Self-feeding speculation in housing, currencies, and commodities through complex financial instruments where appropriate prices could not be determined led to a divorce from the "real" economy, a new UNCTAD report contends -- and by the time these speculative bubbles burst, the global financial crisis was a foregone conclusion.
The herd behaviour that characterized these speculative positions went unregulated. Reforms should be made to the international financial and monetary systems allowing appropriate government intervention and international oversight so that these systems to do not get so far out of balance in the future.
"The United Nations must play a central role in the reform process," the report urges, "not only because it is the only institution which has the universality of membership and credibility to ensure the legitimacy and viability of a reformed governance system, but also because it has proven capacity to provide impartial analysis and pragmatic policy recommendations."
The report, titled The Global Economic Crisis: Systemic Failures and Multilateral Remedies , was released today. It was written by economists serving on UNCTAD´s Secretariat Task Force on Systemic Issues and Economic Cooperation in advance of several upcoming international conferences on the global economic crisis.
Financial deregulation, driven by blind faith in the virtues of the market, allowed forms of financial innovation that were completely detached from productive activities in the real sector of the economy, UNCTAD experts contend. Such instruments favour speculative activities that build on apparently convincing information which is little more than an extrapolation of trends into the future. "Speculation on excessively high returns can support itself -- for a while," the report says. But the realities of slow growth of the real economy, where investment can generate increases in real incomes, eventually catch up with the illusions of risk-free speculative finance.
The sudden and almost simultaneous collapse of speculative positions across global financial markets may have been triggered by the bursting of the United States housing-price bubble. But other bubbles, including those related to speculation in currencies and commodities such as oil, also were unsustainable. They would have popped sooner or later even without the spark caused by the US mortgage debacle.
Without greed, the crisis would not have erupted with such force, the report says -- and regulations and practical policies should have been in effect anticipating such greed and short-sightedness. Experience has shown that financial markets do not function well without effectively designed and enforced regulation. "We have learnt now that financial market participants not only have no idea about the equilibrium, but they tend to drive financial prices systematically away from the equilibrium. Governments do not know the equilibrium either, but at some point they are best-positioned to judge when a market is in disequilibrium."
In a globalized economy, interventions in financial markets call for cooperation and coordination by national governments, and for specialized institutions with clear orders for international surveillance.
In confronting the next wave of the crisis, it will be critical to stabilize exchange rates by direct and coordinated government intervention, supported by multilateral oversight, the study contends. Governments should not leave it to the market to find the "bottom line," and international institutions should not make their emergency finance to crisis-stricken countries conditional upon pro-cyclical policies such as public-expenditure cuts or interest rate hikes, which would be damaging in the current situation.
Excessive speculative financial activity should be tackled as a whole, the report recommends. Establishing national regulations to prevent housing bubbles and the creation of risky financial instruments alone would only intensify speculation in other areas such as stock markets, it points out. And preventing currency speculation through a global monetary system with automatically adjusted exchange rates might simply redirect speculators searching for quick profits into commodities futures markets, thus increasing volatility there. The same is true for regional steps to fight speculation, the report says -- that might only make other regions the focus of speculators. "Nothing short of closing down the big casino will provide a lasting solution."
Speculation that develops into a sustained pattern of betting on ever-rising prices is not stabilizing. On the contrary, it destabilizes prices. The key condition for stabilizing speculation is that the "true" price be known in a global economy characterized by objective uncertainty. But this "true" price cannot be known in markets spiralling upwards amidst uniform, but wrong, expectations about long-term price trends. During the recent speculative boom, many agents disposing of large amounts of money bet on the same "plausible" outcome, and saw their expectations confirmed by media opinion, by analysts presumed to be experts, and by policy makers who respected their opinions, the report says There were no regulations -- and little oversight -- in place to halt the upward spiral and to break the illusion of risk-free profits.
The report highlights three specific areas in which the global economy experienced systemic failures. While there are many more facets to the crisis, UNCTAD examines here some of those that it considers to be the core areas to be tackled immediately by international economic policy-makers because they can only be addressed through recognition of their multilateral dimensions.
The global economic crisis: systemic failures and multilateral remedies
The report investigates three interrelated issues of importance to developed and developing countries alike, and proposes measures to address the systemic failures they have entailed:
- how the ideology of financial deregulation within and across nations allowed the build-up of pressures whose unwinding has damaged the credibility and functioning of the market-based models that have underpinned financial development throughout the world;
- how the growing role of large-scale financial investors on commodities futures markets has affected commodity price volatility and fed speculative bubbles; and
- the role of widespread currency speculation in exacerbating global imbalances and fuelling the current crisis in the absence of a cooperative international system to manage exchange rate fluctuations to the benefit of all nations.
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