A partnership with academia

Building knowledge for trade and development

Vi Digital Library - Text Preview

The Global Economic Crisis: Systemic Failures and Multilateral Remedies - Executive Summary

Report by UNCTAD, 2009

Download original document (English)

The report highlights three specific areas (financial deregulation, large-scale financial investors, currency speculation)in which the global economy experienced systemic failures and proposes measures to address them. While there are many more facets to the crisis, UNCTAD examines here some of those that it considers to be the core areas to be tackled immediately by international economic policy-makers because they can only be addressed through recognition of their multilateral dimensions.


The Global Economic Crisis:
Systemic Failures and
Multilateral Remedies

Report by the UNCTAD Secretariat Task Force on
Systemic Issues and Economic Cooperation

Executive summary


New York and Geneva, 2009

The Global Economic Crisis: Systemic Failures and Multilateral Remedies



Symbols of United Nations documents are

composed of capital letters combined with figures.

Mention of such a symbol indicates a reference to

a United Nations document.

The designations employed and the presentation of

the material in this publication do not imply the

expression of any opinion whatsoever on the part

of the Secretariat of the United Nations concerning

the legal status of any country, territory, city or

area, or of its authorities, or concerning the

delimitation of its frontiers or boundaries

Material in this publication may be freely quoted

or reprinted, but acknowledgement is requested,

together with a reference to the document number.

A copy of the publication containing the quotation

or reprint should be sent to the UNCTAD





Copyright © United Nations, 2009

All rights reserved

Report by the UNCTAD Secretariat Task Force on Systemic

Issues and Economic Cooperation: Executive summary


Key messages

UNCTAD’s longstanding call for stronger international

monetary and financial governance rings true in today’s

crisis, which is global and systemic in nature. The crisis

dynamics reflect failures in national and international

financial deregulation, persistent global imbalances,

absence of an international monetary system and deep

inconsistencies among global trading, financial and

monetary policies.

National and multilateral remedies

x Market fundamentalist laissez-faire of the last 20
years has dramatically failed the test. Financial

deregulation created the build-up of huge risky

positions whose unwinding has pushed the global

economy into a debt deflation that can only be

countered by government debt inflation:

– The most important task is to break the spiral of

falling asset prices and falling demand and to revive

the financial sector’s ability to provide credit for

productive investment, to stimulate economic growth

and to avoid deflation of prices. The key objective of

regulatory reform has to be the systematic weeding

out of financial sophistication with no social return.

x Blind faith in the efficiency of deregulated financial
markets and the absence of a cooperative financial

and monetary system created an illusion of risk-free

profits and licensed profligacy through speculative

finance in many areas:

The Global Economic Crisis: Systemic Failures and Multilateral Remedies


– This systemic failure can only be remedied through

comprehensive reform and re-regulation with a

vigorous role by Governments working in unison.

Contrary to traditional views, Governments are well

positioned to judge price movements in those markets

that are driven by financial speculation and should

not hesitate to intervene whenever major

disequilibria loom.

x The growing role and weight of large-scale financial
investors on commodities futures markets have

affected commodity prices and their volatility.

Speculative bubbles have emerged for some

commodities during the boom and have burst after

the sub-prime shock:

– Regulators need access to more comprehensive

trading data in order to be able to understand what is

moving prices and intervene if certain trades look

problematic, while key loopholes in regulation need

to be closed to ensure that positions on currently

unregulated over-the-counter markets do not lead to

“excessive speculation”.

x The absence of a cooperative international system to
manage exchange rate fluctuations has facilitated

rampant currency speculation and increased the

global imbalances. As in Asia 10 years ago, currency

speculation and currency crisis has brought a number

of countries to the verge of default and dramatically

fuelled the crisis:

– Developing countries should not be subject to a

“crisis rating” by the same financial markets which

have created their trouble. Multilateral or even

Report by the UNCTAD Secretariat Task Force on Systemic

Issues and Economic Cooperation: Executive summary


global exchange rate arrangements are urgently

needed to maintain global stability, to avoid the

collapse of the international trading system and to

pre-empt pro-cyclical policies by crisis-stricken


Global economic decision-making

x The crisis has made it all too clear that globalization
of trade and finance calls for global cooperation and

global regulation. But resolving this crisis and

avoiding its recurrence has implications beyond the

realm of banking and financial regulation, going to

the heart of the question of how to revive and extend

multilateralism in a globalizing world.

x The United Nations must play a central role in
guiding this reform process. It is the only institution

which has the universality of membership and

credibility to ensure the legitimacy and viability of a

reformed governance system. It has proven capacity

to provide impartial analysis and pragmatic policy

recommendations in this area.

Report by the UNCTAD Secretariat Task Force on Systemic

Issues and Economic Cooperation: Executive summary


Foreword by the Secretary-General of UNCTAD

The global deleveraging that first hit the world economy in

mid-2007 and that accelerated in autumn 2008 could not have been

possible without the rare coincidence of a number of market failures

and triggers, some reflecting fundamental imbalances in the global

economy and others specific to the functioning of sophisticated

financial markets. Chief among these “systemic” factors were the

full-fledged deregulation of financial markets and the increased

sophistication of speculation techniques and financial engineering.

Other determinants were also at play, particularly the systemic

incoherence among the international trading, financial and monetary

systems, not to mention the failure to reform the global financial

architecture. Most recently, the emergence of new and powerful

economic actors, especially from the developing countries, without

the accompanying reform needed in the framework governing the

world economy, accentuated that incoherence.

For many years, even when the global economic outlook was

much more positive than today, UNCTAD stressed the need for

systemic coherence. It has regularly highlighted the shortcomings of

the international economic system and has defied mainstream

economic theory in its justification of financial liberalization without

a clear global regulatory framework. UNCTAD has drawn attention

to the fact that the world economy was overshadowed by serious

trade imbalances and has questioned how they could be corrected

without disrupting development. We have warned that, in the absence

of international macroeconomic policy coordination, the correction

could take the form of a hard landing and sharp recession. In recent

years, we noted the growing risk that the real economy could become

hostage to the whims and volatility of financial markets. Against this

background, UNCTAD has always argued in favour of stronger

international monetary and financial governance.

A better understanding is required of how lack of proper

financial regulation set the scene for increasingly risky speculative

operations in commodities and currency markets and of how across-

the-board financial deregulation and liberalization have contributed to

The Global Economic Crisis: Systemic Failures and Multilateral Remedies


global imbalances. In doing so, a clearer vision may emerge of how

these and other systemic shortcomings can only be remedied by

vigorous reform of the international monetary and financial systems

through broad-based multilateral cooperative processes and

mechanisms that strengthen the role of developing countries in global


Against this backdrop, I established in October 2008 an

UNCTAD interdivisional Task Force on Systemic Issues and

Economic Cooperation, chaired by the Director of the Division on

Globalization and Development Strategies. This group of UNCTAD

economists was tasked with examining the systemic dimensions of

the crisis and with formulating proposals for policy action nationally

and multilaterally. Needless to say, the development dimension and

the appropriate responses are at the forefront of UNCTAD’s concerns

and the issues addressed in this report were identified with that in


There can be no doubt that, apart from the need to strengthen

financial regulation at the national level, the current problems of the

global economy require global solutions. The United Nations must

play a central role in this reform process, not only because it is the

only institution which has the universality of membership and

credibility to ensure the legitimacy and viability of a reformed

governance system, but also because it has proven capacity to provide

impartial analysis and pragmatic policy recommendations in this area.

Supachai Panitchpakdi

Secretary-General of UNCTAD


Executive summary

The global economic crisis has yet to bottom out. The

major industrial economies are in a deep recession, and growth in

the developing world is slowing dramatically. The danger of

falling into a deflationary trap cannot be dismissed for many

important economies. Firefighting remains the order of the day,

but it is equally urgent to recognize the root causes for the crisis

and to embark on a profound reform of the global economic

governance system.

To be sure, the drivers of this crisis are more complex

than some simplistic explanations pointing to alleged government

failure suggest. Neither “too much liquidity” as the result of

“expansionary monetary policy in the United States”, nor a

“global savings glut” serves to explain the quasi-breakdown of the

financial system. Nor does individual misbehaviour. No doubt,

without greed of too many agents trying to squeeze double-digit

returns out of an economic system that grows only in the lower

single-digit range, the crisis would not have erupted with such

force. But good policies should have anticipated that human

beings can be greedy and short-sighted. The sudden unwinding of

speculative positions in practically all segments of the financial

market was triggered by the bursting of the United States housing

price bubble, but all these bubbles were unsustainable and had to

burst sooner or later. For policymakers who should have known

better to now assert that greed ran amok or that regulators were

“asleep at the wheel” is simply not credible.

Financial deregulation driven by an ideological belief in

the virtues of the market has allowed “innovation” of financial

instruments that are completely detached from productive

activities in the real sector of the economy. Such instruments

The Global Economic Crisis: Systemic Failures and Multilateral Remedies


favour speculative activities that build on apparently convincing

information, which in reality is nothing other than an extrapolation

of trends into the future. This way, speculation on excessively

high returns can support itself – for a while. Many agents

disposing of large amounts of (frequently borrowed) money bet on

the same “plausible” outcome (such as steadily rising prices of

real estate, oil, stocks or currencies). As expectations are

confirmed by the media, so-called analysts and policymakers,

betting on ever rising prices appears rather risk-free, not reckless.

Contrary to the mainstream view in the theoretical

literature in economics, speculation of this kind is not stabilizing;

on the contrary, it destabilizes prices. As the “true” price cannot

possibly be known in a world characterized by objective

uncertainty, the key condition for stabilizing speculation is not

fulfilled. Uniform, but wrong, expectations about long-term price

trends must sooner or later hit the wall of reality, because funds

have not been invested in the productive capacity of the real

economy, where they could have generated increases in real

income. When the enthusiasm of financial markets meets the

reality of the – relatively slow-growing – real economy, an

adjustment of exaggerated expectations of actors in financial

markets becomes inevitable.

In this situation, the performance of the real economy is

largely determined by the amount of outstanding debt: the more

economic agents have been directly involved in speculative

activities leveraged with borrowed funds, the greater the pain of

deleveraging, i.e. the process of adjusting the level of borrowing to

diminished revenues. As debtors try to improve their financial

situation by selling assets and cutting expenditures, they drive

asset prices further down, cutting deeply into profits of companies

and forcing new “debt-deflation” elsewhere. This can lead to

deflation of prices of goods and services as it constrains the ability

to consume and to invest in the economy as a whole. Thus, the

attempts of some actors to service their debts make it more

Report by the UNCTAD Secretariat Task Force on Systemic Issues and

Economic Cooperation: Executive summary


difficult for others to service their debts. The only way out is

government intervention to stabilize the system by “government

debt inflation”.

* * *

It is instructive to recall the end of the Bretton Woods

system, under which the world had enjoyed two decades of

prosperity and monetary stability. Since then, the frequency and

size of imbalances and of financial crises in the world economy

have dramatically increased, culminating in the present one. Since

current-account imbalances are mirrored by capital account

imbalances, they serve to spread quickly the financial crisis across

countries. Countries with a current-account surplus have to credit

the difference between their export revenue and their import

expenditure to deficit countries, in one form or another. The

dramatic increase of debtor–creditor relations between countries

also has to do with the way in which developing economies

emerging from financial crises since the mid-1990s tried to shelter

against the cold winds of global capital markets.

Financial losses in the deficit countries or the inability to

repay borrowed funds then directly feed back to the surplus

countries and imperil their financial system. This channel of

contagion has particularly great potency in today’s world, with its

glaring lack of governance of international monetary and financial

relations. Another important reason for growing imbalances is

movements of relative prices in traded goods as a result of

speculation in currency and financial markets, which leads to

considerable misalignments of exchange rates. Speculation in

currency markets due to interest rate differentials has led to

overspending in the capital-receiving countries that is now

unwinding. With inward capital flows searching for high yield, the

currencies of capital-receiving countries (with higher inflation and

interest rates) appreciated in nominal and in real terms, leading to

The Global Economic Crisis: Systemic Failures and Multilateral Remedies


large movements in the absolute advantages or the level of overall

competitiveness of countries vis-à-vis other countries.

The growing disconnection of the movements of nominal

exchange rates with the “fundamentals” (mainly the inflation

differential between countries) has been a main cause of the

growing global imbalances. For rising economic welfare to be

sustainable, it has to be shared without altering the relative

competitive positions of countries. Companies gaining market

shares at the expense of other companies are an essential

ingredient of the market system. But if nations gain at the expense

of other nations because of their superior competitive positions,

dilemmas can hardly be avoided. If the “winning” nations are not

willing to allow a full rebalancing of competitive positions over

the long run, they force the “loser” nations into default. This is a

phenomenon that J. M. Keynes some 80 years ago called the

“transfer problem”; its logic is still valid.

In addition to all these factors, overshooting of commodity

prices led to the emergence of – partly very large – current-

account surpluses in commodity-exporting countries over the past

five years. When the “correction” came, however, the situation of

many commodity producers in the poorer and smaller developing

countries rapidly deteriorated. There is growing evidence that

financialization of commodities futures markets played an

important role in the scale and degree of market volatility. Prices

in many physical markets for commodities can be driven up by the

mere fact that everybody expects higher prices, an expectation that

may itself be the result of futures prices that are driven up by shifts

of speculative power between financial markets, commodity

futures and currency markets.

* * *

The global financial crisis arose amidst the failure of the

international community to give the globalized economy credible

global rules, especially with regard to international financial

Report by the UNCTAD Secretariat Task Force on Systemic Issues and

Economic Cooperation: Executive summary


relations and macroeconomic policies. The speculative bubbles,

starting with the United States housing price bubble, were made

possible by an active policy of deregulating financial markets on a

global scale, widely endorsed by Governments around the world.

The spreading of risk and the severing of risk – and the

information about it – were promoted by the use of

“securitization” through instruments such as residential

mortgages-backed securities that seemed to satisfy investors’

hunger for double-digit profits. It is only at this point that greed

and profligacy enter the stage. In the presence of more appropriate

regulation, expectations on returns of purely financial instruments

in the double-digit range would not have been possible.

With real economic growth in most developed countries at

under 5 per cent, such expectations are misguided from the

beginning. It may be human nature to suppress frustrations of the

past, but experts, credit rating agencies, regulators and policy

advisors know that everybody cannot gain above average and that

the capacity of the real economy to cope with incomes earned

from exaggerated real estate and commodity prices or misaligned

exchange rates is strictly limited. The experience with the stock

market booms of the “new economy” should have delivered that

lesson, but instead a large number of financial market actors began

to invest their funds in hedge funds and “innovative financial

instruments”. These funds needed to ever increase their risk

exposure for the sake of higher yields, with more sophisticated

computer models searching for the best bets, which actually added

to the opaqueness of many instruments. It is only now, through the

experience of the crisis, that the relevance of real economic

growth and its necessary link to the possible return on capital is

slowly coming to be understood by many actors and policymakers.

The crisis has made it all too clear that globalization of

trade and finance calls for global cooperation and global

regulation. But resolving this crisis and avoiding similar events in

the future has implications beyond the realm of banking and

The Global Economic Crisis: Systemic Failures and Multilateral Remedies


financial regulation, going to the heart of the question of how to

revive and extend multilateralism in a globalizing world.

* * *

In financial markets, the similarity of the behaviour of

many financial market participants and the limited amount of

information that guides their behaviour justify considerably

greater government intervention. Contrary to atomistic goods and

services markets and the colossal quantity of independent data that

help form prices, most of the information that determines the

behaviour of speculators and hedgers is publicly accessible and the

interpretation of these data follows some rather simple explanatory

patterns. Neither market participants nor Governments can know

equilibrium prices in financial markets. But this is not a valid

argument against intervention, as we have learnt now that

financial market participants not only have no idea about the

equilibrium, but their behaviour tends to drive financial prices

systematically away from equilibrium. Governments do not know

the equilibrium either, but at some point they are the best

positioned to judge when the market is in disequilibrium,

especially if functional/social efficiency is to be the overriding

criterion of regulation.

If the failure of financial markets has shattered the naïve

belief that unfettered financial liberalization and deliberate non-

intervention of Governments will maximize welfare, the crisis

offers an opportunity to be seized. Governments, supervisory

bodies and international institutions have a vital role, allowing

society at large to reap the potential benefits of a market system

with decentralized decision-making. To ensure that atomistic

markets for goods and for services can function efficiently,

consistent and forceful intervention in financial markets is

necessary by institutions with knowledge about systemic risk that

requires quite a different perspective than the assessment of an

individual investor’s risk. Market fundamentalist laissez-faire of

Report by the UNCTAD Secretariat Task Force on Systemic Issues and

Economic Cooperation: Executive summary


the last 20 years has dramatically failed the test. A new start in

financial market regulation needs to recognize inescapable lessons

from the crisis, such as:

¾ Financial efficiency should be defined as the sector’s ability to
stimulate long-term economic growth and provide

consumption smoothing services. A key objective of

regulatory reform is to devise a system that allows weeding

out financial instruments which do not contribute to

functional, or social, efficiency;

¾ Regulatory arbitrage can only be avoided if regulators are able
to cover the whole financial system and ensure oversight of all

financial transactions on the basis of the risk they produce;

¾ Micro-prudential regulation must be complemented with
macro-prudential policies aimed at building up cushions

during good times to avoid draining liquidity during periods of


¾ In the absence of a truly cooperative international financial
system, developing countries can increase their resilience to

external shocks by maintaining a competitive exchange rate

and limiting currency and maturity mismatches in both private

and public balance sheets. If everything else fails, back-up

policies, such as market-friendly capital controls, can limit

risk accumulation in good times;

¾ Developing countries regulators should develop their financial
sectors gradually in order to avoid the boom-and-bust cycle;

¾ Regulators based in different countries should share
information, aim at setting similar standards and avoid races to

the bottom in financial regulation.

As for the growing presence of financial investors on

commodity futures exchanges, several immediate areas are

suggested for improved regulation and global cooperation:

The Global Economic Crisis: Systemic Failures and Multilateral Remedies


¾ Comprehensive trading data reporting is needed in order to
monitor information about sizeable transactions in look-alike

contracts that could impact regulated markets, so that

regulators can understand what is moving prices and intervene

if certain trades look problematic;

¾ Effective regulatory reform should also close the swap dealer
loophole to enable regulators to counter unwarranted impacts

from over-the-counter markets on commodity exchanges.

Therefore, regulators should be enabled to intervene when

swap dealer positions exceed speculative position limits and

may represent “excessive speculation”;

¾ Another key regulatory aspect entails extending the product
coverage of detailed position reports of United States-based

commodity exchanges and requiring non-United States

exchanges that trade look-alike contracts to collect similar

data. Stepped-up authority would allow regulators to prevent

bubble-creating trading behaviour from having adverse

consequences for the functioning of commodity futures


¾ Renewed efforts are needed to design a global institutional
arrangement supported by all concerned nations, consisting of

a minimum physical grain reserve (to stabilize markets and to

respond to emergency cases and humanitarian crises) as well

as an intervention mechanism. Intervention in the futures

markets should be envisaged when a competent global

institution considers market prices to differ significantly from

an estimated dynamic price band based on market

fundamentals. The global mechanism should be able to bet

against the positions of hedge funds and other big market

participants, and would assume the role of “market maker”.

In a globalized economy, interventions in financial

markets call for cooperation and coordination of national

institutions, and for specialized institutions with a multilateral

Report by the UNCTAD Secretariat Task Force on Systemic Issues and

Economic Cooperation: Executive summary


mandate to oversee national action. In the midst of the crisis, this

is even more important than in normal times. The tendency of

many Governments to entrust to financial markets again the role

of judge or jury in the reform process – and, indeed, over the fate

of whole nations – would seem inappropriate. It is indispensable to

stabilize exchange rates by direct and coordinated government

intervention, supported by multilateral oversight, instead of letting

the market find the bottom line and trying to “convince” financial

market participants of the “credibility of policies” in the

depreciating country, which typically involves pro-cyclical

policies such as public expenditure cuts or interest rate hikes.

The problems of excessive speculative financial activity

have to be tackled in an integrated fashion. For example, dealing

only with the national aspects of re-regulation to prevent a

recurrence of housing bubbles and the creation of related risky

financial instruments assets would only intensify speculation in

other areas such as stock markets. Preventing currency speculation

through a new global monetary system with automatically

adjusted exchange rates might redirect the speculation searching

for quick gains towards commodities futures markets and increase

volatility there. The same is true for regional success in fighting

speculation, which might put other regions in the spotlight of

speculators. Nothing short of closing down the big casino will

provide a lasting solution.