A Giant Sucking Sound: The Financial Multipliers of Globalism

 

Takeaway

  • Efforts are being made to prevent European bank meltdowns from taking down valuations of the rest of the world’s financial assets
  • Highly leveraged banks are being forced to sell their troublesome assets, much of which is government debt

Federal Reserve Chairman Bernanke testified this week that “the situation in Europe poses significant risks to the U.S. financial system and economy.” This indicates the extent to which financial globalism has become a controlling factor in U.S. economic and financial prospects and policy.

While globalism wasn't supposed to have that level of influence, there was a memorable warning in the great North Atlantic Free Trade Agreement (NAFTA) debate of 1992. As it was conceived of at the time, globalism meant trade rather than finance, and the costs and benefits became a presidential campaign issue. It was at that time that Ross Perot famously associated globalism with a “giant sucking sound” of jobs being lost to low-wage countries.

Today, the issue is not trade but financial globalism, and all efforts are being made to contain Euro bank meltdowns from also taking down the rest of the world’s financial asset valuations.

This is not easy when Euro banks are highly leveraged — that is, funded by short-term financial claims such as deposits or Repo loans that can and do run without notice. This forces the sale of the banks’ troublesome assets, not just for liquidity but to also to downsize the book of assets that can only be a fixed multiple of the bank’s declining net worth.

That all fits the description of a financial crisis, but the crisis is even more severe when the bank's questionable assets are government debt. The forced selling only makes it more transparent that the government is nearly insolvent and can't backstop the bank’s insolvency as well.

This unstable equilibrium is destabilized one step further when other arm-twisted governments are coerced into seeking bailout aid, because the costs of the spreading financial meltdown exceed the bailout costs. So the implication of financial globalism is indeed the giant sucking sound of sapping resources across the globe into a financial black hole which used to be called Greece, Ireland and Portugal but now also includes Spain.

Read the full version of this article on Dr. Spellman’s blog, The Spellman Report.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.

About The Author

Lew Spellman

Professor, Department of Finance, McCombs School of Business, The University of Texas at Austin

Lewis Spellman received his BBA and MBA from the University of Michigan and his MA and Ph.D. from Stanford University. His research interests include...

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