Thursday, September 18, 2008

Thoughts on Financial Turmoil

I've been following the latest developments in the financial crisis with some interest this week, and trying to work out what they mean. Surely credit will be tight enough to cause a fairly big recession in the developed world over the next couple of years, but it's a bit harder to judge the longer term effects. Still, here goes.

Presumably there will be much tighter regulation of the financial sector. In other industries companies are mostly competitors, so that the remaining companies are strengthened when a firm goes bankrupt. In finance the competing banks are also counterparties to a whole range of deals, and a corporate collapse actually weakens the remaining entities. It's an amusing paradox that you have to limit competition in the capital distribution system, which is really the heart of a capitalist economy, but there you go. The countries with loose lending standards, weak capital requirements and innovative financial firms (US, UK) have been the source of the upheaval, to the extent that their governments are having to bail out the market and take over large chunks of it. Better to have stricter rules to begin with.

Tighter financial regulation will be a good thing, but will probably encourage excessive government intervention in other parts of the economy. This could really look attractive if some of the Asian economies remain strong over the next few years e.g. China, Singapore, Korea. That could hold everybody back by limiting useful competition and creative destruction in industries other than finance. Not to mention that widespread government control of the economy would encourage repressive politics as well.

On a geopolitical level I see the present crisis hastening the end of the United States' global dominance. The American economic system was recently seen as effective and capable, albeit somewhat harsh, but now it's seen as the source of all the problems. The United States will be weakened as the rest of the world doesn't invest in its economy to the extent that it has over the last 2 decades. I think China will take over as the obvious superpower around 2020, whereas I used to think that would happen some time in the 2030s. I'm not looking forward to the transfer of world leadership from a democratic government to an autocratic government, but it's starting to seem inevitable.

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