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Contributions from
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Monitor
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Vietnam, a UN test case
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BMZ budget 2007
Financial markets: Sitting on a powder keg
Somalia: Experts fear escalation
Female genital multilation: Scarring body and soul
Informal institutions: sometimes good, sometimes bad
01/2007
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[ Financial markets ]
Sitting on a powder keg
After Asia’s financial crisis of 1997/98, many observers predicted that the affected countries would not recover from recession for a long time. Their forecast was wrong. The economies of all world regions have grown significantly since the crisis, including countries such as Indonesia, South Korea and Thailand, which were worst affected by the 1997/98 turmoil. Heiner Flassbeck, chief economist of the UN Conference on Trade and Development (UNCTAD), says that since the Asian crisis developing countries are in a better macroeconomic situation today than ever before.
According to him, poor countries have drawn the right lessons from the crisis. At a conference in Berlin in late November organised by advocacy group WEED, Flassbeck praised China as a model of success for economic policy-making. The People’s Republic controls its currency’s exchange rate and keeps inflation as well as interest rates low. This policy has made China unattractive to short-term financial speculators and, at the same time, boosted growth. Flassbeck believes a precondition for this policy-mix was the current account surplus, which, lately, has become typical of developing countries as a group. According to Flassbeck, this trend reduces their dependency on international capital markets. Since 2000, developing countries and emerging economies exported more capital than they imported, by buying foreign currencies, above all the dollar, on a grand scale. South Korea, for example, has increased its foreign-exchange reserves ten-fold since the Asian crisis. In the same period, all developing countries together have more than trebled such resources from some $ 700 billion to $ 2.3 trillion.
Countries in Africa, Asia and Latin America have no other choice than to protect themselves from shocks on the world’s financial markets. As Flassbeck emphasises, there have been no serious attempts to stabilise the markets through multilateral regulation, even though a “new international financial architecture” was called for after the Asian Crisis, and that demand was not only raised by globalisation skeptics. Governments, particularly in Asia and Latin America, have since turned their backs on institutions such as the International Monetary Fund (IMF), and are discussing unilateral or regional approaches to crisis management. Out of dissatisfaction with the IMF, 13 East Asian governments, at a meeting in the Thai ressort Chiang Mai six years ago, set up their own fund for mutual support in the event of a crisis. On the other hand, the IMF’s contingent credit line, which was created in 1999 in order to be able to deal with crises, was scrapped as early as 2003. The reason, according to Heribert Dieter of the German Institute for International and Security Affairs (SWP), was that there was no agreement within the IMF on approval criteria. As Dieter elaborated in Berlin, it is in no way possible to spend three weeks discussing credit conditionality if a crisis actually strikes.
Of course, self-help strategies go along with costs and risks. Large foreign-exchange reserves tie up capital, which poor countries could use for investments in education, health care or other sectors. According to Dieter, the costs amount to up to $ 120 billion annually – that is around twice the sum donor nations spent on official development assistance in 2005. Furthermore, Asian countries’ acquisitions of dollars have contributed to the USA’s current account balance sliding deeper and deeper into the red, a trend which, according to experts, is destabilising the global economy and the international financial system.
Some economists, however, see no grounds for concern. They argue that what is considered an imbalance is really a balance. After all, emerging economies, primarily in Asia, are growing fast because they are exporting cheap consumer goods to the USA. The US Federal Reserve prints the money required for that to happen, passing it on to consumers in the form of loans. Asia, above all China, is funding the US trade deficit by investing in US treasury bonds. As long as all parties profit from this cycle, it will be sustainable, say the proponents of this so-called “Bretton Woods II” hypothesis.
Views similarly diverge on financial-market innovations such as hedge funds or derivatives. Rüdiger von Kleist of the German Finance Ministry regards hedge funds primarily as innovative tools for providing risk capital, without which many an investment would never occur. By contrast, Jörg Huffschmid, an economist from Bremen, believes hedge funds have become entirely disconnected from the real economy. In his view, they only serve a single function, that of delivering finance speculators the highest possible returns. In order to do so, he says, fund managers even create risks – for example by supplementing their investors’ capital with bank loans and thus increasing leverage. Similarily, derivatives, which were originally invented to minimise investors’ and traders’ risks, have become prime objects of speculation themselves.
Government official von Kleist believes the risks that arise from such practices are manageable; and he would like to see misuse and negligence punished. Huffschmid and other financial-market critics, however, liken the attitude of investors and policy-makers to sitting on a powder keg. The skeptics believe that even minor crashes may trigger incalculable chain reactions today, because the sums at stake are enormous, because various facilities and instruments are intricately interwoven, and, most of all, because non-transparent transactions done outside the stock exchanges (“over the counter”) have increased tremendously. (ell)
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