The United Nations Conference on Trade and Development (UNCTAD) launched a report on the causes and implications of systematic failures in the global economy. The Global Economic Crisis: Systemic Failures and Multilateral Remedies contends that the systemic failures – driven by financial deregulation, large-scale financial investments on commodity futures markets, and widespread currency speculation – have deeper roots that call for in-depth analysis and need to be approached through recognition of their multilateral dimensions. This, according to the report, is especially important now major industrial economies are in a deep recession and growth in the developing world is slowing dramatically. It creates the danger of falling into a deflationary trap, which cannot be dismissed for many important economies.
A Crisis Foretold
The financial crisis arose amidst the failure of the international community to give the globalized economy credible global rules, especially with regard to international financial relations and macroeconomic policies, the report highlights. Speculative bubbles, starting with the United States housing price bubble, were made possible by an active policy of deregulating financial markets on a global scale, widely endorsed by Governments around the world. In addition, the spreading and severing of risk were promoted by the use of “securitization” through instruments such as residential mortgages-backed securities that seemed to satisfy investors’ hunger for double-digit profits. At this point, “greed and profligacy enter the stage” the report stresses, noting also that “good policies should have anticipated that human beings can be greedy and short-sighted.”
According to UNCTAD, financial deregulation – driven by an ideological belief in the virtues of the market – has allowed “innovation” of financial instruments that are completely detached from productive activities in the real economy. Such instruments favour speculative activities that build on apparently convincing information, which in reality is nothing other than an extrapolation of trends into the future. Contrary to the mainstream view in economic literature, speculation of this kind is not stabilizing; rather, it destabilizes prices. UNCTAD warns that as the “true” price cannot possibly be known in a world characterized by objective uncertainty, the key condition for stabilizing speculation is not fulfilled. “Uniform, but wrong, expectations about long-term price trends must sooner or later hit the wall of reality, because funds have not been invested in the productive capacity of the real economy, where they could have generated increases in real income. When the enthusiasm of financial markets meets the reality of the relatively slow-growing real economy, an adjustment of exaggerated expectations of actors in financial markets becomes inevitable.”
In this situation, the performance of the real economy is largely determined by the amount of outstanding debt. As debtors try to improve their financial situation by selling assets and cutting expenditures, they drive asset prices further down, cutting deeply into profits of companies and forcing new “debt-deflation” elsewhere. The report cautions that this can lead to deflation of prices of goods and services as it constrains the ability to consume and to invest in the economy as a whole. Thus, the attempts of some actors to service their debts make it more difficult for others to service their debts. This is also exactly what is happening among deficit and surplus countries. The report suggests that the financial losses in deficit countries or the inability to repay borrowed funds directly feed back to the surplus countries and imperil their financial system: “This channel of contagion has particularly great potency in today’s world, with its glaring lack of governance of international monetary and financial relations.” The only way out is government intervention to stabilize the system by “government debt inflation.”
Another important reason for growing imbalances between countries is movements of relative prices in traded goods as a result of speculation in currency and financial markets, which leads to considerable misalignments of exchange rates and to overspending in capital-receiving countries. With inward capital flows searching for high yield, the currencies of capital-receiving countries (with higher inflation and interest rates) appreciated in nominal and in real terms, leading to large movements in their absolute advantages or level of overall competitiveness vis-�-vis other countries. If nations gain at the expense of other nations because of their superior competitive positions, dilemmas can hardly be avoided, the report stresses. And if the “winning” nations are not willing to allow a full rebalancing of competitive positions over the long run, they force the “loser” nations into default.
One of the direct consequences of price and exchange rate speculation (bubble-creating trading behaviour), the report notes, is that the build-up and eruption of crisis in the financial system was paralleled by an unusually sharp increase and subsequent strong reversal of the prices of internationally traded primary commodities. The price boom between 2002 and mid-2008 was the most pronounced in several decades in its magnitude, duration and breadth. It put a heavy burden on many developing countries relying on imports of food and energy commodities, and contributed to food crises in a number of countries in 2007–2008. In strong juxtaposition, the price decline since mid-2008 stands out for its sharpness and number of commodity groups affected and was one of the main channels through which the dramatic slowdown of economic and financial activity in the major industrialized countries was transmitted to the developing world. Given that food prices can be a matter of survival for millions of poor around the world, that sort of speculation should not be accepted, the report strongly contends.
Fighting today’s crisis
Instead, the report calls for more transparency in futures markets for commodities such as food and petroleum and stresses that regulators should have greater power to step in when such futures speculation – which is aimed at profits for arbitrage investors rather than as a hedge to protect producers against normal price swings – drives up prices for vital goods such as food.
UNCTAD points out that monitoring and possibly intervening in such developments will require regulatory changes and better information; currently there is a lack of data on purchases of futures by category of investor, making it difficult to tell who is influencing prices.
UNCTAD also underlines that the problems of excessive speculative financial activity have to be tackled in an integrated fashion, which covers the whole financial system. Otherwise, speculation will just shift to other areas. For example, preventing currency speculation through a new global monetary system with automatically adjusted exchange rates might redirect the speculation searching for quick gains towards commodities futures markets and increase volatility there. Therefore, in a broader response to the economic crisis, developed and developing countries need a combination of currency stabilization with expansionary monetary and fiscal polices, the report argues. And coordinated “countercyclical” macroeconomic policies – that is, policies to stimulate economic demand during a downturn when demand is falling – have to be implemented without delay. Moreover, in order to confront the next wave of the crisis, UNCTAD stresses that it will be critical to stabilize exchange rates by direct and coordinated government intervention, supported by multilateral oversight. Governments should not leave it to the market to find the “bottom line,” and international institutions should not make their emergency finance to crisis-stricken countries conditional upon pro-cyclical policies such as public-expenditure cuts or interest rate hikes, which would be damaging in the current situation.
Instead, interventions in financial markets call for cooperation and coordination of national institutions, and for specialized institutions with a multilateral mandate to oversee national action. UNCTAD underlines the importance of the United Nations in this regard, “not only because it is the only institution which has the universality of membership and credibility to ensure the legitimacy and viability of a reformed governance system, but also because it has proven capacity to provide impartial analysis and pragmatic policy recommendations.”The report as well tables the idea of the establishment of a global bond: “If every country and every government acknowledges that the global crisis is foremost a systemic crisis – due to the failure of the global community to govern the globalized economy properly – then broad solutions, such as a global bond that can be used at fixed exchange rates to bail out any needy country may be possible.” Finally UNCTAD provides more specific recommendations to stabilize exchange rates, to avoid currency speculation and to endure symmetric responses. It calls for a multilateral code of conduct, which ends the competition of nations, and for a new global organization of the current financial system. Within this new organization a new global institution with supervisory and advisory powers has to be created and has to practically manage the new financial system, which will include several “linked” lead currencies (“planets”) and regional blocks (“satellites”).
In conclusion, the report notes: “It is obvious, a coherent and effective approach can only be found at the international level and with the inclusion of as many countries as possible. A broad international agreement about the distortional effects of large-scale speculation in different areas on growth and employment is absolutely crucial to create the framework for a globalization that has the potential to deliver rising living standards for all.”
The full report is available online.