By Neville Bennett The year 2008 was one of the most important in history. It severely wounded capitalism and created an on-going turbulence that bewilders us all. No one is entirely sure what is happening now, for "credit crunch", "slump' or "global recession" etc. do not quite fit. The future is an enigma. I have never been so perplexed about the future. Having read frantically over the summer without much enlightenment, I was alerted by a perceptive reader to the World Economic Forum's release on Jan 15, 2009 of a report on "The future of the Global Financial System" prepared for the next Davos meeting. It is stimulating although, ironically, many contributors come from organizations which have been mutilated by the crunch.
Moreover, the study reaches no consensus on the shape of the future; it presents four very different scenarios. Nevertheless, it is interesting because of the depth of the evidence reflecting the work of 250 thinkers gathered in eight major workshops. It is especially valuable on what went wrong. End of "Age of Moderation" In retrospect, the two decades before 2007 were halcyon years, an age of moderation. It was a period of great macroeconomic growth, stability, declining inflation and unemployment. Recessions were few, shallow and short. The financial system enjoyed unprecedented earnings growth due to expansionary monetary policies, globalisation and sustained economic expansion. Debt increased massively, however. US household debt grew from 45% of GDP in 1984 to 97% in 2008: financial sector debt grew from 19% GDP in 1984 to 118% 2008. Interest rates generally declined: US 10-year bonds yielded 16% in 1984, 4% in 2008. In a low-yield environment, investors welcomed risk and the market responded with highly leveraged products. The era was built on excessive deregulation and excessive credit and leverage. The Report does not mention the housing crisis at this point, but I consider it a crucial part of the growing imbalances of the era. That era has passed and cannot be resurrected. Three new drivers 1. Deleveraging Deleveraging bank and household balance sheets will place severe stress on the global economy, especially price declines and falling values in equities. Moreover, tighter and more expensive credit has forced investors to sell-off leveraged assets. Leverage occurred over 20 years, and deleveraging will also be protracted. Unwinding consumer debt will have enduring effects, most probably inducing a long recession, and shifting power from industrialising to emerging countries 2. More Government intervention Governments have assumed banking-sector risk in exchange for greater regulation and oversight. Interventions will strain national fiscal positions, raising the risk of sovereign default and IMF intervention. Risks have increased sharply in emerging countries, renewing pressure on inflation, devaluation, deteriorating foreign direct investment and poor economic growth. Governments will become important players in the markets they regulate. Their interventions will be felt acutely by the newly semi-nationalised institutions which will be torn by competing objectives set by sovereign and private shareholders (for example, government might want low interest rates to stimulate growth while shareholders want profits). Private shareholders are also expected to be more activist. 3. Less cross-border activity Governments will regulate to introduce early warning systems, to prevent market failure and systemic risk. Other issues are controls on capital flows. Capital flows are already diminishing and trade is falling sharply. Having shored up domestic banks, some governments will be tempted to reduce foreign competition. The prospect for globalisation is much less certain than before. Long-term Scenarios The Report goes beyond merely extending current trends, and explicitly considering critical uncertainties, potential discontinuities and system dynamics in order to support strategic decision making and collaborative action. There are two critical uncertainties: the pace of the geo-economic power shift to the emerging world, and the degree of international co-ordination on financial policy. Other drivers include energy use, commodity prices, fiscal policies, trade regimes, climate change, exchange, demographics, and global wealth distribution. Four major scenarios are sketched. A. Financial regionalism Blame shifting and desire to avoid contagion in the future leads to three major blocs on trade and financial policy, forcing global companies to construct tripartite strategies to operate globally. B. Re-engineered Western-centrism a highly coordinated and financially homogenous world that has yet to face up to the realities of shifting power and the dangers of regulating for the last crisis rather than the next. C. Fragmented protectionism a world characterized by division, conflict, currency controls and a race-to-the bottom dynamic that only serves to deepen the long-term effects of the financial crisis. D. Rebalanced multilateralism a world in which initial barriers to coordination and disagreement over effective risk management approaches are overcome in the context of rapidly shifting geo-economic power. Each of these scenarios describes key forces and possible turning points that could shape the financial system. They are regarded as plausible. It will be noted that these are very gloomy for liberals who want little regulation and open access to the world. None predicts more free-trade, tariff reduction, or globalisation. The World Economic Forum, nevertheless, assumes the Report will be useful for its insights, and it can be the basis of global collaboration to strengthen the financial system when the Forum gathers for its annual meeting this year. The preface says there is "a unique and timely opportunity to shape the post-crisis world (sic) in a holistic and systemic manner". I had not realized that the crisis was over. Each week bring fresh scares in the financial world (Britain has announced a second bank rescue), and in the real world demand is falling very rapidly. To be sure the Report acknowledges the risk of "a severe global recession that will affect many sectors, asset classes and regions in tandem", and that it will take "years to work through the crisis and adjust to its long-term effects". Another watershed Ben Bernanke departed with tradition when he made a major policy speech outside of the USA. He spoke at the London School of Economics on January 13, and interacted very well with student questions. He regards the crisis as deepening. I wonder how a central bank can operate without manipulating interest rates. Are interest rates dead? www.weforum.org/scenarios/TheFutureoftheGlobalFinancialSytem.pdf *Neville Bennett is an LSE alumnus and was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.