KUALA LUMPUR, Malaysia, Aug 14 (IPS) – When history repeats itself, the first is a disaster; what follows is a farce. If we fail to learn from past financial crises, we risk making avoidable mistakes, often with irreversible, even catastrophic, consequences.
Between a rock and a hard place
Many people around the world suffered greatly during the GFC and the Great Recession of 2008-2009. However, the experience of many developing countries was very different from that of the global North.
The varied responses of developing nations reflected their circumstances, the constraints of their policy makers, and their understanding of events and choices.
Thus, the global South reacted very differently. With limited resources, many developing countries are responding in a very different way than rich countries.
Hit hard by the GFC and subsequent Great Recession, the financial conditions of developing countries have been further weakened by the rapid growth since then. Worse, their foreign exchange and fiscal balances decline as private debt increases.
Most emerging markets and developing economies (EMDEs) mainly save US dollars. Several countries with large trade surpluses have long been buying US Treasury bonds. This finances US financial, trade, and current account deficits, including military.
A variety of finances
After the GFC, international investors – including pension funds, pension funds, and hedge funds – initially continued to be risk averse in their exposure to EMDEs.
Thus, the GFC spread across the world through different channels at different times. As EMDE’s earnings and prospects decline, investor interest declines.
But with more profits to be made in cheap currencies, due to ‘devaluation’, money flowed to the Global South. As the US Fed raises interest rates as early as 2022, capital has fled to developing countries, especially the poorest.
Long funded by easy debt, the housing and stock markets collapsed. As finance became more powerful and influential, the real economy weakened.
As growth slows, developing countries’ export earnings fall as capital flows. So, instead of helping counter the cycle, capital flowed out when it was most needed.
The results of this change have been very varied. Sadly, many who should know better choose not to see such dangers.
After globalization peaked at the beginning of this century, many rich countries reversed earlier trade liberalization, using the GFC as an excuse. Therefore, growth slowed with the GFC, that is, before the COVID-19 pandemic.
Markets are falling
Previously supported by the easy money of the Great Moderation, stock markets in EMDEs plunged in the GFC. The turmoil is arguably hurting EMDE more than rich nations.
Many wealthy and middle-income households in EMDEs own shares, while many pension funds have invested heavily in stock markets in recent decades.
Financial turmoil directly affects many wages, assets and the real economy. Even worse, banks stop lending when their credit is most needed.
This forces firms to reduce investment spending and instead use their savings and earnings to cover operating costs, often leading to layoffs.
As stock markets crash, solvency is adversely affected as firms and banks become overpowered, causing other problems.
Falling stock prices cause recessions, the economy slows, unemployment rises, and real wages and working conditions worsen.
As government revenues decrease, they borrow more to cover the deficit.
Different economies deal differently with such impacts as government responses vary.
Much depends on how governments respond with countercyclical policies and social protection. However, early withdrawals and reduced methods often sap their energy and skills.
Policy matters
Official policy responses to the GFC endorsed by the US and the IMF included those that had criticized East Asian governments for their actions during the 1997-1998 financial crisis.
Such efforts included requiring banks to lend at low interest rates, financing or ‘rescuing’ financial institutions and restricting short selling and other previously permitted practices.
Many forget that the US Fed’s mandate is broader than that of other central banks. Instead of providing financial stability by containing inflation, it is also expected to continue growth and full employment.
Many wealthy countries adopted bold monetary and fiscal policies in response to the Great Depression. Low interest rates and increased public spending have helped.
With the global economy in a prolonged recession since the GFC, tight fiscal and monetary policies from 2022 have hurt developing countries the most.
Effective counter-cyclical policies and long-term regulatory changes were not encouraged. Instead, many yielded to market and IMF pressures to reduce deficits and inflation.
Financial reform
Nevertheless, calls for government intervention and regulation are common in times of crisis. However, procyclical policies replace countercyclical measures when the situation is less threatening, as in late 2009.
Quick fixes rarely provide adequate solutions. They do not prevent future problems, which rarely replay past problems. Instead, measures should address current and possible future risks, not past ones.
Financial reforms for developing countries must address three issues. First, the necessary long-term investments must be adequately financed with affordable and reliable funds.
Well-run development banks, which rely heavily on formal resources, can help finance such investments. Commercial banks should also be regulated to support desired investment.
Second, financial regulation must face new conditions and challenges, but regulatory frameworks must adapt. As with monetary policy, reserves should increase during good times to strengthen resilience.
Third, countries must have appropriate controls to prevent inappropriate financial inflows that do not promote economic development or financial stability.
Precious financial resources will be needed to prevent the disruptive outflows that often follow financial turmoil and to mitigate their effects.
IPS UN Bureau
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© Inter Press Service (2024) — All Rights ReservedOriginal source: Inter Press Service
