Chapter 4 Electronic Money and the Casino Economy Richard Bamet and John Cavanagh Deregulation of banking and financial markets, combined with the new rules of free trade and the new technologies that offer instantaneous worldwide money transfers, have combined to profoundly transform the modes of financial activity all over the planet. Incomprehensibly large amounts of money are shifting from market to market and then back again in the time it takes to make a keystroke. Governments are left nearly helpless to ensure the stability of markets or currency values in the face of the tremendous acceleration of speculation. The role of the global financial gamblers in creating many of the current money crises has been seriously underreported in the media. In this chapter a condensed history of these enormous changes and their consequences is presented. Richard J Barnet is a former arms control expert in the Kennedy administration. He has written 14 books, most recently (with Ann Bamet) The Youngest Minds, and (with John Cavanagh) Imperial Corporations and the New World Order. Bamet cofounded the Institute for Policy Studies in 1963 and is currently a Distinguished Fellow at the institute. He has published hundreds of articles on foreign policy, globalization and domestic policy in the New Yorker, Harpers Magazine, the New York Review of Books, the Nation and other publications. John Cavanagh is director of the Institute for Policy Studies and vicepresident of the , board of the International Forum on Globalization, where he chairs the Alternatives WöfkirfyGroup. He has coauthored ten books on the global economy, most recently (with Sarah Anderson and Thea Lee) A Field Guide to the Global Economy. His articles appear in the Washington Post, the New York Times, Foreign Policy andother publications. Cavanagh has degrees from Dartmouth College and Princeton University and has authored, studies on transnational corporations for the United Nations Conference on Trade and Development and the World Health Organization. On 30 January 1995,24 hours before President Bill Clinton orchestrated a US$50 billion bailout of the Mexican economy, the world financial system came perilously close to meltdown. As news spread around global financial markets that Mexico was on the verge of defaulting on government bond payments, capital Oed stock markets from Brazil and Argentina and even from countries as far away as Poland and the Czech Republic. On that day, Asian markets were spared only because stock markets were closed in observance of Chinese New Year. Just two and half years later, in mid 1997, a similar financial panic spread across the world. This time, the crisis began in Thailand but quickly moved to the Philippines, South Korea, Indonesia, Russia and Brazil. As international investors panicked in country after country, their 'hot money left much faster than it had arrived. Big-time currency speculators such as George Soros deepened the crisis by betting against the currencies of the crisis nations. International Monetary Fund (IMF) policy advice only quickened the exodus. Currencies and stock markets from South Korea to Brazil nosedived, spreading pain, dislocation, death and environmental ruin. This sort of crisis is more than likely to recur in the coming years, and next time it might have even more devastating effects worldwide. The root causes of these crises are twofold: 1 the total deregulation of the global financial systems that leaves banks and other financial institutions without controls; and 2 the corresponding revolution in communications technology that has brought radical change in the scale, speed and manner of financial activity. This combination of factors has enabled currency speculators to run wild, moving their immense resources electronically, instantaneously, from country to country, beyond the abilities of any government to control the process. In this cybertech globalized world, money has become free of its place and, as we will see, from most connections to its former sources of value: commodities and services. Money itself is the product that money buys and sells. Because of the tremendous financial requirements for playing in this global money game, banks and finance houses are quickly diminishing in number but increasing in size; as a result, they are becoming still more difficult to control. The net effect is that the world financial system has become exquisitely vulnerable to technological breakdown, the high-risk consequences of short-term speculation and freelance decision-making. If anything goes wrong in this fragile arrangement, which is increasingly likely in the context of a wired-up economy based on free trade, then the following scenario is likely. When a crisis in one place directly affects financial flows everywhere else, speculators panic, speculative funds will be moved without warning (as happened in Mexico, Asia, Russia and Brazil), and we will be quickly threatened by a rapid domino effect among the worlds interdependent stock markets. Global economic collapse is possible. The following are some elements in this larger story. OU engines of Globalization The Nature of Electronic Money Most business and personal financial transactions still involve cash that is rU nnleľo eL™„l ľ T 'ra°SaCt,0°S d<> "0t * "*« in PÄ "»• The economy. ^ US$6 that move Ir> the world exists except as an entry on a computer tape' (Passell, 1992T ^ 24-hourtradingLwLvtľr0fmonUeS ^ ^ "^ ^ PC™ks and so on - all acrolthľľwľ ľ^f ° ľ" ~ securities> °P«°ns, futures banking. As FeĹ Rohatý oft ľp " ^ ^ human rdadons °f an electronic sc^TheľdÍl ť ľ ľ"* * ^ ^ and scl1 bliPs on *« Phone in 1^^»^^» almost like modem warfare where «ľni ■ u7 , °°k at SCreens- Its ^ŕT and ^^-^^^^ 18'UScents. By deX"*Ĺ« ľ ^ ' * *! aCCOmPlished «* Just Trust was able to aSa^T^^*^"*"^*^ B-kers rime, according t0 ^87 0^0^7^7* "*" "^ " ™šh four orTive trades The on™/ Technol°^ A*«»*« study, to execute wl.aÍr"etdXfbTnbt cľ''f ""7" "*"*» *" ^ networks have expanded tkľnľ, t Cf°mP ""' dcC"0nic »"""nnicariom of making BBfaX„T K i"*"^ '""'''^ ""d re TT *" \ ^^ ^ ^ ^ &™ b^ "P- SuW nut ttSfndS t0 T'6 aCCOUntJ at the end °f kS b™ ** the "'—nie entnes would be reversed - unwound in global-banking lingo - and every bank engaged m a transfer to or from the defaulting bank would feel its effect The e involved or a stock market crash is also occurring, could triggers chain reactZ of bank failures. The system could be shut down for weeks, during which time that such scenarios are htghly improbable, but they acknowledge that the complex! ny, speed, and dynamism of global banking arrangements expose the syZTo adľalcľ^ ßtoal a fi aS W11 ° u" techn0l°Sical catastroPhes - from Chernobyl to p a nnancial markets computer breakdown would ultimate v ininrp mnocent workers and civilians just as it has in Mexico, Asia and elsewhere ' Globalization Ař|D the Pressure to Deregulate The technology of money lerjding and the explosion in money packaging have outpaced banking regulations designed for a simpler and slower L The ZsZ ľeWslnX^ XBs?hrfl;r^ Changes in Japanese banking regulations are also putting Tokyo-based banks n a.stronger competitive position. On 18 October, L wfeks befo the m2 presidential electron, Secretary of the Treasury Nicholas Brady gave a speech to the American Bankers Association in which he said that increasing the competitiveness of the US financial services industry was critical to stimulating growth in the US economy. The key, he said, was to eliminate 'the old arbitrary legal framework that governs the banking system, especially outdated restrictions on products and geography. In other words, banks should be free to leave their original neighbourhoods - where they may have helped local business and the public — and go to Asia or Europe, or wherever the action is, to serve themselves. The argument that globalization requires deregulation is at least a quarter-century old. Deregulation of the US financial services industry has actually been underway for years, as part of a global shift in the relationship between governments and banks all over the world. To a great extent the US financial services industry deregulated itself. By resorting to creative corporation rearrangements, such as holding companies and mergers, the banking, brokerage and insurance industries slipped out of the legislative restraints intended to limit their geographical reach and their permissible activities long before Congress acted to loosen them. Through its parent corporation, Citicorp, which is not a bank under the law, Citibank could operate as a credit-card banker in all 50 states, rendering irrelevant and unenforceable the New Deal legislation that was supposed to keep banks serving their own communities. To get around legal requirements that banks lend only a certain percentage of their cash reserves, Citibank could sell its loans to Citicorp, which is not subject to these requirements. (In 1998, a giant financial conglomerate, Travelers Group, acquired Citicorp for US$72.6 billion; the new merged firm is called Citigroup.) Congress had not anticipated that the nations largest bank would make such effective use of the one-bank holding company to escape regulation, and friends of the banking industry in the US Senate effectively blocked efforts to plug the loophole. By the 1980s, banks were not only operating across state lines but had become sellers of insurance as well. Brokerage houses and automobile manufacturers were now deeply involved in the real estate market. All had, one way or another, jumped over the fences Congress had put up to separate investment banks from commercial banks and to keep brokerage firms, insurance companies and thrifts concentrated on the businesses for which they were chartered. Thanks to information technology and the ingenuity of lawyers, money now travelled faster, farther and in ways never envisioned by banking legislation and regulatory authorities. As Clive Crook in the Economist puts it, deregulation 'is often no more than an acknowledgement that the rules are no longer working' (Crook, 1992). But deregulation, whether by circumvention of official policy or by law, had unanticipated and extremely unpleasant consequences. Like war plans, bank regulations are written with the catastrophes of the previous generation in mind. After the Great Depression, when the national banking system collapsed because of risky loans, the Federal Reserve was given authority to set interest-rate ceilings on deposits. Regulation Q, as this grant of regulatory authority was known, was designed to stop banks from offering higher interest rates as a way the Federal Der.™;, I^ ^ deposits were now insured by fan z^ín^rľ (FDrIC)'the risk wou,d eventuai1" member banks pZ in totheFdTc ^ '" "^ «^thc fees a" ^ in trouble; but iflilľr ľ were to reaT ' *° ^ ^ dCp°SltS °f banks exhausted, and ConZ3d h " ""^ ^ FDIC W™ WOuld be depositors This i 5 couľe ÍÍ7 t "T "P ^ ^ ^ t0 W off r is, or course, exactly what happened in the lare iQ«n l infamous savings and loan industry debacle Bm thTr c t f? '" C planted decades earlier. ^ ^ r°°tS °f the Problem w^e Evolution of Homeless Money financkl institutions such as UU,. i , °ard aSrced '° let matkc, tat« „„ consul™ Z„,s°Ťľ ' mS"'a°Ce T"""'" ™ r«nt„s fo, co„s„m„s „„. ^ZZj^lTZ 7 ^ rates soared in the 1970s mnr,™ ~—'-.....r^, -^näs- As nommal interest Germain Act of 1982 Essential 7ľ i u f ' °thcr the Garn~St merest rates for ^ÄÜS ľ^ HmÍtS°n but nof they Je" peľmtdľ °í^"—W money in the nation, estate rjns AtThesamľtme ^.^T" loans »d commercial real- mortgage market By traditionsľl P ^ mt0 the com™™l supply working apftľand Zľt Y ľ T^ ^ Werc in b™s to inľthe rL ZZ^ta^^ f t0 "^ But nOW ^ -she« million 4vS$ll7^^^^^^^™™ -eededofficebuildingsspelleddisasteľS^^ SoSľe^ " ^ľ Our children and millions more taxpayers yet nnh nu d,saPPe^d. something under US$1 trillion ^2^ ^ *" * — ^ ™h All through the last three decades, US banks pursued another strategy to escape the regulators. They shifted more and more of their activities beyond US shores, well out of reach of the treasury or the Federal Reserve. Here, too, regulators inadvertently spurred the process. As US corporations, armies, military installations and government aid programmes spread around the world in the 1950s, all spending billions in US currency in other countries, the glut of dollars in the hands of foreigners became a serious world problem. By this time, Germany, Japan, and the other industrial countries were recovering from the shocks of World War II and were producing a flood of goods. It was neither necessary nor advantageous to import so much from the US. Non-Americans had accumulated hundreds of billions of dollars more than they could possibly use to buy goods and services from the US. Except for the fact that the dollar was the world's reserve currency backed by gold, the overvalued offshore dollars were becoming risky holdings. If the holders of offshore dollars were to cash them in, the US would face financial catastrophe, because the treasury promised to redeem dollars with gold at US$35 an ounce. The obvious alternatives for the federal government were either to scale back expensive military commitments or to devalue the dollar. Both were inconsistent with Americas self-image in the 1960s as the world's number one superpower. For the first time, the nation experienced severe balance of payments problems. As foreigners piled up unwanted, overvalued dollars in banks in London, Paris, Geneva and Hong Kong, the doors of the gold depository at Fort Knox kept swinging open to accommodate the heavy traffic in gold bars bound for Europe. To stem the flow of gold, the Kennedy and Johnson administrations tried to limit the amount of dollars US banks could lend to foreigners and taxed foreign bonds issued in the United States. But these measures only succeeded in accelerating the outflow of dollars. US banks, led by Citibank, were now firmly established in Europe and Asia, and offshore lending exploded in reaction to the US government's efforts to keep Wall Street banks from lending to foreigners. By the 1970s, for every dollar US banks were lending to non-Americans from their domestic bank offices, they were lending six or seven more from vast offshore facilities that collectively came to be called the Euromarket. This pooling of funds, mostly in dollars, started in Europe to accommodate the financial needs of communist China, but it soon became a global money pool that could be used by borrowers anywhere. The distinguishing feature of the Euromarket is that the money is denominated in a currency different from the official currency where the deposits are located. All such money is largely beyond the reach of national regulators in the countries of origin. When US companies in need of capital abroad resorted to the Euromarket, they were complying with the US policy to restrict capital outflow from the United States. But the buildup of this huge pool of offshore dollars created a formidable alternative to the US capital market. IBM was the pioneer among US-based companies to make creative use of the Euromarket, but soon many US companies operating outside the United States were financing their overseas operations without resorting to banks in then home country The Euromarket expanded into bond issues and then beg n offenng a menu of mcreasingly arcane money products. Soon it was serving as" con cung rod for ^^ ^ ^ ^ Emergence of Casino Economics Money ltself was b a tmly globaJ product in Eurocurrency accounts all over the world was US$315 billion; by 1987, the total was nearly US$4 tnllion. This fantast, expansion was hastened by th se ils of deregulates of mternational money transacts that began whL the ŇLn admm.stranon forced the end of fixed exchange rates if August 1971 and governments everywhere lost much of their power over money. The value of money was now set in increasingly mtegrated global marketplaces, as foľeign xchange traders all around the world haggled over how many'hre or drachmas an ever fluctuanng dollar could buy at any mstant in time. In the 1970s the eminent econom.st Milton Friedman convinced the Chicago Mercannle Exchange which had established a lively futures market in hog bellifs and other gncuZi products m order to protect farmers and food companies from the X% ľf fa m prices, Aat, f market for money $ *ot The more h flucmated) the more .merested mvestors dot m hedging then bets with contracts to buy or sell at a set p„ce on a set date tL betung posstb.hues were limitless. By 1989, 350 varieties of futures contracts exZ eltat hT Ť' "" "*" * ^ "" " ** ^ ™ exchanges that had sprouted up across the world marte H!^ ^ ** ^ ^ " *" transfor—« <* world financial dosed 1 Z d"" A ?š°x OCCaSÍOnS- The firSt WaS Ín 1971' When Ni»n do ed the gold wmdow. No longer was it possible to redeem dollars for gold Th meant that non-Americans had to keep their dollars on deposit somewhere m the world or convert them into some other currency. The second event came tld to7 ""ľ11" PaUVVOkker' then ChaÍr «^ *^ ReserveB a" fed tonfigh mflatton m the US by cutting the money supply. He used the standard tool - charging substantially higher interest rates to commercialbanks o obtam do lars from the Federal Reserve. Since the dollar was the res3cUrre^ Índ b ľ er' ^ Feď had UnW,ttÍn^ raÍSed inte™ -«s everywherľ nd both mterest rates and exchange rates began fluctuating wildly. As Mchad t-Zľedfri rtLtar's-Poker(1989)''°verni^the^"-*«£ mmsformed from a backwater mto a casino. The buying, selling and lending of monetary products worldw.de became businesses in themselves" Most of it had Hľw::eľtlngh0 Wlth^nVCStment in ^ Paction or commerce (However, as exchange rates became more volatile, hedging became almost a hlectronic Money and the Casino Economy necessity for some transnational businesses.) Foreign direct investment in the developing world fell as the leading commercial banks of the wotld saw that they could teap quicker profits in commissions, fees and interest by 'recycling' tens of billions of 'petrodollars' from the coffers of Kuwait and Saudi Arabia to the governments and their business associates in poor countries. As Richard O'Brien, chief economist of American Express Bank, notes (1992), 'Deregulation and liberalization clearly encourage globalization and integration. Liberal markets and systems tend to be open, providing greater ease of access, greater transparency of pricing and information.' The flow of accessible information offers a global environment that is hospitable to homeless money, promoting what O'Brien calls 'the end of geography in the finance and investment business. The rise of global financial markets makes it increasingly difficult for national governments to formulate economic policy, much less to enforce it. In the increasingly anarchic world of high-speed money, the dilemma facing national political leaders is clear: impose regulations, then sit back and watch how quickly financial institutions slip away by changing their looks, disappearing into othet corporations, or otherwise rearranging their affairs to make life difficult for the regulators. At the same time, bankers argue that to the extent the regulations are observed, they pose a handicap in international competition. Yet, the history of deregulation is littered with scandals and financial foolishness for which a handful of bankers, but mostly millions of taxpayers and depositors, have paid a heavy price. Global Race to Deregulate On 27 October 1986, the 'Big Bang', as the chair of the London Stock Exchange first called it, went off in the city of London, ending 200 years of comfortable, stately, and expensive trading practices on the London Stock Exchange. Overnight, the market was deregulated and opened to foreign banks and securities firms of all sorts. An electronic marketing system modelled on the new US computer-age stock exchange, NASDAQ, was installed to take the place of old-fashioned floor trading. Traders could now bypass London and deal directly with markets in New York and Tokyo at much less cost. Deregulation was a strategy for trying to get lost business back. As the New York Stock Exchange had done more than ten years earlier, the London Stock Exchange abolished fixed commissions for traders, and it now permitted firms to act as both wholesale dealers and brokers. Suddenly, US commercial banks that were barred from the securities business at home could plunge into this market in London, neatly jumping over the wall of separation between investment and commercial banking provided under the Glass-Steagall Act of 1933, the cornerstone of modern US banking regulation. (With the Great Crash and its consequences still fresh in mind, the act was intended to forbid banks to act as underwriters for corporate securities.) 68 Engines of Globalization The global expansion through large corporate mergers and acquisitions gathered steam in the 1970s, and this global restructuring of industry required the amassing of huge amounts of capital. At first, large banks dominated this market because they were the ones with the financial power and connections to syndicate large loans through networks of foreign banks. But in the 1980s, as capital needs mushroomed, corporations in search of funds found that it was much cheaper to raise the capital by issuing bonds and other sorts of commercial paper. Financial institutions of all sorts packaged a bunch of small loans and sold them as securities on world markets. Borrowers all over the world, including the largest corporations, could now shop around the world for money, and they could borrow it in many different forms on a wide variety of terms. Investors could hedge against risks in one national economy or in one industry by buying foreign stocks. Global markets in securities offered opportunities for diversification. Laws and regulations that had previously put international investments out of bounds came tumbling down. Markets in securities were losing what few geographical ties were left. It was now possible to invest in the New York market by buying New York Stock Exchange index shares on the Chicago Board Options Exchange. The Big Bang triggered an explosion of deregulation in other financial centres all over the world. Screen-based markets offering instantaneous flows of global information took over an ever larger share of business from traditional floor trading. In addition to the speed and convenience, there were fees and taxes to be saved. Stocks in foreign companies became internationally traded products. London, Amsterdam, Paris, Frankfurt and Zurich competed in offering the most cosmopolitan menu of stocks, options, swaps, and futures in companies around the world. By 1990, the buying and selling of foreign equities on the London Exchange exceeded that of British equities. The Final Barrier s With the juggernaut of deregulation having just about completed its sweep across the developed world, there remained one final barrier to ultimate freedom of movement for money and for the ability of the great financial conglomerates to control world markets. That barrier was among the poor countries of the developing world, who still stubbornly refused to open their commercial banking sector to'outside domination. The Uruguay Round of the GATT took care of that. In most of the world's poorest countries, foreign banks were traditionally welcomed for the services they performed, but only up to a certain point. The foreign banks were appreciated as sellers of retail credit and providers of capital under controlled, specific conditions. But foreign banks, with few exceptions, had been prohibited from buying into ownership positions in commercial Electronic Money and the Casino Economy {^) banking. Developing world governments argued that since finance is central to development, the financial services industry should remain firmly in domestic hands, serve domestic interests, and keep money within the economy. The US led the challenge against the developing world's control of its own financial markets during the Uruguay Round of GATT negotiations. The US and other Western nations argued that efficiency' and 'fairness' required that all foreign banks be accorded national treatment in every country. National treatment essentially means that foreign banks must be treated just as if they were local banks, so, for example, US banks must be permitted entry into developing world financial markets even if they gain full control of the local institutions. Load governments would have to give up all attempts to sustain control over local financing activity. . This was one of several important points that kept GATT negotiations stalled for seven years; but eventually the US and the other Western powers forced the poor nations to cave in and, under the WTO, a financial invasion is now underway. While those negotiations proceeded, the US pushed hard for deregulation of financial services with Mexico and secured an agreement that the US negotiator said would give US banks 'dramatic new opportunities', a situation later solidified by NAFTA. As a result, one treasury official bragged at an off-record briefing, 'They [Mexico] gave us their financial system.' Indeed they had, and in January 1995 the world was given a taste of the consequences. The Mexican economy will not recover for a long while. Ordinary Mexican citizens will ultimately pay the bills for the bailout by the US of hundreds of its own speculators, notably Chase Manhattan and Goldman Sachs. Clearly, Mexico in 1995 and much of the rest of the world in 1997-1998 were just the first of many such debacles to come. In a globalized economy, wired together by technologies capable of moving unimaginable funds instantaneously around the globe at the behest of speculators and immune to any ability to regulate or control this movement, we ate in for more frequent catastrophes. Yet, this is a condition the world will not be able to tolerate for long. It makes banking services even more difficult and distant for local communities, small businesses and ordinary people. Worst of all, it puts the entire international economic apparatus into a most precarious situation. Global finance could tumble down quickly, like the house of cards it has become. Ultimately, change must come in the form of a financial system not based on speculation, but a system that uses funds with geographic roots and some connection to goods and services that cater, as they once did, to the interests of local and regional economies. The examples of the Grameen Bank in Bangladesh and the South Shore Bank in Chicago, running directly counter to the trend, are informative, optimistic models. Only by such a change in direction can the financial community be remotely in service to ecological and social sustainabihty.