Roger Altman in The Financial Times:
We need not fret over omnipotent markets
December 1, 2011
By Roger Altman
The succession of political dramas in Europe, most recently the end of Socialist dominance in Spain, again shows the financial markets acting like a global supra-government. They oust entrenched regimes where normal political processes could not do so. They force austerity, banking bail-outs and other major policy changes. Their influence dwarfs multilateral institutions such as the International Monetary Fund. Indeed, leaving aside unusable nuclear weapons, they have become the most powerful force on earth.
The power of financial markets, however, is a double-edged sword. When that power is flexed, the immediate impact on society can be painful – wider unemployment, for example, frequently results and governments fall. Yet history suggests the longer-term effects can be often transformative and positive. For all the recent hand-wringing over the role of the markets, this could yet be the case in Europe, too.
After all, the Latin American debt crisis of the 1980s ultimately toppled Authoritarian regimes in Brazil and Argentina. The subsequent and de facto Mexican and Russian defaults transformed the budget and financing policies of those nations. The 1997-98 Asian crisis led to broad IMF-mandated reforms in Thailand, Indonesia and South Korea.
In hindsight, those crises look like tremors compared to the 2008 credit market collapse in the US and the current sovereign debt and banking crisis in Europe – events that have brought about stunning changes.
In late 2008, financial market pressures forced the US Congress to create the Troubled Asset Relief Program, which was charged with investing up to $700bn of taxpayer funds into weakened financial institutions. Tarp, which was seen as a Wall Street bail-out, was deeply unpopular. The programme’s creation and the sweeping financial re-regulation legislation that followed would have been unthinkable under any other circumstances.
In Europe, the elected leaders of five European Union members have been swept aside in just 18 months. Silvio Berlusconi’s near perpetual grip on power in Italy was broken almost overnight. Further, forced austerity is now spreading across Europe, despite public opposition.
How did the markets amass so much power? The answers lie in globalisation, external imbalances and the surge of financial assets and financial technology. The expansion of global trade over the years led to a rise in global money flows. As Asia, India and Latin America became more global, the capital transfers between these regions and advanced economies grew. And it was the emerging countries that imported capital from advanced nations because internal savings were too small to finance development. But global finance changed when this historical pattern reversed. Many export-centred developing countries adopted conservative fiscal policies, which led to excess savings. China, for example, is sitting on $3tn of accumulated monetary reserves. In the US, savings declined and a large current account deficit developed. The result was an unprecedented recycling of capital from poorer countries to richer ones.
This change – together with a surge in the use of technology, deregulation, the emergence of larger financial institutions and an ageing, and increasingly wealthy, population in the west – expanded the scale of finance and the pressure for investment returns. The ratio of global financial assets to global gross domestic product has grown from 2.5x to almost 4x since 1990. In absolute terms, such assets now total $212tn. America’s six largest banks have seen their total assets expand from 17 per cent of US GDP to 63 per cent over the same period.
It was inevitable, then, that global trading volumes in financial assets would rise sharply. Bond and commodity investing, for example, were revolutionised by the introduction of new financial instruments, the availability of greater leverage and new technology.
Whether this power is healthy or not is beside the point. It is permanent. Even a resumption of traditional patterns in global capital flows would not change it.
Today’s remarkable economic growth in Brazil was facilitated by reforms emanating from the 1980s’ debt crisis. Both growth and governance in South Korea were accelerated by the late 1990s’ Asian crisis. Perhaps it is a Panglossian view, but, in the long term, Europe could be strengthened by the current crisis. After all, a smaller role for the state in Europe could facilitate a more competitive private sector to face the economic challenge posed by China and other emerging markets.
But, above all, there is no stopping the new policing role of the financial markets. There may be more frequent market crises. We should not rush to conclude that they will end in tears.
The writer is chairman of Evercore Partners and was US deputy treasury secretary under President Bill Clinton. The perspective piece was published by the Financial Times on December 1, 2011.