Redesigning The Global Financial System

By M. Isi Eromosele

During the great period of globalization before the First World War, the international economy was based on global trade and global finance with monetary policy largely fixed under the gold standard. After the Second World War, a new international system was designed based upon global trade, fixed exchange rates and essentially domestic finance.

This system did not include global financial regulations as finance was to be largely nationally constrained. Over the succeeding decades, however, capital markets became global. The consequences have been a return to a level of financial and monetary instability not seen since the period following the First World War. The most dramatic example of this instability is the lingering global financial crisis.

There is a fundamental need to redesign the architecture of today’s global financial system to meet the requirements of this new reality, with established mechanisms to address economic coordination, macroeconomic and monetary management, development and financial crisis prevention and resolution, as well as promote trade.

The Global Financial Crisis 2007 – 2011

Unlike in the Asian financial crisis, the majority of activities in response to the recent global financial crisis has taken place at either the domestic level or at the European regional level through the EU. At the international level, coordination initially took place through the G7 and at a multilateral level through the FSF and the world’s major central banks.

However, from late 2008 this coordination shifted to the G20. During the initial phases, which mainly affected developed countries, the IMF, MDBs and WTO played a limited role. Only as the crisis began to spread beyond the G7 did the IMF and MDBs begin to be involved and even then only in minor ways, at least until the crisis returned full circle to Europe in 2010 with the Greek and Eurozone financial crises.

No Real Changes

While much has been taking place in the context of the international financial architecture, it is not apparent that an effective, comprehensive international design has emerged.

Given that the world is living through the aftermath of the largest financial and economic crisis since the 1930s, what is remarkable about the changes enacted in response to the recent one is that they have been so minor. While there has been a raft of changes in regulations, which are still evolving at the time of writing, all are essentially at the fringes.

No major changes, such as the introduction of a global financial transactions tax, or a global sovereign bankruptcy regime or a fundamental re-conceptualization of the role of ratings’ agencies have been implemented.

The Obama Administrations’ plan (implemented through the  Dodd-Frank Wall Street Reform and Consumer Protection Act) to require banks that accept deposits to close their proprietary trading desks is a significant step, but in all probability not one that would have avoided the global financial crisis. A bank does not need to trade its own money to be able to generate toxic loans, and repackage them into highly-rated securities of questionable value.

Intellectual Trick

In Germany, in Japan and in developing Asia, finance was meant to provide capital to industry and individuals and that remains the major role of financial institutions in most economies. Now, however, in the global markets, financial products are seen as an end in

themselves, as a source of profit to the financial institutions that invent them.

More fundamentally, however, the assumption is if money is a good, then trading in it is beneficial. The doctrine of comparative advantage, the idea that trade between nations is mutually welfare enhancing, is almost universally accepted and if the playing field is roughly fair, trade certainly works. And if we treat money as an end in itself, more trade in money must make countries better off.

This is an intellectual trick, and it is the trick that underpins financial globalization. The globalization of finance offers real benefits: cheaper credit and more sophisticated hedging instruments with which to manage risk. But money is different from goods. So the globalization of finance brings with it real risks.

Since the 1994 Asia financial crisis, sovereign financial crises, globally, have become appallingly frequent. There is a good reason for this. For as long as capital is treated as something it is not, speculators can believe that the ongoing liberalization of national financial systems will make everyone better off. For as long as we misunderstand money, the global financial system will remain dysfunctional.

It is not that financial globalization does not bring benefits, but the ways in which capital

differ from goods means it has to be managed and regulated far more carefully than has been the case.

Conceptual Remedies

The financial crisis was a direct result of treating the creation of financial products as an end in itself, as a valuable driver of economic growth independent of the products’ effects. A financial sector exists to provide capital, a necessary input into the productive process. Just like telecommunications, electricity and roads, a financial system is an important piece of infrastructure.

Rethinking the global financial system is vital. What is needed now is for governments around the world to open their minds and imagine a truly functional global financial system that serves the interests of all nations. A global financial transactions tax would be a great place to start.

Without such a fundamental rethinking of the true role of finance and the current system, another global financial crisis in the years to come is almost certain. For things to change, fundamental reconsideration is necessary to support change in preventing similar crises in future, and so far no fundamental changes have been effected.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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