Global fi nancial market in the 1990s

In the 1990s, the fi nancial market already had a global character and thus allowed for diversifi cation of investment across instruments, currencies and regions. Its main threat, which was in fact particularly evident in the case of the 1997 East Asian cri-sis, came from fi nancial contagion, that is, the cumulative negative eff ects of imbal-ance and crisis phenomena which had previously had a primarily local character.

Th e global liquidity and savings supply were relatively large and growing. Th e international share of Treasury Bill and Treasury Bond transactions grew from

7 Insuffi cient supervision, vague structures of corporate governance in Japanese corpora-tions and corruption were also the cause of the second banking crisis in Japan.

8 In recent years mistakes regarding the property market have also been made by Euro-pean banks – see the banking crisis in Sweden or the biggest EuroEuro-pean banking disaster of the French bank, Credit Lyonnais. Japanese banks reached around US$580 bn of credits in an ir-regular situation.

the level of roughly 3% of American GDP in 1970 to about 136% of American GDP in the mid-1990s. In this period, direct foreign investment increased three times faster and foreign trade twice faster than world GDP growth. Th ese pro-cesses were accompanied by a sudden growth in foreign exchange turnover, with its daily rate equalling roughly US$1.5 trillion at the end of the 1990s.⁹

Short-term and ultra-short-term fund fl ows are by nature highly sensitive to interest rate fl uctuations and new relevant information. On the one hand, these fl ows have a tendency to contribute to the lowering of interest rates on the global market. On the other hand, however, they can compound uncertainty as they are completely detached from commercial transactions or direct foreign investment.¹⁰ Th e large increase in capital fl ows in the 1990s was a result of several reasons.

One of the most important was the growing ability and tendency to save in new market economies and in economies exporting raw materials, a drop in public sector borrowing requirement in OECD countries and low interest rates in these countries.¹¹ Th e general growth in the propensity to save, and a higher appetite for liquid assets off ered by investment funds, was also connected to demographic factors and the weakening of trust in public retirement programmes. On a global scale this led to growth in demand for fi nancial instruments off ering liquidity and high return on investment and fi ercer competition between investment funds.

Th is was the background of a growing interest of institutional investors in high-risk fi nancial markets, such as in East Asia.

Resource reallocation, risk monitoring and assessment are the most fundamen-tal functions of fi nancial intermediaries. Th is is why investors attach signifi cance to transparency and standards of data published by countries and businesses. De-spite growing standardization, especially that pertaining to information, countries that build market economies were still very much diversifi ed and an assessment of their economies or of particular businesses required experience and prima-ry information collected by specialised companies. Th erefore, one of the main problems for investors acting in new fi nancial markets had been, and still is, the acquisition of appropriate microeconomic information. Lack of information or its inadequacy, as well as diffi culties in selecting experienced employees, led to incorrect risk assessment and insuffi cient monitoring of local institutions. Th ese factors in turn induced “herd behaviour” among investors. Hence, one of the “ex-ternal” sources of destabilisation and consequently the crisis were mistakes and

9 At the beginning of the 1970s daily foreign exchange turnover was around US$20 bn.

10 Th ese were the reasons for which J. Tobin put forward the idea to levy a tax on this type of investment. Such taxation would require international coordination and could result in an increase in interest rates, which would limit accessibility of capital.

11 In 1997, for example, all EU member states (apart from Greece) narrowed their budget defi cits to the level below 3% of GDP and Denmark, Finland, Sweden and Luxembourg re-corded a budget surplus.

insuffi cient care of investment funds and international fi nancial institutions re-garding investment portfolios and risk assessment.

Another cause, linked to the aforementioned factors, was separation between ownership and governance, which created conditions for short-termism and speculation. Th e infl uence of this factor was particularly seen in periods of ex-pected economic recovery. Th e years preceding the East Asian crisis were glob-ally relatively prosperous, leading to high stock market prices, particularly in the USA but also in the EU countries.

In the face of the threat of a global-scale crisis, aft er the main participants of the fi nancial market recognized the seriousness of the situation, the main coun-tries could adopt the strategy of coordinated and energetic action, the strategy of delayed action or of awaiting the course of events, or the competitive strategy – separate actions taken to cushion the eff ects in one’s own fi eld carrying evident negative consequences for one’s economic partners. Th e delayed action strategy proved to be the most feasible and pragmatic.

Th e regulatory experiences of the 1980s and 1990s supported the strategy of limited action as they gave empirical evidence of a potential for self-regulation of market mechanisms. Autonomous adjustment mechanisms are on the whole, at least in the medium- and long-term perspective, more effi cient than the attempts at resolving the temporary problems by means of interventionist regulations and accompanying administrative structures. Besides, it seems that there is currently a relatively high willingness to accept the necessary short-term social costs of eco-nomic adjustments for the sake of the creation of long-term growth conditions.

Th e fact that in reality the crisis occurred mostly in the new market econo-mies of East Asia and to some extent in Japan, and also in Brazil in 1998, was a hindrance to common action. Th e East Asian events had a negative impact on the global economy and undermined trust in the currencies of other emerging economies, including in particular Russia. According to Camdessus [1998], in Russia the problems had origins far beyond the purely economic domain. In eco-nomic terms, the principal causes of the Russian crisis stemmed from domestic fundamentals; they were enhanced by exogenous factors (including the impact of lower oil and gas prices) triggered by the events of 1997. Camdessus [1998, p. 3] maintains that “even if in a totally diff erent context, the problems of Rus-sia at the beginning of 1998 were strikingly similar to those which at that very moment were destroying Asian prosperity”. From the institutional point of view these were a macroeconomic defi ciency, particularly in fi scal policy, weakness in the fi nancial intermediation sector and capitalistic cronyism.

Th e negative eff ects of fi nancial market disturbances infl uenced diff erent coun-tries to a diff erent extent.¹² Th is fact made it hard to coordinate actions both

12 Diff erent eff ects could also be seen in particular US states. See: Th e Economist, October 3rd, 1998, p. 75.

tween the USA, Japan and the then emerging Eurozone, as well as within the latter.¹³

Th e question of whether or not international regulation and the supervision of speculative capital fl ows would be possible and justifi ed requires separate inves-tigation. Such a solution does not seem to be real or justifi ed. Speculative capital on its own does not endanger the functioning of economies pursuing a sound macroeconomic policy. Speculative capital has an important and peculiar func-tion as it identifi es the macro- and microeconomic centres of wrong decisions and in this sense it disciplines the participants of economic life.