Financial Globalization
Current Events
• Headline: Currency Trade Reaches $5.3 Trillion
a Day Amid Yen Turnover
• ~1.5 Trillion/day in 1997
• If we add in stocks, bonds, CDS, speculative
investments much, much higher
Current Events
•
Businesses May Be Next Target of Higher Taxes
– Corporate earnings are also vulnerable to the strengthening dollar, which reduces the value of
revenue from exports and foreign earnings by U.S. multinationals. And exports and foreign
earnings of U.S. companies are under pressure, especially in developing countries where
growth has slowed.
– China’s growth is slowing as it shifts to an economy led by consumer demand and away from
exports, which are depressed by weak demand from the U.S. and Europe. China has also vastly
overbuilt its infrastructure. Vacant cities and other excess capacity could become considerable
problems, particularly for the lenders who financed them. Deceleration in China implies slow
growth for the other developing countries that have thrived by exporting commodities and
components to the Chinese manufacturing juggernaut.
– Meanwhile, the prospective tapering of Federal Reserve asset purchases and the related
interest rate increases that have already occurred are causing financial harm to those nations.
– Earlier, the likes of Brazil, India, Indonesia and Turkey were almost overwhelmed by inflows of
hot money that drove up the value of their currencies and financed their large currentaccount deficits. Now that hot money is rushing out, leaving them with three unsavory
choices. They can allow their currencies to slide, which aids exports but also promotes
inflation as import prices jump. They can raise interest rates to help retain foreign money, but
that threatens growth. Or they can impose capital controls to keep money from leaving, but
that discourages future inflows and triggers huge outflows when controls are lifted.
Some Basics
• Balance of payments
– Current account (exchange of real goods and
services + remittances)
– Capital account (stocks of capital abroad yielding
flows of revenue)
• Exchange rate regimes
– Fixed
– Flexible
Theories about Economic Stability
• Efficient Market Hypothesis (recent ‘Nobel’)
– Prices of financial assets based on market
fundamentals
– Reflect NPV of all future returns
– Regulation undesirable
– Crisis = ‘correction’
• Financial instability hypothesis
– Hedge, speculative, ponzi investments (e.g. housing
bubble)
– Increasing confidence and risk: Destabilizing stability
– Collapse inevitable
U.S. Stock (inflation adjusted)
S&P Price/Dividend Ratio
Financial liberalization
Causes of Crisis: conventional view
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Leverage
Moral Hazard
Adverse selection
Selling short
Causes of Crisis
• “Fundamentals” wrong
– High current account deficits
– Excessive money creation
• Bernanke injecting another $trillion?
• Vs. $3 trillion drop in M3
– Overvalued exchange rates
• Relative to what?
– Large deficits/debt
Financial Instability
Hypothesis
Causes of Crisis: EE view
• Biophysical limits
– Oil production
– Resource depletion
• Financial liberalization
– Money can go where it
wants
– ‘Hot’ money
– Imperfect information
• Complex systems
– Positive feedback loops and self fulfilling prophecies
– Collapse is inevitable outcome of exponential growth
Financial contagion
• What is contagion?
• Speculative flows
– 5.3 trillion per day in currency alone, vs. ~$70 Trillion global
GNP
– Over $1 quadrillion in CDS
– What does speculation contribute to economic output?
• “Speculators are harmless as bubbles on a steady stream of
enterprise. But the position is serious if enterprise becomes a
bubble on the whirlpool of speculation. When the capital
development of a country becomes the by-product of the
activities of a casino, the job is likely to be ill-done.”
John Maynard Keynes
Examples of Contagion
LA debt crisis (1982)
ISI and the energy crunch
Petro-dollars
Reagonomics
Capital flight, exchange rate depreciation
Switch from ISI to Export promotion,
implementation of Washington Consensus
• “The lost decade”
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Tequila crisis (1994)
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Clinton’s comments
Uprising and assassination
Political uncertainty
Capital flight and devaluation
Asian flu (1997)
• Real estate bubble
• Financial speculation, selling
short and devaluation
• Impacts of devaluation on
debt
• Impacts on trade competitors
• IMF role: interest rates, taxes,
government spending,
bailouts
Asian flu (1997)
• Spread to Russia
– Deficits and fixed exchange rate
– Fear of collapse caused collapse
• Infected other former USSR
countries
• Spread to US (LTCM)
• Spread to Brazil and Argentina
Current Crisis
• Origins
– Dot.com bust real estate boom
– Hedge  speculative  Ponzi
• ARMS, falling asset prices, and inability to refinance,
asset liquidation, falling asset prices, etc.
– Mortgage securities and moral hazard
– Exotic derivatives sold, imperfect information, and
moral hazard
• Rated AAA
– Excessive leverage
Current Crisis
• Origins
– Dot.com bust real estate boom
– Hedge  speculative  Ponzi
– Exotic derivatives sold and imperfect information
• Rated AAA
– Financial speculation
– From liquidity crisis to liquidity surplus
• Biophysical constraints
• Contagion
Financial Crises and Distribution
• Concentrated wealth and speculation
• Too big to fail
• Growth rates greater than economic
growth
Response to Crisis
• Conventional
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Poor countries
Rich countries
Liberal
Conservative
• EE
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Redefining crisis
Restricting capital flows
Taxation (Tobin, income, throughput, rent)
Regulation
Replacing horizontal money with vertical money
Ecological Restoration