Systematic regulatory reform with the objective of "weeding out" financial instruments that do not contribute to long-term economic growth is needed to put the world economy on steady footing, according to a report released Thursday by the United Nations Conference on Trade and Development (UNCTAD).
The ideology of financial deregulation "allowed the build-up of pressures whose unwinding has damaged the credibility and functioning of the market-based models that have underpinned financial development throughout the world." The United Nations agency also investigated how the growing role of large-scale financial investors on commodities futures markets has affected commodity price volatility and fed speculative bubbles; and the role of widespread currency speculation in exacerbating global imbalances and fueling the current crisis.
"Market fundamentalist laissez-faire of the last 20 years has dramatically failed the test," UNCTAD said. "Financial deregulation created the build-up of huge risky positions whose unwinding has pushed the global economy into a debt deflation that can only be countered by government debt inflation."
Speculation in commodities, housing and currencies based on "uniform but wrong" expectations about long-term price trends created bubbles whose bursting resulted in the global financial crisis. National regulations to prevent commodity bubbles, regional steps to fight speculation -- even the creation of a global monetary system -- would not prevent a repeat of that cycle, the report concluded. "Nothing short of closing down the big casino will provide a lasting solution."
Global cooperation and global regulation are called for, and the United Nations "must play a central role in guiding this reform process," according to UNCTAD. Key loopholes in regulation need to be closed to ensure that positions on unregulated over-the-counter markets do not lead to "excessive speculation." The United Nations group report recommended that regulators be given access to more comprehensive trading data in order to be able to understand what is moving prices "and intervene if certain trades look problematic."
The report calls for more transparency in commodities futures markets and says regulators should have greater power to step in when futures speculation that is aimed at profits for arbitrage investors, rather than as a hedge to protect producers against normal price swings, drives up prices for vital goods.
UNCTAD said U.S. banking regulations that were designed to control risk through the measured capital ratio used by commercial banks backfired because bank managers circumvented the rules either by hiding risk or by moving some leverage outside the banks. The shift in leverage created a "shadow banking system" that escaped normal bank regulation. "At its peak, the U.S. shadow banking system held assets of approximately $16 trillion, about $4 trillion more than regulated deposit-taking banks," the report said. "While the regulation focused on banks, it was the collapse of the shadow banking system which kick-started the crisis."
The report, titled "The Global Economic Crisis: Systemic Failures and Multilateral Remedies," was prepared in advance of next month's G20 summit in London.
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