The news on the international economic slowdown for this week is not any better than it was last week. It is becoming increasingly evident that the recession is more the result of extremely negative business and consumer sentiment, than an actual lack of purchasing power.
This is more so since the rate of inflation is definitely pointing downwards. The negative sentiment has caused a drop in demand and this in turn is causing job losses and a sliding further down into the recession.
The declarations made by key political leaders such as Gordon Brown and Barack Obama, as well as the messages that have been sent from the annual economic forum of Davos, all indicate that there needs to be a strong pick up of business and consumer confidence.
It is also fairly clear that banks have not as yet got to grips with their own situation and with the situation in general and therefore are more wary than ever in extending credit. The bailout money provided by governments was used to plug some of the wholes in their balance sheets and not to ease the credit crunch as had been hoped. Some of the bailout money even went into bonuses for senior executives.
Thus, irrespective of what economic thinking may or may not prevail at present, there are those who are clamouring not just to have better regulation of the financial services sector all over the world, but also to bring both retail and investment banks under some form of state control.
These measures all sound very drastic and beg some questions. How big is the international financial services sector? How did it grow to this extent?
Why did the situation get out of hand?
This giant seems to have a life of its own, different from that of the rest of the economy, so much so that analysts refer to the financial sector as distinct from the real economy. Does this mean that the financial sector is all surreal?
One figure says it all. It is estimated that in 2007 the global financial system (equity, bonds and bank deposits, all three in their various forms) was worth just under $200 trillion (that is two with fourteen zeroes after it), which represented 3.6 times the gross domestic product produced by the whole world. However, there are more figures that indicate the extraordinary growth of this sector. In 2007, it grew by 15 per cent compared to an average annual growth rate of around nine per cent in the previous 15 years. Twenty years ago government bonds represented 18 per cent of the global financial system, while today they represent only 14 per cent.
Ten years ago there were eleven countries whose financial system was over 3.5 per cent of their gdp. Today, there are around 25 countries in this situation. Capital flows from one country, in the form of loans and deposits (driven by the internationalisation of banks, insurance companies, hedge funds, private equity firms and the like) increased by 19 per cent in 2007 over 2006. In terms of cross border loans, as much as two-thirds of it, had a due date of less than 12 months, and so was very susceptible even to the smallest of downturns in the economic cycle.
What does this data indicate? It needs to be remembered that most of this so-called wealth was in paper form and not in the form of physical assets and hence the risks proved to be definitely greater, especially since it appears no one knew what that commercial paper was really worth. The growth in the financial system is largely attributable to the increasing role that the private sector is taking in the global economy.
What has fuelled this growth in the increasing ease with which capital is moved around the world. The International Labour Organisation did warn some 15 years ago that the ease with which capital moves around the world will eventually cause a crisis in employment.
However, what is even more worrying is that one can no longer speak of any significant distinction between the financial sector and the real economy. In the last years, consumer spending rose more as a result of people feeling richer (thanks to higher property and equity prices) than as a result of people producing more and earning more.
One last thought about the woes of this giant global financial sector. A study by the International Monetary Fund shows that historically, economic recessions caused by a crisis in the banking system are deeper than other forms of recessions.