Bill Gross, the US’ “bond king,” who made his fortune betting on IOUs from companies and governments, is suing his erstwhile employer for US$200 million, it emerged last week.
His colleagues were driven by greed and “a lust for power,” he alleged.
His chutzpah was a timely reminder of the vast sums won and lost in the world of globalized capital, but also of the power that still lies in the hands of men — they are mostly men — like Gross, who sit atop a system that remains largely untamed despite the lessons of the past seven years.
Illustration: Mountain People
To those caught up in it, the US’ sub-prime crash and its aftermath felt like a unique — and uniquely dreadful — chain of events, a financial and human disaster on an unprecedented scale. However, it was just the latest in a series of periodic convulsions in modern capitalism, from East Asia’s financial crisis to the Argentine default, to Greece’s humiliation at the hands of its creditors.
The first tremors of the next earthquake were sensed by the central bankers and finance ministers gathered in Lima for the IMF’s annual meetings last week. Many were fretting about the knock-on effects of the downturn in emerging economies — led by China.
Take a step back, though, and both the emerging market slowdown and the boom that preceded it are just the latest symptom of the ongoing malaise afflicting the global financial system.
Seven years on from the Lehman Brothers’ collapse in September 2008, there has been some re-regulation, but many elements of the financial architecture remain unchallenged.
Capital swills unchecked around the world, governments feel compelled to prioritize the whims of international investors such as Gross — who tend to have a neoliberal worldview — over the needs of domestic businesses; and credit ratings agencies remain all-powerful, despite their dismal record.
The theory behind free-flowing capital is that it allows the world’s savings to find the most profitable opportunities, and provides the impetus for investment and entrepreneurialism, aids economic development and boosts growth.
However, as the UN conference on trade and development (UNCTAD) detailed in its annual report last week, the reality is very different. Capital flows are often driven more by global financial weather than by the investment prospects in emerging economies.
They can be disproportionately large and they can change abruptly with the market mood, overwhelming domestic efforts to promote stable development.
Recent IMF research found that a quadrupling of corporate loans in emerging economies over the decade to last year was driven mainly by international factors — most obviously the flood of cheap money from central banks as they fought to reflate Western economies. This might have financed productive projects, but it left firms vulnerable to a shift in conditions — such as an increase in global interest rates, or a “sudden stop,” when capital is abruptly withdrawn.
Emerging markets as a bloc are expected to suffer a net capital outflow this year for the first time since 1988 as investors seek to protect themselves from plunging commodity prices and anticipate higher US interest rates.
The IMF warned governments to be prepared for a flurry of corporate failures as the tide turns and warned that corporate losses could quickly hit banks’ balance sheets.
This would prompt them to rein in lending and could unleash a new credit crunch in emerging markets.
UNCTAD argues that as well as inflating bubbles, an indigestible influx of capital can strengthen a country’s currency to the point where local industries are unable to compete with cheap imports.
Policymakers in economies heavily dependent on external capital can also be tempted to keep interest rates high as they pander to the demands of global investors for low, stable inflation. UNCTAD bemoans the “lost opportunities for growth and for an expansion of higher-quality employment.”
Separate research has found that a big banking sector tends to pump up credit bubbles, rather than funneling investment into long-term projects that boost productivity and ultimately foster sustainable growth.
Bank for International Settlements economist Stephen Cecchetti has suggested that this might be because finance favors industries that have tangible assets they can pledge as collateral (such as property), rather than “high research and development intensity,” which might take longer to bear fruit.
UNCTAD’s experts would like to see new global rules that would, among other things, allow governments to erect barriers against hot money flows, clip the wings of ratings agencies and establish a formal, fair mechanism allowing countries to go bankrupt. It would also like to see governments in rich countries focus on boosting wages to increase domestic demand, instead of relying on debt-fueled growth.
Others warn that a more radical approach might be necessary, to break the cycle in which healthy expansion always brings with it a credit bubble. Former UK Financial Services Authority chairman Adair Turner — who witnessed the credit crunch first hand — has become increasingly vocal in arguing that some of the global debt mountain might have to be written off; or financed directly by central banks.
He might well be right, but as a fresh crisis looms, it must be time to tame global capital and make it work for all the world’s citizens, not just for Gross and his fellow titans of finance.
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