Financial crashes are not random; they follow booms. If we want to prevent financial crashes, and the consequences of not doing so are so severe that this is a rhetorical question, then we need to moderate the preceding booms. Much will be gained from moderating unsustainable booms, but some things will be lost too. I don?t want to get romantic about booms as they sow the seeds of much destruction, are the veil behind which frauds grow and allow a select few to make off like bandits. However, we should not be blind to some of the positive things that happen in a boom.
Booms are full of optimism?unbridled, excessive optimism for sure, but an optimism that will be missed as we enter the Age of Pessimism. In the optimism of the boom the private sector finances grand infrastructure projects that they would not in their right mind finance otherwise?railroads and the cabling of America come to mind. And this boom was a real boon for many developing countries.
We may not want to think so, but it is not a mere coincidence that the last ten years of financial boom have been the best for developing countries on many measures of income. Africa and Asia had their best decades on record. Interestingly, this time around, developing countries did not benefit so much from the free-flow of finance, but from the rise in demand for the commodities, textiles and manufactures that many developing countries produce. My point is that it should be our starting point that as this boom unravels into inevitable misery, developing countries will have a rough decade. There will be a few exceptions, but for many others it could also be worse.
We are at one of those unique points in history where the future is easier to predict than the present. There are four things we know for certain. The first is that banking will be repressed. A good thing, everyone is thinking I am sure, though bear in mind that less credit means less growth. Banks will be voluntarily repressed. The immediate aftermath of a crash is perhaps the only time you do not need to tell banks to cool their lending. Banks will be involuntarily repressed too by additional regulations, some of which will be good and necessary, others less so.
The second thing we know for certain is that banking and finance will be more national. Taxpayers are waking up to the realisation that they are the ultimate guarantor of banks and while they will reluctantly bail out their own bankers, they will draw the line at foreign bankers. Consequently, we will see a switch away from home country regulation of banks to host country regulation. Regulatory boundaries will rise and bank activities in one country will be regulated there. This will mean less efficient, more costly international banking, but this will be viewed as a price worth paying. Trade finance has already become curtailed and financial protectionism is on the rise.
The third thing we know for certain is that national savings rates will rise, especially in advanced economies and where savings were previously low. Higher savings mean less consumption and slower growth. The fourth thing we know for certain is that government debt will rise substantially. In the case of the UK, debt-to-GDP ratios are likely to rise from 50% to closer to 200%. This extra borrowing will crowd out investment, slow growth and raise long-term borrowing rates for emerging economies.
None of these four things are good for developing countries. The Age of Globalisation and even the Asia Age will be interrupted. It is not clear what developing country governments can or should do about this.
There is much grand talk of the creation of a new global regulator. The Financial Stability Forum, an ad hoc body of regulators, will likely be given more responsibility for international financial regulation in the April 2, G-20 meeting and be asked to become a wider more representative body. But developing countries will be wary of new international initiatives. Global initiatives where developing countries have effective representation have no clout and global initiatives with clout are those where developing countries have no representation. Power does not like being shared. The most likely area for progress is also the most interesting. Talk of a new global currency is gaining momentum. The US, now a deficit country, appears to be less interested in preserving the dollar?s role as the world?s major currency. Indeed, the dollar?s existing role is not acting as any constraint on US monetary policy.
But developing countries must now not put too much store in global agreements. They should do what they must always do, which is to focus on primary education and public health. And they must consider how best to boost business facilitation and value-for-money. They will need every last penny.
?The author is chairman Intelligence Capital Ltd and emeritus professor, Gresham College