(Permanent Vice Chairman, China Center for International Economic Exchanges)
From the second half of 2008, a financial crisis originated in U.S. swept across the world like a tsunami. After more than two years, with joint efforts from governments and organizations, people finally see the dawn of recovery. What does this crisis taught us? What are the root causes? In the post-crisis era, everyone who cares about the economic globalization prospect and the future of the world economy have to seriously consider the issues of how to learn a lesson, to seek to prevent the crises from happening again in a right way and to allow the world economic development to go on a safe path.
After the crisis, economists from different perspectives summarized its causes. To sum up, there are three popular points of view: first, excessive exports in developing countries that led to global imbalances; second, the proliferation of financial derivatives that led to an over-leveraged economy; third, the expansion of governmental debt that led to the sovereign debt. After re-introduced by mainstream international media, these seemingly correct views were believed by many people that they are the root causes of the crisis.
Indeed, if by some countries’ and interest groups’ positions, or from a side view, those conclusions have a certain sense, but not the root causes of this crisis.
Developing countries took their advantages in labor and resources to attract capital and technology in order to speed up economic development and growth in export, which is a result of optimal allocation of factors of production in the globe. With increased exports, developing countries also expanded imports, which in turn have injected a steady flow of energy to increase employment and economic growth for developed countries. Meanwhile, multinational corporations in developed countries invested in developing countries also created a direct profit growth for developing countries. This win-win economic activity is the inevitable requirement of economic globalization and an historical trend for all countries to develop in a common progress. Looking at the history of world development, imbalance of the development is an absolute term and the balance of development is relative. In modern times, the U.K. and U.S. had been major exporting countries and had long-term trade surplus. Today, the U.S. is still a major exporter of services; Japan, Germany and other developed countries are still major exporters of technology-intensive and knowledge-intensive products. It is completely upside down to say that the exports from developing countries, mainly as labor-intensive and resource-intensive products were the cause of world economic imbalance that triggered the global financial crisis.
The proliferation of financial derivatives that led to over-leveraged economy is another one of the direct reasons which triggered financial crisis, but what are the reasons that cause the proliferation of financial derivatives? Why international investors compete to buy the high-risk financial products including Credit Default Swaps? Why the proliferation of financial derivatives takes place in the U.S. rather than in other countries? After the big crisis in the 30s of last century, the U.S. learned a lesson and adopted laws to strengthen the financial supervision. But to the 80s, those laws were abolished because they were considered as impediments in the development of financial industry. In the period of the proliferation of financial derivatives, there were insights from the U.S. economists and government that raised the concern to strengthen financial supervision legislation, but these laws were rejected when they were submitted to the Congress. Why members of Congress who claim to represent voters’ interests would allow the proliferation of financial derivatives? Whose interests have driven behind? In short, over-leveraged economy is only a superficial phenomenon. There are deeper underlying causes.
Over-expansion of government debt that led to sovereign debt crisis seems the 3rd reason of financial crisis, but still not the root cause. Fiscal deficit and government debt have pressures on currency issuance and they should be maintained within a reasonable range of fiscal revenue and GDP. If they have been accounted for more than a certain percentage, it means the inevitable result of currency over-supply, which will lead to inflation. The U.S. relies on fiscal deficit and government debt to meet expenditure in the long-term. After the financial crisis, the volume of fiscal deficit and government debt increases. In 2010, the federal government had $1.4 trillion fiscal deficit, accounting for 9.4% of GDP; public debt was $9.02 trillion, accounting to 62.1% of GDP, which ranked at a very high level among developed countries. Thanks to the world’s major reserve currency status of the country, which attracted foreign capital and cheap products, thus the U.S. high rate of deficit and high debt ratio didn’t trigger inflation and the interest rates remained low. It is visible that either before or after the crisis, the U.S. government debt only played a role in boosting the accumulation of energy for the financial tsunami. Some European countries’ sovereign debt crisis occurred under the condition of fiscal policy and monetary policy separation and its impact on global economy was limited. Therefore, the sovereign debt crisis is absolutely not a root cause of financial crisis.
The root cause of the financial tsunami is: The U.S’ abuse of sovereign credit in the long-term, the misuse of its status as a global major reserve currency issuing country, the promotion of twin deficits in current account and fiscal budget, and the maintenance of domestic resident’s excessive consumption and government’s over spending, which continuously accumulated huge energy for the financial tsunami. U.S. credit rating agencies used their monopoly status in the globe to cover up sovereign credit risk, reversed the risk relationship between debtor countries and creditor countries, attracted international capital to high risk concentrated regions and these actions have caused the loss of the last barrier for the prevention of financial crisis.
Market economy is a credit economy and the economic globalization made the sovereign credit be a most important component in a country’s competitiveness and economic strength. Good sovereign credit can reduce a country’s national government and enterprise financing costs, enhance the attractiveness to foreign investors, and become an important motivation for economic development. On the contrary, bad national credit, especially as a major reserve currency issuing country in the world who abuses its sovereign credit, steals other countries’ wealth, accumulate and distribute financial risk, will ultimately bring a disaster to its national economy and the global economy.
This time, the U.S.as the hotbed of the global financial crisis unmistakably tells us that financial products which created by relying on sovereign credit should be compatible to its country’s scale of real economy. Excessive expansion of the virtual economy, builds the U.S. economy like an inverted pyramid on a sand beach. Before the financial crisis, there was about $2 trillion as the bottom of subprime lending; ordinary mortgage was about $12 trillion; corporate bond which included Collateralized Debt Obligation (CDO) and Credit Default Swap (CDS) was about $62 trillion. According to BIS data, financial derivatives that held by major U.S. financial institutions are about $300 trillion. For such a financial building with heavy top, if there is a problem in any chain, it will collapse in a moment. If we say the economic crisis in the capitalist economy in history is brought about by excessive capacity of material production; then, in today’s highly developed financial industry, unbridled supply of financial products which relied on sovereign credit is the root cause of global economic crisis under the new historical conditions.
Once identified the origins of this financial crisis, we should actively explore the fundamental strategy to avoid the crisis from happening again, and build move efficient and safer global financial system. This is a historic responsibility for the economists and governments in the world. I believe that the priority is to discuss the establishment of the multi-currency competitive international monetary system, the international reserve currency monitoring and early warning system, and the international financial risk relief mechanism, which formed as three protective doors to defend the international finance safety.
1) The establishment of the multi-currency competitive international monetary system.
The establishment of the multi-currency competitive international reserve currency system is a fundamental way to maintain the stability of international financial system. If looking ahead, the future global reserve currency system might be a multi-currency system including U.S. dollars, Euro, Yuan, Yen, pound sterling and other components. There are competitions, checks and balances, and intermediation among currencies. If one currency has a depreciation risk, people will sell it; if one currency is stable and has a potential to appreciate, people will buy it. The usage of the competition and preferred mechanism can promote international reserve currency issuing countries’ governments to adopt a prudent monetary policy, to keep their currencies stable, and to maintain their sovereign credit. Only by establishing such an international reserve currency system, can the phenomenon that international reserve currency’ over-reliance on one sovereign currency and avoid the exposure of international financial risk to one certain currency be changed. After the cancellation of gold standard for international reserve currency, replacing the gold standard with competitive mechanism and form a steady mechanism for international reserve currency is a right choice under the conditions of economic globalization. It should be noted that some U.S. economists such as Robert Mundell, Jeffery Sachs, and Fred Bergsten and so on, have also proposed similar views.
2) The establishment of the international reserve currency monitoring and early warning system.
With the collapse of the Bretton Woods System in the 70s of last century, the value of international currency decoupled from gold. The U.S. dollar, which was based on its country’s own sovereign credit, became the major reserve currency in the world. This allowed the U.S. to transfer debt to foreign countries through currency depreciation. From 1971 to 2010, the U.S. dollar depreciated 97.2% against gold, and caused huge losses to those countries that took the U.S. dollar as the reserve currency. If the depreciation of dollar that steals the wealth of owners with dollar-dominated assets is a slow process, then this financial crisis that makes some of the dollar-dominated securities assets vanishes instantly. It indicates that as a world’s major reserve currency issuing country, the impacts of its financial security have crossed the national boarders, and the impacts are highly related to the vital interests of all residents, enterprises and foreign governments who own dollar-dominated assets. Therefore, the early warning and international monitoring for the major reserve currency’s supply and circulation is necessary and well reasoned. It is completely feasible for international financial organizations to implement the monitoring and early warning system. Some professionals from European Union and International Monetary Fund have proposed ideas and recommendations in this regard, worthy in-depth discussion and further consensus.
3) The establishment of international financial safety co-operation and risk relief mechanism
Under the conditions of increasingly closed economic ties among countries, one country’s finance problems will be chain reactions to many others. In order to maintain international financial safety, every country should unite and establish the international financial safety co-operation and risk relief mechanism. The “Chiang Mai Initiative” is such an action after the Asia financial crisis. Currently, the International Monetary Fund should give a full play to its function on financial safety cooperation. It should expand the scale of Special Drawing Rights (SDR), adjust the proportion of SDR for each country based on their proportional changes in economy and trade in the world, and include currencies of emerging economies in the SDR basket. If one country has financial crisis, the IMF could give timely and effective relief to prevent the crisis from spreading, and help the country to find a correct way out of the crisis, and lead it to a healthy developing path gradually in order to facilitate the stability of global monetary system.
4) G20 should play its role in the construction of new international monetary system
G20 is a new international organization that includes developed economies and emerging economies, and it has an irreplaceable role in addressing global economic issues and coordinating national economic activities. The current missions for G20, if I may say, are:
How to establish a multiple competitive international reserve currency system in order to accomplish a transition from the excessive reliance on one sovereign currency to a plural competitive system. The construction of more efficient and safer international financial system should be a gradual historical process. In the near future, the dominant position of U.S. dollar as the international reserve currency is still irreplaceable. Given the new negative impacts on international economy and the financial stability that emerged from the implementation of quantitative easing monetary policy by the Federal Reserve, we should study common approaches in order to maintain the rare recovery trend of the world economy after the financial crisis and then let the world economy proceed to a stable growing situation.
Put early warning and monitoring and necessary restrictions on the large-scale flow of international capital that aimed at short-term arbitrage. The large-scale flow of international capital in a short-tem and its speculation in the capital market is an important reason for international financial volatility. Each country should take united actions to strengthen the monitoring and necessary restrictions on international hot money, such as regulations on the time limit of capital inflow and outflow, and collection of capital gains tax, etc.
Mediate the investment channels and attract investment of excess liquid capital to the real economy. Through the admitting of Qualified institutional investors and various funds, providing sound capital market functions, and expanding inter-government aid loans, in order to attract capital to nations and regions with high investment demands; and combining the huge demands of industrialization and urbanization in developing countries and capital and technology in developed countries, in order to promote the free flow and optimal allocation of factors of production in the globe. Thus, it will not only ease the global inflation pressure but also enhance employment in developed countries and then promote common development in all countries.
Set up a permanent executive office for G20 that responsible for taking the consensus reached at summits into actions. It should take the establishment of a multiple competitive international monetary system, the international reserve currency monitoring and early warning system, and the international financial safety relief mechanism as priority in the short-term. The money supply and circulation of the major reserve currency should be transparent, and the effectiveness of corresponding decisions should be evaluated and published by international financial organizations. It should reconstruct the international credit rating system, strengthen the professional ethics for credit rating agencies, break the monopoly of a few agencies on international credit ratings, and promote the objectivity and fairness of the credit ratings released by credit rating agencies through a competitive mechanism. G20 is expected to make a historical contribution for establishing more efficient and safer international monetary system.