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Who Runs the Global Financial System?

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In terms of world economic leadership, the twentieth century is considered American, just as the nineteenth century was British and the sixteenth century was Spanish. Chinese and Europeans believe it will be the next global economic power. It’s like that; And would they really want to be? Harold James, professor of history and international relations at Princeton, and Domenico Lombardi, director of the Global Economy program at the Center for International Governance Innovation (CIGI) answer the questions.


The larger an economy, the greater its systemic importance and the greater influence its political representatives have in the international decision-making process. The United States is the world’s largest economy, with a GDP of about $16.7 trillion. The Eurozone’s 12.6 trillion ranks it in second place and China, with a GDP of 9 trillion dollars, follows in third place. In other words, all three economies are theoretically large enough to act as global economic leaders.


But the future prospects of an economy are also crucial to the prospects of leadership – and there are serious challenges ahead. No one believes that the Eurozone will grow faster than the US in the coming years or decades. While China is expected to overtake the US in output from 2020, harsh population control measures taken over decades will dampen growth in the longer term, leaving the US economy as the most buoyant of the three.


Another key requirement for global economic leadership is systemic importance in trade, monetary and economic terms. Unlike China, a major trading power with underdeveloped monetary and economic capabilities, the eurozone meets the requirement of systemic importance in all three areas.


There is also a less specific aspect to leadership. To be a true global leader is to shape and connect the global economic structures within which states and markets operate – something the US has done for nearly 70 years. At the Bretton Woods conference in 1944, the US crafted the postwar international monetary and economic order. The core framework, centered around the US dollar, has survived financial crises, the breakup of the Soviet Union and the integration of several developing countries into the global economy.


Today, American leadership in global trade and economic and monetary governance rests on interconnected forces. The US provides the world with the key international exchange rate, which serves as the link of global demand, sets trends in economic regulation, and has a central bank that acts as the de facto global lender of last resort.


In addition to providing a global public good, providing the global central exchange rate has significant domestic benefits. Because the US can borrow and pay for imports in its own currency, it does not face a hard balance of payments constraint. This allowed them to run large and persistent current account deficits, fairly stable since the early 1980s.


These deficits raise persistent concerns about the system’s viability, with observers (mainly outside the US) long predicting its imminent collapse. But the system survives because it is based on a functional exchange, in which the US uses the money of other countries to act as the main driver of global demand. In fact, export-oriented economies like Germany, Japan and China owe much of their success to America’s ability to absorb a huge share of global exports – and they should continue to pay America to play that role.


Given this, major exporters have been under pressure in recent times to “fix” their external surpluses in the context of responsible global citizenship. While this has contributed to the sharp contraction of the Chinese and Japanese current account surpluses, the eurozone surplus is growing, with the International Monetary Fund expecting it to stand at 2. 3% of GDP this year (slightly less than the Chinese surplus).


Having the world economy run by a surplus country seems more logical, given that creditors usually dictate the terms. At the time of the Bretton Woods conference, the US accounted for more than half of the world’s industrial production


Chinese or European leadership would probably be more like the pre-war Pax Britannica (in which the UK provided funds to the rest of the world in anticipation of its own relative economic decline), with the ruler providing funds on a long-term basis. But this scenario assumes that a deep and well-functioning financial system mediates capital – something that China and the Eurozone have been unable to achieve.


Despite the financial crisis of 2008, the US remains the undisputed leader in the world economy. Indeed, US financial markets offer unparalleled depth, liquidity and safety, making them magnets for global capital, particularly in times of economic distress. This “pull”, central to US economic dominance, strengthens the dollar’s global role as investors seeking safe, liquid assets pour money into US Treasuries.


The belief that a common currency and capital market would further support financial institutions and deepen markets was a principle that led to the formation of the eurozone. But given the lack of a single instrument equivalent to US Treasury bills, the crisis caused divergences in the sovereign debt yields of eurozone member states. Bank lending then retreated across national borders and the idea of ​​a European capital market disintegrated.


The Europeans and the Chinese should ask themselves whether they really want to take the risks associated with a position at the center of a large and complex global economic system. System control is the grail of global leadership. But for economies that are not adequately prepared for it, the elixir can turn out to be poison.

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