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THE CAUCASUS & GLOBALIZATION
Vladimir LUKYANOV
Ph.D. (Econ.), Associate Professor, National Academy of Management
(Kiev, Ukraine).
THE FINANCIAL ECONOMY IN A GLOBALIZING WORLD
Abstract
This article is concerned with the current realities and development prospects of a civilization phenomenon known as the financial economy. It examines the basic imperatives of globalization changes in financial markets as the key drivers behind
the rise of the financial economy. Another purpose of this article is to analyze the main sources, instruments and mechanisms of the development of the financial economy in the context of the current possibilities of national economies.
KEYWORDS: Financial economy, financial globalization, financialization, financial markets, financial instruments.
Introduction
The financial economy is a natural product of globalization. One of the basic trends of the modern economy is an intensification of cross-border financial flows that determines the rapid development of financial markets and the accumulation of huge financial resources. In developed market systems, the financial market economy is increasingly asserting itself as an essential civilization
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imperative that has an inevitable impact on the development prospects of modern states.1 The global financial and economic crisis of 2008-2009 and the debt crisis of 2011-2012 have clearly shown the importance of an objective and systematic assessment of global trends in world markets, since they inevitably affect national economies.
The Financial Economy as a Natural Product of Financial Globalization
Current economic strategies show every sign of the rise of the financial economy as a civilization phenomenon, primarily through the expansion of financial markets. In fact, the financial economy is nothing but the ultimate embodiment, in terms of both scale and concentration, of modern financial markets with an appropriate infrastructure. Whereas in the past the financial component only served the physical economy, today it is increasingly positioning itself as a financial economy which (under the impact of globalization changes) is turning into a self-sufficient force and to a large extent dictating its own rules of behavior. As the Azerbaijani economist R. Kuliev rightly notes, "globalization has changed the structure of the world economy and determined the rapid development of financial markets. Whereas only a few decades ago the main purpose of financial markets was to ensure the functioning of the real sector of the economy, in recent years the world financial market has begun to show self-sufficiency."2
The financial economy is a natural product of financial globalization, which results in the rapid development of innovative financial products and thus in the accumulation of huge financial resources, actually provoking their separation from material production. In other words, competition for financial resources is going global. As the British historian Niall Ferguson (now a professor at Harvard University, U.S.) aptly put it, "Planet Finance is beginning to dwarf Planet Earth. And Planet Finance seems to spin faster too."3
Today there is good reason to believe that financial globalization is a specific transformation strategy based both on economic forms and methods and on noneconomic factors such as ultramodern technologies. But at the same time, money flows and financial resources do not seek to support the real economy "as a matter of protocol," and this inevitably results in increasing amounts of virtual capital due to the widening gap between real capital and its market value.
In this context, I think it is incorrect to say that modern financial capital has not detached itself from its basis: the real economy.4 The autonomization of financial resources and their separation from the so-called physical economy is fueled by the active positioning and distribution of a wide range of financial instruments and services, while "financial instruments and services are dematerialized and rest on purely psychological categories such as expectations, preferences and uncertainties."5
As professor I.A. Liuty correctly notes, "in the past, globalization processes were primarily encouraged by superstates and transnational companies, whereas today globalization demonstrates its own powerful driving forces."6 Such is the creative might now displayed by the financial economy.
1 See: J.M. Buchanan, R.A. Musgrave, Public Finance and Public Choice: Two Contrasting Visions of the State, CESifo Book Series, The MIT Press, Cambridge, Mass., 1999, 282 pp.
2 National Financial Systems in the Era of Globalization, ed. by Prof. I.O. Liuty, Galitskaia Akademiia Publishers, Ivano-Frankovsk, 2008, p. 253 (in Ukrainian).
3 N. Ferguson, The Ascent of Money: A Financial History of the World, Penguin Books, 2009, p. 4.
4 See: L.N. Krasavina, "Tendentsii razvitia mezhdunarodnykh valiutnykh otnoshenii v usloviakh globalizatsii mirovoi ekonomiki," Dengi i kredit, No. 11, 2011, p. 13.
5 V. Milovidov, "Filosofia finansovogo rynka," Mirovaia ekonomika i mezhdunarodnye otnoshenia (MEiMO), No. 8, 2012, p. 10.
6 National Financial Systems in the Era of Globalization, p. 13.
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The market infrastructure of the financial economy is multifaceted and diverse. For example, entities operating in the global financial space include super-powerful transnational corporations, bank syndicates, hedge funds, international stock exchanges and brokerage firms, offshore financial centers, regional monetary unions and other modern financial conglomerates. In this context, it must be admitted that the very infrastructure of the financial economy stimulates and intensifies the oligopolistic nature of the world financial market. The financial economy also includes numerous trading floors, depository institutions and clearing centers, which handle a vast array of contracts and agreements on hundreds of types, varieties and modifications of securities, derivatives based on them, and other financial innovations with numerous attributes, criteria and characteristics.7 A natural response to such civilization achievements was the establishment of a special group chaired by Joseph Stiglitz and including four other Nobel Prize winners, whose task was to propose new indicators of economic performance and social progress in the actively forming financial economy.8
The Globalization Content of the Financial Economy
The key imperative of the globalization content of the financial economy is so-called financial-ization. This term was first used officially in the UNCTAD 2009 Trade and Development Report, which included a special section called "The Financialization of Commodity Markets."
Of course, the current information content of the financial economy provides a public choice, namely, two opposite views of the interaction between market forces and the regulatory role of the state. In other words, there is a "financial secret" behind every civilization phenomenon. Evidently, this is precisely why current mainstream economics shows a lack of understanding of the essence of the financial economy as a key phenomenon of our time, i.e. its sources, drivers, content and forms of manifestation, as well as transformation influences.
The lack of competitiveness in economic views concerning the economic substance, causes and effects of financialization and, in this context, of the development of the financial economy is only a temporary negative trend because the term "financialization" used to denote the new global process has a solid basis. In countries which have successfully passed the fifth and are now at the sixth technological development level, the role of the physical economy (rooted in the "smokestack era" with its generally dominant material production) increasingly resembles that of a "maintenance worker."
As I see it, financialization is an aggregate concept denoting the process of financial globalization, on the one hand, and the result of the impact of this process on national economies, on the other. As a global phenomenon, financialization integrates national capital markets into a single investment area where the accumulated financial resources of individual countries seek profitable investment opportunities throughout the world while national capital-intensive projects are financed by foreign capital.
Financial markets and their infrastructure segments are one of the basic drivers of financializa-tion. The modern financial economy is an aggregate of diverse financial markets. Among these, a special role is played by money and foreign exchange markets, the market of financial services, the market of basic securities (stocks and bonds), and also the market of fictitious speculative capital, whose core consists of derivatives and financial instruments based on them.
7 See: D.Yu. Rayevsky, "Raskrytie poniatia 'derivativ' v otechestvennoi praktike," Finansy i kredit, No. 39, 2012, p. 16.
8 See: M. Fleurbaey, "Beyond GDP: The Quest for a Measure of Social Welfare," Journal of Economic Literature, Vol. 47, No. 4, 2009, pp. 1029-1046.
THE CAUCASUS & GLOBALIZATION
Thus, there is reason to say that financialization is a civilization phenomenon whose considered use helps, first, to enhance the competitiveness of money and stock markets, as well as financial services markets; second, to meet international requirements and standards and thus to reduce the vulnerability of national financial markets to external factors and influences; third, to implement new financial instruments and products effectively applied in developed market economies; fourth, to lower the barriers to the attraction of financial resources available in the world market, etc.
The financial economy as a polysystemic category contains a conglomerate, a discrete set of fictitious speculative financial instruments such as derivatives. Although the semantic meaning of the term "derivative" is "that which is based on (derived from) something else, secondary," it is not right to link all derivative financial instruments without exception to this concept. For example, one researcher basically denies the very concept of "derivative financial instrument." In his opinion, any derivative instrument is fully equivalent to the concept of "derivative."9 But modern financial engineering keeps spawning exclusive financial products that are virtually unrelated to derivatives.
Such things as warrants, options, swaps10 (currency, equity, credit default11), forward contracts, futures contracts, etc., are exclusive types of derivatives. At the same time, the use of financial products not directly associated with ("unrelated to") derivatives is growing exponentially. Numerous financial instruments are specific financial innovations. For example, financial instruments such as depositary receipts, covenants, collateralized debt obligations (CDOs), trades, securitized instruments and other products of modern financial engineering are not derivatives.
Financial innovations taking the form of diverse and previously unknown derivative instruments as a product of "financial alchemy" produce a synergistic effect, which feeds the pyramid of the financial economy. Today, global GDP (based on newly created value) is over $70 trillion.12 At the same time, in the financial sphere there is an unprecedented multiplication of previously unknown financial instruments. Their value is an order of magnitude larger than global GDP as the market of derivatives and over-the-counter (OTC) financial instruments has already reached $800 trillion.13 Some authors estimate the global derivatives market at the astronomical amount of $1,500 trillion.14 Thus, the developed financial economy demonstrates an excessive level of innovative productivity: the real (physical) economy in non-CIS countries now accounts for only 10% of the total economy, while the remaining 90% is the ever-growing market of derivatives and other financial instruments.15 Such dynamics naturally involve systemic risks.
Systemic Risks of the Financial Economy
The financial economy, which is increasingly asserting itself in the global dimension, keeps demonstrating its pro-cyclical nature. The existing differences in the development dynamics of financial markets largely determine the phenomenon of decoupling, i.e. all kinds of distortions and risks in the patterns of operation of the financial economy. In the last decade, excessive growth of the financial economy has become one of the most serious risks of modern economic development. Mea-
' See: D.Yu. Rayevsky, op. cit., p. 73.
9 <
10 Swaps are derivative financial instruments by means of which the parties involved exchange certain assets (cash flows) for a specified period of time, including with guarantee of their subsequent sale.
11 Incidentally, credit default swap obligations on the eve of the global financial crisis were four times the size of U.S. GDP.
12 See: L.N. Krasavina, op. cit.
13 See: Ibidem.
14 See: P.V. Alexeyev, "Aktual'nye voprosy formirovania mezhdunarodnogo finansovogo tsentra v Rossii," Finansy i kredit, No. 40, 2012, p. 66.
15 See: "Dolgovoi krizis v Evrope i perspektivy evro. Materialy kruglogo stola," Dengi i kredit, No. 12, 2011, p. 58.
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sures are being taken on a global scale to regulate the financial sphere. This includes steps (albeit only the first few steps) to clean up the mess around derivatives and the use of an ever-growing array of financial instruments.
The above-mentioned facts are one of the most serious macroeconomic risks, and the global crisis of 2008-2009 is convincing evidence of this. The financial crisis has convincingly refuted the belief that it is possible to keep risky assets off bank balance sheets and thus to ensure an optimal allocation of risks across the financial system. In reality, it was the other way round: risks accumulated at the very heart of the financial system.16
There is reason to believe that research in the field of finance has recently attracted "financial engineers" rather than financial policy makers. The successes of financial engineering are precisely what leads to excessive financialization of the economy, to the development of a speculative financial market, which inevitably causes financial bubbles and crisis phenomena in the global and domestic financial systems.
The first systemic crisis of the globalization era in its excessive financialized version has had a very negative effect on modern financial markets. Global trends in the form of the information (network) age or post-industrial society17 and the intensification of cross-border financial flows resulting in a total financialization of economic relations permanently extend to all aspects of the modernization process through various transformation interactions and influences.18 "One can say that financial globalization is a specific financial investment strategy designed to reform the modern financial market of universal financial services based both on economic forms and methods and on the wide use of non-economic factors: ultramodern knowledge-intensive technologies."19
Information technologies, the basis of the fifth technological order, have set the stage for the so-called post-industrial era, whose attributes include rapidly developing internetization (which has removed the obstacle of "economic distance" between countries and continents so that the global economic space can now function in real time), on the one hand, and the resulting global financializa-tion that affects virtually all national economies, on the other.
But most post-Soviet countries (including Ukraine), when following the advice of foreign advisers and consultants regarding the financialization of their national economies, usually enter an area of particular risk. Direct contact with markets of speculative financial capital, as a rule, is based on principles that have no proper legal basis. But in the absence of proper legal and regulatory restrictions, financial flows may suddenly come to a halt, and not necessarily for internal reasons in a particular national economy.
The fictitious virtual type of financial capital is precisely what provoked the huge supranational money flows that burst the legal dams of national borders and dictate their strategy for the development of national and global financial markets. That is why one cannot agree with the over-optimistic forecasts of some researchers who believe that in the next 20 to 30 years we should expect to see a new world economic system in which "trade in air" is limited by necessity, with the possibility of an active reindustrialization policy, i.e. a return to real production.20
A sudden cessation or reversal of the flow of financial capital can lead to the bursting of speculative bubbles with extremely grave consequences for the economies in question. Such phenomena highlight the need for cross-border regulation of financial markets, especially exchange and OTC trading in financial instruments.
1 See: Niall Ferguson, op. cit.
See: M. Castells, The Information Age: Economy, Society and Culture, in three volumes, Blackwell, Oxford, 1996-
1998.
18 See: V. Milovidov, "op. cit., pp. 10-11.
19 G.W. Kolodko, Mir v dvizhenii (in Russian, translated from the Polish), Magistr, Moscow, 2009, p. 25.
20 See: M.G. Yermolayeva, "Global'nye tovarnye rynki, global'nye denezhnye i kapital'nye potoki: osnovnye tendentsii i perspektivy," Finansy i kredit, No. 33, 2012, p. 45.
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The Growing Need for International Regulation of Securities Markets
Intensifying globalization processes in the financial sphere make it necessary to regulate the practical use of new financial instruments. The scale and diversity of financial markets, their infrastructure and basic products are truly boundless, and this explains the continued absence of rules and norms backed by effective law enforcement. So far this problem has been addressed more or less effectively only in the European Union, especially within the limits of the eurozone.
Nevertheless, one must also admit that the greater share of derivatives and other financial instruments is sold over the counter, where trading does not comply with any standards, leaving no opportunity for the prompt elimination of accumulating financial imbalances. This situation is a serious concern for the Group of Twenty. At its recent summits, G20 members have spoken of the need to develop principles and mechanisms for ensuring more effective regulation of exchange and OTC markets.
At present, the basic regulator of the global OTC derivatives market is the International Swaps and Derivatives Association (ISDA), which now includes more than 800 financial institutions from 55 countries.
For its part, the Bank for International Settlements (BIS) is one of the largest analytical institutions which monitors issuing activities in securities markets, the situation with foreign exchange transactions, deals with derivative financial instruments on organized exchanges and in the OTC market, etc.
In monitoring these activities and summarizing the information obtained, the two regulators keep track of the processes taking place in this area and develop recommendations for standardizing contracts and transaction terms in the swap market, on the one hand (ISDA), and help to hedge financial risks in the securities market, on the other (BIS). But ISDA, which brings together only the biggest players in the OTC market and sporadically performs control functions, at the same time pays no attention to other (smaller) players in the OTC derivatives market. That is why it is over-optimistic to say that the International Swaps and Derivatives Association is the main regulator of this market. After all, even today each transaction in the use of over-the-counter financial instruments such as swaps is non-standardized and in a way unique as it does not depend on legal regulators but on current market conditions and the reconciliation of the parties' interests. Such situations are not exceptions but typical manifestations of the financial economy.21
Exchange-traded securities and financial instruments are obviously overvalued because otherwise there is no point in trading them on organized exchanges or trading floors. As a result of market speculation, they are obliged to create the illusion that they constitute real capital whereas in fact we have a process whose only purpose is to "beat the market." Obviously, moral principles here are low down on the list of priorities.
Conclusion
In the light of the above, we can draw the following conclusions.
■ First, the international implementing entities that have appeared in recent years are the most adequate expression of financial globalization, on the one hand, and a necessary prerequisite
See: J.C. Hull, Options, Futures, and Other Derivatives, Pearson Education, Inc., New Jersey, 2006.
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for regulating and keeping in shape the huge body of rapidly developing international financial and economic relations, on the other.
Second, financial globalization carries obvious risks of loss of sovereignty by national economies. Moreover, rapidly increasing globality often makes transparent the hidden dependencies between countries, actively limiting (or even destroying) national sovereignty.
And third, permanent growth of virtual capital combined with a diversification of financial instruments can be seen as the key imperative of the financial economy.
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