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Global financial order needs revamp

Global financial order has failed. Voices are now being raised to make a suitable substitution of the current financial order to deal with the crisis

The crisis at Wall Street has spread like a contagion and its effects are being felt now within walls of each street in the world. The slump in bourses gradually travelled and crossed the ocean; the crisis is trans-continental. The economic slowdown is gradually metamorphosing into a worldwide recession.

The architect of 'economic and housing boom', Allan Greenspan, former Chairman of US Federal Reserve had also candidly accepted mistake in the free market ideology.

Greenspan, hailed as the 'genius of serial bubble maker' and sometimes 'harbinger of post-war economic boom' has become villain now.

The housing bubble did burst, because financially, it was inherently malicious based on excessive fiscal leverage and un-principled greed. Results, as we see today, are devastating both in terms of money, morality and mundanely.

The burst led to withdrawal spree, which banks and other financial institutions failed to withstand against, culminated into bankruptcy of a number of banks like Lehman Brothers, Stanley-Morgan and Merrill Lynch.

Most of the banks in America by now had moved far away from the basic preamble of Glass-Steagall Act of 1933, which was the first legislation to keep the banking industries away from the investment ventures.

Even the bailout packages have been misappropriated by many banks, and reports suggest that bankers might instead use this money in giving dividends and bonus to its executives, buying other banks.

FBI is probing into the matter, it is also probing into the mortgage fraud in general and role of Fannie Mae and Freddie Mac, the mortgage giants of USA, vis-a-vis burst of bubble in particular.

chart04_US_economy.jpgIt is important, therefore, to understand the workings of the banking system of USA, because the collapse of the banks was largely due to inherent weakness in the banking system itself. Here are some important bubbles in economic history of world.

Banking in USA
The banking sector in America was initially based on English Model, which advocated for   separation of banking and investment. Banks should not be allowed in investment, is the crux of this model.

USA adopted this model in 1865 and passed one National Banking Act (NBA) of 1865. With passage of time, this system felt the strain of pro-investment lobby.

In response to the growing competition from trust companies and the pressure of the lobby, state-chartered commercial banks demanded additional powers from the state legislatures.

By the early 1900s, legislatures granted most state banks many of the same powers to engage in investment activities already possessed by trust companies.

National banks, however, were left out, and they sought justification for securities activities under the NBA. One of the first national banks to engage in underwriting activities was the First National Bank of New York.

In 1908, in response to criticism from the comptroller concerning its securities dealings, the bank formed a securities affiliate, the First Security Company. The affiliate was incorporated under state law and was arguably free to conduct investment activities.

In 1911 a second affiliate, National City Company, was organised, and by 1916 that affiliate was active.

Thus, it is clear that the restrictions imposed by NBA on banks had by now eroded almost completely. Banks started full-fledged activities in securities and investments and had for all practical purposes, adopted German Model which advocated for banks to venture in investments also.

As it always happens, unless you are ill, you are not diagnosed. Here came great depression in 1930, and prescriptions were written to cure the ailing economy.

Roosevelt came and saved the economy by injecting small ample of 'socialistic drugs' into the 'liberal democracy blended with Laissez-fairre', in form of 'new deal'.

It was felt that banking sector, which keeps deposits of millions of citizens and are the pulmonary arteries of the economy, should be protected against unhygienic financial exposures of speculative stock markets.

In this background, the entire banking sector was again overhauled. Senator Carter Glass brought a law called Glass-Stegall Act (GSA), 1933.

This Act was based on twin features, firstly, it sought to insulate bank's depositors from risk involved when a bank deals in the securities and to prevent bank collapse like one happened in 1930.

Secondly, it prohibited commercial banks from owning full service brokerage firms. The GSA of 1933 remained guiding principle for the banks, but it too, gradually faced rough weathers due to changing politico- economic milieu after 1990s.

The 'post war boom' as evident from the USA's share in global GDP (see graph) necessitated some drastic changes in the banking industry.

chart03_US_economy.jpg

Increase in NNP and GDP in USA, during contemporary period emboldened the financial system of entire Europe and America, if not the whole globe. Graph suggests that the wars in any part of the globe have by and large benefited US economy.

The post 'first gulf war' with Iraq has helped American economy to experience boom which further instilled pseudo-confidence in the policy makers of entire western world.

In fact, it is in this background, Bill Clinton got a legislation called Graham- Leach Bliley Act (GLBA) passed on  November 12, 1999 further unfettering the financial system to a maximum level.

chart01_US_economy.jpg

GLBA did away with most of the restrictions imposed on banks by GSA and a new era of freer and unbridled banking industry ushered in. Here lies the difference between Indian and US banking.

Indian Banking
RBI Act of 1934 is the corner stone of banking industry in India. Ours is also a democracy, but flavoured with a socialistic pattern.

Even in 1990s, when the liberalisation, privatisation and globalisation, became new mantras of development, we did not let the banks completely free from the clutches of the government.

Narsimghan Committee formed to bring reforms in banking sector gave its reports and the Cash Reserve Ratio (CRR) and Statutory Liquid Ratio (SLR) were rescheduled.

These jugglery (CRR and SLR as per section 42 of RBI Act) for a common man is that the banks have to keep a minimum cash  with RBI and with themselves respectively, before lending and doing some other businesses. It ensures safety of depositor's money, an element conspicuously absent in American banks.

On contrary, in the US, the banks can lend up to US $8, as against US $1 deposit. Such is the risk and such is the unbridled state of affairs. This unjustifiable risk played a vital role in the mortgage crisis, and banks after banks failed because every bank knew about other's liquidity.

Nevertheless, this crisis came and came with great intensity. Some called it great depression, some economic tsunami and other economic slow or meltdown, but the after-effects and pains emanating from it, does not seem different owing to this different nomenclature.

It would, however, be financially naive to prescribe remedies for what had happened, because, it is easy to write prescription in retrospection. But certainly, this does not mean that no inference is drawn from this economic catastrophe.  

It would, however, be wastage of time to further analyse the causes and circumstances which led to this fiasco, but it would be great injustice to the economic history also, if some glaring aberrations and maladies of this financial order are not enunciated and diagnosed.

Crisis is the engine of change; therefore, this crisis would also bring about changes in the global financial order, an order which came into existence after Bretton-wood conference.

It is, therefore, when the global economy is facing the threat of recession and global financial order has failed, the demands are being made not only by the leaders of the developing nations but also by developed nations like the UK and France to change the global financial order.  

Bretton Wood Conferece 1944
Bretton Wood system of monetary management came into being after a meeting attended by 730 delegates from 44 allied Nations who gathered in Mount Washington Hotel in Bretton wood, New Hampshire on July 22, 1944.

This agreement led to establishment of two important financial institutions viz IMF and IBRD. This duo played very important roles with respect to economic and financial order of the world thereafter.

Although, this system sought to establish a just and equitable global financial order, it was hijacked by US and some European countries right from the outset. The IMF and IBRD (it later became 5th wing of World Bank) failed to serve the interests of the entire globe, especially poor and developing nations.

The succession list of managing directors suggests that no Asian has ever been made managing director of IMF. These figure suggests that how the IMF is working and how is the discrepancy.

chart05_US_economy.jpg

chart06_US_economy.jpgSimilarly, World Bank also failed to represent the globe in real sense of term. See the figure-

The workings of World Bank has always been under severe criticism, even the Chief Economist of this organisation Joseph Stieglitz criticised it by saying so-called free market reform policy is often harmful for the developing nations.

It proved correct in this crisis also. Even the President of the World Bank is nominated by the US President and the world on the other hand, has no say whatsoever, on this issue.   

So far as the monetary policy adopted during the Bretton wood conference is concerned, it was agreed upon that all nations would adopt monetary policy that would maintain the exchange rate of its currency within a fixed value in terms of gold.

But in 1971, US created a unique situation by resorting to suspension of convertibility from dollars to gold and made dollar as reserve currency.

Today USD has become an undeclared world currency so much so that monetary health and even budget statements of many countries of Asia, Africa and even Europe are explained in terms of USD.

Until this crisis, world was apparently comfortable with dollars, but now situation has changed, although, US is trying to convince the world that it shall again be comfortable with it, but much water seems to have spilled over.

Demand to have a new global financial order is being made surprisingly not only by Asia, but also by the west—the trusted economic satellites of the US.

The feeble hatred of west is not unfounded and the roots are lying in post gulf war situation. The post second Gulf war situation slanted strategic balance of power towards US, and these international financial institutions came under almost total control of the US.

The eclipse of USSR in the 1990s paved the way for unipolarisation of world both militarily and financially and the financial order slanted in favour of US.

The American military, financial and economic hegemony were by now, established firmly. The first gulf war, which actually did not take place as coined by Baudrillard, a French philosopher, further encouraged America which resulted in second venture of US into Iraq by Junior Bush in 2002-03.

This proved too costly for America, because it increased the war debt by 79 per cent. Grounds were being prepared for this crisis, which unfortunately, no one including US Federal reserve could understand. This graph suggests how Europe and America have made fortunes during concerned periods.

chart02_US_economy.jpg

The crisis has exposed all the inherent weaknesses in the liberal democratic economies based on unbridled and unfettered financial order. Now the demand for a more just and equitable global financial order is not going to halt.  

Brown and Sarkozy have unambiguously raised this issue and called for a global summit in New York to discuss this problem.

Bush was virtually forced to accept this proposal. Europe is hobnobbing with powers of Asia to garner support.

The developing nations are also set to raise demands of their due share in the proposed financial order. China, India, South Africa, Brazil and South Korea are poised for take off.  

IMF and World Bank, the engine of economic development, hitherto driven by west and America, need new co-drivers, because the drivers alone have failed to drive it smoothly.

Change is Key to New Global Financial Order

Now the wheel has turned and no one can prevent change of guard. Following changes can be made so that the proposed new global financial order fulfills aspirations of billions of under-nourished and starved people across the world.

IMF and World Bank's functioning should be overhauled to make them more democratic. Voting rights of member countries should be changed and 'bossism' of west should go. Each nation equal vote theory should be enshrined into.

Appointments in IMF especially on the post of managing director (MD) should be made in a more transparent manner so that poor nations should also get a comfortable say. The system of nomination to President of World Bank by US President should be done away with.

World Bank and its different organisations should also undergo radical changes. The basis of percentage of voting in World Bank should be changed so that developing nations should have a greater say in fund distribution and other administrative matters.

In nut shell steps to evolve mechanism of, what Indian Prime Minister Manmohan Singh says substantial increase in multilateral institutional funding of economies should be taken.

Some short of global financial regulatory body may be set up to ensure proper monitoring of global monetary health and to inject curative drugs when necessary. The fate of global market can no longer be left in the hands of elements of excessive financial leverage enjoyed by greedy speculators and fund managers.

United Bank of Switzerland (UBS) or Swiss Bank has been depository of hundreds of trillions dollars from across the world. Corrupt politicians and big business men have used Banking Act, 1934 of Switzerland in their favour, because this law enables this bank to maintain secrecy with respect to money deposited into it.

Tonnes of gold deposited during Nazi's Nuremberg trial can play vital role in tiding over this crisis. Time has come to amend or repeal this law altogether, so that the rich men from poor nations cannot drain the wealth and make the citizen to suffer.

Radical changes are required in WTO also. Protectionism and favouritism should be done away with. The present food crisis is likely to be metamorphosed into global food crisis if not addressed to immediately.

The bio fuel and US role on this issue is going to create an unprecedented situation in the world very soon, if it is allowed to go unabated will be more devastating that this economic crisis also.

The unequal distribution of wealth and prosperity has resulted into creation of a number of economic blocks in the world. Safta, Nafta, IBRA, Asean, Saarc, Opec, OIC and EU are manifestations of growing tendencies of groupism and blocism, which ultimately are proving hindrance to free flow of trade and commerce, harming the world at last.

If proposed new global financial order addresses all such issues, such groups and blocs would render useless and prosperity would transcend to all sections and all territories across the globe.

If we see the graph (GDP of India, China and America), we find that the 16th, 17th and even 18th centuries were the time of India and China, the Asian giants.

Hopefully, history would repeat itself and 'this duo' would occupy the driving seat of the future international financial institutions.

Permanent membership in Security Council to countries like India, Brazil, Japan and Germany should be given so that this world forum may not arbitrarily be used in one country's favour and against other.

The West's honeymoon with west type liberal and free economy and American type democracy seems to be on the verge of divorce.

Therefore, world is set to emerge with new set of politico-strategic-economic ideologies based on weltgeist (world spirit), which is more equitable and less discriminatory. Market is a good servant but bad master, therefore; regulation and restriction on servant is essential.

Prioritisation of development has to be rescheduled, after all in spite of all sorts of sky soaring achievements, bread, cloth and shelter would remain on the top of the list.

No civil society can afford to ignore the equitable distribution of these basics otherwise, the social fabric will tatter like what is happening today.

The writer had rightly predicted the change in the finaciial order. In G-20 the change has come. The new order has been created.

Nice article and predicts rightly for the emergence of India.

How do u claim that India would play a leading role in the emerging world economy. GDP of China is 8 trillion USD and india is staggering at only 1 trillion USD only?

The world bank and IMF chief has predicted global GDP as below one percent and the GDP of India below six percent. it means that the country has come into the grip of slowdown. The country should enhance the domestic demand and see the economy gets going.

It seems that the global financial order is changing. Obama is trying to change it. The reversal of oil policy announced by Obama yesterday has hinted the reversal of policy. Bravo carry on.Gopzeefrom Moscow

The world is set to change and China is going to be the power house of the world economic order. Prof Fargusson has rightly coined the term Chimerica.

Ot is an eye opener for Indian govt. It must stake claim strongly to get a lion's share in the new global economy because it is the ripe time to do so.

It is a good prediction and rightly said that the time has arrived in India to stake claim for a greater share in the would financial order.

The writer has rightly predicted that the time of American bulling every Asian and poor nation is over. The future is ours provided the leaders and industrialists work in unison and work for commoners also. If the slice of growth is distributed amongst the poor the country would stand tall and would be in the queue of developed nations.

It is a wonderful article and has rightly predicted the economic trends. It is the social security network in India which is preventing the recession to usher here in our economy.

worth reading!! it should also be kept in mind that enough of regulation is also not very good for an econmy.
An economy can not survive as a mixed economy for a longer period of time. It has to tend towards either of the economy (capitalist or socialist economy). After all it is demand and supply that plays an important and primary role. rest are the secondary things.

This is a wonderful article and the writer has rightly advocated for the change in global financial order. Mixed economy of India is certainly is good choice. If market is allowed to act freely, would not allow poor people to survive.

This article gives a brief information
about the global crisis happening around
the globe and how small investors are not getting benefit due to crisis in stocks.

This article graphically proves that India has been exploited financially by imperial powers from 18th century onwards. Had we not been enslaved by Britishers, we would have certainly been super power today.

It is one of the finest articles that I have read. The writer has very clearly described the financial system of the world. The need to have a new financial order is the need of hour. Unless we have a just and equitable order we cannot survive.

This is a very good article from Mr Yadav who is well known for this type of articles. In fact the basic question which should be asked in present economic scenario is that whether government should interfere in economic affairs or not, and the answer seems to be, of course yes. In modern governance, the most important question about the people is totally ignored, so there is always a scope for government intervention whenever people suffers. Well said by Mr Yadav: "market is a good servant but a bad master." Economic policy makers should always remember this. In 19th century there was a well known debate among the German economists and there was a stream known as nationalist economists pioneered by Frederich least. This is a good time to remember them. In India I think rethinking about the mixed economy should be started. In fact, the Nehru model was not so bad as described in later decades but unfortunately all of us have been trapped in the glamour of free market. In fact, nothing is free in this market, somewhere someone suffers for your smile, someone pays for your gain, and someone has to leave when you achieve. Thanks to Mr Yadav for a good informative article.

the writer has rightly pointed out that India had been richer tnan many european countries. It is our unfotunate that India fell victim to colonial powers and the properity turned into miseries. If the wheel turns, India would become richer.

it is an indepth analysis of the world economic system. A very few people really know that this system came into being bretton wood conference.

It is wonderful to know that India was richer than America in 16th century AD. It is also thrilling to know that the colonizations of India in 18th century impoverished this country. The writer has also successfully delineated the picture that how American economy has boomed during war periods. This depression has exposed the discriminatory economy of the global financial order. It is also heartening to know that the Indian growth over years is remarkable.

It is an excellent piece of economic understanding. The writer deserves credit for his rare graph which make us understand that India was richer than USA and many European countries in the medieval period. It is the the colonial powers that have ruined the country.

It is a wonderful and well informed article. It gives rarest of rare data and graph about pre-colonial period growth rates. The future seems waiting for developing nations and perhaps the days of west hegemony are over. It is the time when the entire east should join hand and fight against the discriminatory policies of the West

It is probably one of the best analysis I've read so far on the collapse of financial institutions in the US and why it's not likely to appreciably affect the banking system in India. The share of GDP of India in the World's Economy from 16th to 18th century and after the country was colonised is a great eye opener. Colonialism never led to prosperity of any country in the world as some people advocate. The basic premise of colonialism was exploitation of colonised countries to the advantage of the subjecting country.The writer deserves a sincere congratulation for this eye opener article.

Excellent article, www.igovernment.in. has done a commedable job to include such an excellent and mind blowing article. India is certainly poised to become a world power. The medieval period GDP of India suggests that India used to dominate world economy, it may repeat.

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