Bank is hardly an everyday occurrence!).

    If there is a systemic fault in the context of the monetary union, now with the world’s second reserve currency, they have also to be corrected.

    But my basic point is that the underlying causes of financial instability lie in the real world and good old-fashioned struggles for raw materials and military and political power. The debate among economists seems to me to take place in a rather rarefied virtual world which tends to ignore these aspects.

    Rodrik, for example, says;

    “Many economists now believe that financial liberalization and globalization have enabled financial interests to capture political systems, with pernicious effects on the quality of governance.”

    While he does not say whether he agrees with this view or not, it is, IMHO, if not naive, not of general application.

    He also says;

    “In particular, the experience of the euro-zone should be a cautionary tale on the likelihood of building the transnational governance needed to run an integrated financial system.”

    Time will tell how correct this view is. My own is that it is erroneous and an example of the misjudgements that occur when economists venture outside their area of technical competence or, rather, assume that this has a kind of general application across the entire range of issues impacting the global community.

  11. Gavin Kostick Says:

    I read paper 397.

    Some quotes that popped out.

    “Indeed, in part, financial innovation was directed at cross-border regulatory arbitrage, chopping up the financial intermediation chain to minimise tax obligations and maximise regulatory flexibility.”

    *

    “The “long equity, short debt” strategy pursued by many advanced economies clearly carried risks. While this mix might earn a positive net return during normal times, it is destabilising during a crisis period since a decline in equity values reduces the net worth of domestic investors at the same time that tighter conditions in credit markets increases funding risks for debt liabilities.”

    *

    “However, Lane and Pels (2012) show that differences in growth projections across countries emerged as a strong correlate of current account imbalances during the 2003-2007 period in which the level of dispersion in external positions sharply increased. To the extent that these
    growth projections were extrapolations from the unsustainable expansion of the non-traded sectors in some countries (Ireland and Spain and some Eastern European countries come to mind), these types of current account deficits were not necessarily welfare enhancing. Indeed, these authors show that a primary source of the covariation between growth projections and the current account during 2003-2007 was an increase in construction investment in the deficit countries, which was a danger signal in terms of repayment capacity (see also Blanchard 2007, Giavazzi and Spaventa 2011, Chen et al 2012).

    “In summary, we can consider financial globalisation to have contributed to the origination of the crisis by enabling the scaling-up of the US securitisation boom that was the proximate trigger for the crisis”

    *

    “In passing, it is worth noting that the exit from foreign markets was far from uniform, with the composition of the investor base mattering for the scale of the capital flow reversal. For instance, De Haas and Van Horen (2011) show that banks were most likely to pull back from destinations that were more geographically distant from the home market. In similar fashion, Galstyan and Lane (2011) show that foreign investors were more likely to reduce portfolio equity and portfolio debt positions in further-distant host countries.”

    *

    “domestic speculators who had done well during the real estate boom in Ireland doubled down by making aggressive purchases in the property sector in other hot markets (Central and Eastern Europe, United Kingdom, United States). This pattern boosted levered returns during the global real estate boom but exacerbated the losses once the global property prices went into reverse.”

    *

    “Taking a longer and broader view of the crisis, the full attribution of losses on debt positions is incomplete, since there are typically long delays before losses on bank loan books are fully acknowledged, while the distinction between ” hold to maturity” securities and ” trading” securities means that the accounting treatment of bank holdings of sovereign debt only partially reflects mark-to-market principles. Still, the writing down of 107 billion in Greece’s sovereign debt obligations to private-sector investors (corresponding to 50 percent of Greek GDP) will primarily fall on foreign investors, substantially improving its net international investment position. On a more minor scale, the write down of 14 billion on the subordinated debt issued by Irish banks corresponds to about 9 percent of Irish GDP and will also overwhelmingly fall on foreign investors. Over time, the scale of national and sectoral debt burdens in Europe makes it likely that external balance sheet adjustment will partly take place through further debt write downs (see also Reinhart et al 2012).”

    Actually I’ll stop there for now for length. The paper is worth reading in full.

    Just one last quote from Dani Rodrik’s reply:

    “Many economists now believe that financial liberalization and globalization have enabled financial interests to capture political systems, with pernicious effects on the quality of governance.”

    Philip Lane (and other authors like him), present the world as a depopulated place. I find myself having to blink and remind myself that real people and competing interest groups made these decisions in real time. I take it that this is a way in which the battle of ideas can be engaged in without the whole thing ending up as accuations and finger-wagging.

    For a more red in tooth and claw approach to a BIS paper, here is Bill Mitchell.

    ‘What have mainstream macroeconomists learnt? Short answer: nothing’

    http://bilbo.economicoutlook.net/blog/?p=22113

    Taking my life in my hands, I wonder if the Dork agrees with the analysis of paper 397, if not the conclusions?

    @ OMF

    I thought you were being a bit OTT there, but looking at the case and many sobersides reporting of it you seem to be about right.

    It is expressed very mildly above but that quote from Rodrik above would seem to suggest that this view of the problem has gone mainstream.

  12. The Dork of Cork. Says:

    @Gavin

    “If the appropriate international and national institutions are put in place, financial globalisation
    retains its potential to positively contribute to risk diversification, consumption smoothing and
    efficient capital allocation. Indeed, under an improved institutional framework, a lower volume
    of cross-border financial trade might deliver more genuine benefits from financial globalisation,
    if “smart” international asset trade is enhanced at the expense of “distorting” international 18
    asset trade. I leave it to each reader to assess the likelihood and timing of these insitutional reforms”

    efficient capital allocation is the problem
    This means leverage

    Banks should have nothing to do with money

    I would prefer to see a King raise any bank bet with his Greenbacks to prevent a bank extracting capital and calling it a profit.

  13. rf Says:

    “The debate among economists seems to me to take place in a rather rarefied virtual world which tends to ignore these aspects. ”

    I tend to agree, although in fairness to Rodrik he’s been banging on about the incompatibility of greater economic integration, democracy and the nation state for a while.

    Somewhat relatedly I found this quite interesting

    http://wkwine.web.unc.edu/files/2012/01/FinNetOct2011.pdf

  14. seafóid Says:

    @PQ

    ‘Policy makers with a first-best mind-set put the emphasis on removing the pre-existing market imperfections that create the second-best complications. Their list of recommendations revolves around improving macroeconomic policies and financial regulations and erecting the requisite global regulations and institutions”

    The experience with Irish debt over the last while shows how difficult it is to deliver any sort of fairness in a market where information is distributed asymmetrically. The average small pension fund vs the hedgies.

    http://www.ft.com/intl/cms/s/0/495d72d4-63c6-11e1-8762-00144feabdc0.html

    “Historically, the return of so-called “dumb money” has been eagerly greeted by the professionals intent on selling out of the market”

    “Removing market imperfections” is as utopian as hoping that all marriages work out.

    Our faith in law or economics models to solve such problems is misplaced. There are limits to what law or economic models can do.

  15. DOCM Says:

    @ rf

    The paper you linked to is a classic example of the phenomenon in question i.e. trying to fit the real world to the tidy model when the model should reflect the reality and its validity be constantly checked against it. (There is an example of it on another thread in relation to behaviour of inflation in Ireland).

    As to the mathematics, they often remind me - although I will not pretend to even begin to understand them - of the symbols of alchemists before the establishment of a solid basis for the science of chemistry. There is certainly a role for mathematics but only where real measures can be established.

    Maybe someone will eventually come up with an economic version of the periodic table.

  16. rf Says:

    “The paper you linked to is a classic example of the phenomenon in question”

    I agree, although I think its a more interesting way of doing it. IMO theres use working from models, prevents you getting lost in the weeds

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