CRASH INSTEAD OF CASH
The Role of Global Financial Markets – Problems and Alternatives
By Attac Austria
[This position paper published October 2007 is translated from the German on the World Wide Web,
http://www.attac.at.]
Many people associate “global financial markets” with negative developments like dangerous crises, speculation and too much power in a few hands. Actually financial markets often no longer support the economy but dominate it. Both businesses and states are under their increasing pressure. Many things seem inverted.
In principle, financial markets perform an essential function. They finance the production and consumption of goods and services in the so-called real economy. Whoever has saved money can invest it on the financial markets. Then this money is made available to businesses, governments and private persons for investment or consumption. In addition, currencies can be exchanged on financial markets to buy foreign products in international trade or invested abroad.
1. WHAT ARE FINANCIAL MARKETS?
Three partial markets of global financial markets can be distinguished:
CREDIT MARKET: Banks give credits to businesses, governments or private persons to finance investments or consumption. For banks, there are security measures. They are subject to oversight and must hold minimum reserves.
SECURITIES MARKET: The issuance of stocks or the circulation of shares is an important form of financing for large corporations and governments. With a stock, one acquires a share of the business – one becomes a co-owner. On the other hand, shares are debt prescriptions that will be paid back with interest. New shares or stocks are issued on the “primary market.” These securities are then handled on the “secondary market.”
Derivatives are the most modern kind of securities. While they originated as insurance instruments, they represent bets with high risks and high profit chances. This realm has exploded in the last years. 60-times the annual economic output is turned over daily on the derivative markets.
In principle, securities traded on exchanges are subject to monitoring. All the more alarming, trading with derivatives occurs outside the exchange “over-the-counter” (OTC) where there are no controls.
CURRENCY MARKET: To handle international trade, currencies are exchanged on the currency markets. The exchange rate, the price of a currency, is determined here.
Through liberalization of capital transactions since the 1980s, the international currency markets have gained enormously in their range. Only a fragment of trading actually implies the purchase of foreign goods or transactions of border-crossing real investments. Most are pure financial enterprises or speculation.
2. FROM BRETTON WOODS TO CASINO
The international financial markets as we know them today first arose in the 1970s. The system of Bretton Woods ensured stability. Because of the disastrous worldwide economic crisis in the 1930s, the allies of the 2nd World War agreed on a system of fixed exchange rates with the dollar as the key currency. In addition, the influx and outflow of capital to industrial countries was regulated by capital transaction controls. The International Monetary Fund (IMF) and the World Bank (WB) were created to carry out this system.
Despite problematic sides – above all the US dollar as the key world currency – the system of Bretton Woods provided the framework for a stable development in many countries and contributed successfully to the prevention of international financial crises.
In 1978 the Bretton Woods system broke down since the US abandoned the key function of the US dollar to print money to finance the Vietnam War. Since then, most currencies have fluctuated freely. Exchange rates are formed on the currency markets. Control authorities for capital transactions were successively removed and free capital traffic was realized. Capital can move around the world today.
These developments produced new actors, so-called “institutional investors” like pension-, hedge- and investment funds whose goal is more and more short-term speculation profits, especially on currency markets, and less and less long-term investments in businesses. For example, if the value of a currency is expected to rise, this currency can be bought at the current price in the hope of selling it later at a higher price. In the meantime these speculations have reached an enormous dimension. Only four trading days on the currency market would be equivalent to the entire international trade and foreign investments of a year. The rest is speculation.
3. MISDEVELOPMENTS ON THE GLOBAL FINANCIAL MARKETS
Deregulation of financial markets and liberalization of capital transactions have far-reaching consequences for democracy and the economy. Feminists criticize the male-dominated decision=making structures that function according to the principles of competition and profit-maximization. Financial markets have massive repercussions on the real economy and lose their supportive function for the real economy.
SHAREHOLDER VALUE DOMINATES BUSINESSES
Since the beginning of the 1970s, a power shift has occurred in favor of shareholders. Management is rewarded and stock prices are roused – often through mass layoffs, wage cuts and outsourcing. If necessary, investors immediately threaten to sell their shares so that prices will fall. If stock prices do fall, gaining new capital becomes more difficult and one runs the risk of being taken over cheaply. Real investments need a long time to post profits and thus become comparatively unattractive.
LOCATION- AND TAX-COMPETITION
Through the possibility of shifting production sites or private assets abroad, corporations and rich persons can threaten migration and put whole states under pressure. Governments yield to the threats and lower social- and environmental standards as well as taxes on corporate profits and assets. Public revenues fall and states must “save.” Public assets become privatized, social benefits cut and money for benefits like childcare or nursing are lacking. For women, these adjustments have very negative consequences since they do this liberation work largely unpaid.
HIGH INTERESTS BURDEN THE STATE AND THE ECONOMY
Free capital transactions lead to higher interests because financial capital gains power on account of liberalization and can enforce its interests – high interests. But high interests make credits expensive for small businesses that want to invest. Big businesses prefer to invest in the financial system, instead of factories. Few jobs are created. The rising unemployment weakens unions. Wages and salaries fall. In Germany, average real incomes have not risen for ten years although the economy in part grew enormously.
For the state, high interests lead to problems since tax revenues fall on account of the paralyzed economic development. Costs for unemployment soar and repaying state debts becomes more expensive. This enlarges the budget deficit and the state has to save more.
PRIVATIZATION OF THE PENSION SYSTEM AND SOCIAL CUTS
The capital markets have carried out basic changes with pensions. For a long time, the working population paid the pensions of retirees in so-called transfer processes. This “generational agreement” was based on solidarity and social balance. Supposedly this cannot be financed any more. People – with state encouragement – are driven into private “pensions. This does not change the fact that the population ages and is more full of risk and unsocial (see Attac position paper on pensions). Despite lower incomes on account of their higher life expectancy, women must pay higher premiums than men. In countries where pensions are partly privatized, old age poverty increases by leaps and bounds. Nevertheless there are tendencies to expand the capital market model to nursing and education.
DEVELOPING AND THRESHOLD COUNTRIES ENDANGERED
The growing instability on the financial markets is especially problematic for developing- and threshold countries. On account of their mostly less stable banking- and financial systems, for example, they cannot resist a sudden influx or outflow of mammoth amounts of capital. Serious crises are triggered. This often leads to severe devaluation of their currency so debts in foreign currencies increase tremendously. The dependence of stricken countries on their creditors intensifies even more.
Nevertheless the International Monetary Fund (IMF), the World Bank and the World Trade Organization (WTO) force developing- and threshold countries to open their capital markets. Since the 1970s, this led to great financial crises: Mexico, Asia, Russia, Argentina and Turkey. Higher poverty, unemployment and indebtedness are the consequences.
Thus liberalization of the financial markets started a mechanism in which the world population loses. Only a few financial corporations and wealthy persons are winners.
4. CRISES
Since the end of Bretton Woods, there were more than 160 financial crises according to the IMF. Although every financial crisis is unique, there is a basic pattern to their development.
1st Phase: Through some external event, expectations about economic development change and new profit perspectives open up. Everything can be a subject of the changed perspectives: tulip bulbs, real estate, securities or currencies.
2nd Phase: Through purchases, prices rise and expectations are fulfilled. This leads to herd behavior. An onslaught begins. In this phase, assets are bought on credit. The prospect of high profits leads to increasingly risky financing.
3rd Phase: Real economic data does not follow the boom. The first speculators sell and take their profits. Prices do not rise any more. This forces part of the investors to sell to pay off their credits.
4th Phase: Prices now begin to fall. A panic wave of selling breaks out along with a flight to other assets. Prices fall enormously. Many businesses cannot pay back their credits received during the boom phase. Banks that do not receive payments cancel credits – even to productive businesses. The crisis strikes the real economy.
In the worst case, the banking system breaks down because businesses cannot repay their credits and vast numbers of savers withdraw their money. The financial crisis plunges the real economy in a recession.
With foreign credits, states often assume the liability so private debts become public. Foreign debt service increases since the value of the indigenous currency declines through devaluations. The state has to save. Cuts in social spending are often the consequence, which aggravates the crisis. Unemployment and poverty soar. The population bears the after-effects of the crisis while the financial investors evade all responsibility and often emerge with massive profits from the crisis.
5. DEMANDS
Democratic politics must define the rules for the financial markets so they benefit the economic interests of the whole population.
CAPITAL TRANSACTIONS CONTROLS AND CREDIT RESTRICTIONS
To avoid grievous financial crises, China, Chile and Malaysia successfully applied controls on capital-imports and capital-exports. In addition, credits that only serve speculation should be prohibited.
TOBIN TAX AND STOCK TURNOVER TAX
With the financial transactions tax named after Nobel Prize winner James Tobin, the international financial markets could be stabilized (see Attac position paper on the Tobin tax). A stock turnover tax would limit speculation with shares and stocks.
CLOSING OFFSHORE CENTERS
Institutional investors and the super-rich deposit their money in tax havens (offshore centers) where it is hardly taxed or not taxed at all and assessments are barely regulated. These “law-free” zones could be easily abolished since they are mostly answerable to western states and depend on access to the global financial markets.
REGULATION OF DERIVATIVE TRADING AND PROHIBITION OF HIGH-YIELD FUNDS
High-risk derivative trading mainly carried out with speculative intentions should be greatly restricted. The unregulated trade outside the stock exchanges (OTC) is included here. Hedge-funds (high-risk speculations) should be prohibited. Private equity funds (participation in businesses with extreme profit demands) should be limited.
LIABILITY OF INVESTORS IN FINANCIAL CRISES
International investors can now confidently take high risks. In the case of a financial crisis, they receive their money back from the debtor countries since the IMF bails them out with emergency credits from tax money. If they had to jointly bear the costs of the crisis, they would forego high-risk speculations.
GLOBAL CURRENCY COOPERATION ACCORDING TO KEYNES
In 1944 Keynes identified the central construction flaw of the Bretton Woods system. An artificial currency, the “Bancor,” should be the key world currency, not a national currency. If the central banks set and defended the exchange rate for the Bancor, everyone would profit from high stability. Regional currency alliances could be an interim step to this global solution.
REFORM OF WORLD BANK AND INTERNATIONAL MONETARY FUND
The World Bank and the International Monetary Fund must be subject to the UN and voting rights democratized. A world central bank as the last creditor should be considered. Credits must have the approval of the affected population. The structural adjustment policy must be ended.
JUST DISTRIBUTION AND SUSTAINABLE DEVELOPMENT
There is money galore after more than 50 years of uninterrupted economic growth. That this wealth is concentrated in a few hands is unfair and harmful for national economies. In Austria, 10 percent own two-thirds of all the assets. This is not spent for investments and consumption, which would raise employment. Instead it is directed to the financial markets where it seeks high profits and leads to instabilities and less employment. Therefore economically sensible and socially just financial-, monetary- and fiscal policies should ensure redistribution from top to bottom, across-the-board credits on easy terms, high real profits and incomes and low financial profits.
RELATED LINKS:
“Disarm the Markets!” by Peter Wahl, Attac Basis text, March 2008
http://portland.indymedia.org/en/2009/04/390375.shtml “Attac Catalogue of Demands for Democratizing the Financial Markets”
http://portland.indymedia.org/en/2009/05/391310.shtml “The Foxes Guard the Henhouse” by Susan George
http://portland.indymedia.org/en/2009/04/390766.shtml “The Quiet Coup” by Simon Johnson
http://www.theatlantic.com/doc/print/200905/imf-advice?x=36&y=1 “US Foreign Economic Policy in the Global Crisis” by Simon Johnson
http://www.iie.com/publications/papers/paper.cfm?ResearchID=1147 “Needed: A Global Response to the Global Financial Crisis” by C. Fred Bergston
http://www.iie.com/publications/papers/paper.cfm?ResearchID=1146 “From Bubbles to Living Economies” by Jakob von Uexkull
http://www.worldfuturecouncil.org/fileadmin/user_upload/PDF/From_Bubbles_to_Living_Economies_JvUexkullApril_2009.pdf