The financial markets in an era of deglobalisation
Why the global volume of foreign-exchange trading is shrinking
FOR more than two decades after the early 1980s, it seemed as if the financial markets were moving in only one direction. More and more money was flowing across borders; capital markets were becoming increasingly integrated.
Since the 2008 financial crisis this particular aspect of globalisation has stalled, and even partly retreated. The reversal is illustrated by the triennial survey of foreign-exchange markets, conducted by the Bank for International Settlements (BIS). Daily turnover in April was $5.1trn, down from $5.4trn in April 2013.
That is still a huge number compared with the turn of the century, when daily turnover was around the $1trn mark. But it is a sign that markets are getting a little less frenetic; spot (or instant) currency trading has fallen by 19% in three years.
Other data from the BIS confirm the trend. Cross-border banking claims peaked in the first quarter of 2008 at $34.6trn. By the second quarter of 2010, they had dropped to $27.9trn, and they have never recovered their pre-crisis levels. In the second quarter of this year (the most recent data), claims were $28.3trn. Part of this may be a consequence of events in the euro zone, where the sovereign-debt crisis caused banks to cut back their lending to weaker economies. Add up all financial flows, including direct investment, and in 2015 cross-border volumes were only half 2007’s level, according to McKinsey, a consultancy (see chart).
This is not necessarily bad news. After all, as Asian countries found out in the 1990s, too much “hot money” flowing into an economy can be destabilising. It can drive exchange rates out of line with economic fundamentals, making a country’s exporters less competitive. A rising currency may also tempt domestic companies to borrow abroad. Then, when the hot money flows out and the exchange rate collapses, those borrowers will struggle to repay their debts. The result can be a financial crisis.
The implications of deglobalisation depend on why the slowdown is happening. There may be a link to economic fundamentals. World trade volumes were regularly growing at an annual rate of 5-10% in the run-up to the crisis; in recent years they have managed only 2% or so. In 2015 exports were a smaller proportion of global GDP than they were in 2008. If trade is growing less rapidly, so is the demand for credit to finance it.
However, as the BIS points out, trade accounts for only a small proportion of capital flows. The downturn is mainly because of events within the financial sector itself.
Before the crisis, cross-border banking activity was closely correlated with measures of risk appetites. When the economic outlook was good, banks were happy to lend abroad; in the face of shocks, they retreated back to their home base. Research by the Bank of England shows that the picture changed after the crisis; there was simply a more general retreat by the banking sector from foreign commitments.
Part of this may reflect a lack of demand for loans from companies and individuals that had overstretched during the boom years. But the biggest reason is probably the weakness of the banking sector. It has been deprived of some sources of funding (money-market mutual funds, for example) and has been forced by the regulators to rebuild its balance-sheet.
In the currency markets, the BIS says, there has been a shift in the type of people that are participating. Institutional investors such as pension funds and insurance companies are being more active. They may decide to buy, say, Japanese equities without wanting to be exposed to fluctuations in the yen, so they will hedge this exposure in the currency markets. In contrast, there has been a reduction in risk-taking activity by hedge funds and bank trading desks, which suffered a big shock in January 2015 when the Swiss National Bank suddenly abandoned its policy of capping the franc’s exchange rate. The sharp jump in the value of the franc that followed caused turmoil for some brokers, forcing them to raise their fees and cut their client lists.
A market less in thrall to speculators might seem like an unalloyed boon. But the retreat of banks from currency trading (and from market-making in other instruments such as corporate bonds) may not be quite such good news. In a crisis, the banks may not be around to trade with investors seeking to offload their positions; the BIS notes signs of “volatility outbursts and flash events”. Lots of investors and companies want to hedge their currency exposure. They need an institution to take the other side of the trade.