Why International Financial Crises?

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Yves here. I have some small quibbles with this otherwise fine post.

The first is that, as Keynes stressed, the problem with past international monetary systems like the gold standard was that there was no punishment for countries that engaged in mercantilist strategies and ran trade surpluses. Countries have strong incentives to do so because they effectively steal demand, and thus jobs, from their trade partners. The US has been willing to accommodate this desire because it saw ways to get geopolitical advantage from this situation. Second is that the US has been explicit about trying to make the world safer for US banks and later investment banks. Among other things, it was seen as a way to promote US multinationals. Believe it or not, globalization was supposed to be a force for peace. See this tweetstorm.

Note also that Carmen Reinhart and Ken Rogoff had a simpler explanation: they looked at 800 years of financial crises and concluded that higher levels of international capital flows lead to more frequent and severe financial crises. And before you blame that on trade deals, keep in mind that the Bank of International Settlements found that the ratio of money movements related to securities transactions has exploded. In the runup to the crisis, international capital flows were over 60 times the level of trade.

By Jomo Kwame Sundaram,  former UN Assistant Secretary General for Economic Development and Anis Chowdhury, former Professor of Economics, University of Western Sydney, who held various senior United Nations positions in New York and Bangkok. Originally published at Inter Press Service

International currency and financial crises have become more frequent since the 1990s, and with good reason. But the contributory factors are neither simple nor straightforward. Such financial crises have, in turn, contributed to more frequent economic difficulties for the economies affected, as evident following the 2008-2009 financial crisis and the ensuing Great Recession still evident almost a decade later.

Why International Coordination?

Why is global co-ordination so necessary? There are two main reasons. One big problem before the Second World War was the contractionary macroeconomic consequences of the “gold standard.”

In 1944, before the end of the Second World War, President Franklin Delano Roosevelt convened the United Nations Conference on Monetary and Financial Affairs – better known as the Bretton Woods Conference – even before the UN itself was set up the following year in San Francisco. After almost a month, the conference established the framework for the post-war international monetary and financial system, including the creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), or World Bank.

To be sure, the Bretton Woods system reflected sometimes poor compromises made among the negotiating government representatives. Nevertheless, it served post-war reconstruction and early post-colonial development reasonably well until 1971.

In September of that year, the Nixon Administration in the US – burdened with mounting inflation and unsustainable budget deficits, partly due to the costly Vietnam War – unilaterally withdrew from its core commitment to ensure full US dollar convertibility to gold at the agreed rate. Thus, the unilateral US action did not involve a transition from the Bretton Woods system to any coherent, internationally agreed alternative.

Birth of a “Non-System”

The pre-1971 post-Second World War period has often been referred to as a Golden Age, a period of rapid reconstruction, growth and employment expansion after the devastation of the Second World War. It was also a period of development and structural transformation in many developing countries.

All this came to an end when coordination and multilateralism collapsed following President Nixon’s decision to renege on 1944 US commitments at Bretton Woods which became the basis for the post-war international monetary system.

The leading international monetary economist of the post-war period, Robert Triffin, described the post-1971 arrangements as amounting to a “non-system.” Now, with the international monetary system essentially the cumulative outcome of various, sometimes contradictory and ad hoc responses to new challenges, the need for coordination is all the more urgent.

A strong case for co-ordination has long been made by the United Nations. For example, soon after the global financial crisis exploded in late 2008, the 2009 mid-year update of the UN’s World Economic Situation and Prospects showed how better coordinated and more equitable fiscal stimuli would have benefited all parties – developed countries, developing countries, transition economies and, most of all, the least developed countries.

Anarchy and Fragility

Since the collapse of the Bretton Woods system in 1971, a small handful of currencies – especially the US dollar, the international favourite by far – have been held by others as reserve currencies. This has allowed the issuers of these currencies – especially the US – to run massive trade deficits, contributing to unsustainable global imbalances in savings and consumption.

A second underlying cause of international financial crises has been the ascendance, transformation and hegemony of the financial sector – termed “financialization” – over the past three to four decades. Partly as a consequence, many decision-makers are now often more concerned with short-term financial indicators than other key economic indicators, often presuming that the former reflect the latter despite the lack of such evidence.

A third factor has been growing “financial fragility,” partly due to the global financial “non-system” in place since the collapse of the Bretton Woods system. Referring to this “non-system” as an international financial “architecture” is really insulting to architects. The lack of coherence and coordination has been exacerbated by financial deregulation, liberalization and globalization over the past three decades.

Finance Calling the Shots

The growing and spreading subordination of the real economy to finance in recent decades is a fundamental part of the problem. While finance is indeed a very important, if not an essential handmaiden for the functioning of the real economy, the subordination of the real economy to finance has transformed macro-financial dynamics, with unproductive, contractionary, even dangerous consequences.

So, to address the root causes of crises, much better, including more appropriate regulation of the financial system is needed to ensure consistently counter-cyclical macro-financial institutions, instruments and policies, and to subordinate the financial sector to the real economy.

The 2008 financial crisis has catalyzed many debates on these issues – some old, some new – for instance, between Keynesian/Minskyian economists and their opponents; between Anglo-American and continental European worldviews; and between the global North and South. Any sustainable solution will clearly require much better international cooperation and co-ordination.

Hence, almost a decade since the 2008 global financial crisis began, there is no shared political commitment to much needed international financial reforms. It took fifteen years from the beginning of the Great Depression, a world war and Roosevelt’s extraordinary leadership before the world was able to reform the international financial system in 1944. But sadly, there is no Roosevelt for our times.

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  1. epynonymous

    Why, the last tool in any journalist’s kit.

    I’ll take your second-to-last paragraph. Solution to what? – Theory being what it is.

    Keynes and I can mostly remember his idea of gold as a funerary good, something you dig from the ground to put back in the ground formally, just on principle. Especially, his idea of the added value of the velocity of money to create ‘value’.

    Further, international cooperation on what level? Institutional I suppose, and not inter-personal. Obviously, I’m being contrarian, but in what sense is the Bretton Woods agreement real?

    Consider the roots of credit, and the idea of international agreements… Agreements founded on what? Some sort of credit, or an idea that ‘commitments’ will be honored?

    I am in agreement, but what is the Paris Climate Accord, really? Is it any different than spending grants to study the language of fish, as Brexit proves?

    I am more and more Nixon every day, but was he just the Rockefeller’s controlled opposition? Why was he impeached and by who. And again, why?

    1. Disturbed Voter

      The author doing political economics, and leaving the politics out. Some big elephant in the room, the Cold War. Peace is war by other means. Finance was weaponized by Bretton-Woods et al.

      Coordination is occurring, but only on the Elite level … per conspiracy theory. Really important political economic activity has to occur outside of public scrutiny.

  2. epynonymous

    Theoretically, the Paris Climate agreement should be a neutral proposition, with no industrial state standing to lose.

    Conservatives always say that money costs jobs, but Keynes says it creates jobs. Like New Jersey demanding full-service gasoline stations. Conservatives are right that they may not be the right jobs, but Keynes says any jobs are better than none.

    So I suppose Keynes is a liberal.

    Of course, your answer to what problem/solution is the re-appearing financial crises.

    Volatility has obvious winners. The insurance industry is both winner and loser here.

    – Should have bought bitcoin

    1. Disturbed Voter

      Profit and loss occur together, and neither can occur without instability. Think of balancing feather on the end of your finger … and getting paid for it. What matters is who is doing the balancing, the securitizing of everything, the privatizing of profits and the socializing of losses.

      The reason why this is tolerated, is that people don’t want to escape wage slavery and debt slavery, they simply want to be successful in the existing system. The alternative is a no-win no-loss system … which is called stagnation by economists … who are paid to say that.

      1. epynonymous

        I ultimately concluded that Nixon was actually, unexpectedly, opposing Rockefeller, somehow. I’d say the Trump parallel is obvious, controlled opposition. He’s pretty much in Hillary’s pocket… and if we accept the premise of Kayfabe((it’s a story-line for the uninformed, deplorable, etc.)) then maybe he wasn’t supposed to win.) Hillary came first, so there’s no way she’s his alter-ego. Also, there is still no messaging on the Democratic side.

        We are off-script.

        Today, I’m am watching the Whitest Kids You Know sketch group. I’m currently enjoying “Moon Bears”


  3. Susan the other

    This is close to what Steve Keen was saying, that finance gets ahead of the real economy and there’s no way to get the balance back… I like the way this is written. There is no system. So matter-of-fact. What is better, the deflation caused by a gold standard or inflation without one? That’s an argument that never gets resolved. Because it’s not the real question. The thing we should ask is what is better, a sustainable, healthy planet or capital gains? Keen was talking about the folly of the “great moderation” and the levels of debt in the system killing the real economy and so is this article. It indicates we need an overriding theme – like, say, survival? My first thought is always the planet. Financialization has devastated the planet and caused awful inequality and at the same time has allowed sustainability to become a lost cause because it is essentially too expensive so it becomes an “externality”. Fixing the planet is our best solution to our global/financial non-system. I don’t care how many ratholes money gets poured down as long as it is put into maintaining the proper ecology of the earth – which must include equality. Sustainability and equality will be the countercyclical we need. And money is just cooperation.

    1. JTMcPhee

      Only cavil I offer is that there indeed is a “system,” the one that is made up of Goldman Sux, et al., and shadow banking and central banks and the black economy of desire (sex, drugs, slavery) and the exudate of all those, the weaponization of all of human-space. All “legitimized” and “made all nice and legal,” or at least immune to any regulation, by the wholly owned subsidiaries of the other elements, those things we call “governments.” From small to large, the disease is manifest — from the local city and county governments and agencies, and zoning commission and school board, to “Tallahassee Nights,” in the Florida example, up in the Panhandle, to “our great imperial capital” in DC. And the other capitals and centers of power across the human-desecrated landscape.

      “We” have no agency to decide what’s “better, a sustainable, healthy planet, or capital gains.” That happens way above “our” pay grade and reach. Best “we” can do is as you imply — think globally (understand the disease processes) and act locally.

  4. LT

    In addition to debt peonage for the masses, over-financialization and monopolies go hand in hand.

  5. Jim Haygood

    Why the “subordination of the real economy to finance”?

    When debt is used as the monetary base, creation of more debt is incentivized.

    And they’re STILL DOING IT. Since the ECB is running out of German debt to buy, now there’s a proposal for eurozone structured sovereign debt, so the ECB can buy EVEN MORE debt.

    Prepare for MOAB (Mother Of All Bubbles). It ends in a supernova.

  6. JTMcPhee

    Category error: there is no “world,” as assumed in this sentence: “Despite the high cost of financial crises, the world seems no closer to making needed reforms.” What entity has agency as “the world”? The many parasites and metastatic tumors that plague the planet (not just the collective “humanity”) have agency, and by individual and concerted action, over millennia now, have brought “us” to where “we” are. Which is the condition that gets so well discussed and analyzed here at NC. “We” know what’s wrong (though there are lots of marginal debates over minutiae of “the condition”) and various exhortations about what “we” must, need, ought to do !Right Now! about various larger and smaller parts of the great cancer that makes all the little incursions by parasites and disease pathogens of the political-economic kind so much easier.

    And there’s no reservoir of “comity,” and no wellspring of amity or altruism (itself selfish and self-serving, per recent studies and theorizing) to look to, for any kind of anodyne. The incentives and momentum are all on the side of looting and self-serving and self-pleasing. And the fundamental pathogen in all of this is “our” basic human physiology, the limbic system, which is all about doing what’s “right” for the individual, instant by instant. Lizard-brain, as the trope is, beats chess-brain every time.

  7. Oregoncharles

    “All this came to an end when coordination and multilateralism collapsed following President Nixon’s decision to renege on 1944 US commitments at Bretton Woods ”

    There are a couple of problems with this. First, I thought the gold standard was deflationary? Not according to this.

    Second, and more important: The period from 1945 to 1971 corresponds exactly with the period of reconstruction after WWII, when the US started as the only intact economy in the world. By the end of that period, Europe and Japan were largely rebuilt and I was seeing articles about the advantages of a NEW physical capital base. The US’s was already depreciating – in the physical sense.

    In Other Words, “America’s Golden Age” (Gore Vidal) (my youth) was a unique period of post-war recovery, as well as predating resource constraints and benefiting from the full effect of the New Deal/New Society programs. It can’t really be taken as proving much of anything, except that it’s nice to be the last economy standing in a still un-exhausted world.

    But Nixon’s problems do disprove that a gold standard is inherently deflationary, at least given sufficient mismanagement.

    And it’s interesting to be reminded that Tricky Dick is the godfather of fiat money and, hence, MMT.

  8. Robert NYC

    Not sure why anyone would claim that there is “no punishment for countries that engaged in mercantilist strategies and ran trade surpluses.” No country can run trade surpluses, or conversely trade deficits, for any extended period of time without fairly serious consequences. Under a hard money standard, one country would suffer inflation and the other deflation which would eventually put pressure on trade bringing it back towards balance. Under a funny money standard, as we have now, one of the two trading parties must eventually go broke under such an arrangement. Yes, there can be periods of imbalances, sometimes large and for extended periods of time, but eventually something must give. Periods of extended trade imbalances always result in monetary problems in due course regardless of the type of monetary system. History has shown this over and over and over again. Germany – Greece is a recent example of why serious trade imbalances always cause problems, and one day the U.S. will be the biggest example of all.

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