The global financial system: waiting for change

In recent years, shock, anxiety, a sense of uncertainty, and growing instability in business and politics have become decisive in the life of the world, countries and individuals. The hopes of Russians that after the all-round turbulent 1990s, the long-awaited calm will set in are not coming true. This time, not only Russia is being affected so much – the global political and economic system is searching for new sources of growth and new rules of the game. It is not only and not so much about growth or reduction of the influence of the United States and the West in general. The world is feeling for new concepts of world and national finance, more efficient forms of money, alternative loan principles, and a better balance between the interests of states and markets in the national and global finance.

In recent years, shock, anxiety, a sense of uncertainty, and growing instability in business and politics have become decisive in the life of the world, countries and individuals. The hopes of Russians that after the all-round turbulent 1990s, the long-awaited calm will set in are not coming true. This time, not only Russia is being affected so much – the global political and economic system is searching for new sources of growth and new rules of the game. It is not only and not so much about growth or reduction of the influence of the United States and the West in general. The world is feeling for new concepts of world and national finance, more efficient forms of money, alternative loan principles, and a better balance between the interests of states and markets in the national and global finance.

Making forecasts for the future, people first try to predict changes in science and technology, and the effect that these changes will have on the economy, lifestyle and structure of the society (Alvin Toffler). Secondarily, resources come under analysis: experts are trying to paint a picture of the world in which there will be a feeling of acute shortage of water, arable land, oil, and other resources. There has long been a school of social forecasting, creating different scenarios of the society of the future (T. Campanella, Ye. Zamyatin, George Orwell). Conventional military and political forecasting is also used.

Money and organization of its circulation in the economy and society are perhaps the only area that most people feel has not unchanged. People are keenly interested in how to increase the amount of money at their disposal, but few pay attention to the fact that the nature of money and the principles of the monetary system change, and change very quickly. You either have money or not: it’s as simple as that. That is how the average citizen thinks, not realizing that what he uses now is not quite the money used twenty or fifty years ago.

In the last decade, there have been several interesting papers dedicated to the evolution of money and the monetary system. The founder of modern futurology Alvin Toffler and his wife [1] started the debate. They developed the concept of “paramoney” – a variety of alternatives to the current currencies established under a different legal and technical basis (corporate money, electronic settlement system, a new barter).

Despite individual intellectual breakthroughs, there is not yet an adequate debate on the future of money and the global financial system since the methodological and institutional framework necessary for such a debate does not exist. A number of different processes that do not necessarily relate to the monetary sphere as such should be discussed simultaneously. For example, the issue of political sovereignty is central with regards to the international monetary system. However, experts on monetary policy are typically not well versed in matters of this kind. Political analysts prefer to use the terms “prestige” and “effect” [2], but are reluctant to deal with issues of the international monetary and financial system, attributing them to the area of responsibility of economists.

So, what can be the area of discussion on the issue of evolution of the international financial system? For this, analysis will need to involve Swan, Pike and Crawfish, i.e., one will have to discuss several different but related questions: what happens to the nature of money? What happens to the methods of its use (finance) at the micro level? And what happens to money circulation at the global, international level?

The nature of money, financial development and international money

Photo: ababica.ru
Bond. Ural-Volga. 1902

Economic development of countries, growth and decline of their political influence are inseparable from the history of money and finance in general. Being an embodied system of interrelations between the lender and the borrower money gave rise to the banking system, which was designed to make lending and borrowing even more large-scale. Those countries and cultures that did not adopt the concept of the time value of money lagged for long in economic and political development (this, in particular, is the reason for the relative economic stagnation in the Muslim world in the XVII-XX centuries).

Starting from the XIII century, government securities (bonds) have been ensuring securitization of interest payments. From the XVII century, it became possible to buy and sell shares in corporations governed by the rules of the regulated financial markets, which were originally created for trading in government debts. In the XVIII century, insurance companies and later pension funds began to take advantage of the economies of scale and provide protection against risk. In the XIX century, new financial instruments to protect against risk appeared – the first derivatives (futures and options). In the XX century, households were massively involved in financial turnover (in the Anglo-Saxon world), which allowed constructing a kind of political model called “homeowners democracy”. At the end of the XX century, financial markets developed new tools of securitization, derivatives of the second and higher order. On one hand, this increased the profitability of financial activities, but on the other – broke away financial markets from their real value fortifying them and led to frequent financial crises.

The evolution of the financial and banking system would not have been possible if money had not changed in its nature from being a commodity to being a debt because the commodity nature of money prevented the financial sector from developing. The nature of money gradually changed, losing its independent value and increasingly assuming the nature of an obligation to pay (give value) in the future. Internationally, this transition finally took place in the early 1970s, with the collapse of the Bretton Woods System and the refusal by the United States to exchange U.S. dollars for gold. All the major world currencies – dollar, yuan and ruble – are not backed up with specific goods, but are based solely on the reputation of a certain government and the power of the economy representing the given currency, i.e., on trust.

Photo: moreinternetincome.com

A change in the nature of money gradually led to a change in the characteristics of its source. People have long been accustomed to the thought that a substantial part of money is made not by the state but by banks (credit), but they cannot yet get used to the phenomenon of private money. But if money is just a promise to pay (to give some value), and if we trust the person giving the promise, then why not accept his money? As a result, we see the emergence of private money such as Yandex Money, various Travel Miles, and in some European countries – urban and regional money. It seems this trend will continue in the XXI century since many money consumers put more trust in obligations (“money”) issued by reputable and successful commercial firms than in lightweight pieces of paper issued by certain governments. There will also be a continuation of the trend to replace local currencies with more credible currencies issued by other states and, possibly, by international institutions. If a money consumer trusts another country or an international institution more than his own country, he will try to use the currency of that foreign country (this is quite consistent with the views of Friedrich Hayek on the nature of currency legitimacy). Affected states, in their turn, will fight against the spread of the “foreign currency”, but will lose, especially under a political democracy.

At the international level, where states are still the regulators of financial processes, the situation is complicated by the need to have rules and institutions that will ensure the compatibility of different national currencies. Such rules and institutions were and are created by states for the benefit of their own economies. Due to the economic and military superiority of the West in the second half of the XX century, it turned out that today’s world financial and monetary architecture is based on a basket of “Western currencies” – under the supremacy of the dollar and the crucial role of Western countries in international financial institutions. The Western world is also undergoing profound changes, as evidenced, inter alia, by the creation of the European currency. The world “table of ranks” of different currencies is also changing. The moment China decides to make the yuan convertible, the global financial system will no longer be able to remain the same.

Harmonization of financial interests of a state (for example, in terms of financing social expenditures) and interests of financial markets is a separate question that for now remains without any satisfactory answer. Today, the market mechanism of financing public spending has led to the deepest financial crisis in Europe and raised, along with others, the question of money issue sources: should in the future states continue relying on borrowing in financial markets?

There are a growing number of questions about the finance sphere, but most of them have no answers yet. The future of the global financial system will depend on the interaction of several dynamic processes:

• change in the ratio of the commodity and debt components in the nature of money;
• change in the ratio of public and private modes of money production;
• the process of regionalization and globalization of currencies;
• change in the degree of confidence in international currencies as a result of uneven economic and political development of individual countries and regions;
• change in the world political system, transition of leadership positions to a different configuration of states.

What can we expect from the global financial system in the future?

It is an impossible task trying to predict the direction of the development of the global financial system at a time when the planet has entered a period of profound changes. Having said that, one can still tell of some fairly obvious observations and assumptions.

Currently, the cycle of the relative autonomation of financial markets, the period of invention of new financial instruments, is apparently coming to an end. This is connected with the end of the next technological cycle of the development of the world economy and the cycle of financial activity generated by it (N. Kondratiev, J. Schumpeter). In the next 20 to 30 years, money is likely to be backed up to a larger extent by the real value. Already, there are ongoing talks of the need to return to the commodity nature of money, at least in part [3]. The argument in favour of the need to return the commodity nature of money is diverse, but the most convincing are arguments based on the idea of repeatability of technological and financial cycles. At the previous stage, capital financed deployment of new global technologies (informatization, distributed production, global logistics) and, having exhausted profit opportunities in the real sector, plunged into financial speculations. This behaviour of capital caused the financial crisis. Now, it is looking for a new idea, a new global application (technology) to start a new cycle of financing of the real economy [4]. It is impossible to say whether this would be “gold” money, “energy” money or something else, but one thing is clear: paper money (fiat money) is today creating too many problems for the world economy.

It seems that, frightened by the global financial crisis, for a while the world will set about “nationalization” of money and financial instruments. Despite the criticism of the effectiveness of measures taken by governments to overcome the crisis, today only governments can calm the raging financial ocean. Therefore, they will strengthen financial regulation, which will mean weakening of the role of markets in the creation of financial instruments and, in a broader sense, money.

Photo:Map of Eurasia, Oceania and Eastazia,
George Orwell, 1984

We should expect a pause in the deepening of financial globalization. The financial markets that broke free are living their own lives, often in conflict with the interests of states, while the world financial system based on the dollar and a narrow group of reserve currencies, has proved to be limited in its effectiveness. Without cancelling globalization, the center stage will be taken by creation of regional financial markets and currency zones, which is already happening in East Asia, Eurasia, Latin America (the yuan – in East Asia, the rand – in South Africa, a derivative of the Russian ruble (in the future) – in the post-Soviet space). Probably, the basket of world currencies will become more diversified. Neither monetary and financial nor political uniformity should be expected in the coming decades in the world: no currency will be able again to dominate globally, as it was with the dollar. The boundaries between currency zones will be blurred, technical facilities will allow economic agents to use just “money” from electronic accounts, without thinking much in what currency this “money” is denominated. The ruble will get a certain place in this system, but there should be no special illusions here – it will be one of many currencies and not at all the most powerful one.

Global financial institutions will also change. There is a sense that global financial institutions will recede into the background for a time, as their former organizing and guiding core gradually weakens, whereas new economic power centers are not yet ready to take on a global role and responsibility. It seems that the next few decades will be a period of prosperity for regional financial institutions. Welcome to the world of the currencies of Oceania, Eurasia and Eastasia! Let’s hope that George Orwell’s prediction [5] will come true only partially, in the financial and monetary sphere.

1. Toffler A., Toffler H., Revolutionary Wealth. Moscow: AST, 2007.

2. Morgenthau H., Thompson K. Politics Among Nations. N.Y., 1985.

3. Hilferding R. Financial Capital: A Study of the Latest Phase of Capitalist Development. M., 2011.

4. Perez C. Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages. M., 2011.

5. George Orwell 1984. M., 2009.