Bill Emmott - International Author & Adviser


Globalisation and the credit crunch
Exame - September 2007

August was such a hot month in the financial markets that it brought out all the sweatiest old cliches in the market-commentators’ lexicon. Traders were said constantly to be nervous, because of all the uncertainty, as if every day in the financial markets is not defined by its uncertainties; when equities or debt made even quite a small move downwards it was said to be caused by “panic selling”. Perhaps it all just proved that there is a limited number of words and phrases that can be used to describe market movements, just as the hardest problem for a writer about wine is find new words to describe the tastes and smells.

One instant reaction raised a different and more lasting issue, however. It was a reaction heard not just among market commentators but also politicians, businessmen and even some economists. The reaction was that since capital markets are now global, and since losses from the early August collapse in prices of asset-backed securities linked to American subprime mortgages were found all over the world—in German banks, London-based hedge funds, even Chinese state-owned banks—this must mean that the world is far more vulnerable than before. Globalisation, in other words, has tied us all together. We may rise together, as we have in the past almost five years of rapid, credit-fuelled growth. But we will also crash together.

This is not a new worry. It was heard in 1987, for example, when the New York stockmarket suffered its extraordinary “Black Monday” collapse, which seemed to have been prompted by policies at the German central bank, and which led to big falls in equities in many markets. It was heard even more loudly in 1997-98, when the East Asian financial crisis spread to Russia and hurt other emerging markets too. George Soros, one of the greatest fund managers and philanthropists of modern times, wrote a book in response called “The Crisis in Global Capitalism”, published in 1998. Markets had been allowed to get way out of control he said, and the collapse is going to get much much worse.

As we now know, Mr Soros’s timing and sense of market direction proved to be not as good in his writing as it had been in his active days in money management. The crisis never happened. Things got better again, not worse. There was then another collapse, in a different set of global securities markets, in 2001: chiefly the hi-tech shares epitomised by NASDAQ, but also traded widely in Europe and Asia too. Things got better again, surprisingly quickly given that the terrorist attacks of September 11th 2001 took place during the same period.

So the question is, should we be sanguine once again? To ask that question is not simply, as some may think, to gloss over the damage caused to real economies and jobs and lives by even quite short periods of financial instability. That damage can be real. To ask it is to wonder whether the lesson of the past few decades might in fact be that the instant worries about globalisation making things worse have got it upside down. Could globalisation actually be helping to make these crises less severe, not worse?


Countervailing forces

In practice, we will not be able to answer this question with certainty until afterwards: it cannot be a matter of ideology, but rather one of experience. And although globalisation now seems a very familiar, even old idea, in reality the connecting together of most of the world’s economies through trade and capital flows is a very recent phenomenon, the creation of Chinese market liberalisation in the 1980s, the fall of the Soviet Union in 1991, and the spread of liberal thinking in Latin America and India during the 1990s. So we don’t yet have enough economic cycles to be sure.

            Nevertheless, some clues can be gained from the crises that did happen in 1998 and 2001, when globalisation was almost as advanced as it is today. On both occasions, the immediate effects in financial markets were dramatic: surely more dramatic than they would have been had capital markets not been so global. But the reassuring clues lie in subsequent effects.

            After the 1998 East Asian crisis, the economies of the region, and to a lesser extent other emerging economies, were supported by the strength of American demand for their exports. This was a consequence of the internet-led investment and employment boom that was under way in that economy, but also a consequence of America’s openness to trade. When Asian imports became even cheaper, Americans bought more. The second thing that happened was that, in open markets, investment capital was able to return quite quickly to the troubled emerging markets, looking for bargains.

            The 2001 dotcom bust was perhaps more localised, affecting a very special category of securities. But it brought with it worries that a new sort of recession might occur in the United States, one that would hurt the rest of the world too: a recession caused by a collapse in investment. It didn’t happen, in part because the Federal Reserve slashed interest rates to prevent it. But it also didn’t happen because global investors—particularly Asian central banks—were eager to buy American securities, especially Treasury bonds. That prevented bond yields from rising, and from causing corporate investment to collapse—which is what often brings on recession.

            What about now? The collapse of America’s housing market, and with it the repricing of credit risk in all the snazzy new credit derivatives markets, will surely damage the American economy. Its effects will take several months to become clear, because it will take that time to find the losses and to see how many home-owners default. That slow process will also be true of other financial systems where these securities have been bought. It will take time to find out how big the losses are.

            The important thing, though, is to be aware that there will also be countervailing forces, as was the case in 1998 and 2001. Demand for American exports may grow, as the dollar weakens. Investors may desert derivatives and provide abundant money to other markets. Growth in China, India and other emerging markets may offer support. Oil and commodity prices may drop, allowing interest rates to be cut and boosting demand. We cannot yet know how these forces will balance out. But globalisation should make us optimistic: we may crash together, but also our economies support each other. The next few months will be a test of how globalisation really works.


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