Global financial markets, present and future

It was not so long ago that global financial markets were hailed as the bringers of democracy. Yet between that time and now, a couple of crises showed that financial markets not only do not necessarily bring democracy to nations, but also sometimes jeopardise the stability of their economies.

Democratisation of finance was at the heart of the ‘subprime narrative’: efficient markets would promote ‘social housing’ without emptying taxpayers’ pockets, but rather filling those of savers.

Then came the crisis, and the consequent need for ever more massive bailouts, not of this or that operator, not of this or that market, but of markets as such

In fact, for the last thirty years there has been nothing more multinational than financial markets, which have prospered thanks to a systematic campaign aimed at dismantling national barriers against capital mobility, a dismantling carried out and sought precisely by states themselves. And indeed, almost more decisively by ‘left-wing’ governments than by ‘right-wing’ ones.

The representation of globalisation as an apparently inevitable process arises even more directly for finance than for other domains, on the assumption that by promoting the liquidity and depth of markets, capital mobility produces the typical beneficial effects of scale economies. Wide and border-free markets, so it has been claimed for years, on the basis of their alleged allocative efficiency, distribute resources in the most judicious way, since they operate on the basis of mechanisms that are as rational as they are impersonal, i.e. without regard for anyone.

Capital mobility is a mode of voting, carried out by what Noam Chomsky called in 2010 the ‘virtual senate’: “Financial liberalisation also creates what some international economists have called a “virtual senate” of investors and lenders, who ‘conduct moment-by-moment referendums’”.

Chomsky’s not too veiled reference is to Renan’s famous formula: the ‘plébiscite de tous les jours’ (everyday plebiscite). Except that Renan referred to the nation, whereas, with a radical reversal of meaning, here the ‘plebs’ called upon to vote are the global creditors of national economies…

This is the reality of modern capitalism, one would say. It remains to be seen whether this reversal of the balance of power has at least a basis in efficiency. For if the globalised finance of globalised markets could exhibit an evident allocative superiority, there would be nothing left but to surrender to progress. But right here begins the critical part of our discourse.

The efficient markets hypothesis, mainly associated with the name of Eugene Fama, rests on the assumption that, with a greater or lesser degree of precision, markets are able to price the fundamental risk of an asset, with only temporary deviations bound to be reabsorbed. Now, this assumption was challenged very early on, well before the GFC, by Shiller in his famous 2003 article. The irony, or rather the hypocrisy, is that in 2017 the Bank of Sweden’s prize in honour of Alfred Nobel for  economics was awarded jointly to Fama and Shiller.

The great crisis of 2007 took it upon itself to disprove this supposedly efficient assessment capacity of markets.  Particularly in the case of the sovereign debt crisis, a mostly concordant literature argues that a large part of the risks priced in by financial markets are risks created by markets themselves and by vagaries in market sentiment. Here too, a large literature on multiple equilibria now tells us that expectations can heavily distort the evaluations of fundamentals, especially in the case of sovereign debts: “Sovereign bond markets are potentially subject to multiple equilibria. At a low interest rate, the probability that the debt is sustainable is high, justifying the low rate.  Think of this as the good equilibrium. But there may well be another one, in which investors get worried, ask for a higher premium, increase debt service, and in so doing make their worries self-fulfilling and make debt unsustainable. Call it the bad equilibrium. Multiple equilibria can emerge nearly at any time, but they are more likely in the current circumstances when investors are edgy”

Let us now turn to the latest crisis, related to the pandemic. If the advanced economies were able to be saved from collapse, this was essentially due to the joint action of national governments, which passed large deficits, and their central banks, which supported them with systematic asset purchase policies.  The end effect has been, even un Europe, a greater financial stability than during the 2007 crisis.

What is the moral here? That we must shy away from the temptation to absolutize: no one, neither states, nor central banks, nor markets, is capable alone of effectively pursuing the efficiency objectives that all of us rightly deem important in finance. No one: neither national public bodies nor international private actors.

What the pandemic and the exit from the crisis give us is therefore a very specific political task: that of balancing the action of all three players in the name of the goal of a sustained, sustainable and socially acceptable growth.
If quantitative easing policies have saved the day so far, they have done so by vastly increasing inequalities, i.e. at a social price that it is no longer reasonable to continue to pay. New ways have to be found.