THE EUROZONE DEBTCRISIS CentrePeriphery interaction under financial globalization

THE EUROZONE ‘DEBT’CRISIS ‘Centre’-’Periphery’ interaction under financial globalization; the case of Europe

Complete paper • European Crisis: A New Tale of Center–Periphery Relations in the World of Financial Liberalization/Globalization? , International Journal of Political Economy, 44: 3, 174 -195, DOI: 10. 1080/08911916. 2015. 1035986 To link to this article: http: //dx. doi. org/10. 1080/08911916. 2015. 1035986

Cross-border financial flows; “boom” and “bust” and its consequences for debtors and creditors

Fast growth of private finance and financial globalisation • The privatisation of the international monetary and financial system; • A lot of talk has been addressed to the accumulation of foreign exchange reserves – by public bodies - and, most specifically, by emerging and developing countries, as in fact it has been the case as may be gathered from the following graphs.

• Such accumulation of resources by public bodies would seem to counter the tendency for privatisation. But in fact, the amount of foreign exchange reserves is minimal relative to the volume of cross-border finance. • In spite of their fast rate of accumulation those reserves stood somewhat above US$ 11 trillion about 11% of global cross-border assets that had reached US$ 101 trillion by 2011. • By far beginning in the 1970’s private cross-border finance has become dominant vis à vis national public resources and also those of Bretton Woods institutions. • IMF resources – total assets including buildings and unusable currencies - only amounted to US$ 490 billion and those of the World Bank to another US$ 324 billion. In terms of their lending, credit outstanding by the IMF is US$134 billion and that of the World Bank US$ 144 billion. • Thus, national and multilateral public resources were minimal compared with those more than US$ 100 trillion of cross-border assets, their potential expansion depending on that of the reserves currencies – mainly the U. S. dollar – or of a multilateral currency, i. e. , SDRs. • Moreover, cross-border finance – almost fully private - in only 20 -odd years has tripled in relation to world GDP, its volume reaching almost 1. 5 times that of world GDP to become a major force in the performance of the “real” economy as is also the case with “financialisation” at large, the amount of global financial assets having reached by 2011 US$ 225 trillion, 3. 5 times world GDP.

Acute instability of finance and crossborder finance • There are well established and documented cycles of finance even in advanced countries, the major forces being the behavior of private sector credit and property prices (Borio, 2013); • Peaks in those financial cycles coincide with what Kindleberger would have called “financial distress”; • The “Great Moderation” – the victory on inflation central banks were so proud off – was precisely the building ground for the crisis starting in 2007 (as Minsky would have imagined stability leading to more risk taking). • Experience has also shown that the cross-border component of credit is much more volatile than the domestic side of it.

The financial and business cycles in the US

• To understand the impact of cross-border finance on the performance of the world economy attention should be placed on gross capital flows, in the following graph we are visualizing the behaviour of EM countries gross private inflows that in spite of rapid growth are still a small part of the world total as, at global level, gross flows concentrated in transactions between the advanced economies. • Going back to EMEs. First thing, the sizable amount of gross flows relative to the size of the recipient economies making up to an average of some 5 per cent of their GDP (“Big Fish in Small Pond” (Haldane) or “Herd of Elephants in a Pond” (Sheng) problem). Second, proverbial instability of gross capital inflows to Emerging Market Economies; from 2008 to 2010 a cut of more than 8 points of the recipient countries’ GDP. Net capital inflows, of course, are smaller than gross inflows but, most important, gross flows are more volatile as shown in one of the following graphs.

• Gross inflows, also, even at global level, are larger and much more unstable than current accounts and changes in reserves; current account imbalances moderating after the crisis in the presence of a vertical decline in gross flows. • As Bruno and Shin (2013) have shown, gross capital flows are dependent on the leverage cycle of banks in its turn, something verified by other authors, associated with global factors mainly financial markets risk perceptions – as proxied by VIX - and although less so by the monetary policy stance in the major advanced countries. • Global “supply push factors” dominate local “demand pull” factors in Emerging Market Economies associated with the “fundamentals” in the recipient countries (Tucker 2014, points to “carry trade” as one main force in capital flows movements). In fact, there is the sad story examined by Eichengreen and Gupta (2013) that those countries that had made an effort to deepen their domestic financial systems denominated in their own currencies suffered most during the crisis.

• As analysed by Borio and Disyatat (2011) so-called “global imbalances” – current accounts – performance tell us little about global finance and its impact on domestic financial conditions. For instance, as surveyed by these authors the largest source of capital inflows into the U. S. was Europe – one-half of total, out of which more than half came from Great Britain, a country running a current account deficit. Volumes were larger than those originating in China and in Japan both countries with a significant surplus in current account. • But the major point is a conceptual one, very clearly made by these authors which is to draw a clear distinction between savings and finance. Current accounts are tied to “savings” – a national accounts concept of income not consumed – but finance is provision of purchasing power in the form of money. Consumption and investment require financing but not savings; eventually, after spending that finance, as we all know from national accounts identities, differences between saving and investment will be equal to current accounts. • And, then, global banks are instrumental by funding themselves in financial centers and allocating resources on an international basis. Thus, Shin (2012) speaks about “global banking glut” rather than “global savings glut” European banks, for instance, exposed to the U. S. financial market for a higher figure than the exposure of local banks. • There is no cross-border transmission of “savings” but of “finance” in which the degree of leverage of banks is as important as the monetary conditions in their funding places.

Figure 1. US balance of payments (As a percentage of US GDP) Notes: 1 4 -quarter moving average. 2 Sum of US Treasury securities, foreign assets in US dollar and US liabilities to unaffiliated foreigners. Sources: Bureau of Economic Analysis; authors’ calculations.

• Now, as posited very clearly by Hélène Rey in her Jackson Hole presentation of August 2014 (Dilemma and Not Trilemma), under the influence of waves of capital flows, without some form of “capital flows management” there is no monetary policy independence (“the impossible duality” as baptised some years ago by H. Flassbeck). • There is an accumulated experience of those regulations in recipient countries that quite a few EMEs have introduced to avoid the de-stabilising effect of the variability of international finance. And although attention has been drawn to their use in managing exchange rates, their significance for financial stability should be taken into account, currency crises having gone hand-in-hand with banking crises. • Also, there has been insufficient discussion of regulations on the originating side. EMEs lending is an “asset class” by itself and additional to the renewed preoccupation about speculative waves in real estate, some countercyclical regulations have to be applied to speculation in lending to EMEs. Big banks being very much part of the game the risks involved end up combining with the “Too-Big-To-Fail” question as witnessed by the European crisis and previous ones in more far away lands (Latin America in the 1980’s, East Asia and Russia in the 1990’s…).

• Back in 2010, the IMF proposed to the G 20 a levy on non-core liabilities that could have dampened the leverage cycle of banks that is the main force behind financial instability. It did not find sufficient support. But new avenues should be explored through other vehicles for macroprudential regulations. • Simultaneously, as Shin ( 2011, 2012) has observed the main and almost single reserve currency is the one that dominates the world of international banking being their funding currency of choice. Foreign bank branches in the U. S. borrow more than US$ 1 trillion, a large part of which is sent to their main offices that actually could re-lent it in the U. S. market as it was the case in the last decade. • “Finance” again is decisive in determining through gross capital flows developments in the various financial markets. In fact while foreign reserves are placed almost only in government paper , it is cross-border private finance that is highly exposed in the private market , for instance, European banks in the U. S. CDOs. • But in the other direction no doubt monetary conditions in their funding market get transmitted to the rest of the world so that the question of the reserve currency comes up. Not to chastise the monetary authorities in the U. S. for their expansive monetary policy – the only instrument almost they were left with to support an economic recovery because of the politico/ideological paralysis in which fiscal policy has been thrown. • It is a call for a new currency reserve system not based on any national currency neither on the high throne of “castor oil” disciplines imposed on the whole world by a political unaccountable bureaucracy.

Financial Globalisation in European Banks were active decisive participants in the process of financial globalization.

Europe’s Web of Debt

From the perspective of the recipient countries one may detect the intra-EZ concentration

The relative size of the largest European banks to the GDP of the countries of their main offices is much larger than that of the U. S. ones Country Largest Bank Size in Assets Country's GDP Quotient France BNP Paribas 2494 2, 778. 09 90% Germany Deutsche Bank 2974 3, 607. 36 82% United Kingdom Royal Bank of Scotland 3808 2, 431. 31 157% United States Citibank 2188 15, 075. 68 15% Sources: The Banker's and IMF-WEO, Database, Oct. 2012

Leverage of EZ ‘centre’ countries banks – as may be gathered from its inverse – the median ratio of capital to assets that went down from 4 to 2% – was fast increasing till 2008

But financial institutions of the ‘centre’ were funding their lending to the ‘periphery’ outside their own markets; so that mention to current account balances and/or to savings transfers among the EZ countries is totally misleading