Better Global Financial Governance – The Need for Reforming the System and Abandoning Free Market Ideology

Here is a talk that I gave at a Shadow G20 Workshop in Paris (29-30 October 2011)

Better Global Financial Governance – The Need for Reforming the System and Abandoning Free Market Ideology

Speech by Jan Joost Teunissen (founder and director of FONDAD) at the Shadow G20 Workshop in Paris, 29-30 October 2011 (Columbia Global Center, Reid Hall, Paris)

What kind of world are we living in?

If a psychologist would say, ‘You should think this, do that and accept what I tell you,’ a normal person would react by saying: ‘Hey, wait a minute, you cannot prescribe me how I should think or what I should do or accept.’ If a sociologist would do the same and prescribe how people in a society should think and behave, a normal person would say, ‘Sorry, you cannot prescribe us how we should think and behave.’ But, for some strange reason, when an economist does the same and prescribes how we should think and behave and what we should accept, it is felt as normal.

But this is not normal. Let me give another illustration of the absurdity of our world.

“If your unions are too strong and fight against lower wages and unemployment, or for healthy labour conditions, we will lower your credit rating thus forcing you to lower wages, increase unemployment and make labour conditions tougher.”

“If Greece has a problem in repaying its debt, we will increase the costs of repaying its loans.”

“If you refuse to privatise public companies or refuse to make it easier to lay off workers, we will not give you the loans we have promised you.” (said to Greece and Italy)

This is the world that is presented to us as “normal”. Why do people accept it as normal? Because they are told so, because they think it’s OK, because they are indoctrinated every day.

1. In this panel we discuss Global Financial Governance (GFG) and I suppose we have to give ideas of how it can be improved. But my immediate question is: Better GFG of what? Of the current international monetary and financial system? No, please not. I would prefer better GFG of a better system, because the current system has enormous problems and should have been reformed and fundamentally improved long ago. Why?

Let me give four reasons (there are more):

- First, because the current system has led, since the end of the 1960s, time and again, to financial crisis and economic instability, creating a lot of suffering for ordinary people.

- Second, because the system gives too much power and freedom to the financial sector.

- Third, because it creates credit and debt bubbles, as some experts realised already many years ago and now, with the crisis in the heart of the system, has become clear to everybody.

- Fourth, because the current system gives too much priority to finance instead of the real economy.

I would like to dwell briefly on the second point that there is far too much power in the financial sector. Every day you can hear in the news that governments are warned by the financial sector that they should do this or that, otherwise the financial sector, or the financial markets as they are usually called, will punish them with a lower credit rating and higher interest rates on loans. Governments seem to be powerless victims of a monster that they themselves have created when they decided in the early 1970s to let the private financial sector dominate international finance, and not reform the international monetary system as they had agreed in 2-year long negotiations (1972-74). And in the 1980s they deliberately deregulated the financial sector embracing fully the neoliberal agenda of deregulation, privatisation and free capital, an agenda faithfully advocated by mainstream economists.

Even though I think many people working in the financial sector have behaved and are still behaving irresponsibly, given the economic facilitating role that they ought to play – finance should be a means and not an end – and given the public responsibility of the financial sector, I blame first of all governments and mainstream economists for the mess we are in. Historically and politically, they are the ones responsible for it. They allowed the foreign financing of US deficits. They allowed the greed of bankers to have free play. They allowed the United States to finance its wars and have its military around the world including Europe, to defend Europe, with dollars lent by the rest of the world. They allowed global imbalances to emerge. They allowed the creation of a huge derivatives market of so-called innovative financial products that amounts to over 600 trillion dollars. And now these same governments feel powerless, or show they are powerless, against the vagaries, greed and profit-seeking of people switching huge anounts of money through international financial markets.

Yes, I’d like to stress it’s PEOPLE who are doing this. The neutral term “financial markets” is misleading. Financial markets are being talked about as if they are part of nature, as storms or rain showers that plague us and we are unable to protect ourselves against. But markets are managed and run by individuals, by so-called financial experts and economists. And their colleague economists working in the ministries of finance, in the central banks and other supervising bodies, and in the international financial institutions, let them largely do their tricks. They do not really limit the power of people operating in financial markets.

So this is not the global financial and monetary system that I would like to see governed or managed better by having, for example, a more powerful representation of emerging economies in international financial institutions (which I favour), or by making these same international financial institutions more powerful players in the global financial and economic arena. We need to reform the system! And we need to reform the dominant values, the ideology that maintains the system.

2. Even though over the last 4 years, after the crisis started in 2007, there has been much talk about the need to reform the system, and even though there have been many good technical and political proposals by individuals and groups coming together for this purpose, the effort of policymakers still seems to be largely to keep the current system going – with all its in-built problems and the certainty that it will lead to another crisis. Why do policymakers stick to the current system even though it has such serious problems and shortcomings?

Let me give you three reasons (but there are more):

- First, because policymakers are afraid of reforms that they do not know or are not sure about how they will function and what effects they will have. They rather prefer to stick to the routines they are familiar with.

- Second, policymakers are against reforms or are scared of reforms that do not have the agreement of mainstream economists and of people operating in the international financial markets.

- Third, policymakers have an interest in keeping the system basically as it is and only are prepared to make minor adaptations (which they themselves may see as major adaptations) to it. How they themselves would define this interest, I do not know. But I think they defend certain economic interests, certain political interests, and certain power relations that guarantee the continuation of these interests. I also think that policymakers see international financial markets as a key element of the system, and believe that governments and international financial institutions should intervene as little as possible in these markets, and only where it is really needed.

3. It is not the first time that the need for reform of the international monetary and financial system is being discussed and that sensible proposals to this effect have been made. Neither is it the first time that sensible proposals were not adopted, let alone implemented.

Efforts at reform of the system have been made on various occasions since the 1960s. The first efforts date back to the 1960s when dollar crises erupted because of US balance of payments deficits and the loss of confidence by other countries in the capacity of the United States to exchange dollars for gold. So there was a flight into gold and European currencies. These gold-dollar crises were “resolved” in 1971-73 by decoupling the dollar from gold and by moving from a system of fixed to flexible exchange rates. Then, in 1979, when there was another crisis of confidence in the value of the paper-dollar, it was “resolved” by a steep rise in US interest rates and by embracing neoliberal, monetarist policies. After that, in 1982, we had, primarily as a result of this steep rise in the US interest rate, the debt crisis of the 1980s in Latin America and a few other countries. Then, in the 1990s, we had several debt crises in emerging economies. During all these crises, wise men and women came together to suggest sensible reform proposals. Why have they had so little success in getting their proposals adopted and implemented?

I think partly because of the same three reasons I gave already: (1) policymakers are scared of reform, (2) policymakers are against reforms that meet the opposition of mainstream economists and people of the financial sector, and (3) policymakers have an interest in keeping the system as it is.

Let me elaborate on the last reason.

Policymakers want to keep the system as it is, not only because of sticking to certain economic policies and interests, but also because of sticking to certain political policies and interests. For example, in the 1970s and afterwards, NATO countries saw an interest in maintaining the US dollar as the key reserve currency of the system, as this would allow the US to finance with foreign-held dollars its military force for maintaining western dominance in the international political arena, and for military intervention.

Now, elaborating on the second reason, policymakers’ resistance to reform proposals that do not have the approval of mainstream economists and people of the financial sector, I see a serious problem with mainstream economists. They largely determine the terms of the “real”, or one could also say, the “false” debate. The problem of mainstream economists is that they have a biased and limited view of man & society, of how man and society should behave, and of what is “normal” or economically sensible behaviour. They presume, for instance, that normal behaviour should be driven by competition instead of cooperation and solidarity, and ruled by so-called free markets. I think we need a broader, social, political, ecological and philosophical view of man & society instead of the narrow view of mainstream economists.

There is yet another reason why reform proposals are not adopted, and that is that policymakers base their policies on limited and biased analysis of the crises, both of the crises of the past, and the crisis of today. A good example is the debt crisis of the 1980s in Latin America, in which the standard explanation was that developing countries had borrowed too much and western banks lent too much, while the alternative explanation stressed that the crisis was caused by a dollar-dominated global financial system that should have been reformed at least ten years earlier. I am one of those who presented in the mid-1980s the alternative explanation in an extensive article for the journal Alternatives that included long conversations with the famous economist Robert Triffin, who had advocated reform of the international monetary system since 1958.

4. What reform proposals of the system have been made over the last couple of years? Various reform agendas have been proposed, both by individuals and groups. Let me mention three group proposals that are relatively moderate, the one more than the other, but have not been adopted yet.

- The first is a report by a UN Commission, “Reforms of the International Monetary and Financial System”, headed by Joseph Stiglitz and presented in March 2009.

Stiglitz highlighted its proposals in a short article (Guardian, 27 March 2009) as follows. ‘There are several important lessons from the crisis. One is that there is a need for better regulation. But reforms cannot be just cosmetic, and they have to go beyond the financial sector. Inadequate enforcement of competition laws has allowed banks to grow to be too big to fail. Inadequate corporate governance resulted in… excessive risk taking…’

The UN Commission recommended the establishment of a Global Economic Coordinating Council, to co-ordinate economic policy, to identify gaps in the global institutional arrangement, and propose solutions. ‘For instance,’ said Stiglitz, ‘there is a need for a Global Financial Regulatory Authority… There is a need for a Global Competition Authority… There is a need for a better way of handling defaults of countries…’

The other important recommendation by the UN Commission was the creation of a new global reserve system. ‘The existing system,’ said Stiglitz, ‘with the US dollar as reserve currency, is fraying. The dollar has been volatile. There are increasing worries about future inflationary risks. At the same time, putting so much money aside every year to protect countries against the risks of global instability creates a downward bias in aggregate demand weakening the global economy. Moreover, the system has the peculiar property that poor countries are lending trillions of dollars to the US, at essentially zero interest rate, while within their country there are so many needs to which the money could be put. A new Global Reserve System is "feasible, non-inflationary, and could be easily implemented".’

- A more recent set of proposals for Reform of the Global Reserve System – from an Asian perspective – was made in a June 2010 ADB report, edited by Jeffrey Sachs and others. Its contributing authors included Joseph Stiglitz, Charles Wyplosz and Wing Thye Woo among others.

In its Recommendations, the report states that the group sees the global reserve system evolving into a multi-currency reserve system, with Asia holding close to half of the world’s total reserves. At the regional level, the report recommends to increase regional economic integration and policy coordination in Asia. At the international level, it recommends to ‘strengthen prudential capital market regulations, given the obvious failure of the financial system to effectively police itself.’ It also recommends convening ‘a brain trust of independent international monetary experts as chronic current account imbalances and varying exchange rate regimes, for example, can cause unnecessary friction between countries.’

Haruhiko Kuroda, President of the Asian Development Bank (ADB), stressed in the preface to the report: ‘Asia is no longer a minor player. It must take a more active global role. (…) I sincerely hope that this report will stimulate constructive debate – both within and beyond Asia – on how we can move to a more stable, efficient and equitable global reserve system that will better facilitate global trade and capital flows.’

These ADB recommendations are not radical reform proposals. In the individual contributions, several authors advocated more radical reforms. For example, Stiglitz repeated his plea for a new global reserve system (like Triffin did before, for more than 30 years during the 1960s, 70s and 80s). ‘The choice facing the international community,’ he said, ‘is whether to create… a new global reserve system, or to “muddle through,” moving from the dollar-based system to a two- or three-currency reserve system, which could be even more unstable and volatile. This paper argues that a new global reserve system is absolutely essential, if we are to restore the global economy to sustained prosperity and stability.’

- A third report, “Reform of the International Monetary System” (the Palais Royal Initiative), published in February 2011, was prepared by Tommaso Padoa-Schioppa, Michel Camdessus, Alexandre Lamfalussy and others.

Recently, on 4 October 2011, Camdessus presented its key messages at a Conference on Reform of the IMS organised by the Triffin Foundation of which Lamfalussy is the chair (I am one of its board members).

Camdessus started his presentation by conveying two convictions of the group: ‘first, that our collective failure in establishing over four decades a system deserving really this name has been one of the key factors of the crisis. No real system means no effective discipline, weak and uneven surveillance, and excesses of all kind: in current account imbalances, in indebtedness, in accumulation of reserves, in exceedingly volatile and destabilizing swings in capital flows, in exchange rates fluctuations with unjustified deviations from fundamentals... These are major misgivings, indeed.

From there, the conviction n° 2 that, as long as no credible responses are given to these problems, our increasingly integrated world economy becomes all the more vulnerable as it is simultaneously engaged in a process of transition toward a multicurrency regime.’

To face these risks, the Camdessus group proposed four avenues for reform: (1) better surveillance by the IMF, with ‘real transparency, teeth and fairness’; (2) strengthening of IMF instruments ‘in a world where financial developments overwhelm now the mere monetary and current exchange developments’; (3) a re-examination of the scope of the SDR to play a greater role in the system as a reserve asset; and (4) improving the governance of the IMF and its relations with regional organisations.

5. What can be done to get these three and other reform proposals adopted? How to influence policymakers? I know that the authors of the three reform reports mentioned are doing their best. There is a large role for journalists, politicians, students, intellectuals, unions, social movements, and for economists and other academics working within the institutions.

But let me go back to the provocative remarks at the beginning of my talk. The danger is that when unions and other people who go out demonstrating on the streets or occupying squares, lead to the lowering of credit rating, higher financing costs, loss of investor confidence and threats to governments that they will not receive promised loans, democracy is seriously undermined. You need countervailing views and values. And there is the other danger that is already manifesting itself, the danger that the current capitalist system, with its privileges for business and political elites, creates anger and frustration among people and stimulates xenophobic, nationalistic, anti-establishment, anti-intellectual movements and parties like we already have in the Netherlands.

So there is a task for all of us to demonstrate our concern, to defend democracy, particularly in the sphere of economic and financial decision-making that is too much dominated by the power of the financial sector and the opinion of mainstream economists. We can all contribute to creating a more democratic world, a world that no longer is dominated by financial markets and mainstream economists, a world in which economists broaden their view and look at the social, political and ecological aspects of society, talk to people, and listen to them.