Financial Globalization

MEMORANDUM / POLICY BRIEF

Introduction

Financial globalization - like trade in goods and services - is not new. Indeed, it has been with us for centuries. Financial globalization has, over the very long run, experienced extended intervals of very rapid growth and intervals of sharp contraction. These relatively long cycles have typically been driven by powerful and multiyear economic, technological, political, and financial trends that, for the most part, contributed to economic growth and rising standards of living. However, we have also witnessed events, including infrequent but very costly systemic financial meltdowns that have impaired the global system of financial intermediation and called into question the benefits and the future of financial globalization.

These infrequent but major systemic financial meltdowns have triggered cumulative declines in economic activity which, in turn, has resulted in contractions in financial intermediation especially on the part of internationally active financial institutions and markets.

As we have seen in the recent past, build-ups in adverse financial forces having contagion elements tend to amplify the consequences of the initial financial shocks.

Not surprisingly, these events also trigger powerful political and public demands for financial and regulatory reform - a phenomenon that is very much in evidence in much of the world today.

Analysis

To finance its large current account deficit, the United States must follow the following:

Attract the equivalent amount of surplus foreign savings; the U.S. deficit has been large enough to absorb the lion's share of surpluses generated abroad.

Indeed, from 1999 through 2006, the cumulative U.S. borrowing of $4.4 trillion amounted to some 85 percent of the net external financing provided by countries with surplus saving.

Despite heavy borrowing, the United States has been the destination for little more than 30 percent of total gross cross-border investments by other countries, a figure that only slightly exceeds the U.S. share of global GDP and is below the U.S. weight in global financial portfolios.

As a result, the United States has been able to finance its large current account deficits without laying claim to a disproportionate share of global foreign investment or causing foreign external portfolios to become dominated by U.S. assets.

Financial Globalization and the U.S. Current Account Deficit

We are at risk of recreating national financial silos, a system in which resources are inefficiently allocated and the costs of doing business are artificially high. The current sovereign debt problems of the euro area and the consequent questions about the safety and soundness of a number of European banks are raising the threat of financial compartmentalization. The risks of providing inter-bank funding across borders or of relying on this as a funding strategy are rising, and the conditions that appeared in late 2007 could return. But there are other forces at work against global finance:

Concerns about the liquidity and solvency of foreign banks in the wake of the Lehman collapse have led regulators around the world to put in place liquidity requirements on foreign branches and other regulatory requirements that make a global branch system less of a network and not much ...