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IS GLOBALISATION RECOVERING? CHALLENGES AND OPPORTUNITIES AFTER THE GREAT CRISIS
by GIOVANNI FERRI
(University of Bari, Italy)
I. INTRODUCTION
The Great Crisis of 2007-2009 led many experts to ask whether globalisation was (once more) dead. Indeed, the suddenness and intensity of this crisis could only find a parallel in the Great Depression of the 1930s. On the occasion, several economists observed that the most important channel of transmission of the crisis - triggered by the Great Crash of Wall Street in 1929 - from the US to the rest of the world was the drop in international trade. To be sure, also this time, particularly after the bankruptcy of Lehman Brothers, the entire world experienced a brisk dip in international trade. Since in the Great Depression, with the collapse of exports, many countries adopted «beggar thy neighbour» policies restricting imports and eventually stubbing globalisation to death, pundits were asking themselves whether de-globalisation was on the way again.
Those initial worries were soon corroborated by remarkable supporting evidence that international trade was indeed contracting at a pace that was unprecedented since the 1930s1. However, fortunately for humanity, most of the policy mistakes aggravating the Great Depression were avoided this time around. First, in contrast with the tight monetary policy of the 1930s, this time the Bernanke-led Federal Reserve swiftly enacted zero interest rate policies and quantity monetary easing. Second, instead of limiting the liquidity support provided to the distressed banks, as in the early 1930s, the Fed and the Treasury bestowed unlimited support for all the biggest (or most interconnected) financial institutions - with the only exception of Lehman, whose bankruptcy was judged by many a terrible mistake - that were not let go bankrupt. Third, government spending profligacy promptly replaced the fiscal stringency of the first few years into the Great Depression. Forth, the US were not left alone in undertaking these expansionary policy actions that were almost invariably replicated - to a different degree depending on the national specificities - in all the countries. Whats more, those actions were to some extent concerted within the newly entrusted forum of the G20 - the group of the 20 most important countries by economic mass -, a highly representative institution of the world.
The chronicle of the few quarters after the peak of the crisis is comforting. Thanks to the expansionary policies that were deployed, the world seems to be skidding away from financial and economic implosion.
While many emerging economies just experienced some reduction in GDP growth below their recent trends and are now returning to those trends, even the harder-hit developed countries are seeing economic recovery. Thus, can we conclude that the crisis is over and everything is in order to take the world economy back to the full speed it enjoyed in the years up to 2006? Probably not, considering that the problems paving the way to the crisis were barely tackled and certainly not solved. Lets evaluate this in detail.
First of all, the analysis of the exit from it requires an assessment of the crisis intrinsic nature. Specifically, was it a standalone event or, rather, it was one episode in a sequence of repeated crises? And, if it belonged to a sequence, how were the single crises in the sequence interrelated among themselves? In turn, were there theoretical and policy errors in the background to allow the unfolding of such an aggravating sequence? Finally, which scenarios are more likely to emerge in the near future?
II. A SEQUENCE OF SYSTEMIC FINANCIAL CRISES: INDEPENDENT OR INTERRELATED?
First of all, it seems inappropriate to look at the recent global financial crisis as an isolated crisis, as implied in a view a la «Black Swan» (Taleb, 2007). On the contrary, as Reinhart & Rogoff (2008, 2009) argue convincingly, this crisis is similar to the financial instability crises happened in the past decades, like the asset bubble followed by the debt-deflation crisis of Japan in the 1990s. To some extent, this crisis resembles also the systemic crises of the emerging economies across the 1990s and the beginning of the new millennium (Mexico, 1994; East Asia, 1997; Russia 1998; Brazil, 1999; Argentina and Turkey, 2001). Those crises were interpreted along the paradigm of the twin crises (Kaminsky & Reinhart, 1999)2. The chief difference with respect to those is that the latest systemic crisis started at (and hit) the centre of the worlds financial system, rather than its periphery, and excess debt was denominated in the domestic currency (the US $) rather than in a foreign hard currency. As such it seems to need re-regulation as a condition to find a proper solution.
Figure 1. The Political Economy Cycle of Finance
Source: DApice & Ferri (2010)
According to various observers (e. g. Eichengreen, 2008a, 2008b, 2009; Wolf, 2008), the international financial system became increasingly inconsistent and instability-prone as it progressively abandoned the gold exchange standard (1971) and then, via deregulation and financial liberalisation through much of the 1980s and 1990s, became weakly regulated/supervised at both the national and global level.
Some authors identify a possible political economy cycle of finance (e. g. DApice & Ferri, 2010; Figure 1). In practice, after the Great Crash of 1929 already in the mid-1930s, countries had developed a consistent regulatory framework to achieve financial stability. Only after the Second World War, was the framework finalised at the international level, with the definition of a new monetary order centred on the US dollar. While supporting economic growth, at the same time, financial innovation, deregulation and globalisation have progressively generated inconsistencies in the original regulatory framework, providing the background factor of previous crises as well as of the recent one. Abandoning the gold-exchange anchor was at the heart of the Latin American crises of the early 1980s. This resulted from the generous loans the international banks made in allocating to those sovereigns the re-cycling of the surplus of oil-rich countries after oil re-priced in the 1970s.
Also the systemic financial crises of the 1990s would have been largely caused by inconsistencies in the financial regulatory/supervision framework3. Analogous reasoning would apply to the mega-corporate bankruptcies of the beginning of the new millennium4. All of these episodes might then be interpreted as initial signals of a mounting wave of financial instability. One could ask whether the recent crisis - which is the largest one since the 1930s - might bring that political economy cycle of finance to a close.
The idea that crises may recur and strengthen over time until they reach an unsustainable intensity is in the famous essay of Kindelberger (1978) on Manias, Panics, and Crashes. He takes the traditional thought that people are rational beings and introduces the fact that speculation leading to destabilisation is very much present, and that many of historys crashes have come from this irrational behaviour, i.e. manias, panics, and ultimately crashes. Kindelberger stretches his interpretation to encompass more than three hundred years of financial crises. He also asks the important question of whether or not there was a lender of last resort acting to halt a run out of illiquid assets into money by making more money available, through a discount window. But Kindelberger warns that this is not the whole solution. Having a lender of last resort can pose its own problems. Many institutions, because there is someone to bail them out, partake in more risky practices. By simply bailing out these mismanaged firms, we are not giving them incentive to improve their operation. Thus, for Kindelberger when the system runs from bubble to bubble and the subsequent panics and crashes are methodically cured with lender of last resort bailouts - as it seems to have happened over the fifteen years before the 2007 crisis in the US - those stabilisation interventions turn out increasingly destabilising5.
The natural extension of Kindelbergers view is that at some point the financial system needs to be fixed again through in depth re-regulation, in a way to regain a set up coherent with financial stability. In fact, financial deregulation and liberalisation have amplified the scope for speculation and the extent of speculation can no longer be cured with bailouts that soothe one crash only to intensify moral hazard and prepare for a larger bubble and crash in the near future. So, re-regulation is likely to happen when - after a sequence of crises at the periphery - a major financial crisis hits the centre of the financial system and, through contagion, hits the entire world unnerving public authorities and shaking the public opinions belief in the free market.
In all, have we reached that point for re-regulation at the present stage? On one hand, the authorities vocal call for stricter regulation - e. g. those at the London meeting of the G20 in April 2000 - could provide some support for that interpretation. On the other hand, the signs of recovery seem to have led to postponing the reform of finance in the political agenda. Thus, it is too soon to draw firm conclusions.
III. THE THEORETICAL AND POLICY ERRORS IN THE BACKGROUND
The genesis of the financial excesses and rising leverage in the pre-crisis USA and elsewhere is related to various underlying factors. Poor incentives were provided in a context of intense financial innovation accompanied by regulatory loopholes. On its part, an exceedingly lenient monetary policy underestimated the perils of inflation in asset prices. Furthermore, the setup for the governance of globalisation proved inadequate. Thus, the issues we raise here go to the heart of the sustainability of the development model cast by the USA on a world scale. As globalisation was to a large extent walking on the legs of the financial system, this global financial crisis is also a crisis of the way global relations were arranged.
Behind the accumulation of the excessive indebtedness leading to the crisis laid three main theoretical/ policy errors: i) questionable risk pricing models derived from the finance theory; ii) fallacious evolutionary view subordinating banks to financial markets; iii) improvident monetary policy conduct by the Fed. These are errors derived from theory that led to wrong business decisions and faulty regulation.
Two additional issues - the unsatisfactory set up of regulation/supervision and the major conflicts of interest - though, need to be mentioned. While the stream of structured products was rapidly swelling, much of it was transacted on little transparent unregulated (OTC) markets and hinged on the poorly regulated shadow banking system. This comprised the investment banks, that were greatly expanding their leverage ratios, the hedge funds and the Structured Investment Vehicles (SIVs). Compensation schemes also favoured excessive risk taking. Regulatory and supervisory loopholes were extensive also because inadequate global coordination opened up to massive international arbitrage, particularly to financial centres providing regulatory and tax heavens. In turn, even within the US, the multilayered setup of regulation and supervision - involving the Fed, the SEC, the Comptroller of the Currency, the FDIC, and individual States - made the environment less conducive to rein in excessive risk taking at financial institutions6.
In addition, a key part of the pre-crisis easy finance impinged on the presence of conflicts of interests7. These conflicts of interests will need to be addressed with some form of separation and oversight. Nonetheless, as we will see, the three theoretical errors were per se enough to make stabilisation interventions destabilising. So, by bailing out the intermediaries that had made wrong choices and thus amplifying the moral hazard for financial intermediaries, the policies to overcome one crisis triggered by the explosion of a financial bubble were involuntarily intensifying systemic risk and consequently paving the way to a new - probably bigger - financial bubble.
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Figure 2. Trends of Sovereign CDS
- Questionable risk pricing models derived from the finance theory
The experience that risk pricing models had some problems was acquired at least since 1998. The Hedge Fund Long Term Capital Management (LTCM), technically bankrupt, was then salvaged via the arrangement on the part of the Fed of a consortium of banks to bail it out. LTCM was no anonymous passer by but the star of Wall Street (Lowenstein, 2001), with its trading models created by two Nobel-prized economists: Merton and Scholes. LTCM went bankrupt because those models underestimated the «tail risk» (i.e. the occurrence of particularly devastating, though unlikely, events; Taleb, 2007), which materialised then following the Asian crisis and the Russian sovereign default. Also, without the due revisions, those models became thereafter even more dominating - and even some pieces of regulation came to be based on them - up to the current crisis.
Whats more, the base models of finance hinge on the hypothesis that private risks and sovereign risk be uncorrelated (see e. g. Cuthbertson & Nitzsche, 2004)8. However, such hypothesis is untenable as also the recent crisis reminded us when the unavoidable State interventions to salvage banks determined, at the same time, a reduction in the default risk of the banks (lower spreads on bank CDS - Credit Default Swaps) and an increase in the default risk of the sovereigns (larger spreads on CDS; Figure 2).
- Fallacious evolutionary view subordinating banks to financial markets
The banking business model based on «relationship banking» appears to have been less affected by the deep financial instability of 2007-09. It is true that significant bank distress was experienced also in many countries of Continental Europe, which normally rely more on banks than on financial markets in the international comparison. However, if we look at the individual intermediaries we notice that those suffering distress were generally the larger-sized banks and those banks that came to rely more on financial market-related non-interest operating income as a source of revenue. It is useful to observe that - in line with the findings of IMF economists Hesse & Cihak (2007) - more stability was enjoyed by the cooperative banks (with the exception of their central financial intermediation units, like Natixis in France). Indeed, mutual and cooperative banks are everywhere champions of retail banking along the relationship banking model.
Households-Firms
Mortgage Brokers Banks
Investors
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Figure 3. The Dark Side of the Transformation of the Banks From OTH to OTD
Source: DApice & Ferri (2010)
Indeed, the Anglo-American transformation of financial intermediaries in the last twenty years had at its centre the advent of the new banking model «originate to distribute» (OTD) - whereby banks originated loans to be immediately securitised on the financial market - as opposed to the traditional «originate to hold» (OTH). With the benefit of hindsight, we now know that the widespread recourse to OTD was one of the fundamental causes behind the generalised loss of responsible behaviour on the part of the banks (Ashcraft & Schuermann, 2008; DellAriccia et al., 2008; Mian & Sufi, 2008). Specifically, it is easy to understand that when the bank knows ex ante that - through securitisation - it will sell at once those loans it is granting, the bank loses the appropriate incentives to duly perform its screening and monitoring on borrowers (Figure 3). Thus, a generalised deterioration in lending standards is in the cards. And this is particularly worrisome in those contexts where the risk of borrowers default is systematically high, such as in the subprime mortgage segment.
However, the crisis was compounded by deeper theoretical mistakes. The progress made by the theory of intermediation based on the asymmetric information approach (e. g. Stiglitz & Weiss, 1981; Diamond, 1984) was rather neglected. The ICT evolution had rooted the wrong perception that risk could be segmented and traded without major adjustment, a view which stood at the basis of securitisation but affected also other segments of the credit market. This approach neglected the problem that if one un-bundles complex financial relationships into segmented contracts this will, most likely, weaken the intermediaries ability to asses and govern the overall dimension of that risk, thus amplifying systemic risk. When a borrower entrusts all his financial dealings on a single banking counterpart, in fact, that bank will have access to private (soft) information (Scott, 2006), which will instead be lost when that customer fragments his business among various counterparts, let alone if his debt is securitised on the financial market. At the same time, within a single banking relationship, the bank has the appropriate incentives to screen and monitor its borrowers, thereby acquiring private information on them. It is true that, as a consequence of the hold up problem, the relationship bank might try to extract rents from its borrowers. Nevertheless, this might be a price worth paying to avoid falling into irresponsibility.
Eventually, in fact, through the advent of the OTD model, the responsibility of assessing the risk of the underlying loans was mostly transferred from the banks to the credit rating agencies. But the rating agencies were also part of the problem in four respects: i) they underestimated risks implicit in structured assets because they overlooked that systemic liquidity problems would impinge on the market valuation of these assets; ii) they failed to see how the transformation of the banking model - from OTH to OTD - had undermined the incentives to screening and monitoring borrowers, thus lowering credit standards; iii) they ventured into rating extremely complex structured finance products by «marking them to model» on the basis of too rosy assumptions (Mason & Rosner, 2007); iv) sometimes, the rating agencies underwent conflicts of interest problems whenever they acted as consultants in the structuring process of the products and then rated those products.
Theory and regulation contributed to spread the fallacious view that individual risks could be separated without appropriate system adjustment. On its part, regulation contributed to shape a less secure banking system, for example through the international accounting standards (IAS) and Basel 2, which - adopting the marking to market approach - introduced a regulatory incentive to rely exclusively on the rating/scoring technologies. It may suffice to consider the pro-cyclical trends potentially induced by the diffusion of credit scoring and disseminated to the banks minimum capital requirements through banks internal rating models9. This may be labelled the dark side of credit scoring (Ferri, 2001). Credit scoring is a substantially mechanic method to come up with the decision to grant credit on the basis of the collection of standardised information on applicants. This method relies on statistical models to assign the applicants to various ex
ante risk classes and choose the threshold values to accept or reject the loan applications. As such, credit scoring is a potent instrument able to lower noticeably the administrative/management cost of the loans, to the point that, according to some authors, it could reduce asymmetric information and financial constraints (Petersen & Rajan, 2002). In our view, however, adopting credit scoring has shortcomings as well. It is a well recognised fact that, in reality, the main role of the banks stems from their ability to develop relationship banking with their borrowers, a special situation facilitating ca Pareto improving exchange of information between the borrower and the bank. And relationship banking hinges in a critical way on the extraction by the bank of proprietary information on the borrowers, thanks to multiple interactions between the two parts (Boot, 2000). In that, credit scoring lowers banks ability to gather and process soft information on borrowers, that are often crucial to overcome the asymmetries of information between the borrower and the lender. In truth, credit scoring implies totally trusting standardised data and automatic mechanisms, an approach, which is the opposite of using soft information, which are by nature information that one cannot circumscribe in standard formats and that require relationships rather than mechanical instruments. From this perspective, credit scoring - as it reflects the borrowers current situation rather than his future prospects - may induce pro-cyclical fluctuations in the cost and the availability of credit, something that could amplify the endogenous fluctuations in the loan supply (Rajan, 1994) and, thus, in economic activity. Analogous considerations apply to ratings and, so, also to Basel 2.
The approach postulating the need for banks to evolve form the OTH to the OTD model (Bryan, 1988) implied a subordination of the banks to the financial markets, where their loans would now be priced as securities on the basis of statistical models rather than the bankers intuitus personae. This subordination derived from the evolutionist view whereby multilateral financial markets would do a better job at allocating risks (Goldsmith, 1966; 1969). Alas this vision was based on a transactional view of the bank, which had been questioned by theory and evidence.
Perhaps, as Allen & Gale (2000) suggest, it is more fruitful to look at financial markets and banks as complements rather than substitutes. The two actors can fruitfully play different functions in the financial system. Both are needed. In spite of that, we do observe that - even though some convergence took place over the last twenty years - differences exist across financial systems. As we will detail later, financial systems are often distinguished as financial «market-based» (MB) - when they rely to a larger extent on financial market transactions - whereas they are labelled «bank-based» (BB) - when bank intermediation has a larger weight. An interesting study by the IMF (2006) indicates that these underlying differences in financial structures may affect the response of households and firms to changes in the economic environment, and thus influence the cyclical behaviour of national economies. Specifically, the study reaches the following main findings. First, within the common trend to bank disintermediation in favour of the financial markets, the pace has varied and still important differences persist across financial systems. Second, in MB financial systems households seem to be able to smooth consumption more effectively in the face of unanticipated changes in their income, although they may be more sensitive to changes in asset prices. Third, in BB financial systems firms appear to be better able to smooth investment during business cycle downturns, as they are better positioned to access external financing based on their long-term relationships with financial intermediaries. However, when faced with more fundamental changes in the environment that require a reallocation of resources across sectors, MB financial systems seem to be better placed to shift resources to take advantage of new growth opportunities.
- Improvident monetary policy conduct by the Fed
On its part, the Fed seemed at length overly hesitant to take action against the build up of unsustainable U.S. indebtedness. In truth, the Fed was comforted by mainstream academia, which mostly suggested that central banks should worry just about CPI inflation10, rather than financial imbalances and asset price booms. Also, the gradual monetary policy tightening since mid-2004 affected only the short-term fed funds rate but had little impact on long-term interest rates. This «decoupling» of long-term rates - attributed in part to large capital inflows, mostly from surplus countries - implied that monetary policy tightening had only modest effects on aggregate demand (Wu, 2006). Nevertheless, it is clear by now that keeping short-term rates very low for so long helped increase maturity mismatches: before the crisis investment banks entrusted some 25% of their funding to overnight repos and an additional 15% to three-month asset-backed commercial paper, while holding assets with much longer maturities on their asset side. Therefore, too lenient monetary policy was for sure part of the problem.
In addition, the Feds easy monetary policy contributed to create global liquidity also indirectly. The supplementary impact came from the many emerging market economies - some of them quite important - which have their currencies pegged to the dollar. To keep the peg, they had to follow the expansionary policies and this contributed to the expansion of world liquidity.
Moreover, perhaps the great «moderation of inflation» of the previous 15 years depends also on globalisation (with production being relocated to lower cost of labour countries) besides the Central Banks credibility and the rigor of their monetary policies (Benati & Mumtaz, 2005; Benati & Surico, 2008)11. It is also useful to recall that: i) during the first globalisation of the 1800s developed countries experienced a drop in their price level - between 1870 and 1900, prices decreased by 1.2% (0.8%) per year in the US (in the UK) - and not simply a lower increase in prices, i.e. a moderation of inflation; ii) at that time the international monetary system, based on the gold standard, ruled out discretionary monetary policy. If we consider i) and ii) together we may actually doubt that, effectively, the discretionary monetary policies of the main Central Banks have been the only driver lowering inflation in the recent phase.
This takes us back to the mistakes made by the Fed, which kept too low interest rates for too long while the US were cumulating their external imbalance. Furthermore, salvaging the LTCM hedge fund (in 1998) and lowering rates decidedly after the burst of the new economy bubble (in 2000), the Fed had heightened the moral hazard for financial intermediaries, to the point that pundits described a kind of «Greenspan put», i. e. an option with which if things went well they cashed in the profits and if things went awry the Fed would come to their rescue lowering interest rates. All in all, the undesired fallout of the stabilization policies to solve crises generated increasing moral hazard and exorbitant systemic risk and this what explains how those stabilisation policies became destabilising. The crux of the problem, as we have tried to explain was however that those policies were founded on theoretical mistakes.
For the future, as BIS (2009) argues convincingly, we need to enlarge the focus of monetary policy with Central Banks not merely aiming at CPI inflation while big imbalances grow at the macro level and, under the glitter of innovation, perilous fragilities undermine the financial system. However, even if leaning against asset price inflation will be embodied as an additional target, the problem will still exist of how to spot early on the bubbles, which normally become known only with the benefit of hindsight.
IV. CHALLENGES AND OPPORTUNITIES FOR THE FUTURE
Keeping globalization going is a very important objective for mankind. But achieving it cannot be taken for granted12. In particular, the task will require ensuring the sustainability of globalization particularly in three dimensions: the environment, society, and the economy. I will briefly touch on the first two dimensions and then focus on the third one.
Environmental sustainability is a key question on the agenda of all the countries and in the international fora. A wrongly framed globalization could trigger a competition in laxity in environmental standards. The depletion of the environment is normally not factored in within the national accounts. Also, it is doubtful that the price mechanism can fully capture the environmental degradation and correct for it. In fact, the future generations - the major stakeholders that are damaged by such events - are not represented today, apart from the limited offsetting exerted by the benevolence of the current generations may have towards them.
The second main challenge is societal sustainability. A globalization that is not properly governed could exacerbate inequality. Even the Chinese economic miracle has shown its limits cumulating growing inequality over the years. In some respects inequality can be seen as a negative spillover on society, in a similar way to the spillovers from environmental pollution. Indeed, when it goes beyond some physiological threshold, inequality translates into societal degradation and may even provoke social unrest. On the contrary, it is essential that society at large perceives nobody is excluded from sharing the benefits of globalization. In all, both environment and social sustainability are therefore crucial to allow globalization to keep going.
However, lets turn now to the sustainability of the economy. The main evolution over the latest two decades is, perhaps, the (re-) inclusion of a large fraction of the world population into the international economy. The continent that came back more forcefully is Asia, particularly in its Eastern part. It so happened that the two largest countries in the world, China and India, came back to the world arena after a long period of oblivion. Given that both countries have a surface comparable to Western Europe their multiple size in terms of population tells us the long affluence China and India enjoyed in the past two millennia. Indeed, the data estimated by Maddison (2001) is clear on that: Up to 1500 both Indias and Chinas share of world GDP were about % each and by 1820 China accounted for 36%.
The economic success in the recent decades has been astounding for the emerging economies. The quartet of the BRICs - Brazil, Russia, India and China - is often taken as the symbol of the entire category. Indeed, those four economies represent quite a lot of the entire emerging countries set. To be sure, one can notice that the share of the world GDP this quartet represents has been growing with great speed. In 1973, the BRICs accounted for 15%, the USA for 22% and Western Europe for 26%. After 33 years, in 2006 the weights had changed, respectively, to 28%, 20% and 18%. The Great Crisis brought about a further acceleration and, according to forecasted growth, by 2010 the new weights should be: 34% for the BRICs, 18% for the USA, and 16% for Western Europe.
This reshuffle in the distribution of economic power will need to be considered in the allocation of responsibilities in international institutions. The passage form the concept of the G8 to that of the G20 is already reflecting that. But much needs still to be done at the IMF as well at other world fora.
Achieving economic sustainability will be the major challenge. The inclusion of most emerging economies - particularly the East Asian ones - in the global framework has largely hinged on those countries following an export-led development model. Well, that development model is not sustainable. As much as
there is scope to be sceptical about the «savings glut» and the «portfolio choice» interpretations - whereby Chinas excessive savings and the countrys eagerness to invest its enormous current account surplus in the sophisticated on the sophisticated US financial markets were accused of forcing the American consumers to indulge in excess profligacy - we should probably admit that the export-led model endogenously builds in into the system a temptation for some other country (typically the reserve currency country) to spend beyond its budget constraint. While building cross-country macroeconomic imbalances cannot be forbidden by law, it should however be discouraged to the extent that these imbalances amplify the economic and financial fragility in the international order. Thus globalisation will be a lot safer when the fast growing emerging economies - particularly the two largest ones - will find home-grown demand factors to support their increasing output capacity.
The appreciation of the currencies of those countries that have been cumulating large current account surpluses while pegging to the US dollar is certainly not enough to eliminate their large external imbalances. However, that move goes in the right direction and its adoption should be welcomed13. By making the countrys exports (imports) more (less) costly for foreign (domestic) agents, this sets in motion some adjustment. To be sure, the extent of currency appreciation may contribute to the adjustment should not be overstated. In fact, the excessive savings characterizing these situations largely depend on individual lacking forms of security support that are normally available in developed countries. By this token, extending and deepening the social safety net as well as the provision of state funded pension schemes could be particularly valuable. Some observers have even conjecture the establishment of global minimum wage standards to secure a more balanced globalisation (Duncan, 2003). The idea seems to make sense. However, it is a question whether it is also feasible. Furthermore, there is a need for strengthening the pillars of fair trade, particularly via the phasing out of the large agricultural subsidies by the developed nations. If all these measures were taken together the prospects of making globalisation sustainable would be greatly improved, thus securing incommensurable benefits to humanity.
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1. Eichengreen & ORourke (2010) compare the drop in trade between the early 1930s vs. 2007-2009.
2. Kaminsky & Reinhart (1999) found that problems in the banking sector usually precede an exchange rate crisis. That exacerbates the banking crisis, triggering a vicious circle. Increased financial freedom also often precedes a banking crisis. The anatomy of the twin crises suggests that they occur when the economy goes into recession following a prolonged economic boom nourished by credit, inflows of capital and over-valued exchange rates.
3. The IMF pointed out the weaknesses of the East Asian countries in terms of financial regulation/supervision were as the major causes of the 1997 crisis suffered by the region (Fischer, 1998).
4. For example, the possibility - according to the GAAP - to avoid consolidating the accounts of the many Special Purpose Entities not entirely owned by the company allowed Enron to overstate at length its profits while leaving much of the losses with those SPEs. This was achieved with the help of the accounting firm Arthur Andersen that was operating under an evident conflict of interest and was later dissolved.
5. For this reason, Roach (2009) criticised the re-appointment of Bernanke as Chairman of the Fed.
6. The US blueprint for financial reform recognises this was a serious problem. Its Section D is devoted to «Clos Loopholes in Bank Regulation». In it, it is said: «One clear lesson learned from the recent crisis was that competition among different government agencies responsible for regulating similar financial firms led to reduced regulation in important parts of the financial system. The presence of multiple federal supervisors of firms that could easily change their charter led to weaker regulation and became a serious structural problem within our supervisory system». (US Treasury, 2009, page 32; emphasis added).
7. Still US Treasury (2009), recites: «Securitization, by breaking down the traditional relationship between borrowers and lenders, created conflicts of interest that market discipline failed to correct. Loan originators failed to require sufficient documentation of income and ability to pay. Securitizers failed to set high standards for the loans they were willing to buy, encouraging underwriting standards to decline. Investors were overly reliant on credit rating agencies. Credit ratings often failed to accurately describe the risk of rated products. In each case, lack of transparency prevented market participants from understanding the full nature of the risks they were taking» (page 6; emphasis added).
8. Only through this assumption that private risks and sovereign risk be uncorrelated it is possible deriving the CAPM (Capital Asset Pricing Model) fundamental formula: ERi = r + pi(ERm - r) where ERi is the equilibrium expected return on risky asset i, r is the risk free rate (approximated by the return on government securities), ERm is the equilibrium expected return on the diversified portfolio and pi = cov(Ri, Rm)/var(Rm).
9. Adrian & Shin (2008) show that in a continuous marking to market set up, leverage is strongly pro-cyclical.
10. Though some authors (e.g. Cecchetti et al., 2000; Borio & Lowe, 2002) argue that central banks should sometimes act against asset price bubbles, other authors
(e. g. Bernanke & Gertler 1999, 2001; Kontonikas & Ioannidis, 2005; Alexandre & Ba^ao, 2005) show that monetary policy optimally stabilizing inflation (i.e. focusing on CPI and disregarding asset prices) is normally superior. It should be mentioned that both Bernanke and Gertler were, at that time, academics external to the Fed.
11. Pain et al. (2006) show that, in OECD countries: i) import prices have become a more important driver of domestic consumer prices since the mid-1990s; ii) the sensitivity of inflation to domestic economic conditions has declined whereas the sensitivity to foreign economic conditions has risen, working through import prices; and iii) the strong GDP growth in the non-OECD economies over the past five years has contributed to the growth of real oil and metals prices. Thus, they conclude that globalisation has put upward pressure on inflation via higher commodity prices and downward pressure via lower non-commodity import prices with the latter effect having dominated in most OECD economies. On the contrary, Ihrig et al. (2007) find little support for the hypothesis that globalisation dominates inflation dynamics. At the same time, they acknowledge that the fact that the volatility of real GDP growth has declined by more than the volatility of domestic demand suggests that net exports increasingly are acting to buffer output from fluctuations in domestic demand.
12. See, e. g., the in depth discussion in Stiglitz (2006).
13. The recent move by China to enlarge the fluctuation bank of the renmimbi against the dollar is good news in this sense as many see it a preliminary move to appreciation.
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