Global Finance

B

The Global Governance Report Card grades international performance in addressing today's most daunting challenges. It seeks to inspire innovative and effective responses from global and U.S. policymakers to address them.

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Subject

  • Good

    Managing Financial Crises

    After the financial crisis struck, states took a number of steps to bolster flailing economies. As a temporary bandage, the International Monetary Fund (IMF) created the Short-Term Liquidity Facility in October 2008 to help provide capital to countries "with strong economic policies that are facing temporary liquidity problems." The IMF also coordinated emergency financing for fourteen states. Four months later, the G20 pledged $250 billion in trade financing to boost the world economy and tripled the resources of the IMF so that it could disburse bigger loans and prevent critical economies from collapsing. (These funds became available in March 2011 through the IMF New Arrangements to Borrow.) However, eurozone members still squabbled over how to fix the structural problems underpinning the eurozone crisis while forcing excessive austerity on states that received bailouts.

    Another important policy move was the growth of crossborder central bank swaps to prevent banks from freezing short-term credit lines. The United States, the United Kingdom, Japan, the European Central Bank, and Switzerland agreed to unlimited currency swaps to avert currency and solvency crises in 2008. That same year, the U.S. Federal Reserve offered currency swap arrangements to Brazil, Singapore, Mexico, and South Korea as well. By the fall of 2008, the U.S. Federal Reserve had provided roughly $600 billion of these currency swaps—most of which were paid down already. Again, in November 2011, the United States, as well as the central banks of Canada, England, Japan, and Switzerland, announced dollar liquidity swaps in order to provide a lifeline to floundering eurozone banks.

    Together, these coordinated global actions since 2008 contributed to remarkable rebounds of important economic indicators, even after initial shocks that were more disastrous than those of the 1929 financial crisis. For example, global foreign investment assets rebounded to $96 trillion per year in 2011—5 percent higher than precrisis levels. Furthermore, given the drastic plunge in world trade volumes in 2008, trade flows could have been expected to be 25 percent lower than precrisis levels, as they were four years after the start of the Great Depression—but instead, global trade volume increased by 5 percent.

    Meanwhile, the eurozone crisis escalated significantly from 2010 to 2012. European leaders attempted to cobble together difficult political compromises to help support the monetary union with more coordinated fiscal policy. These include the European Stability Mechanism (ESM), which, despite delays, issued bonds for the first time in December 2012. Furthermore, leaders agreed in October 2012 to establish a Single Supervisory Mechanism housed in the ECB to monitor banking risks and reduce crossborder contagion. This new supervisory power will allow the ESM to recapitalize banks directly.

  • GOOD

    Coordinating Macroeconomic Policies and Exchange Rates

    The world's biggest economies made halting progress to coordinate policies to expand growth and correct underlying structural flaws that could lead to another crisis. In October 2008, the United States, the United Kingdom, the European Union, and China implemented a round of coordinated interest rate cuts to head off a liquidity freeze. The United States, European Central Bank, and United Kingdom since enacted monetary easing. In industrialized states, central banks more than doubled their lending. These moves served as a "global stimulus" and, according to the Bank for International Settlements, were "crucial" to staving off a steeper recession.

    Perhaps most striking, dire predictions of protectionist trade war escalations proved wrong. Taken together, the few protectionist measures that states did enact in 2008 "affected less than 0.8 percent of global trade." International trade flows recovered, and even surpassed precrisis levels by 2012. In contrast, after the 1929 stock market crash, trade flows plummeted by 25 percent four years after the crisis began.

    Meanwhile, progress on exchange rates and global imbalances was greater than anticipated. The Group of Twenty's (G20) 2009 Framework for Strong, Sustainable, and Balanced Growth (Pittsburgh Framework) tasked [PDF] the International Monetary Fund (IMF) to monitor and support domestic implementation of the framework through the Mutual Assessment Process (MAP). This cooperation signaled an important shift [PDF]: previously, assessments by the IMF excluded analysis of international spillovers resulting from national policies. In 2011, at the Cannes summit, the G20 reached agreement on "key indicators" and "indicative guidelines" that the MAP would evaluate, and at the 2012 Los Cabos summit, the group established the Accountability Asessment Framework to bolster peer review under the MAP.

    The United States also used the G20 to pressure China to loosen control over its exchange rate. In June 2010, U.S. President Barack Obama submitted a letter to the G20 underscoring the importance of "market-determined exchange rates." Three days later, China announced that it would enhance the flexibility of the RMB exchange rate. Subsequently, the RMB nominally appreciated at a rate of 5 percent in 2010 and 2011. In October 2012, the RMB's value hit 6.285 against the dollar for the first time, a nineteen-year low. In real terms, China's appreciation is even more marked, since its inflation rate is higher than that of its main trading partners. In consequence, China's current account surplus came down from 10 percent of GDP at the start of the crisis, in 2007, to a forecast 2.1 percent in 2012. The largest economic imbalance in the global system substantially diminished.

    Nevertheless, the G20 relegated the MAP to the back burner at both Cannes and Los Cabos and the process is now stalled. G20 states also continued to resist an independent role for the IMF that would entail true "naming and shaming" of countries that do not meet the objectives laid out in the Pittsburgh Framework. Leaps forward by the G20 since the financial crisis began in 2008 earned it praise, but as noted above, the forum should fight to maintain momentum.

  • AVERAGE

    Regulating Financial Institutions, Bank Capital, and Liquidity

    In response to the banking crisis, states joined together to regulate bank capital and liquidity—recognizing that ineffective rules and enforcement contributed to the financial crisis and that no single country could enact regulations to address underlying structural problems unless other countries agreed to impose similar regulations on their banks. First, leaders from the Group of Twenty (G20) states reinvigorated the Financial Stability Forum with a broader membership and mandate under the Financial Stability Board (FSB). The FSB coordinates the central banks and financial regulatory agencies from the G20 states, their counterparts from five additional countries, and numerous experts from intergovernmental organizations to implement effective financial policies. It is an important forum for the supervisors of global banking to coordinate policy. As endorsed [PDF] at the G20 summit in Seoul, the FSB also released important reports, such as a list of twenty-nine "systemically important financial institutions" (SIFIs) deemed critical to the global economy, and contingency plans if banks fail. The SIFIs were required to complete a resolution-planning process, popularly called "living wills." These plans sought to help bank regulators wind down complex financial institutions when they fail, reducing the temptation to prop them up with public money. At the same time, the exercise of creating living wills may encourage more responsible banking operations. Though the announcements were monumental, it remained too soon to tell whether they would actually moderate the conduct of banks or of governments if they fail.

    Central bank governors from twenty-seven of the world's biggest economies also agreed in September 2010 to a new set of banking regulations, Basel III. These regulations require banks to hold more than triple the previous amount of equity capital. This established a buffer to prevent collapse of a bank when investments go sour—and although the result may be marginally higher interest rates for banks' customers, there will be a negligible impact on growth [PDF]. Basel III perhaps should have required banks to set aside more capital in light of their continuing risky practices, but the current standard represents solid progress. Given that countries struggled for six years to negotiate Basel II, the fact that Basel III standards took only two years to negotiate demonstrated extraordinary cooperation at a pivotal moment in global finance. If faithfully implemented by the 2019 deadline, these new regulations will reduce the likelihood of another banking collapse like the one that rocked the global economy in 2008.

    In the aftermath of the financial crisis in 2008, financial coordination to fill the regulatory gaps the crisis exposed was impressive. G20 commitments to require oversight of derivatives were matched by progress toward implementation in both the United States and the European Union. Major G20 states also followed through on pledges to address perverse incentives in compensation practices for executives of financial institutions—though it will be difficult for the reforms to reduce such incentives or change a corporate culture that prioritizes immediate profit over sound investment. Furthermore, beginning in 2009, G20 leaders pledged to increase transparency and root out conflicts of interest in credit ratings agencies that understated the risk on bundled securities whose collapse sparked the 2008 financial crisis. The United States, home to the three main credit ratings agencies, enacted legislation [PDF] regulating credit rating agencies (CRAs) and also removed their ratings from the process of determining capital requirements. Dodd-Frank created an Office of Credit Rating Agencies to monitor CRAs, mandated more analytically rigorous reports to back their ratings, and demanded that CRAs publish those reports.

    However, there remained issues to tackle. First, the world apparently abandoned the goal to standardize accounting rules. The United States mandates that its corporations follow different accounting standards [PDF] than the rest of the world, which poses particular challenges to assessing the income and value of corporations. In addition, the London Interbank Offered Rate (LIBOR) scandal, which brought to light reports that traders in as many as fifteen global financial institutions were manipulating LIBOR for their own profits, showcased another gap in banking supervision. Financial regulation is likely to require constant vigilance in coming years.

  • GOOD

    Supporting Development

    Overall, the international financial regime demonstrated progress in ameliorating the crushing poverty that plagues 2.47 billion people living on less than two dollars per day. Despite fiscal tightening, in 2009 Group of Twenty (G20) states injected almost $50 billion [PDF] into the World Bank's International Development Association, which helps drive development to achieve the Millennium Development Goals (MDGs). The 2011 UN report [PDF] on the MDGs suggests that important advances were made: cutting global poverty in half from 1990 levels was achieved well in advance of the 2015 target year, maternal mortality rates declined, access to clean water expanded, and education in the poorest states improved. States also earned points for the striking improvements in global public health, such as expanding vaccine coverage for communicable diseases in developing states. The World Bank also showed impressive leadership through its innovative financing, including support for conditional cash transfer programs like the Brazilian Bolsa Familia, which demonstrably reduced poverty. The World Bank placed itself at the forefront of governance reform by emphasizing the real economic weight of member states within the institution's framework. At the same time, the bank's innovative use of open-source applications increased transparency of its projects and programs worldwide.

    Furthermore, in December 2011, numerous international organizations and 158 states, including developed countries, rising powers, and developing states, endorsed a promising new framework for development aid. This Busan Partnership outlined important steps like universal indicators on peace-building and state-building goals for accountability on implementation of development aid commitments. In contrast to earlier aid effectiveness summits, the outcome included a "New Deal" for fragile states driven by conflict-affected states themselves rather than by wealthy donors. Furthermore, states pledged to work with nongovernmental organizations as they target development assistance—which should help circumvent corrupt regimes.

    However, concerns continued to mount over declining aid levels. In 2011, official development assistance from the Organization for Economic Cooperation and Development fell by 3 percent—the first decline in fourteen years. In light of the fiscal crises in the industrialized world, it was perhaps expected but is a shame that the donor-set goals to dedicate 0.7 percent of gross domestic product to development aid fell by the wayside. Rising powers signaled that they may be willing to fill some of the gaps, but the nascent proposal from the BRICS (Brazil, Russia, India, China, and South Africa) for a new development bank was far from reaching fruition.

  • AVERAGE

    Reforming Governance of International Financial Institutions

    The legitimacy of the world's primary international financial institutions became increasingly undermined by the overrepresentation [PDF] of traditional industrialized states with decreasing resources to devote to solving the world's financial problems. A country's voting share at the International Monetary Fund (IMF) depends on an assigned quota, but European states hold disproportionate sway. In April 2010, after U.S. pressure to reform, states approved important changes [PDF] to the quota system that shifted 6 percent of IMF shares to dynamic emerging market economies. European states also agreed to replace two European seats on the IMF executive board with representatives from developing and emerging market economies. The changes, if enacted, would have placed China as the third-largest shareholder of the IMF and pulled India, Russia, and Brazil into the ranks of its top ten shareholders. However, member states failed to meet the deadline for the proposed quota reform at the IMF/World Bank annual meeting in Tokyo in 2012. Moreover, many of the quota shares would have been taken from other developing economies. In fact, the IMF voting share of more traditional advanced economies decreased by only 2.6 percent. Overall, states should agree to broader changes, such as a transparent, revised formula for deriving IMF quotas. But promises to make the quota formula truly transparent proved difficult. In the absence of U.S. congressional approval for IMF reforms, Europeans also failed to approve agreed-upon arrangements to relinquish two executive board seats by October 2012.

    In addition, a gentlemen's agreement dating back to the founding of the IMF and World Bank ensures that an American always heads the World Bank, while the managing director of the IMF is always European. Rising powers like China, Brazil, and India, as well as underrepresented developing states, continued to protest such decision-making processes. The United States and Europe should institute a more open competition for the institutions' leadership. Most recently, in March 2012, developing states nominated qualified candidates from Colombia and Nigeria. Though emerging powers did not coalesce behind one candidate, the competition ultimately remained unbalanced and opaque and the U.S. nominee, Jim Yong Kim, was selected behind closed doors. Though developed states signaled a willingness to reform international financial institutions, progress was disappointing.

Leader

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U.S. Federal Reserve

Group of Twenty

European Central Bank

Gold Star

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People's Bank of China

World Bank

Most Improved

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International Monetary Fund

laggard

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Germany

Truant

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Argentina

Detention

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Greece

Class Evaluation

The U.S. Federal Reserve, the European Central Bank (ECB), and the Group of Twenty (G20) earned the title of class leaders. The U.S. Federal Reserve kept the U.S. economy (and arguably the global economy) alive with "unprecedented emergency actions" that included widespread purchases of financial securities, aggressive lending, and interbank mediation.

In addition, the Federal Reserve bolstered important economies by offering currency swap facilities. For its part, the G20 provided valuable stewardship during the depths of the financial crisis. The group coordinated [PDF] economic stimulus packages, evaded the perils of protectionism, tripled the firepower of the International Monetary Fund (IMF), increased the flexibility of its loans, and extended its mandate. Lastly, the G20 issued a call for robust, necessary regulations for financial markets and banks that states began to implement at home—including higher capital requirements outlined in Basel III, a set of new banking regulations. This mutual action to save the world economy was unprecedented and earned the G20 high praise, but the group lost steam since 2010 and is at risk of losing its status as class leader.

The ECB helped to shepherd the European monetary union (the eurozone) through a series of sovereign debt crises and prevent it from disintegrating (which would devastate both the European and global economies). The ECB struck a careful balance between providing a lifeline and withholding emergency actions to force leaders in Spain, Greece, Italy, Portugal, and Ireland to design longer-term solutions. The central bank pledged to do "whatever it takes" to support the eurozone. To that end, it established currency swaps with the U.S. Federal Reserve, provided loans to the eurozone banking sector, and bought government bonds.

The People's Bank of China (PBC) also helped avert a global economic depression by pumping two trillion yuan—or almost $300 billion—of new stimulus measures into the Chinese economy in 2009 and 2010 (this number excluded spending that had already been enacted, which Chinese officials included in the announced four trillion yuan stimulus package). This represented the third-largest stimulus as a percentage of gross domestic product (GDP) globally—behind Russia and Saudi Arabia. As a result, China's economy did not contract in 2009—indeed, it grew by 8 percent—and Chinese exports did not plummet as fast as in other major economies. For this action, the PBC earns a gold star—a bright spot on the country's mixed record.

The World Bank also earns a gold star for taking concrete steps to increase transparency [PDF], for fostering innovative antipoverty financing—such as its experiments in progressively paced loan disbursement [PDF] rewarding states for good implementation of projects—and for pursuing a robust institutional strategy to further integrate rising powers. Its sister organization, the IMF, deserves recognition as "most improved" for stepping up to an elevated role in crisis management in advanced economies. Soon after the crisis struck, the IMF took on a bolstered role as a global lender and policy adviser to analyze major economies' macroeconomic policies and their effect on global finance. The G20 also pledged an extra $500 billion for the IMF at the London G20 summit, which the IMF then distributed through a New Arrangements to Borrow initiative. Furthermore, in August 2009, the fund allocated an additional $283 billion in special drawing rights (the IMF's quasi currency) to boost member-state reserves. It also fulfilled its policy adviser role admirably by completing reports for the G20's Mutual Assessment Process, publishing a spillover report to examine external effects of domestic macroeconomic policies in five systemic economies, and, finally, providing invaluable technical assistance as a member of the European troika that oversees bailouts on that continent. Although its role in Europe continues to be controversial, the IMF certainly built up its stature since 2008.

As the eurozone crisis escalated, Germany initially called for fiscal tightening in European states that were experiencing surging sovereign debt, which ultimately correlated with larger contractions in GDP. This call for austerity undermined market confidence and intensified economic challenges in states with large budget deficits—including Portugal, Spain, and Italy. For its initial strict position on fiscal responsibilities, Germany is labeled a laggard. Though notwithstanding this designation, Germany subsequently shored up the region with tremendous financial support and made concessions on regional integration that will increase German responsibility for the economic health of weaker eurozone states. Despite Germany's recent change of course, it was slow to realize that an overreliance on austerity will not solve the crisis.

On the other side of the ledger, Argentina's truancy is regrettable. The country increasingly falsified economic indicators used both domestically and internationally to design appropriate policies. Since 2007, for example, the Argentinian government reported inflation statistics that experts said sets inflation at half of what local economists observe. In September 2012, the IMF board of directors was forced to put Argentina on notice that the fund would for the first time in its history issue a declaration of censure if Argentina failed to provide accurate statistics within two months—after already giving the nation eight months to implement remedial measures. In addition, a series of trade and investment-related actions—such as the nationalization of the Spanish oil company Repsol—violated "all the commitments Argentina has made in the G20 to promote transparency and reduce protectionism," according to UK Foreign Secretary William Hague.

Finally, Greece sits in detention for repeatedly delaying the implementation of labor and pension reforms (which finally passed in 2012), and for failing to enact vital changes to product markets, overhaul tax administration, and privatize a significant chunk of the bloated state sector. In addition, the government did not do enough to tackle corruption or bureaucratic inefficiencies that stifle the economy. As a result, the Greek economy continued to contract and require more funds from the international financial regime. This development eroded confidence in the eurozone and threatened the European and global financial system.

Table of Contents

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Introduction

After the onset of the 2008 global financial crisis, states prevented a financial meltdown from spiraling into a global depression. When the crisis hit, some economists predicted an economic contraction on the scale of the 1930s, but the swift and globally coordinated policy response helped the world economy rebound in the second half of 2009. The economy went on to grow by more than 5 percent in 2010, a year after the peak of the crisis, and by almost 4 percent in 2011. To be sure, growth since slowed again, but the international financial regime earned high marks for defying the predictions of disaster and for taking advantage of the crisis to embark on much-needed reforms.

The first reform was immediate. Advanced market democracies elevated the Group of Twenty (G20), hitherto a club of finance ministers and central bank governors from the world's major economies, to a forum for cooperation at the head-of-state and head-of-government level, supplanting the Group of Eight (G8) as the premier steering committee for global economic cooperation. This crucial step paved the way for broader global collaboration to resolve the international credit crisis. G20 central banks coordinated interest rate cuts and expanded credit facilities; in 2012, the Bank for International Settlements concluded [PDF] that this "decisive action" was "crucial in preventing a repeat of the experience of the Great Depression." In 2009, the G20 successfully coordinated an unprecedented $5 trillion injection into the global economy, including pledges of up to $1.1 trillion for the International Monetary Fund (IMF), international development banks, and trade financing to provide an economic buffer to states at risk of collapse.

These steps assured financial markets that the world's largest economies would muster the political will to cooperate and prevent another Great Depression. The G20's positive response to the financial crisis included reviving and augmenting the war chest of the IMF, creating a Financial Stability Board (FSB)—intended to formulate common regulatory standards for crossborder financial institutions and reduce systemic risk—and engineering new capital requirements for major banks in the Basel III accords. Finally, at G20 summits, member states publicly agreed to enact regulatory corrections, such as reforming incentive structures, instituting oversight of derivatives, and requiring that credit ratings agencies be more transparent. The United States led the way toward implementation of these pledges.

Meanwhile, the international financial regime made progress on the underlying structural imbalances that could lead to another crisis. The G20 tasked the IMF with monitoring current-account imbalances that could have negative spillover effects on other states. Whether because of this pressure or because of autonomous decisions made in national capitals, imbalances subsided. However, on the negative side of the ledger, promised reform of international financial institutions to integrate major economic powerhouses today was disappointing, and the eurozone crisis was a drag on global growth as leaders struggled to design comprehensive policy responses.

This record, albeit flawed, featured important achievements and prevented a long, devastating depression.

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Background

Financial markets are more open and complex than ever before. This brings benefits, but also leads to volatility—and has given rise to repeated crises. In the wake of the most recent crisis, which reached a peak of intensity in September 2008, leaders from around the world made two pledges. First, they would coordinate economic stimulus to keep the global economy afloat. Second, they would overhaul the global financial architecture to prevent a repeat crisis. By 2010, the first pledge had been more or less fulfilled—though global growth has since slowed and problems remain, especially in Europe. Overhauling financial regulation has proved to be a harder challenge.

The major institutions of today's global financial architecture date back to the 1940s. After the crash of 1929, the Great Depression of the 1930s, and the devastation of World War II, world leaders gathered in 1944 to establish a new financial architecture that would protect the world economy from currency swings and help rebuild war-torn Europe. The hallmark of the Bretton Woods conference was a new monetary order based on a fixed exchange rate: the major currencies were pegged to the dollar and the dollar was pegged to the gold standard. Two new international institutions were created to keep the global economy in check: the International Monetary Fund was primarily mandated to "ensure the stability of the international monetary system," while the International Bank for Reconstruction (today part of the World Bank Group) was established to support reconstruction projects, initially in Europe.

This foundation cracked in the early 1970s. The fixed exchange rate system collapsed under the pressure of U.S. inflation, which eroded U.S. competitiveness, leading to a current account deficit and a flood of dollars into other states. Once foreign holdings of dollars greatly exceeded U.S. holdings of gold, the United States was unable to stand by its promise to exchange gold for dollars at the fixed rate, and the gold-dollar peg ceased to be credible; the Bretton Woods regime thus gave way to a new era of floating exchange rates. As a result, foreign exchange trading began to develop. Meanwhile, the advent of affordable computing made it possible to price and trade financial derivatives, adding to the complexity of markets. With the collapse of communism, globalization increased the reach of large financial firms, creating an even larger and more sophisticated financial system along with unprecedented growth and global imbalances. Governments struggled to adapt the global financial architecture to properly address these changes. After the U.S. housing market bubble collapsed in 2006 and 2007, exposing the risks of over-leveraged banks and poorly-regulated activity, the global financial system plunged into turmoil. Soon after, a sovereign debt crisis rocked the European Union and revealed the shaky foundations of the euro, the currency used by seventeen of the EU's twenty-seven members.

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Class Evaluation

The U.S. Federal Reserve, the European Central Bank (ECB), and the Group of Twenty (G20) earned the title of class leaders. The U.S. Federal Reserve kept the U.S. economy (and arguably the global economy) alive with "unprecedented emergency actions" that included widespread purchases of financial securities, aggressive lending, and interbank mediation.

In addition, the Federal Reserve bolstered important economies by offering currency swap facilities. For its part, the G20 provided valuable stewardship during the depths of the financial crisis. The group coordinated [PDF] economic stimulus packages, evaded the perils of protectionism, tripled the firepower of the International Monetary Fund (IMF), increased the flexibility of its loans, and extended its mandate. Lastly, the G20 issued a call for robust, necessary regulations for financial markets and banks that states began to implement at home—including higher capital requirements outlined in Basel III, a set of new banking regulations. This mutual action to save the world economy was unprecedented and earned the G20 high praise, but the group lost steam since 2010 and is at risk of losing its status as class leader.

The ECB helped to shepherd the European monetary union (the eurozone) through a series of sovereign debt crises and prevent it from disintegrating (which would devastate both the European and global economies). The ECB struck a careful balance between providing a lifeline and withholding emergency actions to force leaders in Spain, Greece, Italy, Portugal, and Ireland to design longer-term solutions. The central bank pledged to do "whatever it takes" to support the eurozone. To that end, it established currency swaps with the U.S. Federal Reserve, provided loans to the eurozone banking sector, and bought government bonds.

The People's Bank of China (PBC) also helped avert a global economic depression by pumping two trillion yuan—or almost $300 billion—of new stimulus measures into the Chinese economy in 2009 and 2010 (this number excluded spending that had already been enacted, which Chinese officials included in the announced four trillion yuan stimulus package). This represented the third-largest stimulus as a percentage of gross domestic product (GDP) globally—behind Russia and Saudi Arabia. As a result, China's economy did not contract in 2009—indeed, it grew by 8 percent—and Chinese exports did not plummet as fast as in other major economies. For this action, the PBC earns a gold star—a bright spot on the country's mixed record.

The World Bank also earns a gold star for taking concrete steps to increase transparency [PDF], for fostering innovative antipoverty financing—such as its experiments in progressively paced loan disbursement [PDF] rewarding states for good implementation of projects—and for pursuing a robust institutional strategy to further integrate rising powers. Its sister organization, the IMF, deserves recognition as "most improved" for stepping up to an elevated role in crisis management in advanced economies. Soon after the crisis struck, the IMF took on a bolstered role as a global lender and policy adviser to analyze major economies' macroeconomic policies and their effect on global finance. The G20 also pledged an extra $500 billion for the IMF at the London G20 summit, which the IMF then distributed through a New Arrangements to Borrow initiative. Furthermore, in August 2009, the fund allocated an additional $283 billion in special drawing rights (the IMF's quasi currency) to boost member-state reserves. It also fulfilled its policy adviser role admirably by completing reports for the G20's Mutual Assessment Process, publishing a spillover report to examine external effects of domestic macroeconomic policies in five systemic economies, and, finally, providing invaluable technical assistance as a member of the European troika that oversees bailouts on that continent. Although its role in Europe continues to be controversial, the IMF certainly built up its stature since 2008.

As the eurozone crisis escalated, Germany initially called for fiscal tightening in European states that were experiencing surging sovereign debt, which ultimately correlated with larger contractions in GDP. This call for austerity undermined market confidence and intensified economic challenges in states with large budget deficits—including Portugal, Spain, and Italy. For its initial strict position on fiscal responsibilities, Germany is labeled a laggard. Though notwithstanding this designation, Germany subsequently shored up the region with tremendous financial support and made concessions on regional integration that will increase German responsibility for the economic health of weaker eurozone states. Despite Germany's recent change of course, it was slow to realize that an overreliance on austerity will not solve the crisis.

On the other side of the ledger, Argentina's truancy is regrettable. The country increasingly falsified economic indicators used both domestically and internationally to design appropriate policies. Since 2007, for example, the Argentinian government reported inflation statistics that experts said sets inflation at half of what local economists observe. In September 2012, the IMF board of directors was forced to put Argentina on notice that the fund would for the first time in its history issue a declaration of censure if Argentina failed to provide accurate statistics within two months—after already giving the nation eight months to implement remedial measures. In addition, a series of trade and investment–related actions—such as the nationalization of the Spanish oil company Repsol—violated "all the commitments Argentina has made in the G20 to promote transparency and reduce protectionism," according to UK Foreign Secretary William Hague.

Finally, Greece sits in detention for repeatedly delaying the implementation of labor and pension reforms (which finally passed in 2012), and for failing to enact vital changes to product markets, overhaul tax administration, and privatize a significant chunk of the bloated state sector. In addition, the government did not do enough to tackle corruption or bureaucratic inefficiencies that stifle the economy. As a result, the Greek economy continued to contract and require more funds from the international financial regime. This development eroded confidence in the eurozone and threatened the European and global financial system.

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U.S. Performance & Leadership

B plus

On the whole, the United States demonstrated positive and steadfast leadership. Notable achievements by U.S. leaders include pursuing expansionary economic policy to revive the U.S. economy (which continues to be a significant engine of global growth), reforming the domestic financial regulatory landscape, and working with international institutions, such as the G20 and the IMF, to coordinate rescue packages and broader macroeconomic policy. During the height of the global financial crisis in 2008, the U.S. Federal Reserve coordinated with G20 states on monetary policy and stimulus packages and also extended its currency swap program to Brazil, Singapore, Mexico, and South Korea. These swaps emerged as an important pillar of the global monetary system: because companies all over the world find it convenient to issue debt securities denominated in dollars, they need emergency access to the Federal Reserve's dollar printing press if dollar funding markets dry up. More recently, the Fed helped mitigate some of the effects of the eurozone crisis by providing dollars to the European Central Bank through similar swap arrangements.

The United States also made real progress in moderating the conditions that contributed to the onset of the crisis, in accordance with G20 commitments. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, despite being overly convoluted and admittedly flawed, signaled a willingness to address underlying regulatory gaps of U.S. financial institutions. These included requiring oversight of derivatives, reducing [PDF] conflicts of interest within—and systemic reliance on—credit ratings agencies, and reining in compensation practices that incentivized irresponsible behavior by the leaders of major financial institutions. Furthermore, the Volcker rule to curb trading risks in federally-insured financial institutions may reduce the burden on taxpayers when risk increases. Most important, progress toward implementation of higher capital requirements under Basel III promised to stabilize the overall system and demonstrated U.S. resolve to follow through on multilateral pledges to increase capital requirements and keep leverage within bounds.

However, congressional inaction on the federal deficit subjected the U.S. Treasury bond market to unnecessary risk. Central banks, pension funds, and corporate treasurers around the world view U.S. treasuries as a safe asset, and are therefore willing to hold them in vast quantities. Continued inaction threatens to undermine faith in the U.S. government's credit worthiness, drive up U.S. interest rates, and undermine the dollar's position as the leading global reserve currency. This could destabilize the entire global financial system.

Furthermore, the U.S. Congress did not demonstrate the political will to approve additional resources for the IMF (though it did for the multilateral development banks) and corresponding reforms to the international financial institutions to integrate rising powers, despite promises to do so. There was no change to make leadership contests more transparent and to advance major emerging economies' representation. This failure became apparent in 2012, when the U.S. government reflexively insisted that a U.S. national should fill the vacant position at the helm of the World Bank Group. On the other hand, major emerging economies squandered an opportunity to unite behind either of the qualified candidates to replace IMF Managing Director Dominique Strauss-Kahn in May 2011.

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Managing Financial Crises

Good

After the financial crisis struck, states took a number of steps to bolster flailing economies. As a temporary bandage, the IMF created the Short-Term Liquidity Facility in October 2008 to help provide capital to countries "with strong economic policies that are facing temporary liquidity problems." The IMF also coordinated emergency financing for fourteen states. Four months later, the G20 pledged $250 billion in trade financing to boost the world economy and tripled the resources of the IMF so that it could disburse bigger loans and prevent critical economies from collapsing. (These funds became available in March 2011 through the IMF New Arrangements to Borrow.) However, eurozone members still squabbled over how to fix the structural problems underpinning the eurozone crisis while forcing excessive austerity on states that received bailouts.

Another important policy move was the growth of crossborder central bank swaps to prevent banks from freezing short-term credit lines. The United States, the United Kingdom, Japan, the European Central Bank, and Switzerland agreed to unlimited currency swaps to avert currency and solvency crises in 2008. That same year, the U.S. Federal Reserve offered currency swap arrangements to Brazil, Singapore, Mexico, and South Korea as well. By the fall of 2008, the U.S. Federal Reserve had provided roughly $600 billion of these currency swaps—most of which were paid down already. Again, in November 2011, the United States, as well as the central banks of Canada, England, Japan, and Switzerland, announced dollar liquidity swaps in order to provide a lifeline to floundering eurozone banks.

Together, these coordinated global actions since 2008 contributed to remarkable rebounds of important economic indicators, even after initial shocks that were more disastrous than those of the 1929 financial crisis. For example, global foreign investment assets rebounded to $96 trillion per year in 2011—5 percent higher than precrisis levels. Furthermore, given the drastic plunge in world trade volumes in 2008, trade flows could have been expected to be 25 percent lower than precrisis levels, as they were four years after the start of the Great Depression—but instead, global trade volume increased by 5 percent.

Meanwhile, the eurozone crisis escalated significantly from 2010 to 2012. European leaders attempted to cobble together difficult political compromises to help support the monetary union with more coordinated fiscal policy. These include the European Stability Mechanism (ESM), which, despite delays, issued bonds for the first time in December 2012. Furthermore, leaders agreed in October 2012 to establish a Single Supervisory Mechanism housed in the ECB to monitor banking risks and reduce crossborder contagion. This new supervisory power will allow the ESM to directly recapitalize banks.

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Coordinating Macroeconomic Policies And Exchange Rates

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The world's biggest economies made halting progress to coordinate policies to expand growth and correct underlying structural flaws that could lead to another crisis. In October 2008, the United States, the United Kingdom, the European Union, and China implemented a round of coordinated interest rate cuts to head off a liquidity freeze. The United States, ECB, and United Kingdom since enacted monetary easing. In industrialized states, central banks more than doubled their lending. These moves served as a "global stimulus" and, according to the Bank for International Settlements, were "crucial" to staving off a steeper recession.

Perhaps most striking, dire predictions of protectionist trade war escalations proved wrong. Taken together, the few protectionist measures that states did enact in 2008 "affected less than 0.8 percent of global trade." International trade flows recovered, and even surpassed precrisis levels by 2012. In contrast, after the 1929 stock market crash, trade flows plummeted by 25 percent four years after the crisis began.

Meanwhile, progress on exchange rates and global imbalances was greater than anticipated. The G20's 2009 Framework for Strong, Sustainable, and Balanced Growth (Pittsburgh Framework) tasked [PDF] the IMF to monitor and support domestic implementation of the framework through the Mutual Assessment Process (MAP). This cooperation signaled an important shift [PDF]: previously, assessments by the IMF excluded analysis of international spillovers resulting from national policies. In 2011, at the Cannes summit, the G20 reached agreement on "key indicators" and "indicative guidelines" that the MAP would evaluate, and at the 2012 Los Cabos summit, the group established the Accountability Asessment Framework to bolster peer review under the MAP.

The United States also used the G20 to pressure China to loosen control over its exchange rate. In June 2010, U.S. President Barack Obama submitted a letter to the G20 underscoring the importance of "market-determined exchange rates." Three days later, China announced that it would enhance the flexibility of the RMB exchange rate. Subsequently, the RMB nominally appreciated at a rate of 5 percent in 2010 and 2011. In October 2012, the RMB's value hit 6.285 against the dollar for the first time, a nineteen-year low. In real terms, China's appreciation is even more marked, since its inflation rate is higher than that of its main trading partners. In consequence, China's current account surplus came down from 10 percent of GDP at the start of the crisis, in 2007, to a forecast 2.1 percent in 2012. The largest economic imbalance in the global system substantially diminished.

Nevertheless, the G20 relegated the MAP to the back burner at both Cannes and Los Cabos and the process is now stalled. G20 states also continued to resist an independent role for the IMF that would entail true "naming and shaming" of countries that do not meet the objectives laid out in the Pittsburgh Framework. Leaps forward by the G20 since the financial crisis began in 2008 earned it praise, but as noted above, the forum should fight to maintain momentum.

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Regulating Financial Institutions, Bank Capital, And Liquidity

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In response to the banking crisis, states joined together to regulate bank capital and liquidity—recognizing that ineffective rules and enforcement contributed to the financial crisis and that no single country could enact regulations to address underlying structural problems unless other countries agreed to impose similar regulations on their banks. First, leaders from the G20 states reinvigorated the Financial Stability Forum with a broader membership and mandate under the FSB. The FSB coordinates the central banks and financial regulatory agencies from the G20 states, their counterparts from five additional countries, and numerous experts from intergovernmental organizations to implement effective financial policies. It is an important forum for the supervisors of global banking to coordinate policy. As endorsed [PDF] at the G20 summit in Seoul, the FSB also released important reports, such as a list of twenty-nine "systemically important financial institutions" (SIFIs) deemed critical to the global economy, and contingency plans if banks fail. The SIFIs were required to complete a resolution-planning process, popularly called "living wills." These plans sought to help bank regulators wind down complex financial institutions when they fail, reducing the temptation to prop them up with public money. At the same time, the exercise of creating living wills may encourage more responsible banking operations. Though the announcements were monumental, it remained too soon to tell whether they would actually moderate the conduct of banks or of governments if they fail.

Central bank governors from twenty-seven of the world's biggest economies also agreed in September 2010 to a new set of banking regulations, Basel III. These regulations require banks to hold more than triple the previous amount of equity capital. This established a buffer to prevent collapse of a bank when investments go sour—and although the result may be marginally higher interest rates for banks' customers, there will be a negligible impact on growth [PDF]. Basel III perhaps should have required banks to set aside more capital in light of their continuing risky practices, but the current standard represents solid progress. Given that countries struggled for six years to negotiate Basel II, the fact that Basel III standards took only two years to negotiate demonstrated extraordinary cooperation at a pivotal moment in global finance. If faithfully implemented by the 2019 deadline, these new regulations will reduce the likelihood of another banking collapse like the one that rocked the global economy in 2008.

In the aftermath of the financial crisis in 2008, financial coordination to fill the regulatory gaps the crisis exposed was impressive. G20 commitments to require oversight of derivatives were matched by progress toward implementation in both the United States and the European Union. Major G20 states also followed through on pledges to address perverse incentives in compensation practices for executives of financial institutions—though it will be difficult for the reforms to reduce such incentives or change a corporate culture that prioritizes immediate profit over sound investment. Furthermore, beginning in 2009, G20 leaders pledged to increase transparency and root out conflicts of interest in credit ratings agencies that understated the risk on bundled securities whose collapse sparked the 2008 financial crisis. The United States, home to the three main credit ratings agencies, enacted legislation [PDF] regulating credit rating agencies (CRAs) and also removed their ratings from the process of determining capital requirements. Dodd-Frank created an Office of Credit Rating Agencies to monitor CRAs, mandated more analytically rigorous reports to back their ratings, and demanded that CRAs publish those reports.

However, there remained issues to tackle. First, the world apparently abandoned the goal to standardize accounting rules. The United States mandates that its corporations follow different accounting standards [PDF] than the rest of the world, which poses particular challenges to assessing the income and value of corporations. In addition, the London Interbank Offered Rate (LIBOR) scandal, which brought to light reports that traders in as many as fifteen global financial institutions were manipulating LIBOR for their own profits, showcased another gap in banking supervision. Financial regulation is likely to require constant vigilance in coming years.

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Supporting Development

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Overall, the international financial regime demonstrated progress in ameliorating the crushing poverty that plagues 2.47 billion people living on less than two dollars per day. Despite fiscal tightening, in 2009 G20 states injected almost $50 billion [PDF] into the World Bank's International Development Association, which helps drive development to achieve the Millennium Development Goals (MDGs). The 2011 UN report [PDF] on the MDGs suggests that important advances were made: cutting global poverty in half from 1990 levels was achieved well in advance of the 2015 target year, maternal mortality rates declined, access to clean water expanded, and education in the poorest states improved. States also earned points for the striking improvements in global public health, such as expanding vaccine coverage for communicable diseases in developing states. The World Bank also showed impressive leadership through its innovative financing, including support for conditional cash transfer programs like the Brazilian Bolsa Familia, which demonstrably reduced poverty. The World Bank placed itself at the forefront of governance reform by emphasizing the real economic weight of member states within the institution's framework. At the same time, the bank's innovative use of open-source applications increased transparency of its projects and programs worldwide.

Furthermore, in December 2011, numerous international organizations and 158 states, including developed countries, rising powers, and developing states, endorsed a promising new framework for development aid. This Busan Partnership outlined important steps like universal indicators on peace-building and state-building goals for accountability on implementation of development aid commitments. In contrast to earlier aid effectiveness summits, the outcome included a "New Deal" for fragile states driven by conflict-affected states themselves rather than by wealthy donors. Furthermore, states pledged to work with nongovernmental organizations as they target development assistance—which should help circumvent corrupt regimes.

However, concerns continued to mount over declining aid levels. In 2011, official development assistance from the Organization for Economic Cooperation and Development fell by 3 percent—the first decline in fourteen years. In light of the fiscal crises in the industrialized world, it was perhaps expected but is a shame that the donor-set goals to dedicate 0.7 percent of gross domestic product to development aid fell by the wayside. Rising powers signaled that they may be willing to fill some of the gaps, but the nascent proposal from the BRICS (Brazil, Russia, India, China, and South Africa) for a new development bank was far from reaching fruition.

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Reforming Governance Of International Financial Institutions

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The legitimacy of the world's primary international financial institutions became increasingly undermined by the overrepresentation [PDF] of traditional industrialized states with decreasing resources to devote to solving the world's financial problems. A country's voting share at the IMF depends on an assigned quota, but European states hold disproportionate sway. In April 2010, after U.S. pressure to reform, states approved important changes [PDF] to the quota system that shifted 6 percent of IMF shares to dynamic emerging market economies. European states also agreed to replace two European seats on the IMF executive board with representatives from developing and emerging market economies. The changes, if enacted, would have placed China as the third-largest shareholder of the IMF and pulled India, Russia, and Brazil into the ranks of its top ten shareholders. However, member states failed to meet the deadline for the proposed quota reform at the IMF/World Bank annual meeting in Tokyo in 2012. Moreover, many of the quota shares would have been taken from other developing economies. In fact, the IMF voting share of more traditional advanced economies decreased by only 2.6 percent. Overall, states should agree to broader changes, such as a transparent, revised formula for deriving IMF quotas. But promises to make the quota formula truly transparent proved difficult. In the absence of U.S. congressional approval for IMF reforms, Europeans also failed to approve agreed-upon arrangements to relinquish two executive board seats by October 2012.

In addition, a gentlemen's agreement dating back to the founding of the IMF and World Bank ensures that an American always heads the World Bank, while the managing director of the IMF is always European. Rising powers like China, Brazil, and India, as well as underrepresented developing states, continued to protest such decision-making processes. The United States and Europe should institute a more open competition for the institutions' leadership. Most recently, in March 2012, developing states nominated qualified candidates from Colombia and Nigeria. Though emerging powers did not coalesce behind one candidate, the competition ultimately remained unbalanced and opaque and the U.S. nominee, Jim Yong Kim, was selected behind closed doors. Though developed states signaled a willingness to reform international financial institutions, progress was disappointing.

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Areas for Improvement

Global financial architecture requires improvements in three major areas:

  • While the more flexible fluctuation of the Chinese renminbi in recent years represents progress, China still retains the tools to intervene in currency markets [PDF] to keep the RMB at an artificially low rate. After years of running large current-account surpluses, a fast-growing economy such as China should ideally be running a modest deficit. Chinese currency controls affect countries from the United States to Brazil and the international financial regime should jointly press China to increase the flexibility of the yuan further.

  • The capital requirements for banks should be raised, sooner rather than later. Banks lost 7 percent of their assets from 2007 to 2010—and experts conclude that capital requirements should be higher for banks to remain solvent during and after a shock. As a result, to remain secure, banks should set aside a ratio of at least 15 percent of eligible capital to risk-weighted assets. Although such requirements would slightly affect global GDP, the benefits would far outweigh the consequences.

  • The failure of IMF members to implement the governance and quota reforms by the October 2012 deadline represents a significant step back. Europe remains overrepresented, and the U.S.-Europe grand bargain of appointing the heads of the IMF and World Bank has grown stale and undercuts the legitimacy of the institutions. Emerging economies are growing at a fast clip, and they must be integrated into international financial decision-making structures so they can remain relevant and continue to provide a stable foundation for the international monetary system.

Credits

Produced by the Council on Foreign Relations and Threespot

  • Executive Producer: Stewart Patrick
  • Web Producer: Andrei Henry
  • Producer / Writer: Farah Faisal Thaler
  • Assistant Producer: Isabella Bennett
  • Research Associates: Ryan Kaminski, Alexandra Kerr, Andrew Reddie, Emma Welch
  • Design and Development: Threespot