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University of New South Wales Faculty of Law Research Series |
Last Updated: 31 March 2010
Resilience and global financial governance
Ross Buckley
Citation
This chapter will appear in the forthcoming Resilience and Transformation: Preparing Australia for Uncertain Futures. Steven Cork (Editor). CSIRO Publishing, Melbourne.
Abstract
Resilience is generally seen as a positive attribute that should be enhanced. When a system is dysfunctional and needs to change its structure and identity, however, resilience can be a negative. As this chapter illustrates, our system of global financial governance works to benefit the elites in international banks and developing countries at the direct expense of the common people in those countries. The system is deeply unfair and disfunctional and displays great negative resilience. This chapter analyses ways in which this negative resilience could be reduced.
Introduction
A range of concepts is commonly used in analysing the
global financial system, including stability, volatility, efficiency and others.
Resilience is not among them. Yet we have a very resilient global financial
system. It is unstable, volatile, narrowly efficient
and highly resilient,
principally in the negative sense of being resistant to change.
Resilience is
the capacity of a system to withstand external shocks and retain its essential
characteristics; its identity. Generally
resilience is a positive feature. But
when a system needs to change fundamentally and be restructured, resilience can
be a marked
negative. The global financial system is somewhat functional from
the perspective of OECD nations and the international commercial
banks, and
quite dysfunctional from the perspective of developing countries. It displays a
high degree of negative resilience.
Even the global financial crisis (GFC)
has so far led to little substantive change in the system that produced it. The
GFC has led
to higher capital requirements, particularly for trading, tighter
liquidity controls, closer supervision and restrictions on bankers’
bonuses, but none of these changes are fundamental. If one considers how
profoundly different the global financial system is today
from what it was 30 or
40 years ago, these changes are merely cosmetic. Even the macro-prudential
regulatory function in which systemic
risk across the financial system is to be
assessed and monitored, which is to be carried out by institutions such as the
new European
Systemic Risk Board, is but a belated example of regulation
beginning to catch up with market changes that are decades old.
The only real
change to the system as a result of the GFC has been the handover of economic
coordinating authority from the G7 to
the G20 nations. Comprising 19 nations and
the European Union, the G20 represents 85% of global gross domestic product
(GDP), 80%
of world trade and two-thirds of the world’s people. In
addition to the G7 nations, it includes Brazil, China, India, Indonesia,
Turkey,
Australia, South Africa and others. This is an important change. Brazil, China
and India not having a voice in economic policy
coordination was becoming
increasingly ridiculous.
This change, however, is yet to result in any
fundamental changes to the system, in part because the G20 is merely a gathering
of
national leaders; it is not a formally constituted international organisation
and lacks the capacity to enforce its decisions.
So why is a system that, for
so many of its participants, is deeply dysfunctional so resilient? The answer
lies in whom the current
system serves and the general paucity of knowledge,
outside those it serves, about how it works and its effects.
The strong negative resilience of the global financial governance system
Resilience science teaches us that strongly resilient
systems have strong feedback loops. This concept of feedback loops, developed
in
analysing systems, explains much of the resilience of our global financial
system. The feedback loops in global financial governance
show that the system
tends to reward the international commercial banks and the elites in developing
countries at the expense of
the common people in the debtor countries. A few
examples will suffice.
After the debt crisis struck in 1982 a way was needed
to allow many hundreds of creditors to negotiate with many hundreds of debtors
in each debtor nation. The commercial banks appointed steering committees
comprising representatives from six to eight banks to represent
all creditors
and persuaded the sovereign debtor to also represent all other debtors within
its jurisdiction (including state governments,
state-owned industries and
private corporations). This was sensible. The banks, however, went further and
persuaded the debtor nations
to bring all debt incurred by all entities within
their jurisdiction under their sovereign guarantee. This was completely
unnecessary
and, from the perspective of the common people in the debtor
nations, appalling. The inevitable, massive shortfall between what the
sovereign
now owed the bank creditors and what it could recover from the original debtors
became a charge on government revenues.
The people paid in reduced services so
that the foreign banks could receive a free credit upgrade on most of their
assets.
Likewise in Indonesia after the Asian economic crisis, the
International Monetary Fund (IMF) and the foreign commercial banks insisted
that
the Republic of Indonesia assume the obligations of the local banks to foreign
lenders and then seek to recover the funds from
the local banks; by selling
their assets if necessary. This again proved a difficult task and only about 28%
of the total liabilities
assumed have been recovered (Asian Development Bank
2009). Almost three-quarters of the costs of repaying those foreign loans has
thus been borne by the Indonesian people. Yet there was no reason for Indonesia
to assume responsibility for these loans. The market
mechanism, if left to work,
would have seen many of these Indonesian banks placed into bankruptcy by their
Western creditors who
would have received a proportion, presumably in the order
of 28%, of their claims in the bankruptcy proceedings. Instead, insolvent
local
banks were put into bankruptcy by Indonesia, the creditors were repaid in full
and the Indonesian people bore most of the cost
of that repayment. The funds to
repay the creditors came from the long-term loans organised by the IMF and
invariably were described
as bail outs of the debtor nations. Yet these loans
were required to be used to repay outstanding indebtedness; so the bail outs
were of the foreign banks. In Indonesia, the IMF coordinated a restructuring
that socialised massive amounts of private sector debt
(Buckley
2002).
Similarly, the centrepiece of the G20 response to the GFC in April
2009 was a US$500 billion additional credit facility for debtor
nations. The
conditions required to be eligible for these loans, however, exclude virtually
all African and most Latin American nations.
While it is not apparent on the
face of the conditions, they are carefully crafted so that most of these loans
will go to their intended
destination; the East European countries. The German
banks are heavily over-exposed to these countries. So this additional credit
facility, in large measure, is designed to bail out the German banks. The funds
lent come from the G20 nations, which know they will
be repaid; official credit
always is. The loss will fall on the people of these Eastern European nations,
who will labour under massive
debt burdens for decades to come. Once again
normal market processes, which in Eastern Europe would have led to German banks
incurring
large losses on their ill-judged, excessive lending to the region, are
abrogated to prefer foreign banks at the direct expense of
the people of the
poorer nations.
The benefits of our system of global financial governance to
the commercial banks are thus manifestly clear. The market is given full
rein
when yielding large profits to the banks, but is interfered with when it would
yield large losses.
The benefits to the elites in developing countries are
far less obvious, but are often very substantial and are the reason that voices
well-placed to argue against the current system are rarely raised against it. An
example is in the restructuring of Indonesia’s
indebtedness after the
Asian crisis. When the assets of the insolvent local banks were sold, who was
best placed to bid for those
assets? Who knew everything about the assets and
precisely what they were worth? The families that had owned them and were the
principal
shareholders of the banks. So, in effect, these families were able to
regain control of the assets they had owned before the crisis
with their foreign
debts discharged by their government, all for an average cost of 28%. Who would
speak out against such extraordinary
largesse? Would you if, somehow, you could
repay your home mortgage for one-fourth of the debt owing? Our system of
financial governance
neatly transferred the real cost of the crisis, which
should have been borne by borrowers and lenders that had engaged in imprudent
borrowing and lending, onto the people of the debtor nations who had done
nothing.
As Professor Luis Carlos Bresser Pereria, former Finance Minister
of Brazil, testified before a US House Committee in the aftermath
of the debt
crisis, the elites in the debtor nations often profited from that crisis
(Pereira 1990). Periods of great volatility
and forced asset sales offer huge
opportunities to those with access to better information, power and financial
resources.
Overall, the system of global financial governance has displayed
a quite remarkable degree of resilience. When one analyses whom it
serves, this
is unsurprising. Any system that rewards the powerful at the expense of the
powerless is likely to prosper.
Yet the system was not designed to do this.
Its architects were Keynes and White at Bretton Woods in 1944. Their primary
goal was
the promotion of global trade. Fixed exchange rates were to facilitate
that trade. The IMF was established to provide short-term
loans and technical
advice to nations to facilitate their management of these fixed rates. This
fixed exchange-rate system ended
in the 1970s as the US went off the gold
standard and floated its currency and other developed nations followed suit.
During the
1970s, the IMF’s core mission ended.
Global institutions
are, however, notoriously hard to kill. Witness the Bank for International
Settlements, which Keynes and White
had intended be closed but which lived on to
become the most significant global banking regulatory institution.
So the
IMF continued on until the debt crisis of 1982 gave it a new role. The
commercial banks needed to keep lending to the sovereign
debtors so they could
service their debts, but they didn’t want to advance more funds without
changes to the policies that
had led these nations to the brink of insolvency.
Yet it was politically impossible for a Bank of America or J.P. Morgan to be
dictating
economic policy to a Brazil or Argentina. The IMF stepped in. As a
supposedly independent international financial institution it
was
well-positioned to play the role of crisis manager of nations in trouble. It was
well-positioned for the role but not staffed
or equipped to discharge it. So the
IMF performed poorly, with disastrous consequences for the human rights of poor
people in poor
nations. Yet it has continued to fulfil this function, with
substantially unchanged policies, for over a quarter of a century –
talk
about negative resilience! Over time, as its litany of policy failures began to
mount, the Fund attracted sustained, unrelenting
criticism from both sides of
politics in the US and from developing countries and it was allowed to shrink in
size from a total staff
approaching 3000 to about 1700 (Vines and Gilbert 2004,
Meltzer 2000).
Yet in 2009, another crisis rescued the Fund. The GFC meant
the G20 needed an organisation through which it could channel most of
its US$1.1
trillion funding package, a bill the IMF fitted. And so, today, the credibility
of the IMF has been somewhat restored
by having a new role and its staffing
levels are again climbing.
The IMF continues to exert control over the
economic policies of developing countries in crisis some 35 years after the role
for which
it was established ended. It has proven to be a remarkably resilient
institution, to the detriment of a substantial proportion of
the people on the
planet.
Why such an unjust and dysfunctional system is not remedied
So why do the normal checks and balances of
democratic systems not rein in and redirect the system of global financial
governance
if it so often implements ends that serve the rich at the expense of
the poor? Part of the answer is that voters in rich countries
cannot understand
how international finance works and care far less about the problems of people
in poor countries than they do about
their own backyards. This lack of
understanding is promoted by the media, which does a poor job of covering global
financial governance.
The media typically focuses on the most recent development
and reports it, shorn of context. Its coverage is often inaccurate, promoted
by
the closeness with which information is guarded in this sector. The poverty of
the media coverage means the powerful can continue
to use the system in ways
that suit them free from countervailing pressures from civil society and
democratic voters.
Two examples follow, although there are many others. In
late 1997 the IMF-organised bail outs of Indonesia, Korea and Thailand were
reported widely as if they were grants, not loans. Furthermore, the purpose for
which the bail out funds could be applied was not
reported in the media at all,
as that was only to be found in the fine print which was not generally
available. Yet the loans could
only be applied to debt then due, which was
mostly short-term debt. So the bail outs were essentially bail outs of Western
banks,
not East Asian nations and the bail outs rewarded the lenders who
advanced the most destabilising form of loans – short-term
ones – at
the expense of those who had advanced less-volatile, longer term debt. Thus was
perpetrated a disastrous policy that
received no critical media coverage until
it was old news, many years later.
In 2009 the G20’s principal
response to the GFC was a US$1.1 trillion dollar funding package. US$100 billion
was additional
concessional financing for poor nations. US$250 billion was to
support trade finance, financing for which had been severely limited
by the GFC.
Another US$250 billion was an increase in Special Drawing Rights, the IMF quasi
reserve-capital. And the final US$500
billion was the additional credit
facility. The first two tranches are readily understandable. The last two are
not. Special Drawing
Rights (SDRs) are based on a basket of four currencies
– the US dollar, the pound Sterling, the euro and the yen – and
are
the ways nations make their contributions to the IMF. They are an excellent
source of funding for poorer nations and the increase
in them is a laudable
response to the GFC. However, SDRs can only be drawn down in proportion to a
nation’s quota. Accordingly,
nearly two-thirds of the increase in SDRs is
available to OECD nations, leaving US$100 billion to developing countries,
within which
only US$19 billion is available for low-income nations (Oxfam 2009;
IMF 2009). So reporting the US$250 billion increase in SDRs as
a measure to
assist poor countries, as was often the case, was quite misleading.
The
US$500 billion is, as we have seen, even more opaque. The principal destination
of these funds is intended initially to be the
Eastern European nations and
ultimately the repayment of their loans to the German banks. The media has not,
to my knowledge, reported
the destination of the US$500 billion additional
credit facility because it cannot be divined from the terms of the facility. It
is quite simply beyond the capacity of the media to cover such developments
accurately, a state with which the powerful players are
content.
So if the
system exhibits such strong negative resilience, how might that resilience be
lessened so that needed changes come about?
Steps needed to reduce undesirable resilience
Perhaps the initial principal step that needs to be
undertaken to reduce the undesirable resilience of our system of global
financial
governance is to return the IMF to its original mandate, or what is
left of its original mandate. The skills required to turn around
poorly
performing economies are utterly different from those typically held by central
bankers and PhD graduates in macro-economics;
the two most common backgrounds of
IMF staffers. The IMF is the wrong organisation to set economic policy for
nations in crisis.
Because the IMF is not equipped for the role it stumbled
into, it has been open to capture by the powerful in the international financial
community and the poor countries and it should be removed from this role. If an
international financial institution is required to
play this role, a new one,
with staff equipped with the right skills and attitudes and with the right
culture needs to be established.
This change would limit the IMF to data
collection, technical surveillance and advisory roles.
The next step is to
reform the governance of the IMF and the World Bank. There have been tiny
reforms in the past two years but, essentially,
most votes are in the hands of
the US and the leading European countries. So these institutions, whose clients
are the world’s
poorer countries, do the bidding of the richest countries.
This is absurd. The principal clients of these institutions need a real
voice in
their governance.
The third step is to applaud the move from the G7 to the
G20 and to strengthen further the G20. This could be done by increasing its
size
slightly by the addition of some regional representatives. While it will be
difficult to remove the seat of any current nation,
logically Italy should lose
its seat, Argentina’s seat should go to a regional grouping for Latin
America, Saudi Arabia’s
to a regional grouping for North Africa and the
Middle East and a seat should be given to a sub-Saharan African grouping. If the
G20 were then expanded to a G22 and regional seats added for ASEAN and South
Asia, the organisation would directly or indirectly
represent the great majority
of countries.
The final and most significant step to reduce negative
resilience, or resistance to change, is to diminish the strength of the current
feedback loops. The best way to do this is to make the system more fair and
balanced. The strength of the feedback loops arise because
of the degree to
which the system currently favours the powerful among banks and within
developing nations. The system needs to change
in fundamental ways and this is
not likely to occur without these feedback loops being first weakened.
The UN
established the Stiglitz Commission as part of its response to the GFC and the
best way to disempower many of the feedback
loops would be for the G20 to
implement some of the Commission’s recommendations. The Commission’s
three most readily
implementable recommendations are that: (i) new financial
mechanisms be introduced to mitigate risk, including international institutions
lending in local currencies; (ii) highly indebted countries be given a
moratorium or partial cancellation of debt; and (iii) new
mechanisms be
introduced for handling sovereign debt restructuring, such as a sovereign
bankruptcy regime. The commission also recommended
that the US dollar be
replaced as the global reserve currency. There were other recommendations, but I
will focus upon these four.
There are strong reasons why all reschedulings
of rich country to poor country loans should be in local currency, as should all
lending
by international financial institutions such as the IMF and World Bank
(Buckley and Dirou 2006). Our current system places the currency
risk on the
party least able to bear it; the borrower. This is illogical. Lending in local
currency puts the currency risk on those
best able to bear it and hedge against
it, the lenders.
Likewise there are strong arguments for debt relief for more
countries than currently receive it and for an orderly, rules-based approach
to
sovereign insolvencies (Buckley, in press).
A new reserve currency is needed
because when one nation’s currency serves as the global reserve currency
the extra liquidity
required to meet the global liquidity needs inevitably puts
downward pressure on the currency’s value thereby making it more
volatile
and less attractive as a reserve currency. This is known as the Triffin dilemma.
It has required the US to run consistently
massive trade deficits so as to
inject sufficient dollars into the global system, which is not sustainable.
Premier Wen Jiabao has
said he is worried that China holds most of its reserves
in dollars and well he might be, as the decline of the dollar in recent
years
has cost China a fortune. Twice in 2009 the governor of China’s central
bank called for a new reserve currency regime
focused on Special Drawing Rights.
China Inc. doesn’t make such comments without careful consideration and is
hard at work
researching alternatives, such as denominating and settling its
trade with Brazil in real and renminbi, not the US dollar.
Conclusion
The greatest reduction in negative resilience in global financial governance would be achieved if we were to promote lending to developing countries in their own currencies, grant more debt relief to more poor countries, stop the socialisation of private sector debt in debt restructurings, introduce a fair and independent arbitration process for sovereign bankruptcy and move towards a different global reserve currency, perhaps Special Drawing Rights or some other basket of currencies. These changes would go a long way to making the global financial system fairer, reduce the extent to which it favours the powerful and therefore disempower the feedback loops that make the current system so resistant to change. Of course, the negative resilience of the system means that these changes will be strongly resisted by the system’s powerful participants.
Ross Buckley is Professor of International Finance Law at the University of New South Wales, a Fellow at the Asian Institute of International Financial Law, University of Hong Kong and an Australia21 Fellow.
References
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