Is global finance finally shrinking?

2 Mag

by Jayati Ghosh

from “Real-World Economics Review Blog, April 2, 2013. Shortened by “Sviluppo felice”. According to a new report from the McKinsey Global Institute,[1] … by 2007, global stocks of financial assets (both equity and debt stocks) amounted to $206 trillion. This meant that financial assets were more than 4 times the maximal estimate of GDP in developed countries in that year, and nearly twice the value of GDP in developing countries. 

The estimated value of global financial assets grew rapidly (by more than 8 per cent per annum) in the decade up to 2007, but since then they have grown by less than 2 per cent per annum. Cross-border capital flows fell sharply in 2008 to $2.2 trillion, down from $11.8 trillion in 2007 (at constant 2011 exchange rates). In 2012, they were estimated at $4.6 trillion, around 40 per cent lower than the 2007 peak. Equity assets and securitised loans have actually declined in value. )

Much of this was due to the reduction of capital flows within the developed world. … Nearly half of the decline in cross-border capital flows is because of Western Europe alone. For example, since the last quarter of 2007, Eurozone banks have reduced foreign claims by $3.7 trillion. $2.8 trillion of this was on other banks within Europe, and $1.2 trillion was only on banks from the crisis-ridden GIPSI countries (Greece, Ireland, Portugal, Spain, Italy). But even in developing countries the process of financial expansion is slowing down, though it still continues, especially with the continuing growth in bond markets.

This is essentially good news. Most of the increase in finance in the “roaring 2000s” up to 2007 was not just unsustainable – it was also unnecessary and even undesirable. It did generate booms in some advanced countries (particularly the US and some European countries), which in turn fuelled export-driven expansion in some developing countries including China. But this was only because finance supplied a means of compensating for the potential stagnation and lack of demand that emanated from growing inequalities in income distribution. By generating demand based on borrowing rather than on actual incomes, finance also accentuated asset inequalities, putting more money in the hands of financial intermediaries while drawing people, companies and even governments into eventually un-repayable debts.

The pyramiding of finance meant that an essentially top-heavy and extremely entangled system was created, not just within countries but globally. Most of the so-called “financial deepening” of that period was due to financial system leverage (as banks and other players essentially borrowed from one another) increasing stock market valuations. …

Financial “innovation” in the form of new instruments and products as well as forays into markets like those of commodity futures created the illusion of dynamism that was not based on any real contributions to the economy. … As we have found repeatedly to our cost but still do not seem to learn, such bubbles must burst. 2008 marked one such puncturing, but not a complete one. …

Global capital inflows to developing countries halved from $1.6 trillion in 2007 to only $0.8 trillion in 2009. They have since recovered to $1.5 trillion in 2012. But – and here’s the rub – capital outflows from developing countries also increased and also continued to be more than inflows. In 2012 such outflows amounted to $1.8 trillion. Just under half of this was in the form of reserve holding by central banks, but FDI, cross-border loans and portfolio investment account for increasing shares.

Most of the developing countries’ foreign assets are in advanced countries … The developing world continues to finance the rich North, especially the US. Thus, while $12.4 trillion of foreign investment assets of the developing world are held in the North, South-South stocks of such investment are only $1.9 trillion – amounting to just 2 per cent of all cross-border foreign investment assets. So the developing world as a whole – and each one of the major constituent regions – continues to be net funder of the developed economies. …

Even China’s investment abroad is dominated by the North. Foreign assets held in other developing countries still come to only around 15 per cent of China’s total foreign assets. So even China, whose impact in the developing world is now so significant, still directs the greater bulk of its outward investment to advanced economies.

Meanwhile … financial liberalisation measures … may create temporary mini-booms in certain economies, but … the bursting of those bubbles will be even more painful. … At the same time they will also encourage the same tendencies that continue to make developing countries export capital to the North, at the cost of meeting their own citizens’ needs and fulfilling their own development projects.

So it is more important than ever to restrain finance, since that task is clearly incomplete. To make the financial system fulfil the basic tasks for which it is supposed to exist – to direct savings to productive investment in a stable and socially desirable way – it is essential to shrink it further

* This article was originally published in the Frontline, Volume 30 (06) dated Mar. 23 – Apr. 05, 2013.

[1] “Financial Globalisation: Retreat or reset?”, March 2013.




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