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Symposium 2014

Proposal - The New Global Financial Architecture

The Challenge

The 2008/09 economic and financial crisis taught the world an important lesson: while the nature of the financial industry has become truly global, with an increasing number of actors and institutions ...

The 2008/09 economic and financial crisis taught the world an important lesson: while the nature of the financial industry has become truly global, with an increasing number of actors and institutions on the credit market, regulation is still highly fragmented among different national supervisory authorities. To maintain systemic stability and prevent contagion, more is required than merely ensuring the orderly operation of individual financial institutions. Different regulators—including monetary authorities—must cooperate in order to achieve better, but not necessarily more, regulation. Better regulation should aim at identifying overleveraging and emerging vulnerabilities, ensuring the adequate pricing of risk, and promoting better incentives for prudent behavior. In pursuing these targets, regulation will require changes to institutional structures, the content of rules, and especially the structures of supervisory agencies.

The International Financial System as designed in 1944 is broken. The present system is a non-system, because the world has shifted to a multi-polar power structure, rather than a uni-polar system where G-7 can dictate standards and structures. Even though G20 accounts for 85% of world GDP, 80% of world trade and two-thirds of world population, its legal foundation is not by national treaty or law, but essentially self-appointed.

Although G20 united in action in 2009 to stem the Global Financial Crisis (GFC), post-crisis reforms on regulation have become controversial and painfully slow, as different countries and markets have serious differences on the reform methodology and impact. IMF quota reforms stalled when in 2013, US Congress rejected the quota formula that was agreed in 2009. The single most important international cooperation to stem the GFC was the US dollar swaps with various central banks instituted by the Fed in order to provide US dollar liquidity. The IMF was not able to act as lender of last resort and its role in the Euro-debt crisis was largely advisory.

There is no global lender of last resort for any country or financial institution getting into trouble. Global Liquidity is created offshore in US dollars and other currencies, outside the control of national central banks. However, when banks fail, resolving losses are national. Hence, the world is breaking up into national currency blocs with different allegiance, with shifting interests. Two facts:

  • US Fed swaps with 5 key allied central banks worth $333 billion, compared with PBOC swaps with 21 central banks worth $400 billion
  • IMF + World Bank assets smaller than China Development Bank + Development Bank of Brazil.

However, a series of US action on regulation and scope of legal application has made global banking business uncertain, due to reinforcement of “my currency, your problem”, but also the scope and fines concerned: -

  1. Dodd Frank requirement to subsidiarize all large foreign bank operations in US effectively balkanized global banking into national pockets by law.
  2. Fed/FDIC decision to withdraw lender of last resort facilities for TBTF banks must mean that home central banks/regulators would have to help in the event their banks get into US$ liquidity trouble in US or elsewhere.
  3. Nearly half the number of fines/settlements against global banks are for breaching of sanctions (against US non-allies), not for causing bank failure
  4. Total fines amount to over $100 bn in the US and the FT estimates that another $152 bn may come. IMF estimated that QE subsidized banks by about $300 bn. So what QE gives in subsidies, regulatory fines take away.
  5. Personal sanctions on countries and individuals e.g. in Russia and others possibly involved with future possible sanctions mean that there are uncertain risks in holding US$ assets. Neither would banks want to deal with them or their correspondent banks.
  6. Bottom line is everyone for their self-interests.

The result of a non-system is that no one is looking out for the global public good, but the problems of financial meltdown, social inequality and ecological sustainability require global public goods to solve.

In the past, IMS reform proposals were from a “top-down” financial architecture that was designed by G7 or G20.

The revival of Cold War 2.0 means that the IMS is balkanizing into different currency blocs. Non-G7 members of G20, of which Russia is already subject to sanctions, plus possibly others, will not necessarily agree to any top down formula.

Grand Strategy to fix IMS is dead – the strategy is that there is no strategy – effectively muddling through.

IMS reform can only come from a competition of ideas from “bottom-up” - from different EMEs and within EMEs, a complex mix of interaction between markets, nations, civil society and enterprises to balance short-term needs of employment and self-interest, and long-term needs of social equity and survival from climate change.

Change will come from different individual countries showing the rest of the world how their financial models can positively affect inequality and social sustainability, perhaps better than advanced country models. It is the competition of a bottom-up race to solve the key problems of our era that will shape our global economy and our IMS. This competition is between nations, with global enterprises and civil society shaping both the narrative and the agenda.
This does not mean that individual and small scope for change and financial innovation is not possible for incrementally changing the IMS, but that will come from practice, not theory.

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