World’s Central Banks Need to Cooperate to Deal With Crises
The global real economy and financial system arrived at the growing debt burden and imbalanced situation not simply because of trade imbalances, but also imbalances at the capital accounts. Four primary conditions created the incentives that gave rise to current imbalances that may generate the next financial crisis.
First, the liberal free market thinking rejected the idea of any tax on financial transactions and capital flows, minimizing tariffs and rejecting the possibility of a Tobin Tax. As Tobin and others have argued, a frictionless financial market is an accident waiting to happen, requiring some “sand in the wheels” that “regulates” the speed and scale of flows, contagion and panic capital flight.
Second, free market capitalism rejected a capital gains tax, whereby those with more assets pay less tax.
Third, there is an inherent tax bias for debt, as interest payments and provisions for nonperforming loans are tax deductible. Since raising capital is expensive (initial public offerings cost up to 7% of funds raised in New York) and debt is subsidized, it is not surprising that leverage has increased dramatically since the early 1980s.
Fourth, in order to avoid regulation, official monitoring or taxation, assets and liabilities can be moved off-balance sheet or offshore. Regulatory and tax arbitrage have allowed the creation of huge shadow banking and offshore financial centers that facilitate tax avoidance, evasion and the hiding of illicit money, including those associated with corruption, drug dealing, smuggling, or terrorism purposes.
The cumulative result of these developments was to enable higher income and wealth creation, with the 1% getting richer from either low taxation or shadow reasons, while the 99% became worse off.
The “Pretense of Perfection” free market ideology completely ignored the messy, corrupt and shadowy human behavior that arises from realistic political economic behavior of survival, countervailing power and predation without the appropriate checks and balances.
Because the multilateral financial institutions are constrained by capital and slowness in responding to rapidly emerging crises, what emerged as quick-response crisis management mechanisms are central bank swaps. The Fed signed five major swap arrangements with allied central banks. At the height of the U.S. dollar swap line program, swaps outstanding totaled more than $580 billion (December, 2008), whereas the People’s Bank of China signed more than 30 bilateral currency swap agreements, mostly with emerging market central banks, valued at $490 billion (2017). After the Asian financial crises, emerging markets are reluctant to go to the IMF for assistance due to the fear of stringent conditions associated with IMF loans. The result is more use of macroprudential tools (capital controls), building up reserves or use of more-flexible exchange rates.
Due to the decline in foreign exchange reserves of the People’s Bank of China to $3 trillion, it has become clear that the availability of official reserves is insufficient relative to potential crises demands. Because there is disagreement on policies at the Group of Seven level, it may now be even more complex to negotiate International Monetary Fund (IMF) credit. Hence, the realistic way forward is for the leading central banks to cooperate when the objectives are aligned.
For example, if for geopolitical reasons the U.S. becomes unwilling to allow the IMF to lend to the U.S.’ geopolitical rivals, it may be possible for a coalition of central bank swaps — say, between the European Central Bank, Bank of England, Bank of Japan and People’s Bank of China — to provide funding for emerging markets.
What this implies is that the U.S. and the Fed are no longer the only arbiters of the destiny of the future global financial architecture. In areas such as globalization and climate change, the Europeans are more closely aligned to maintenance of the current order with China and India than the U.S. is. This geopolitical realignment does mean that we are already entering a new era in global governance.
Since the 2007 financial crisis, the EU is moving toward the implementation of a financial transactions tax, something Britain and the U.S. reject on grounds of principle (or ideology). This opens up the possibility that the two largest emerging markets, China and India, both of which still operate capital controls, may want to follow the EU by adopting a uniform financial transaction tax. If this happens, and there is consensus on removing the tax bias between debt and equity, and a minimum level of taxation for all economic activities (a minimum global income tax level), then we may be able to address the distortive incentives in the current system for pro-cyclically pushing leverage.
In short, crises reveal who is naked when the tide goes out. We need clear-eyed analysis and less ideology on thinking through the causes of financial crises and the pathway to a more-sustainable international financial order. The advantage of moving away from a unipolar world order to a multipolar order is that diversity creates the competition for improvement. As nature teaches us, monocultures are unsustainable, while diversity is the source of both innovation and system resilience.
Andrew Sheng is a distinguished fellow of the Asia Global Institute, University of Hong Kong; the chief adviser to the China Banking Regulatory Commission; and the former chairman of Hong Kong’s Securities and Futures Commission.
A distinguished fellow of the Asia Global Institute at the University of Hong Kong and a former chairman of the Hong Kong Securities and Futures Commission.
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