Big Changes at the Top Institutions

A year from now, global economic governance will look very different indeed.

DSK's departure at the head of the IMF has opened up a debate not only on who should replace him, but whether the Europeans should be allowed to appoint his replacement. Voices are increasing for a non-European candidate to succeed Strauss-Kahn. This is a sentiment that I currently believe has merit.

The Basel Committee on Banking Supervision will lose its current Chairperson, the head of the Dutch Central Bank Nout Wellink, within the next few weeks.

The head of the Financial Stability Board in Basel, Mario Draghi, will be leaving to head the European Central Bank this October, and has not yet been replaced. The President of the World Bank Group, Robert Zoellick, has a term of office that extends to the end of June 2012. That will be the last of the pending appointments

Pascal Lamy, head of the WTO, is in office until September 2013, so the focus will be on the financial side for the moment.

The next bubble has started

All bubbles start with hope. And a lot of cash looking for the next big thing to bet on. The trends right now? Social media, real estate and commodities. There is another trend in sovereign debt which needs to be treated separately.

Social media? Microsoft is purchasing Skype for an estimated 8 billion US dollars. Facebook has enlisted Goldman Sachs to run its IPO (its debut onto the stock market, or Initial Public Offering), with a suggested valuation of 50 billion. Zynga, the company that runs games on the Facebook platform like Farmville, is still deciding when to go public, but it will. There is a mantra going around Wall Street that the IPO of any compnay is its bar mitzvah, its coming of age.

Real estate? Unless you have serious money, you've probably heard less about it, but private equity is purchasing real estate worldwide. Prices are lower in some markets, where bargains are to be had, and rising in others, where there are significant returns on investments into the future. Think BRIC countries. The savvy investor looks here and in other emerging markets for growth.

Commodities? Sure, it's volatile, but it hasn't stopped speculation and rising prices. And Glencore's IPO valuation this year is 11 billion dollars.

All of these areas will be key to pushing the search for returns in the years ahead. But how are companies arriving at these valuations? Have we learned anything from the bubbles that burst in the past? I don't see any evidence yet. At the same time, we are already paying a higher price through inflation. It is on its way up, with interest rates following. Strong economies outside the OECD can handle this. The OECD countries themselves are in for a period of interest rates that will hurt those parts of the population not living within the bubble. The gap between rich and poor will increase.

On the other side of the global financial equation, the bubble in sovereign debt is not so much bursting, but making that farting noise that an inflated balloon makes when you let go of the stem and let the air out. Europe is falling apart, American debt has been downgraded, and is likely to slide even further. There will be losses. And they seem to be inevitable.

There is only one part of this bubble that is really concentrated in the traditional OECD countries, and that is in social media. That may provide the illusion of prosperity for a while, but it cannot replace or even balance the increasing shift of economic activity to emerging markets.  

China's global currency card

According to the Wall Street Journal, China is considering allowing currency trading of the Yuan in Singapore. If this happens, it will be the same as or similar to America's use of London as the primary centre and conduit for US Dollar trading in London. That made the expanded use of the dollar as a vehicle for global trade and finance possible. This is not just the trading of dollars, but any financial instrument denominated in dollars.

As I've said in my research workshops and classes for years, China is playing a very smart and methodical game internationally. In the past few years, it has diversified its asset portfolio, has invested in securing its supply chain for production, and has shifted the balance of economic activity to allow more domestic consumption on top of exports to Europe and the United States. The remaining thing it needs to do is expand the share of global transactions and investments denominated in its own currency. With global investors looking to diversify away from the dollar, with excellent economic growth and a huge domestic market to fall back on, their chances of success are excellent.

Looking for a single reporting standard

Financial reporting standards are at the heart of international finance, whether you're an investor or a regulator. If we can't see it, we can't know it's there, and if we can't compare the figures, we know less about what it is going on in financial markets. We lose investment opportunities, make bad ones, or worse yet, we collectively make bad ones because, amongst other things, the information was faulty. Companies typically want to make themselves look as profitable as possible, whilst hiding the risks and liabilities they face in making their money the way they do.

A single global accounting standard is therefore an important goal to pursue and possibly reach. The world is divided into the United States, which uses US-GAAP (Generally-Accepted Accounting Practices) and the rest of the world, which uses IFRS (International Financial Reporting Standards), issued by the International Accounting Standards Board in London. That Board is a private body of 15 accountants, supplemented by public oversight and user advice bodies whose job it is to set principles-based reporting standards that are then applied mostly by accounting companies like Deloitte, KPMG and PriceWaterhouseCoopers.

Since the crisis began, attention has focused on the quality of information available to investors and to regulators, which is one reason why the accounting profession came under official, if attenuated, public oversight. Today, the head of the Basel Committee on Banking Supervision called on the IASB and FASB, its American counterpart, to  achieve convergence on accounting standards. Outstanding issues include the use of Fair Value Accounting and the accounting of financial instruments. The American SEC needs to make a decision this year on taking a decision on convergence.

Apparently the Basel Committee feels that the SEC and FASB need a little push.

Davos: the State of the World in 2011

The World Economic Forum is meeting in Davos next week. This is an opportunity for the public and private sectors to talk with one another and share their viewpoints on the state of the world.

It has been an eventful year, but it is not quite certain how strong or important the changes resulting from them will be. There has been a general move in financial market regulation across countries and in global institutions to address the issue of systemic risk, but it is not yet clear just how powerful those innovations will be when it comes to limiting behaviour with a high risk of collapse and contagion.

One of the key questions is whether the focus on regulating financial markets has been diverted by exchange rate politics and the corresponding pressures it places on fiscal policy for national governments. As Europe deals with its sovereign debt crisis and China and America struggle over appropriate exchange and macroeconomic policies, will the political will that brought about the development of the Financial Stability Board  remain strong enough to develop standards and recommendations? For the FSB is not an international organisation like the UN, the ILO or the WTO. It is based on political will.

That will depend not only on how governments deal with one another in the G20, but how all of them deal with the private sector at Davos next week.

The Politics and Mechanics of Global Economic Governance

The world is changing rapidly around us. New global institutions have arisen and existing ones have been transformed in the attempt to get a handle on systemic risk. There are four trends that are worth noting over the long term that this blog will likely return to regularly.

First, we are witnessing a functionally-driven drive to change the institutional architecture of market regulation at the global level (in addition to the national level). The intent is to overcome the fragmentation of regulatory authority and coordination across countries and economic sectors, particularly in the pursuit of minimising and containing systemic risk to financial and economic systems. We therefore need to keep an eye on institutional developments in global economic governance, on network-based collaboration, and on the linkages between the two.

Second, we are witnessing a push toward more invasive regulation of markets, and financial markets in particular. This extends from central bank intervention to state aid and protectionism to regulatory matters. We therefore need to keep an eye on political developments in global economic governance, with specific reference to how archetypal narratives of state and market evolve across countries and at the international level.These narratives are the conceptual building blocks of institutions and law that lie at the core of global economic governance.

Third, the issues we are grappling with, especially with regard to financial market regulation, apply equally well to countries with established and emerging markets.  This has a significant impact on the decision-makers in national capitals and international organisations when they decide whom to include in talks and on what basis. Where standards were once set exclusively by established market countries, they are now being set with the input of emerging markets. That is a significant change in the way decisions are made.

Fourth, and finally, how will democracies deal with the fact that they must cooperate with dictatorships to make the global economy work? And should they? The age of democratic leadership over the global economy that characterised the second half of the 20th century and the beginning of the 21st is dead. It will never come back. What does that mean for the democratic west?


I look forward to your comments, your suggestions and your evidence-based rebuttals as this blog develops.