In this new market billions can flow in or out of an economy in seconds. So powerful has this force of money become that some observers now see the hot-money set becoming a sort of shadow world government - one that is irretrievably eroding the concept of the sovereign powers of a nation state - Business Week
The importance of finance in a globalised world cannot be underestimated. Movement of global capital (and not any other factor of production) from one country to the other has often been held by economists to be the last mile connectivity of a country in its process of globalisation.
In fact for the past few decades no other factor of production - labour or for that matter technology - has invited as much attention and discussion at the global level as the movement of finance has. It may not be out of place to mention that having realised the potency of this arrangement, developed countries, notably the US have lost interest in the Doha Round of trade negotiations under the aegis of the WTO. Why produce, trade, take risks and complicate issues when one can profit merely through movement of finance?
Put pithily, one who controls finance controls the world of trade, commerce and business.
Evolution of global financial architecture
The manner in which the world of finance dominates the global economy, its disproportionate influence, its extraordinary power in shaping and de-shaping the global economy and yet to remain un-critiqued is one of the most perplexing aspects of modern life.
To understand the DNA of this architecture a reference to the developments since World War II which led to the formation of the World Bank and the IMF is inevitable. Under this arrangement (also called as the Breton Wood arrangement) each participating government guaranteed to exchange its own currency on demand for US Dollars at a fixed rate. The underlying argument that led to this arrangement was that stability of exchange rates was crucial for development of global economy.
In turn, the US Government guaranteed to exchange dollars on demand gold at a rate of at a rate of $35 per ounce of gold. This effectively placed all the currencies on indirect gold standard, backed by the US gold reserves. Governments thus came to accept US dollars as gold deposit certificates and held the USD as a global currency.
But this arrangement was based on a fundamental premise that the US economy would always remain strong enough to support its dollar. But the cost of the Vietnam War considerably weakened the faith of the rest of the world in the dollar as the de facto global currency. This situation had the potential that could have led to a run on the USD with countries and investors surrendering the excess dollar and asking for gold in return.
To pre-empt such a danger the then US President, Richard Nixon, removed the convertibility of the dollar to gold in August 1971. This completely dynamited the very structure of global finance conceived by Breton Woods meet. But in the process the world had inevitably got hooked to the dollar as the global currency by virtue of the rules adopted earlier.
The fixed exchange rate of the Breton Woods system of the post World War II was replaced by a floating exchange rate mechanism. With the result the global financial architecture of post 1971 was a virtual anti-thesis when compared to that of pre 1971. Crucially, what was sought to be avoided by creating the IMF was legitimised through the IMF itself!
Dollar as a commodity
Thus begins the dangerous dollar game. It requires some further understanding of this game to more fully appreciate the global financial architecture as it operates today. After the currencies were floated against one another with no single reference point, the US began to manipulate the new financial floating exchange architecture to ensure that surplus dollars, which had accumulated in the hands of other countries, were brought under its control.
Thus was born the petrodollars phenomenon. By using its political clout with the OPEC, (the global oil cartel) the US persuaded it to carry out a steep increase the prices of Crude. It may be noted that even today as against the estimated cost of production of a barrel of crude at less than $15 in Saudi Arabia, the international selling price is well in excess of $115. This huge profit made from selling oil to you and me virtually runs the US economy.
This sucked the excess USD circulating globally into the hands of a handful of oil producing and exporting countries. The dollars thus sucked by the OPEC countries could not be invested anywhere except the US, as no other country could absorb such gargantuan investment. So these petrodollars are invested back into the US economy by OPEC members as long-term investments, at times less than even one per cent per annum. It is these investments that continue to fuel the growth of US.
In effect, the explicit gold standard of pre 1971 had given arise to an implicit crude standard of the seventies. And this was further expanded to include the entire global trade and multi-commodity regime since the eighties. But the Dollar game does not stop here.
Virtual finance and digital economics
The floating exchange rate mechanism of post 1971, particularly with an unprecedented expansion of various financial instruments, mechanisms and structured products, had the net effect of giving arise to what is colourfully termed by experts as "virtual finance." And then with the proliferation of technology, this arrangement itself morphed into digital economics overwhelming the real or actual economics.
What is crucial to note here is that the sheer size of the virtual financial market viz., the world of virtual finance and digital economics, outnumbers the real economic transactions by approximately over 100 times. This would give the reader the extent of the mind-boggling influence of the virtual finance over the actual in sheer size.
This subsequently expanded into an elaborate network of derivatives market - estimated to be in excess of $500 trillions when compared to the global GDP of approximately only USD 50 trillions and global trade of goods and services not exceeding $10 trillions - which at present is beyond the power of any regulator or monitoring mechanism.
Naturally, this led to a complete disconnect between the global financial system and the global production mechanism. In the process the production sector has been completely marginalized by this global financial order. It may be noted that global trade heavily depends on this financial system, which in turn by its very unstable nature causes currency instability and derails the global economy, trade and commerce. What a messy situation!
In short, when currencies become commodities and begin to be traded on virtual basis, with complete disconnect to the real economy, the consequences are indeed disastrous.
IMF's surveillance programme
Crucially, all these arrangements had the active blessings of the IMF through a well-documented agenda. In fact, the IMF constantly encouraged countries to enter into this game of speculation, virtual finance and of course digital economy. In fact, this has been the agenda of the IMF since the eighties. It is thus no wonder that since then the IMF has been fixated on this system while simultaneously ensuring that there are no systemic risks its flow.
Readers may note that this monitoring is carried out by the IMF through a defined surveillance programme a mandate that was given to oversee the international monetary system, assess the economic and financial developments across continents and advise on risks to global financial stability as well as to suggest appropriate policy adjustments.
Yet, despite this overwhelming concern for finance, it is indeed bewildering to note that the entire global financial architecture is increasingly coming under extraordinary stress. In fact, some experts opine that it has already reached the breaking point as recent events in the US economy and financial markets demonstrate. Further, the recent gyrations witnessed in the commodities, currency and stock markets at the global level are all products of systemic failures and bad surveillance.
The element of surprise is not merely on the size of the crisis, which in my opinion is secondary. What is galling to note here is that such serious systemic flaws have crept in undetected for over couple of years despite multilateral supervision and surveillance.
It is in this connection it is indeed perplexing to note that the IMF - the high priest of supervision of global finance has expressed surprise - yes surprise - on the latest crisis that has engulfed the world of finance, its extent and the consequent implications.
Has the IMF merely winked at these negative developments and proliferation of financial instruments because of the some external pressure or does it not have the appropriate competency to carry out the surveillance of the global financial architecture? Is it a classical case of misplaced trust or is it a part of a deliberate design to be incompetent? Is IMF incompetent or designed to be incompetent?
Part 2: IMF: Incompetence by design or default?
The author is a Chennai based Chartered Accountant. He can be contacted at mrv1000@rediffmail.com
Other articles by the author:
Is the US economy heading for a collapse?
Derivatives: The time bomb in our financial system
Pay panel, an attempt to destabilise India
Anything multiplied by zero is zero indeed!
