Fixing Global Finance
Who Broke Global Finance, and Who Should Pay for It?
Article Summary
The current economic crisis may have one winner: the Chinese financial model, which--together with the IMF--holds the keys to fixing the problem.
HAROLD JAMES is Professor of History and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University and Professor of History at the European University Institute, in Florence.
Fixing Global Finance
Johns Hopkins University Press
2008
230 pp.
801890489
$24.95
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Wolf's narrative blaming China may seem remarkable now that everyone is excoriating the U.S. financial system, the U.S. Federal Reserve, and Greenspan in particular. With the Federal Reserve effectively acting as the Chinese central bank, one argument goes, an overly lax U.S. monetary policy was threatening the world with inflation. But Wolf contests this view, arguing that the Federal Reserve did roughly what central banks are supposed to do, namely, keep inflation in check. In his opinion, growth in the U.S. money supply in the early years of this decade was "not unreasonably high." At the time, the Federal Reserve insisted that its job was to look at price levels generally, not to puncture bubbles in some asset prices. For Wolf, "The United States is at least as much the victim of decisions made by others as the author of its own misfortunes." It was only natural, perhaps even inevitable, in Wolf's view, that the United States would emerge as the borrower of last resort, with its perceived reliability as a debtor fueling global growth.
But instead of quietly expropriating assets held by the Chinese by gradually devaluing the dollar, the borrower of last resort got into trouble itself. Even though the global financial system melted down after Wolf completed his book, his first chapter already warned that the world of finance was "a jungle inhabited by wild beasts." As the subprime mortgage crisis of 2007 mushroomed in 2008, a profound flaw at the core of the U.S. financial system was revealed. Partly due to a glut in global savings, assets had been repackaged so thoroughly and resold so often that it became impossible to clearly connect the thing being traded to its underlying value.
The $700 billion bailout announced by the U.S. Department of the Treasury in late September was designed to remove from banks' balance sheets mortgages and other securities that in some way corresponded to real houses. But it is still unclear today how these assets are to be valued or how that valuation might wind up benefiting or hurting their new owners. In the United States and in Europe, the hope is that governments will assume many of the risks inherent in this uncertain valuation -- and tame the wild beasts of the financial jungle through state-backed and state-run banking systems. To some, this is profoundly ironic. As Russian President Dmitry Medvedev put it in September, the experience shows that "the move from self-regulating capitalism to financial socialism is only one step." American free-market capitalism was not supposed to look like this.
FREE FALL
Wolf himself predicted the dramatic turn of events months before the worst of the crisis. In a Financial Times column last March, when U.S. government efforts to rescue the investment and brokerage firm Bear Stearns seemed to indicate that everything would soon be all right again, Wolf wrote, referring to the day of the bailout, "Remember Friday March 14 2008: it was the day the dream of global free-market capitalism died." Just six months later -- and a decade after it lectured Asian governments -- Washington seemed to adopt a Chinese-style solution to its escalating financial problems: greater state intervention to restrict the movement of capital.
But there are dangers and limitations inherent in this approach, too, especially given that, as Wolf warns, instability and vulnerability will not be confined to the United States and that "financial crises are most significant when they are international." This crisis may have originated in the United States, but it has rapidly become global.
Some emerging markets are highly vulnerable to financial implosion. Collapses have begun to happen in Brazil, Hungary, Iceland, Indonesia, Pakistan, Russia, the Baltic republics, and Central Asia, as investors stampede away from risky assets. And with these failures comes the risk of major geopolitical instability, because many of these vulnerable countries and regions lie on political fault lines. Such crises help promote anti-Western reactions, including militant forms of Islamic fundamentalism. These threats should be taken very seriously.
The possibility of geopolitical turmoil is all the greater because so far the bailouts have been handled in a purely national context, while international institutions have been nervous and hesitant. The discussion has been entirely domestic in the United States and, more surprising, in Europe, too. In fact, the failure to find a supranational mechanism for dealing with Europe's large and internationally active banks is rapidly developing into the Achilles' heel of the continent's ambitious project to build a monetary union. The European Union's governing bodies can only leave bank bailouts and their fiscal implications to national authorities. Germany and Ireland each tried to create what the German finance minister, Peer Steinbrück, has called an "umbrella" over their national banking systems. But in these days of high capital mobility, this appears to be a very poor solution. It is likely only to prompt a wild rush of fund transfers as governments try, in their own idiosyncratic ways, to prop up their banking systems and as depositors move their assets away from countries at risk of needing bailouts. Every state for itself, and every depositor for him- or herself.
