Regulating financial markets vital for revival of world economy

Thousands of people across the world are now facing the consequences of a serious crisis in the world financial system caused by the unrestricted profit motive of the investment banks.

Initially, it started in 2008 with the imminent collapse of the banking system of both USA and UK. Now it has spread to Europe in the form of the debt problem of some European countries like Greece, Italy, Ireland, Spain, Portugal, Iceland and the Baltic states, creating panic in the world economy.

The result can very well be a global recession, from which the emerging countries like India or China cannot escape. Globalisation has massively increased the vulnerability of the world’s financial and economic system. Every day trillions of dollars are being transacted at the speed of light, most of it are unregulated. The derivative products or gambling of various kinds on every financial future market have accrued to the level of hundreds of trillions of dollars, unmonitored by any public authority. In essence, a vast global financial superstructure was created on a fragile foundation by arranging massive loans by some investment banks to countries who cannot afford to pay back.

Companies in the developing countries are now borrowing heavily in the international market to acquire properties abroad. More than half of Indian foreign borrowings are of these private business companies. These countries also allow huge amount of short-term borrowings by its institutions from the international market. International private financial institutions are allowed to operate in the stock market, real estate market and in the food and agricultural market. Thus, the developing countries are getting more and more exposed to the speculative games that the western financial institutions play to ruin a country. In 1998, several East Asian countries became the victims, in the same way as Greece and several European countries are today.

The situation has already created a fear psychosis all over the world of an impending recession of the world economy. European governments decided to fund a bailout largely out of fear that a default might lead to a new financial crisis and the bankruptcy of one country after another. However, the real question is how to stimulate growth, which can  pay off the debts eventually.

According to some economists a lower tax regime can stimulate economic growth. Government’s revenues from taxations could rise thus creating a stimulus for further government spending for capital projects.  However, historical experiences offer no support for this theory. Studies by the US Treasury indicated that tax cuts do not raise tax revenues.

The alternative is the traditional Keynesian policy to increase spending of the government to stimulate growth of the economy. In the current situation, it is difficult to increase government spending when government debts in most countries have reached the crisis levels. There is not much scope to borrow more. Keynesian policy to print new money may create inflation. Keynes argued that under-utilised resources can be employed to create more real products and thus inflation may not happen.

Policy solutions

There are two types of solutions. There is a short-run solution so that the economic system of the world will not collapse creating mass unemployment. The long-term solution must be aimed at reforming the present system so that this type of crisis would not occur in future.

Immediate cause of the crisis is the lack of resources in the Anglo-American banks to maintain the credit system flowing so that companies that depend on them can survive. Huge stocks of worthless option, derivatives and mortgage backed securities (MSB) are worthless assets in the banks, which have reduced their ability to continue lending for real productive investments in the economy. Throwing money to the banks and the companies will not solve the problem, as both the US and the UK governments have tried so far. Nationalisation of the entire banking system is needed to refinance the depleted stock of the banks and to help major companies to survive. That will help their supplier companies, their sales outlets and the corresponding international trading companies to survive.

For the long-term solution, we need to go back to the advice of two great economists during the 1930s depression, which were so far rejected by the world. In 1934 Ragner Frisch has suggested a National Exchange replacing the stock market, where the companies will be allowed to sell their shares only if they will provide complete information about their business.

Investors must keep these shares for a specified period and cannot do speculative trading with these. If the investors want to sell back the shares, they must sell these to the company itself. The company can sell more of its shares only if it is permitted by the National Exchange.

In conclusion, I might say that nationalisation of the banks, including the Federal Reserve System of USA, which is a private enterprise, will help countries to regulate the financial market for the benefit of the economy and the people. Abolition of speculative activities in the secondary stock market will protect the genuine investors. Abolition of the derivative market, the credit-debt swap  and their reinsurance will cool down the financial madness and will help the banking system to survive. A managed trading system will rule out economic destruction of one country by another with cheap export items manufactured by slave labourers and with an artificially low exchange rate, as China is doing now.

The crisis of unemployment, in USA, UK, Japan, is caused by a trading system by which China has managed to ruin their manufacturing industries using its cheap exports. In India as well, about 26 per cent of its manufacturing industry is now taken over by the Chinese exports creating permanent  unemployment.  Thus, solutions cannot be found within the given economic system. An out-of-the-box measure is needed.

(The writer is a professor in international economics at Nagasaki University, Japan)

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