TEN years ago the world awakened about the reality of a financial crisis, rapidly engulfing the world, and turning into a ‘Great Recession’. In July–August 2008, a loss of confidence in the value of sub-prime mortgages in the US caused a liquidity crisis and forced the US Federal Reserve to inject a large sum of capital into the financial market. A month later in September 2008, the Lehman Brothers went belly up.
The events exposed the extent of finance-led global economic integration, making countries highly vulnerable to financial contagions, policy ‘spillovers’ and economic imbalances. It also revealed critical vulnerabilities of the post-World War II US-centric international financial architecture — the Bretton Woods system — modified after its breakdown in the early 1970s.
The Bretton Woods system had been under increasing strains since the late 1960s because of higher US inflation rates with president Johnson’s decision not to fund the unpopular Vietnam War through higher taxes, but by issuing debt. The post-WW II system finally collapsed when the Nixon administration unilaterally decided to withdraw US commitment to gold convertibility of the US dollar in August 1971. Since then, the US dollar has become a paper currency, flooding the world, and what emerged was a ‘non-system’, according to Robert Triffin, a foremost international monetary economist.
|Jan Joost Teunissen interviewing Robert Triffin in Louvain-la-Neuve|
ROBERT Triffin pointed out three systemic flaws of the non-system in the wake of the 1980s global debt crisis causing ‘lost decades’ for developing countries. First, ‘its fantastic inflationary proclivities, leading to world reserve increases eight times as large over a brief span of fifteen years’ (1970–1985). Second, ‘skewed investment pattern of world reserves, making the poorer and less capitalized countries of the third world the main reserve lenders, and the richer and more capitalized industrial countries the main reserve borrowers of the system’. Third, ‘crisis-prone propensities reflected in the amplitude of the present world debt problem’.
Critics have identified further flaws. The first is the ‘recessionary bias’, arising from the asymmetric burden of adjustment to payment imbalances. While the deficit countries must adjust, especially when financing dries out during crises, surplus countries do not face a similar pressure to correct their imbalances. The second is the ‘Triffin dilemma’, arising from the use of a national currency (in this case the US dollar) as a major reserve or global currency. The provision of international liquidity requires that the country (the US) supplying the reserve currency run balance-of-payments deficits. While this may erode the confidence in that currency, it also ensures spillovers from the US monetary policy on other countries. The third is the the ‘inequity bias’, generated by the need of emerging and developing countries to ‘self-insure’ against strong boom–bust cycles of global finance by building up large foreign exchange reserves, as demonstrated since the 1997–98 Asian financial crisis.
Such precautionary measures enabled the emerging economies to undertake counter-cyclical measures during 2008–2009 Great Recession. But they have huge ‘social opportunity cost’ as these reserves are generally kept in low interest perceived safe assets, such as the US treasury bonds, instead of investing to improve socio-economic conditions. Triffin felt very strongly, complaining, ‘the richest, most developed, and most heavily capitalised country in the world should not import, but export, capital, in order to increase productive investment in poorer, less developed, and less capitalised countries… [The] international monetary system is at the root of this absurdity’.
Calls for reforms
THERE have been renewed calls for reforms of the global economic governance architecture in the wake of the global financial crisis, especially from the 2009 UN Conference on the World Financial and Economic Crisis and Its Impact on Development. This included reform of the governance of the International Monetary Fund and the World Bank, on the basis of fair and equitable representations of developing countries to improve the credibility and accountability of these institutions and to reflect current realities of emerging economies in the global economy. Developing countries also called for a ‘multilateral legal framework for sovereign debt restructuring’ through a UNGA resolution (A/68/L.57/Rev2).
There was also a promise to keep the international trading system as open as possible, with the G20 leaders committing to avoid protectionist measures. There was a renewed hope for trade multilateralism and an early successful completion of the Doha Development Round of the World Trade Organisation, giving developing countries better access to developed country markets. This was seen as vital for balanced global recovery and development.
EVERY financial crisis in the past was followed by calls for reforms, but complacency setting in with the green-shoot of recovery. This time, it is not different. Policymakers in virtually every major country turned focus on domestic issues despite their rhetoric of international cooperation for reforms and policy coordination.
Even though the prospects for global financial governance reform seemed promising following the first G20 summit in November 2008, the developed world dragged on and the US Congress was unwilling to approve the agreed limited quota reform of the IMF until very recently. The promises made in 2008 were repeated at successive G20 summits and in other international forums. Yet, the promised reforms have only been partially implemented, resulting in limited changes in global financial governance architecture, still dominated by advanced countries, in particular the G7, thus undermining its legitimacy.
In the absence of a legally binding multilateral, fair, sovereign debt work-out mechanism, developing countries remain targets of private creditors and vulture funds. While creeping protectionist measures are strangling global trade, developed countries have effectively killed the Doha Development Round by insisting to renegotiate settled matters and opting for bilateral and regional free trade deals, the most prominent of which is the Trans-Pacific Partnership. These are weak substitutes for multilateral deals, not least because they are often one-sided agreements written by the strongest signatory.
Ahead of the 2016 annual spring meetings of the IMF and the World Bank, US Treasury secretary Jacob Lew said that it was necessary to have reforms to modernise the international economic architecture set up after World War II. But the aim, in his opinion, is to preserve and strengthen his country’s position and secure benefits for the United States. While not surprising, it ignores the fact that the emerging economies and developing countries are still under-represented in the global financial architecture, even after the US Congress finally approved a much delayed set of limited reforms in 2015 and the IMF has recently agreed to include the Chinese renminbi in the SDR basket.
MEANWHILE, the global economy has become more vulnerable on a number of fronts. First, the unabating rise in income inequality and wealth concentration due to failure to regulate executive salaries while wage growth remains stagnant or falling, exacerbated by perverse fiscal measures involving cuts in top tax rates and welfare programmes — ‘reverse Robin Hood’, and non-conventional monetary policy disproportionately benefiting the owners of financial assets. The econd is the unchecked rise in household debts, partly because of no or little real wage growth. The third is the increased integration of developing countries through global value chains, opening to foreign financial institutions and short-term capital flows (debts) induced by unconventional monetary policies of the US Fed, ECB and the Bank of Japan. These vulnerabilities are compounded in the face of devastating protectionist trade wars looming large.
Less capable of handling
ALAS, 10 years after the worst economic downturn since the ‘Great Depression’ of the 1930s, the global economy is in a much weaker position to handle even a minor crisis. Most developed country governments are now more heavily indebted than they were in 2008–2009 as they bailed out large financial institutions, but failed to jump-start the economy in a robust way. Major monetary authorities are over-burdened and do not have much policy space left after pursuing extra-ordinary expansionary policies for so long. The emerging economies’ precautionary holdings of reserves have also dwindled as the global trade slowed almost to a halt while the concern for debt-sustainability of a number of developing countries is growing. President Trump’s preference for bilateral agreements benefiting the US is unlikely to provide the boost to multilateralism so badly needed now. Consolidating US dominance can only worsen the situation.
Anis Chowdhury, an adjunct professor at Western Sydney University and the University of New South Wales (Australia), held senior United Nations positions in New York and Bangkok.