Reviews & Comments
05.08.09

The Report animates ideas

Author: Sergey Storchak, Deputy Minister of Finance of the Russian Federation

The study of the Postcrisis World Institute is worth special attention. I think that highlighting two of the many merits of this treatise would be enough.

First, its timely analysis, which has been done, as the saying goes, in “hot pursuit”. Unfortunately, such efficiency has not yet become the norm for the Soviet Union and Russian schools of economics.  Second – in a good sense – it’s provocative questioning. The report excites, actually forcing the reader to argue with the authors, even in absentia. I guess one can only dream of such a research result.

At the same time, I’d like to share some assessments and notes of my own that I hope might reasonably be considered constructive friendly criticism, which is extremely important for moving forward in future studies. I would particularly like to offer a comment concerning the Institute’s assessment of the G20 decision making process.  At my request, the International Finance Department of the Russian Financial Ministry has produced the actual mechanism by which summit decisions are reached – which demonstrates that the working groups have been comprised of the Ministers of Finance, not the heads of state. It was their ministers who have been approving the agenda and the documents, although the texts could have been developed in other multipartite sites. Underestimating the role of the Ministers’ of Finance process has led to overestimation of the actual role of the CFF (Construction Financing Fund).

In fact, the Forum has not fulfilled the tasks that were assigned to it in 1999 and, therefore, it has been transformed into the FSB (Financial Stability Board). But the value of this new structure also should not be overestimated. Unlike the IMF (International Monetary Fund), BIS (Bank for International Settlement) and OESD (Organization for Economic Cooperation and Development) the Board being created is, in essence, nothing more that a club whose members are professional financiers and/or regulators, while the aforementioned IMF, BIS and OECD are international organizations whose members are sovereign states. In the draft charter of the FSB, this union is modestly designated as “an international body of financial authorities, standard setting bodies and international financial institutions”.

Furthermore, let’s talk about the reasons for the crisis.

It seems to me that our positions on the causes of the today’s crisis are very similar. Of course, the announced assessment is just an opinion.  Nevertheless… In my opinion, the fundamental cause of the current global crisis is a huge gap between the financial services sector and other economic sectors: industry, transport, agriculture, etc. Moreover, as financial relationships began reproducing themselves across an enormous range, financial institutions nearly stopped serving their traditional role as intermediaries between producers and consumers of goods and services. In any case, in the last decades this role has relatively decreased. This specific feature “infected” both national and international financial relations and the latter increasingly affected not just international, but multilateral financial relations.

No other sector of the economy has technologically changed so much as the financial services sector. Not only mass consumers do not understand electronic money as a measure of value, although they almost won retail now (it happened with corporate finance a long time ago), but, moreover, the product lines proposed by modern financial intermediaries grew to the size that no manager is able to oversee them. Look at the work in the methodological “fixed income market”. These are the “bricks” at 500-1000 pages. Only the list of the bond loans has dozens of positions.
This change in the nature of financial institutions and their relations with the market has produced what I call the self-reproduction of financial relations where, in a sense, the financial industry began to exist by itself, afloat on different kinds of “bubbles (that eventually burst).  That’s when the self-devouring process started that led to the crisis…first in the banking sector, which then could do nothing but spill over to other economic sectors, as their normal existence and development without a financial intermediary is not promising.

The lack of balance in national income distribution is also tightly linked to the financial services “breakaway” from the other sectors of economy. It turned out that the funds left those who were supposed to use them for buying basic products and services for those who had much more money than they were  able to spend. All these factors, on the one hand, created a tendency to develop all kinds of financial innovations and, on the other hand, they have led to a global reduction in demand, which the G20 countries undertook to stimulate. Time will show what comes out of it.

Some thoughtful remarks:

- I can’t agree with the Institute’s conclusion that capital from developing countries “flows into the markets of developed countries.” First of all, it’s not capital, meaning value, which can bring an added-value that “leaves” the group of states, yielding in its development of industrialized countries, but the money accumulated in their banking/financial systems for one reason or another. These funds are not being used as capital simply because the absorptive capacities of the national economies remain very low, and investments in their projects and instruments stay extremely risky. Second of all, the generalization made by the Institute, in my opinion, is not entirely correct. Money overflows emerged, as correctly noted in the study, in 1999; that is, when a steady rise of commodity prices began, especially oil price. It was the “petrodollars” overflows that shaped that particular situation, discussed by many experts. But again, we’re talking about the funds overflow, not capital.

- The Institute’s position that we live in a single currency international financial system is also hard for me to accept. The Russian Reserve Fund and the national welfare fund are placed in financial instruments denominated in three currencies: USD (45%), euro (45%) and pounds sterling (10%).  What is the single currency here? If one doesn’t like the US dollar, why doesn’t he use the ruble or the Swiss franc? Is it restricted by someone? This is not the case. No good contriver will keep his reserves in a substance that might be spoiled. In this regard, the situation with the choice of reserve currency is no different from the choice of food grains kept as the inviolable strategic reserve. For example: as you know, only solid varieties of grains are ok for these purposes. With all the disadvantages of gold currency reserve (or other reserves) stored in US dollars, there is nothing better at the moment and we have to live with that.

- As to the country ”weight” estimation in international financial discussions…
I don’t think I can agree with such a conclusion as a matter of principle. Members of “discussions” are persons – citizens of certain countries. This is a very important element of multilateral policy and diplomacy. If the press is comfortable with using the “country” category while speaking of country proposals (“innovations”), this approach appears to be insufficient when handling scientific studies. My personal experience of G8 and G20 discussions testifies that, in fact, the “country” behaves the way the Head of delegation wants to. Change of the team often has serious consequences in the positioning of any country’s delegation in multilateral forums. The only exceptions are delegations of two or three industrialized countries that obviously have a strong tradition (based on their) civil service organization and established doctrine regarding national interests. Countries with emerging markets, including Russia, can not yet brag about this.
- Effectiveness via fairness of ICFS

Perhaps, from a philosophical point of view, such a question has a right to exist. However, in terms of real politics, in terms of informed decision making, such a contradistinction is hardly appropriate. From my own experience, I know for sure that the “fair treatment” principle has a right to exist and is actually used by the Paris Club of Creditors. But even in this case, “fairness” is one thing for the creditors and another for the debtors. Concerning the ICFS effectiveness or ineffectiveness assessments, we should agree on the criteria. With the global financial crisis, there are many willing to throw stones into this system. But what would happen with the economy of Korea Republic, for example, if the post 1971 ICFS would have been ineffective?

In my opinion, the critical assessment of Russia’s participation in G20 decision making is brought too abruptly in the Report. Draft documents of all four groups have been seriously treated in the Ministry of Finance and the Bank of Russia. Concerning the relatively small representation in certain multilateral forums, this, in my opinion, simply reflects the degree of our country’s financial system’s involvement in the ICFS. A lot of G20 tasks in the frames of the first and the second working groups are not really relevant for us yet. This dictates the (degree of) involvement in their discussions.

In conclusion, I’d like to wish the Institute and you personally the greatest creative success.

Post-Crisis World Institute