Why financial crises?

CURRENCY and financial crises have become more frequent since the 1990s and contributed to more frequent economic difficulties, as evident following the 2008-2009 financial crisis and the ensuing Great Recession.

One big problem before WWII was the contractionary macroeconomic consequences of the “gold standard”.

In 1944, US President Franklin Delano Roosevelt convened the the Bretton Woods Conference, which established the framework for the post-war international monetary and financial system.

The Bretton Woods system reflected sometimes poor compromises made among the negotiators. Nevertheless, it served post-war reconstruction and early post-colonial development reasonably well until 1971.

In that year, the Nixon Administration – burdened with mounting inflation and unsustainable budget deficits – withdrew from its commitment to ensure full US dollar convertibility to gold at the agreed rate. The US action did not involve a transition from the Bretton Woods system to any coherent alternative.

The pre-1971 post-WWII period has often been referred to as a Golden Age, a period of rapid reconstruction, growth and employment expansion. It was a period of development and structural transformation in many developing countries.

This ended when coordination and multilateralism collapsed following Nixon’s decision.

Now, with the international monetary system essentially the cumulative outcome of various, sometimes contradictory and ad hoc responses to new challenges, the need for coordination is all the more urgent.

A strong case for co-ordination has long been made by the United Nations.

Since the collapse of the Bret- ton Woods system, a handful of currencies – especially the US dollar – have been held by others as reserve currencies. This has allowed the issuers of these currencies to run massive trade deficits, contributing to unsustainable global imbalances in savings and consumption.

A second underlying cause of international financial crises has been the ascendance, transformation and hegemony of the financial sector – termed “financialisation” – over the past four decades. Many decision-makers are now often more concerned with short-term financial indicators than other key economic indicators, often presuming that the former reflect the latter despite the lack of such evidence.

A third factor has been growing “financial fragility”, partly due to the global financial “non-system” in place since the collapse of the Bretton Woods system. The lack of coherence and coordination has been exacerbated by financial deregulation, liberalisation and globalisation over the past three decades.

The growing and spreading subordination of the real economy to finance is a fundamental part of the problem. While finance is an important, if not an essential hand-maiden for the functioning of the real economy, the subordination of the real economy to finance has transformed macro-financial dynamics, with unproductive, contractionary, even dangerous consequences.

To address the root causes of crises, much better, including more appropriate regulation of the financial system is needed to ensure consistently counter-cyclical macro-financial institutions, instruments and policies, and to subordinate the financial sector to the real economy.

Any sustainable solution will require better international cooperation and co-ordination. – IPS