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  March 6, 2018

Exposing the Risks of Global Finance: Yilmaz Akyuz on 'Playing with Fire' (2/2)

South Centre Chief Economist explains the deepened financial integration of the Global South as a mechanism of Northern countries to continue compressing wage income. But the growing and massive accumulation of debt worldwide is making the global economy more vulnerable than ever before
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Yilmaz Akyuz is the Chief Economist of the South Centre. He was previously Director of the Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development (UNCTAD) when he retired in August 2003. He was the principle author and head of the team preparing the Trade and Development Report, and UNCTAD coordinator of research support to developing countries (the Group-of-24) in the IMF and World Bank on International Monetary and Financial Issues. Dr. Akyuz has published extensively in macroeconomics, finance, growth and development. His most recent book is "Playing With Fire, Deepening Financial Integration and Changing Vulnerabilities of the Global South."

Peter Dittus is the owner of arCandide consulting and currently working as a consultant to public organizations. Previously Dr. Dittus was Secretary General of the Bank for International Settlements from 2005 to 2016. He joined the BIS in 1992 as an economist and since 1995 had assumed increasingly senior responsibilities in the Bank. In 2000, he was appointed Deputy Secretary General and became a member of the Bank's Executive Committee. Before joining the BIS, he worked as an economist at the World Bank and OECD.


PETER DITTUS: The fragility and the potential exposure to crisis in the world has actually increased and the policy options to deal with it have decreased. And I think that’s a very strong message in this book.

When the crisis hits, what could one do? And it says: Well, don’t trust that someone else is going to do it for you. Because, it says, the international mechanisms that one could think of to deal with them, whether it’s in the IMF or in multilateral organizations, the international mechanisms are totally inadequate to deal with a major crisis and the fallout on your country. And it doesn’t matter which country, just any country.

LYNN FRIES: For The Real News, I'm Lynn Fries in Geneva. And those clips were part of a commentary on "Playing With Fire" featured in Part 1 of this program. In this segment, we feature another commentary on "Playing With Fire," this one by the author, Yilmaz Akyüz. A prolific writer, currently as chief economist at the South Centre and in his former post as chief economist at UNCTAD, where as lead author he wrote "The Trade and Development Report," among other seminal works. "Playing With Fire" is Dr Akyüz’s most recent book release. We go now to the UN Geneva and our featured event.

YILMAZ AKYÜZ: I wrote the book before I read this very remarkable piece by Dittus & Hannoun. I use a lot of material from the BIS [Bank for International Settlements]. I also see common references between the two books to BIS work. For instance, how financial crises distort income distribution, or boom-bust cycles distort income distribution and resource allocation. Again, how monetary policy in the U.S. and elsewhere is leading to debt accumulation.

What I try to do in the book is to look at the sustainability of the situation. This required in-depth analysis of — taking a good picture of — the state we are in. And that required a lot of data collection. And it was one of the most difficult works I have done, with a lot of support. So I needed all that data to analyze why the situation would not be sustainable.

The basic idea was that after a series of crises in the 1990s and early 2000s from Latin America to Europe to Asia, developing countries integrated more and more with the international financial system in the new millennium. I asked, how? Why? Why is it that we [developing countries] were starved of funds in 2000, 2001, and suddenly we were flooded? That was the nature of international capital flows of course.

I saw two things. One is U.S. monetary policy. As Dittus made very clear in their book, monetary policy in the U.S. has been progressively looser since the '80s, in search of economic growth. One of the main reasons is because of inequality in income distribution. Inequality in income distribution is creating an effective demand problem. When there is an effective demand problem, there is very little investment. So, wages lagging behind productivity growth and also allowing monetary expansion without fear of inflation as inflation often comes with a wage push. So the U.S. Federal Reserve has been bringing down the real interest rate and as the chart in the Hannoun-Dittus book shows, as interest rates come [down], G7 debt is going up. And I can show that Third World debt is going up.

And every boom is ending in a bust. And every boom-bust cycle is making it worse by distorting income distribution and resource allocation and therefore requiring even bigger bubbles. After the '80s Savings & Loans crisis, U.S. cut the interest rate almost to zero at the beginning of the 1990s again. After the dotcom bubble, they cut again creating the subprime bubble. And now they’ve gone into the negative territories. So after every bubble bursting, you need a bigger bubble to keep momentum.

Now why are developing countries liberalizing? I think there are a couple of things. One, it is very difficult to resist the wind. There is diversity. But when India sort of had some liberalization, and if it wasn’t the Asian crisis, India would have liberalized earlier. If it wasn’t the 2008 crisis, India would have liberalized more after Dr. Reddy left the Reserve Bank of India. It’s difficult. Particularly if you open on the trade side/the investment side, you cannot really close easily on the finance side. This is difficult. Second, money coming in — a lot of it coming in — has encouraged you to liberalize so that some of that can go out. Even India did it. Rather than trying to block the money coming in, you allow your residents to take money out. Encourage your corporations to take money out. That’s fine. But the problem is that when the foreigners go out, that money will not come back.

Governments are short sighted, it is not just the corporations, and therefore in conditions of a considerable amount of liquidity, very low interest rates, governments start liberalizing. Thirdly, actually they thought that they were liberalizing in order to reduce their vulnerability. Let me tell you how. First, they wanted to shift from debt finance to equity finance because equity finance is less risky. So they opened stock markets to foreigners. They liberalized foreign direct investment regimes. Second, they all suffered from their exchange rate risk – in Asia, elsewhere – in the emerging market crises. And they said, "We don’t want this exchange rate risk. What do we do? We borrow in our own currencies. So let's open our domestic bond markets to foreigners." They did open. And what happened is sovereign debt in many emerging economies today is internationalized a lot more than the U.S. Treasuries. One third of U.S. Treasuries are held by China, India & Japan. Sixty percent of Turkish, Peruvian, etc. Treasuries are held by non-residents. And our [developing country] Treasuries are not held by central banks as reserves. They are held by asset managers, by fickle investors. So we try to solve one problem, we created another problem: losing control over domestic bond market interest rates.

We allowed foreign banks in. The share of foreign banks in developing countries, except Latin America, has increased significantly. Why? We [developing countries] believe that they bring competition. They reduce intermediation margins. They reduce the vulnerability to external financial shocks. But as Dr. Reddy explains, one of his main concerns when he was dragging his feet against the foreign banks was that they make regulatory arbitrage and make it very difficult to regulate the banking sector. And what we saw in Asia, was that. Foreign banks acted as instruments of transmission of crisis in Germany and France to Eastern Europe, drying out resources in Eastern Europe to help their parents in Germany and France.

Banking regulation has improved, no doubt about it, in the South. But now banks are much less important in intermediation of international finance. Money goes directly to the securities market or bond issues have become more prominent than international bank lending.

So after all this we have an increased financial fragility. Our [developing country] local investment base is very shallow, except countries already graduated like Korea. Bond markets, equity markets are highly susceptible to foreign influences.

We had so called low income countries – LICs. The frontier markets going into international capital markets for the first time issuing bonds benefitted from low interest rates and high risk appetite. The amounts are small — five billion in some cases but large with respect to their income, their export earnings. And already some of them started defaulting on their Eurobonds.

As Dr. Dittus explained, I discuss the so-called "the measure" that increased the resilience of developing countries — the moving from fixed debt to floating. I say that’s fine, but no exchange rate regime is infallible. Crisis can happen under fixed or the floating…And at times of crisis, whether you are floating or fixing, it doesn’t help — it goes down, free fall.

Risk of sovereign debt crisis has diminished significantly and the next crisis in the South most probably will be a private sector debt crisis. But after every private sector debt crisis, sovereign debt increases significantly. We’ve seen it everywhere. Look at Spain: pre-crisis the public debt ratio was 30 percent, and now it’s 100 percent. And the crisis was largely through private borrowing.

And finally I discuss this much-commended reserve accumulation. Now in the '90s, when the Asian crisis happened, Korea had a 100 billion short-term debt, 30 billion dollar reserves. They said we did not have enough reserves to meet the short-term debt. Now we have enough reserves to meet the short term international debt. But the short term is a 1990s story. Today everything is short term: bond holdings, equity holdings, deposits and even foreign direct investments. This is what the book is trying to do. I examined the reserves vis-a-vis a kind of liquidity –the liabilities and so on throughout the balance sheet for some countries such as Indonesia, Malaysia etc. On a massive exit from domestic markets, none of them could stand it. Now, of course, governments say that it won’t happen. I hope it won’t happen. But if the situation is not sustainable, it will happen.

The world is addicted to cheap money and accumulated massive amount of debt — in some countries public debt, in others corporate debt, in others household debt. In the South, we have mostly corporate and household debt. We had consumption and property bubbles. In the North, you have more fiscal debt, public debt. And I was telling Richard the other day that in the FFD [Financing For Development], if you want to discuss the public sector resources you should start from the North because they have much higher debt, their fiscal policies have much more important consequences for the global economy.

And I believe in the event of a sharp downturn in the world economy much of this debt can become unpayable even without a significant rising interest rates. I think in such a case we will see a significant rise in risk premium but maybe not the policy rates. Usually, Jan would know this better; the U.S. goes into recession after 18 quarters. Now the U.S. has been expanding consecutively 27-28 quarters. So recoveries also die, people say. So we might have a slowdown in the U.S. We don’t know. And in that event, with contagion much of this debt can become unpayable. Of course, the normalization of monetary policy or a significant turnabout in global risk appetite can make the matters worse.

As Dr. Dittus mentioned, this is all the more worrying because we do not have adequate international mechanisms for effective and equitable resolution of liquidity and debt crises. Developing countries all have sworn not to go to the IMF again in the event of a crisis but I don’t see what other option they have in the absence of an international, multilateral mechanism for debt resolution and the resolution of liquidity crises.

LYNN FRIES: We have to leave it there. Special thanks to Yilmaz Akyüz and to the South Centre. And thank you for joining us on The Real News Network.

Links to archived reference docs by this producer:

Finance as the Dominant Force in Shaping the Global Economy with Richard Kozul-Wright on the 2017 UNCTAD Trade and Development Report

The 2015 resolution agreed by 136 UN Member States in favor of an international mechanism for resolution of debt & liquidity crises explained by Jayati Ghosh

An interview on what governments need in order to finance transformative structural development and deal with financial and debt crises with Stephanie Blankenburg

Homepage for Lynn Fries


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