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The trouble with globalisation and capital markets

by Matt Smith | 27 Jun 2017

The big unintended consequence of the globalisation of capital markets over the last few decades has been uncertainty over where responsibility lies when things go wrong, one prominent economist highlights.1 The trouble with globalisation and capital markets 1

Amid discussions of global regulatory pacts and cross-border bank capital requirements, the global finance industry’s experience in the aftermath of the global financial crisis (GFC) is a reminder that it remains unclear who will be left holding the bag should things go wrong, comments Stephen King, a senior economic advisor to HSBC and author.

King’s comments come at a time when policy makers continue to grapple with the implicit guarantee that governments give to banks deemed too big to fail, an issue that underlines the recent federal and proposed state government levies.

“What really changed the idea that global capitalism would work was the global financial crisis,” King says, during a speech this week delivered to the London School of Economics at the end of June.

Even now, finance companies and society more broadly continue to operate under an ambiguity relating to the effect of the world’s intertwined global capital markets, King highlights.

At the start, the promise of globalisation brought with it the ability for humans to contact and connect with each other in a way unimaginable during the prior cold war period, King notes.

“Freedom of trading goods and services, capital and people... somehow these freedoms could be spread to other parts of the world and these freedoms could be spread around the world, globalisation could make people better off with more trade,” King explains. His speech is published here.

The journey of capital market globalisation can be tracked in the numbers, King outlines.

Steep rise

Around 1900, before World War I, foreign holdings of international capital as a share of the world’s output was about 20 per cent. Half of that (10 per cent) was owned by the British, King notes.

Two world wars later that figure was as low as 5 per cent, he says.

But by 1980, the percentage of foreign holdings of international capital as a share of the world’s output was around up to 25 per cent. Then, following the great globalisation of capital markets that ensued, by the year 2000 that number was up to 110 per cent and it was above 200 per cent by 2007, he says.

“This represents a massive increase in holdings of capital and integration of global capital markets,” King notes.

Globalisation, of course, was cheered on and indeed facilitated along the way by the formation of global monetary pacts, from the International Monetary Fund to the World Bank and General Agreement on Trade in Services – the forerunning agreement to the World Trade Organisation – King notes.

However, the problem with these huge increases in cross-border capital flows is that there’s no institution in the world that could actually cope with it, King says.

The other main problem is that regulators and policy makers didn’t foresee the problems that globalisation of capital markets would bring.

Faux moderation

“Prior to the GFC there was this sense nothing could go wrong, that policy makers have mastered it; low inflation reducing the risk of an economic crisis, what they called the great moderation... there was an almost universal belief there was nothing that could go wrong because the market was allocating assets efficiently,” King describes.

As years have gone by – in the decade and a half following the GFC – scepticism amongst economists relating to the policy settings supposed to tame the now intertwined financial systems has been growing.

The latest calls by John Taylor, the Stanford economist who is likely to take over Federal Reserve chairwoman Janet Yellen’s post, to beware of keeping interest rate settings too low for too long highlight the complexities that have crept in to capital markets since the onset of globalisation.

Governments and political leaders will continue to blame globalisation for problems within their own countries that remain difficult to fix, even though he believes this blame will often be misguided, King concludes.

The biggest issue governments in more developed markets are having to confront now is that economic growth has and will continue to be much lower than in previous generations.


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