An expert on financial derivatives and risk management, Satyajit Das, has worked on both the sell and buy sides of the derivatives business for over 30 years. He is the author of a number of key reference works on these subjects. He is also the author of “Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives”. It has been described by the Financial Times, London as “fascinating reading ... explaining not only the high-minded theory behind the business and its various products but the sometimes sordid reality of the industry”.
Winston Churchill famously observed that “We shape our buildings; thereafter they shape us”. Global finance, a human creation generally assumed to be a munificent agent of prosperity, has shaped the age of capital.
Historically, emerging countries, like India, were colonial properties. ‘El-Dorado economics’, as practised by developed nations, emphasised conquest and exploitation of natural resources of their colonies. Following decolonisation, emerging countries gained independence but remain, for the most part, sources of cheap resources, labour and (in some cases) capital or markets for Western goods. This is ‘El-Dollardo economics’, the world of globalised trade and capital flows, which shapes India in ways that are complex and not always beneficial.
Integration into the global financial system reduces a country’s economic sovereignty, increasing vulnerability to external developments and the effects of policy decisions of foreign nations outside its control.
A key element is reliance on global capital flows for financing. These flows are notoriously fickle as the Asian monetary crisis of 1997/1998 demonstrated. The crisis encouraged countries like China and India to build large foreign exchange reserves as protection against the destabilising volatility of short-term foreign capital flows. But the build-up of foreign reserves became a liquidity creation scheme, where the money was lent back to developed countries. Purchase of government securities, primarily US treasury bonds, helped keep US interest rates low, encouraging debt fuelled consumption, contributing to housing and stock market bubbles. Foreign currency reserves of emerging nations, a large proportion denominated in dollars, now have limited value as they cannot be liquidated or mobilised without large losses.
In the aftermath of the global financial crisis, the US and other developed nations issued massive amounts of debt and followed policies to weaken their currencies. The resultant fall in the value of Treasury bonds and the dollar has reduced the purchasing power of hard earned savings and reserves of emerging economies illustrating another side of global finance.
The low dollar and zero interest rate policies pursued by developed nations have led to rise in commodity prices creating inflation, which, in turn, has destabilised emerging economies.
Killing You Slowly or Quickly
Motivated by high profit margins, global financiers introduce complex products into local market settings. The inadequate expertise and experience of local corporations, investors and regulators results in entry into inappropriate transactions that create unknown risks.
Complex currency derivatives, supposedly ‘hedges’, have led to substantial losses. IMF estimates suggest that as many as 50,000 companies in at least 12 countries lost as much as $530 billion. Many Indian companies, including small and medium sized businesses, together with firms in Korea, Taiwan, China, Philippines, India, Eastern Europe and Latin America, have suffered large losses.
Asian investors also suffered large losses from complex investment products created and sold by international financial institutions, often through local banks. Investors found that equity accumulators (known to dealers as ‘I will kill you later’) kill sooner not later. Minibonds, created and sold by Lehman Brothers, have generated minimum returns and maximum losses.
Global finance requires emerging nations to become ‘embedded’, adopting uniform banking regulations and allowing institutions to freely enter into transactions.
Regulations developed for and influenced by large financial institutions are rarely appropriate for the needs of smaller, less financialised nations. Such regulations inevitably promote the interests of large multinational banks, which have significantly competitive advantages over smaller, less sophisticated local institutions.
During crises, identical regulatory regimes, standard risk metrics, similar business models and complex links between financial institutions can transmit shocks rapidly, destabilising emerging economics, not directly affected by the problems.
Breaking the Circuit