We Need a Hegemon Who Won't Drive Us Crazy...
There is a Rodrik Roundtable over at Economist.com...
Dani Rodrik writes:
[T]he most fundamental objection to global regulation... [is that f]inancial regulation entails trade-offs along many dimensions. The more you value financial stability, the more you have to sacrifice financial innovation.... Different nations will want to sit on different points along their “efficient frontiers”. There is nothing wrong with France, say, wanting to purchase more financial stability.... Nor with Brazil giving its state-owned development bank special regulatory treatment, if the country wishes, so that it can fill in for missing long-term credit markets. In short, global financial regulation is neither feasible, nor prudent, nor desirable. What finance needs instead are some sensible traffic rules that will allow nations (and in some cases regions) to implement their own regulations while preventing adverse spillovers.... Similarly, a new financial order can be constructed on the back of a minimal set of international guidelines. The new arrangements would certainly involve an improved IMF with better representation and increased resources. It might also require an international financial charter with limited aims, focused on financial transparency, consultation among national regulators, and limits on jurisdictions (such as offshore centres) that export financial instability. But the responsibility for regulating leverage, setting capital standards, and supervising financial markets would rest squarely at the national level...
This seems to me to be dangerously wrongheaded. Let me try to explain why:
Go back to 1825, when the Bank of England first explicitly takes on its monetary policy mission in an attempt to stem the systemic impact of the banking crisis of 1825. Before 1825 or so a sudden shock that makes investors seek to hold portfolios of shorter duration and less risk does not have a great impact on values: the economy responds by unloading the trade goods from the ships about to sale for Hudson’s Bay or Batavia or Madras and selling them on the domestic market instead, and the fall in demand for long-duration and risky assets is met by deleveraging the real economy without much impact on values. But by 1825 the capital stock of the economy now has large components that cannot be deleveraged: plantations, canals, factories, and soon railroads. So a crisis shock to the demand for duration and risk now has a big depressing effect on asset prices—and that in its turn has a feedback effect further decreasing demand for duration and risk. And so it is in and after 1825 that we see the origin of central banking: the judgment by First Lord of the Treasury Lord Liverpool that the prices of risky and long-duration assets are too important to be left to the free play of market forces: that it is important for the government to support them, at least in crisis, to prevent mass unemployment by making sure that the firms that should be expanding and hiring workers can get finance to do so on terms that make it profitable for them to expand.
From this perspective monetary policy is and always has been about supporting asset prices at a level that allows firms that ought to be expanding to obtain finance and expand profitably. And ever since 1825 the central bank has done this by, whenever it needs to, taking long-duration and risky assets into its own portfolio--and thus off of the stock that must be held by the private sector whose risk tolerance has collapsed. Given that there are going to be sudden shocks to risk and duration tolerance on the part of global investors, we need a global institution to provide support for asset prices in an emergency: a global lender of last resort.
That lender of last resort needs two things if it is to function. First, it needs to be able to "print money"--to have its own liabilities be and be perceived to be the safest assets in the world so that when it borrows it calms markets by giving them more of the high-quality short-duration low-risk paper for which they suddenly have such a great craving. Second, it needs to know what it is buying--to have sufficient regulatory oversight and control over global finance to be able to limit the growth of potentially toxic assets beforehand and then to understand what prices it should offer when it does decide that it is time to support the market.
As my old teacher Charlie Kindleberger taught me (or, rather, taught Barry Eichengreen, who in turn taught me), when the global financial system has had a hegemonic lender-of-last-resort with the power and the will to exercise this function, things have gone relatively well. And when the possible candidates for the role have lacked either the power or the will, things have gone relatively badly.
Back in the 1997-1998 crisis the U.S. Federal Reserve and Treasury acting alongside the IMF had the power and the will. Right now the U.S. Federal Reserve and the Treasury in cooperation with the IMF and the ECB have the power (but they may not have the will). In the future the world is likely to become a more complicated place without a single hegemonic and dominant public financial institution. To my mind, this creates grave dangers for the next quarter century. But Dani does not see them.
