14 February 2010

Negative resilience in the global financial system

The Review section of The Australian Financial Review, Friday 12 February contains an excellent essay, Rethinking riches: time to put poor nations first, by Professor Ross Buckley, a professor of law at the University of New South Wales, and an expert on global trade and finance.

Professor Buckley considers the operation of the global financial system from the technical perspective of resilience, a concept that derives from systems science and measures the capacity of a system to regain its function and identity after an external shock. He argues that the global financial system is highly resilient, in the negative sense of being resistant to necessary change. He states:

The global financial system is functional from the perspective of Organisation for Economic Co-operation and Development countries and the international commercial banks, and quite dysfunctional from the perspective of developing countries. But it is highly resilient.

Even the Global Financial Crisis (GFC) has so far led to little substantive change in the system which produced it. ...

In addressing why this should be so, Professor Buckley says:

 So why is a system that for so many of its participants is deeply dysfunctional, so resilient? The answer lies in who the current system serves, and the general paucity of knowledge, outside those it serves, about how it works and its consequences.

Resilience science teaches that strongly resilient systems have healthy feedback loops.

The principal feedback loops in global financial governance are that the system rewards international commercial banks and the elites within nations, at the expense of the common people in those countries.

Professor Buckley illustrates this proposition with the example of Indonesia after the Asian economic crisis of 1997:

 ... the International Monetary Fund (IMF) and the foreign commercial banks insisted Jakarta assume the obligations of the local banks to foreign lenders and then recover the funds from the local banks, if necessary by selling their assets. As was entirely predictable in the case of Indonesia, recovery proved difficult, and only about 28 per cent of the total liabilities assumed were recovered. Almost three quarters of the cost of repaying foreign loans was borne by the Indonesian people. Yet there was no reason for Indonesia to assume responsibility for these loans. The market mechanism, if left to work, would have seen many of these banks placed into bankruptcy by their Western creditors who would have received a proportion (presumably about 28 per cent) of their claims in the bankruptcy proceedings. Instead the insolvent local banks were put into bankruptcy by Indonesia, the creditors were repaid in full, and the Indonesian people wore most of the cost of the repayment. The funds to repay the creditors came from the long-term loans organised by the IMF and invariably described as bailouts of the debtor nations. Yet the terms of these loans required they be used to repay outstanding indebtedness so the bailouts were of the foreign banks. In Indonesia, the IMF co-ordinated a massive socialisation of private sector debt.

Professor Buckley goes on to discuss changes to the global financial system which he says would make it fairer, reduce the extent to which it favours the powerful, and disempower the feedback loops that make the current system so resistant to change.

Professor Buckley’s essay is taken from Resilience and Transformation: Preparing Australia for Uncertain Futures, Steven Cork ed., CSIRO Publishing, 2010.

A conference on Shaping Australia’s Resilience, hosted by Australia 21 (www.australia21.org.au) will be held in Canberra on 18-19 February. Conference program is available here, registration form available here.

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