Home > The Economy > Is global finance finally shrinking?

Is global finance finally shrinking?

from Jayati Ghosh

It is obvious that the recent boom in global capitalism had witnessed massive over-extension of finance. What has been described as “financialisation” reflected not only the ever-greater penetration of finance capital into more activities of the real economy and involvement in critical markets such as those for commodity futures that affect traded prices of food and fuel.

But did this actually change from 2008? Is it the case that the global financial crisis and its ramifications have actually had some effect in causing this financial froth to subside? A new report from the McKinsey Global Institute based on its database of financial assets in 183 countries across the world suggests that this might be the case. , but also huge and volatile movements of capital across national borders. By 2007, global stocks of financial assets (both equity and debt stocks) amounted to $206 trillion. This meant that financial assets were more than 4 times the maximal estimate of GDP in developed countries in that year, and nearly twice the value of GDP in developing countries. 

(“Financial Globalisation: Retreat or reset?”, March 2013, McKinsey Global Institute, http://www.mckinsey.com/insights/global_capital_markets/financial_globalization  According to this report, the estimated value of global financial assets grew rapidly (by more than 8 per cent per annum) in the decade up to 2007, but since then they have grown by less than 2 per cent per annum. Cross-border capital flows fell sharply in 2008 to $2.2 trillion, down from $11.8 trillion in 2007 (at constant 2011 exchange rates). In 2012, they were estimated at $4.6 trillion, around 40 per cent lower than the 2007 peak. Equity assets and securitised loans have actually declined in value. )

Much of this was due to the reduction of capital flows within the developed world. The European economic crisis has played an important role in this, such that nearly half of the decline in cross-border capital flows is because of Western Europe alone. For example, since the last quarter of 2007, Eurozone banks have reduced foreign claims by $3.7 trillion. $2.8 trillion of this was on other banks within Europe, and $1.2 trillion was only on banks from the crisis-ridden GIPSI countries (Greece, Ireland, Portugal, Spain, Italy). But even in developing countries the process of financial expansion is slowing down, though it still continues, especially with the continuing growth in bond markets.

This is essentially good news. Most of the increase in finance in the “roaring 2000s” up to 2007 was not just unsustainable – it was also unnecessary and even undesirable. It did generate booms in some advanced countries (particularly the US and some European countries), which in turn fuelled export-driven expansion in some developing countries including China. But this was only because finance supplied a means of compensating for the potential stagnation and lack of demand that emanated from growing inequalities in income distribution. By generating demand based on borrowing rather than on actual incomes, finance also accentuated asset inequalities, putting more money in the hands of financial intermediaries while drawing people, companies and even governments into eventually un-repayable debts.

The pyramiding of finance meant that an essentially top-heavy and extremely entangled system was created, not just within countries but globally. Most of the so-called “financial deepening” of that period was due to financial system leverage (as banks and other players essentially borrowed from one another) increasing stock market valuations. “Plain vanilla” credit stopped being the purpose of the financial system, and instead became the base for an ever more complex system of securitisation and other extensions.

Financial “innovation” in the form of new instruments and products as well as forays into markets like those of commodity futures created the illusion of dynamism that was not based on any real contributions to the economy. Instead, the boom was associated with all sorts of speculative capital movements that were oriented to risky high-return assets, created very uneven and imbalance expansion. The inadequate monitoring in turn was associated not just with irresponsible behaviour but downright malpractice, all masked by the prevailing financial euphoria.

As we have found repeatedly to our cost but still do not seem to learn, such bubbles must burst. 2008 marked one such puncturing, but not a complete one.

The concerns about global finance may be even greater for developing countries. While it is true that these countries still show significantly lower ratios of “financial deepening” it is evident that this is not necessarily a bad thing. But these countries continue to exhibit some of the more glaring anomalies of the implications of the global organisation of finance, such as the continuing net flows of capital from South to North. . Indeed, the relatively slow reduction in financial valuations and the renewed profitability of banks and other financial institutions (with the continuing award of bonuses for senior managers) suggests that if anything, the process has still not gone far enough. Clearly, more reductions in finance are required and will eventually occur.

Global capital inflows to developing countries halved from $1.6 trillion in 2007 to only $0.8 trillion in 2009. They have since recovered to $1.5 trillion in 2012. But – and here’s the rub – capital outflows from developing countries also increased and also continued to be more than inflows. In 2012 such outflows amounted to $1.8 trillion. Just under half of this was in the form of reserve holding by central banks, but FDI, cross-border loans and portfolio investment account for increasing shares.

Most of the developing countries’ foreign assets are in advanced countries, showing how perceptions of power continue to dominate financial decisions even in the developing world. There is much talk of increased South-South investment, and this has certainly increased. But it is still minor compared to the extent to which the developing world continues to finance the rich North, especially the US. Thus, while $12.4 trillion of foreign investment assets of the developing world are held in the North, South-South stocks of such investment are only $1.9 trillion – amounting to just 2 per cent of all cross-border foreign investment assets. So the developing world as a whole – and each one of the major constituent regions – continues to be net funder of the developed economies.

The largest impact of outward investment from developing countries is of course that of China. Certainly in absolute terms and in rate of growth, China’s global financial presence has been significant. China is now a much larger funder than the World Bank in both Africa and Latin America, and its foreign direct investment has also been impressive in the last decade. But evenso, China’s investment abroad is dominated by the North. Thus around half of the total non-foreign exchange reserve holding of foreign assets by Chinese government and companies (around $1.5 trillion) is to other developing countries – but the rest is in advanced countries. Meanwhile most of the foreign holdings are in the form of central banks reserves, which are currently estimated at more than $3.2 trillion. So foreign assets held in other developing countries still come to only around 15 per cent of China’s total foreign assets. So even China, whose impact in the developing world is now so significant, still directs the greater bulk of its outward investment to advanced economies.

Meanwhile, the other concern is that many developing countries are trying to cope with the continuing ramifications of the global crisis by generating their own bubbles in domestic asset markets. This happens in a variety of ways: stimulus measures that target sectors like real estate and housing; other fiscal concessions granted to encourage more financial saving and investment; liberal rules for extension of consumer finance for purchase of durable goods; financial liberalisation measures that encourage more expansion of the sector; and so on.

These may create temporary mini-booms in certain economies, but these are temporary at best and in the current fragile external environment they may be even more short-lived. And the bursting of those bubbles will be even more painful in the context of the global economic headwinds. At the same time they will also encourage the same tendencies that continue to make developing countries export capital to the North, at the cost of meeting their own citizens’ needs and fulfilling their own development projects.

So it is more important than ever to restrain finance, since that task is clearly incomplete. To make the financial system fulfil the basic tasks for which it is supposed to exist – to direct savings to productive investment in a stable and socially desirable way – it is essential to shrink it further.
* This article was originally published in the Frontline, Volume 30 (06) dated Mar. 23 – Apr. 05, 2013

  1. henry1941
    April 2, 2013 at 9:38 am

    What is this piece actually talking about? What, for instance, is “finance capital”? It appears to be a catch-all abstract term. What lies inside the abstraction? Is it obligations to repay debt, or does it consist of land titles, or what? Presumably, FC is the capitalisation of revenue streams of some kind, but what is the source of these revenue streams? Is it rent or monopoly profits or what? Who is paying them, what are they paying for, is it right that they should have to be paid and if so, are they being paid to the right people ie those who are really entitled to receive them?

    I ask the question because the habit of discussing issues in unnecessarily abstract terms makes it nearly impossible to analyse the problem and gets in the way of solutions.

  2. Garrett Connelly
    April 2, 2013 at 12:26 pm

    In the US there are advertisements on shopping carts and in the papers something like this ; “Actively purchasing the family jewels.” The background is a collage of pearl necklaces and gold statues.

    Frederick Soddy described this about a century ago as virtual wealth of immoral capitalist pirates which inevitably grows geometrically to become larger than earthly assets in reality.

    China is a major player in the land and asset grab, operating elbow to elbow with the Harvard endowment and other respectable western land and asset grabbers intent on transforming keystroke digits into actual wealth.

  3. BFWR
    April 2, 2013 at 4:24 pm

    We require an expansion of finance that is an evolution, not a devolution like “financialization.” I suggest a Technological Innovation Dividend/Gradual Jubilee program where every individual over 18 (working or not) receives a $5000/mo. payment with the condition that $4000/mo. be used to pay down personal or business debt. Continue this program for at least 24 months until the debt overhang from the “Great Recession” has been eliminated, people have some equity instead of a mountain of oppressive debt and the economy is reset. Then continue and increase the Technological Innovation Dividend in perpetuity as a way to insure economic democracy and the proper functioning of the economy despite the inevitable and actually beneficial loss of jobs due to the efficiencies of technology.

    Leisure is not idleness, and Man is capable of many positive purposes other than work for pay. It is way past time that society/civilization evolved past the primary economic purposes of profit and employment, and the financial idea that despite ever increasing productivity with its rational reduction of jobs….that production be the ONLY purpose of finance.

    I hasten to add that this is not in any way a call for the elimination of either profit or employment. It is simply making them secondary or tertiary purposes and making individual economic freedom and positive purpose of whatever kind the new primary thrust.

  4. April 3, 2013 at 4:04 am

    For 35 years I worked in the financial sector of the U.S. economy, early on as an accountant and project manager for a bank subsidiary managing the assets of a failed REIT, then managing a bank’s residential mortgage loan program, and finally 20 years as a market analyst and business manager at Fannie Mae. What I learned as an insider experiencing the results of several decades of deregulation of the financial services sector was that the boom-to-bust nature of the global economy is the result of the financial rewards in virtually every country associated with land and natural resource (i.e., rent-seeking) speculation. Every 20 years skyrocketing increases in land costs make their way through every economy to drain profit margins from most businesses and stress the affordability of acquiring and owning residential property. Low cost and minimally underwritten extensions of credit associated with the sub-prime mortgage crisis, as well as highly leveraged acquisitions of commercial real estate made the most recent market crash more severe than it might have been. Now, in the U.S. the Federal Reserve has tried to reignite property (i.e., land) prices in order to end losses experienced by holders of mortgage loans and enable financially-troubled property owners to sell out and pay off outstanding mortgage debt. While this strategy seems to be desirable, the longer run consequence is to set us off on another speculation-driven property market cycle. What should be done? Ideally, government should move to the public collection of land rent as a primary source of public revenue. The most important banking reform is to prohibit any financial institution that accepts government-insured deposits or other guarantees from extending credit for the purchase of land or acceptance of land as collateral for borrowing. In the residential sector what this does is essentially return in the U.S. to conditions of prior to the 1960s, when property buyers were required to make a 20 percent cash down payment, which in practical terms meant they were paying cash for their land parcel and borrowing from the bank to purchase their home. Rising land prices made it less and less possible for buyers to save enough to make a 20% down payment, and the mortgage lenders responded by lowering requirements and introducing private mortgage insurance to cover the increased exposure. By the 2000s, land prices were so high in many markets that down payments had to be waived altogether; property appraisals routinely indicated land-to-total value ratios well above 50% — and in “high cost” markets these ratios might be as high as 80%. Now, central bank policy seems to be based on the assumption that adding fuel to the fire is the only trick left in an empty bag of tricks.

    • Garrett Connelly
      April 3, 2013 at 2:46 pm

      It is good to see a solid proposal that makes sense and would be the best idea were it alone and without companion ideas about taxing energy, facing the lies of war for profit, and tasking what was once destructive war energy to education and healing the planet with human rights.

      These subjects should of course be debated more fully as a new constitution is being written. What do you think of Hugo Chavez’s innovative five branches of government? Once the door is open, seven is a better number.

      Hugo Chavez opened the idea to expanding the branches of government to five; the fourth estate, the press, becomes the fourth branch tasked with information being available and true, expanded to include press, internet and education text books not pushing ideology, religion or propaganda.

      Hugo’s fifth branch is the people’s branch, a small editorial board and staff which reads the legislature’s laws and looks for justice in written law before being sent to the executive branch. This branch is meant to solve the problem that the concept of law has no inherent relation to justice.

      I like a sixth and seventh branch; economy and environment.

      A modern democracy will include the economy and this does not exclude all capitalism. The environment is a living thing that requires the right to health and growth free from damaging exploitation. Branches six and seven work together to ensure prosperity for humans who depend upon an environment built by natural diversity.

      Subsidy is too complex for scientific application and should thus be removed. Maintain maximum education while culture adjusts to justice and equity as replacement for backroom subsidy deals. Maximum education leads to gradual population decline and reduced ecological impact.

      • April 3, 2013 at 7:35 pm

        What has been lost in the U.S. is the sense of community that once existed, a sense of place being important to one’s life because of the relationships with others fostered over a lifetime of service. Our system of law has evolved to favor the corporate form of ownership over others, but the members of corporate boards and the executive management rarely have a strong sense of membership in the communities in which they do business. Corporate headquarters and offices are mostly located in the financial districts of large cities or occupy large tracts of suburban land. Employees, for the most part, commute some distance from their homes to the workplace and are attached in a meaningful way to neither. Strong communities become and remain strong because of a cooperative spirit of people toward one another. Thus, it makes sense that civic leaders should call for changes in laws and taxation to benefit (but not subsidize) cooperative enterprises that are based in the community and reinvest profits in their employees and the community as a whole. Government is, in this scenario, merely the arm of the community that facilities implementation of programs and policies that serve the common good rather than vested interests.

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