Slaughter & Rees Report - You Can’t Always Get What You Want
March 18, 2013 --
Yesterday marked the fifth anniversary of Bear Stearns’ collapse, that “canary in the coal mine” event that culminated with the extreme financial chaos of September 2008. The anniversary came just days after the Dow rose to a new record high, albeit in nominal terms. So is all well and good in the global financial system? To borrow from that noted market maven (and one-time student at the London School of Economics), Mick Jagger, “You can’t always get what you want.”
One of the legacies of the world financial crisis is a dramatic slowdown in financial globalization, a development spelled out in a recent report from the McKinsey Global Institute (MGI). Consider some of the following eye-opening statistics.
- The world’s cross-border capital flows, which totaled $11.8 trillion in 2007, fell to an estimated $4.6 trillion last year—a 61-percent tumble.
- Cross-border bank lending fell from $5.6 trillion in 2007 to only $1.7 trillion last year.
- The stock of global financial assets (defined by McKinsey as “the value of equity-market capitalization, corporate and government bonds, and loans”) grew nearly 8 percent per year from 1990-2007, but less than 2 percent per year since then.
Over the course of history, the globalization of capital markets has generally been a force for good—pools of savings crossing borders to finance the investment of economic development and rising prosperity. But “generally” does not mean “always.” Surges in international capital flows sometimes distort markets and foster boom-and-bust cycles, as the International Monetary Fund acknowledged in a recent report—and as the world experienced in recent years.
Despite the current high asset prices in many parts of the world, global capital markets post-crisis remain fragile in ways no one fully understands. Surely, part of the decline in cross-border capital flows MGI has documented is healthy. Financial regulators have been crafting new policies to force banks to bear the costs of failure they have been imposing on the broader economy and on taxpayers. This fin-reg reform has not been perfect, but it is generally wise: a financial firm’s losses should ideally be borne by its stakeholders, not by broader society. Firms induced to internalize costs in this way tend to shrink and become less profitable. In this sense, parts of the diminished flow of global capital are for the better.
But no one knows exactly which parts, and no one really knows what comes next in the world of capital markets. One big reason for this uncertainty is the continued historic monetary easing of central banks, such as the Fed’s “quantitative easing,” that is contributing to higher asset values like Dow above 14,000. Another contributor to uncertainty is the ongoing twists and turns of fin-reg reform. Here is hoping that time is on the side of continued healthy growth of world capital markets.
Articles © 2013 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2013 Trustees of Dartmouth College. All rights reserved.
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