In theory, a globalised financial market where all players look outwards rather than inwards should be a good thing.
It should mean that borrowers — wherever they may be — have access to the savings of the entire world if they can demonstrate to lenders that they can use the money prudently. It should also mean that lenders can scour the world for the opportunities that give them the best return for the quotient of risk with which they are most comfortable.
The calculus should be beneficial to both sides. For borrowers, the cost of capital should be lower than that on offer in smaller domestic markets, while for their creditors, returns should be far more attractive since they have more options for where to put their money to work.
But since the global financial crisis there has been a gradual disillusionment with this world. The negativity has greatly increased in recent months and has culminated in a more inward-looking view in many parts of the developed world.
It is not only the populism fuelled by those who feel that the system has done little for them that explains this shift. Financiers and regulators have also moved away from embracing globalisation. Much hand-wringing has accompanied this retreat. But the reality of the way globalisation led to the crisis suggests the anxiety is overdone, given the excesses that the crisis spawned — especially if less developed financial markets can improve the way they allocate capital.
The challenge will be to preserve the best possibilities of globalisation while curbing its worst excesses.
Leading up to the crisis, money flowed in perverse ways. It went from higher growth emerging markets to slower growth developed markets. Much of these flows went into US Treasuries to bolster reserves on the part of emerging markets in the aftermath of their financial crisis in 1997-98. Those flows to the US and to the dollar, the only currency to have the privilege of being the world’s reserve currency, meant that profligate Americans could pay for ever-grander properties with money that was cheaper than it would otherwise be, even as emerging market borrowers had to pay more than if their money had stayed at home.
Since dollars were the one currency everyone wanted, and in which international banking business was conducted, European banks and non-banks borrowed those dollars in wholesale markets rather than relying on deposits to fund their own activities. This gave rise to what the Bank for International Settlements referred to as “the transatlantic banking glut”.
Such short-term financial flows sowed the seeds for the European banking crisis, which came in the wake of the implosion of Lehman Brothers and its swift contagion to other securities companies and AIG, the giant insurer, in the US.
Globalisation, in other words, meant poor capital allocation of debt and a huge build-up of that debt to levels that ultimately proved unsustainable. It led to rolling crises as investors looked for high returns in short-term instruments, whether in emerging markets, the US or Europe.
The easy money policies of developed market central banks in response to the crisis merely triggered an artificial rise in asset prices in these markets, which led to even more flighty capital flows into emerging markets as yields were driven down at home. “The Fed should remember that when it makes monetary policy it should take into consideration the impact on the rest of the world,” said Gao Xiqing, then head of the Chinese sovereign wealth fund, wistfully in 2009.
Today, a retreat from globalisation ultimately means — at least partly — a retreat from the dollar and from the US-centric global financial system. This is a retreat US regulators have abetted with rules that extend US territoriality way beyond its shores, especially as they try to curb money laundering and terror financing. The rules have become so onerous for foreign banks that some have surrendered their US branches.
At the same time, regulators in other jurisdictions — concerned with the speed with which the meltdown and the easy money policies of the US sent waves of capital sloshing in and out of their markets — adopted rules requiring local units of foreign banks to put more capital into them.
There is no more dramatic illustration of the extent to which the US has turned its back on the world than to look at the swap lines the Federal Reserve maintains with its overseas counterparts to make dollars available in case of stress. The Fed maintains just five such lines, with Japan, the eurozone, the UK, Switzerland and Canada, according to Eswar Prasad of Cornell University and the Brookings Institution, a think-tank. Emerging market central bankers who have sought such lines have been routinely turned down.
Even as the US steps back, China is taking a greater role on the global financial stage, despite slowing its timetable for dismantling capital controls. In contrast to the five swap lines from the Fed, the People’s Bank of China maintains 37.
The rest of the world is trying to sidestep unpredictable US regulators, central bankers and politicians. “Eighty-five per cent of trade never touches US borders,” notes a spokesman for Citigroup, adding that in response to the growth in intra-Asian trade, the bank has opened more than 30 desks around the world to serve Asian multinationals.
Whether the next phase will be fairer and more efficient is not clear. The biggest companies in the world will always have access to global markets as the planned listing of Aramco, the Saudi Arabian national oil company, shows. Cross-border investment is becoming more difficult for a mix of reasons that include protectionism but also the rise of the sharing economy, which will probably lead to less demand for capital intensive services and products. If companies are forced to look closer to home for funding, as seems likely, that could be a good thing if governments do a better job making sure capital is allocated to the capable rather than the connected. So far, though, there is little evidence this will be the case.