Together But Not In Sync
No. 3 2010 July/September
Sergey K. Dubinin

Doctor of Economics
Moscow State University, Russia
Faculty of Economics
Head of the Finances and Credit Department


ORCID: 0000-0001-8355-2633
SPIN-RSCI: 3881-6845


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The “Split” of the World Cycle and Opportunities for Russia

The world economy is slowly emerging from the recession of 2007-2009. The economic crisis first appeared as a financial disaster on the financial derivatives market, specifically the mortgage sector. Every new stage of the crisis, every effort taken by governments to curb it demanded and will require solutions to various problems of the global financial system. Overcoming the slowdown directly hinges on the recovery of national financial systems and on how successful the creation of what is called a new world financial architecture will be.


Current financial markets are volatile across the board. Prices of financial instruments fluctuate in both directions, while international financial flows remain unbalanced.
Investment banks have created a new world for derivative instruments where derivatives are traded 24 hours a day. Owing to modern communication technologies, these markets have been networked into a global system accessible to commercial banks, insurance companies and hedge funds. According to The Economist, five Wall Street giants have on their balance sheets over 95 percent of the derivatives forming the assets of U.S. investment institutions. In 2006-2008, one-third of JPMorgan Chase’s reported profits came from deals with derivatives.

The derivatives market has seen “bubbles” of both unreasonably high monetary demand and excessive liquidity. The bubbling market fueled an excessive growth in the price of assets. The crisis led to a drop in prices and to a loss of about $10,000 trillion worth of assets on the balance and off-balance accounts of banks, financial institutions and funds. It was the collapse of transactions with mortgage-backed derivatives that pushed global financial markets to the brink of collapse. The 2007-2008 crisis among financial institutions signaled the beginning of a deep recession, and the crisis of sovereign debt in the eurozone marked a new act in the drama. Efforts to counteract the trend and create a huge stabilization fund were the first attempt to establish a new format for state regulation of international financial markets.

Whether this global mechanism can be made to operate smoothly by national regulation is a big question. For instance, in the United States, the role of a regulator for the commodity derivatives market has to be assumed by the U.S. Commodity Futures Trading Commission. If it is made responsible for commodity swaps regulation, the size of the new market to be controlled is likely to be dozens of times bigger than the market regulated by the Commission today. Most likely, the introduction of regulation and reorganization of the markets will require a reduction in the scale of financial operations and their simplification in order to lower investment risks. Indeed, we are faced with the advent of substantially simplified markets.

No doubt attempts will be made to trade derivatives offshore. However, such contracts will be much more risky. For example, in the 1980s, by toughening state regulation of the markets, the U.S. government shifted the operations of offshore-registered, non-transparent financial institutions abroad. Yet it is one thing to switch transactions from New York to London, and quite another thing to create new market mechanisms somewhere between Bermuda and the Cayman islands.

The global economy that had comfortably relied on the so-called Washington Consensus before the crisis secured two decades of continuous economic growth. However, these years were also the time when self-regulatory markets amassed a potential that was enough for the crisis to erupt. The economic history of the late 1990s–early 2000s can be divided into two periods: before and after the collapse of Lehman Brothers. The period that followed has failed to bring harmony even between the leading economies of the world (the G8 and G20); and no coordinated approaches to the long-awaited reorganization of the world economic and financial order have been found so far.


The crisis in the eurozone has substantially fueled the desire of the U.S. and leading European nations to review the rules governing the global financial market. However, at a June 2010 meeting G20 leaders failed to adopt any specific decision introducing new rules of play on global financial markets. The forum resulted in a set of recommendations for introducing stress tests for national banking systems, and even tougher prudential bank supervision standards suggested by the Basel Committee were suspended for an indefinite period of time.

The leading nations have been taking practical steps on their own, with an emphasis on coordinating the efforts undertaken by national regulators, rather than on establishing specialized international institutions. This approach appears to be more practical than plans to expand the authority of the IMF or the European Commission. A certain redistribution of opinions in the World Bank and the IMF in favor of developing countries can hardly change the situation.

In this context, Germany’s ban on the naked short selling of euro-denominated government bonds and derivatives, and on the buying of sovereign credit-default swaps by non-holders of fixed capital is not something improvised or a hysterical response to a situation that threatens to spin out of control. Although many analysts would assess this measure exactly this way, it may in fact be the first step in the direction in which the leading postindustrial nations are about to go.

The U.S. has moved even a step further. The so-called Wall Street Bill recently approved by the Congress most fully materializes new approaches to the regulation of financial markets and the banking sector. This legislative initiative is centered on the regulation regime for the operation of the derivatives markets and their players, specifically bank holdings which control both investment and retail banking businesses. The provisions contained therein demand that derivatives be traded on exchange-like markets (today derivatives are traded through clearing houses).

Commercial banks should not be allowed to use consumer deposits for derivatives deals. If a private investor wants to deal with such high-risk instruments, he can do so through dedicated investment institutions (Volcker’s Rule). The bank holdings that have such instruments will supposedly be allowed to simultaneously own commercial banks that have access to a discount window of the U.S. Federal Reserve System and investment subsidiaries dealing in swap derivatives. However, new restrictions imposed on the capital of these financial institutions will eventually require an additional investment of $110-$200 billion.

In general, despite intensive inter-governmental negotiations, the world community has actually been offered a plan for subdividing and splitting up both the financial markets and the key market players. After which each newly-emerged segment of the market would find itself under government regulation.

Undoubtedly this approach markedly differs from the two-decade-long practice of reducing state regulation in favor of self-regulation by professional institutions of market players. Simultaneously, the increasing presence of the state in defining the restrictions and rules for markets does not mean a resumption of the previous practice of active government interference.

The G20 summit in Toronto showed that there is an apparent contradiction between the desire of all participants to establish rigid rules for financial markets, banking operations and a budget discipline and apparent fears of destabilizing the gradual revival of the global economy. This is especially evident in national budget policies.

The governments’ sovereign debts were used by developed nations to build up government spending and incentives so as to increase aggregate demand. As a result of the anti-crisis measures, the over-accumulation of debt in the corporate and banking sectors, which was characteristic of the pre-crisis period, has changed into an over-accumulation of government debt.

In a number of nations the government debt has exceeded the 100 percent level of GDP. In EU member-states, the average budget deficit stands at 7.5 percent, and the government debt has reached 79.3 percent in 2010. If the current tendency persists, the above figures are likely to grow enormously. In the next few years government debt is expected to reach 300 percent of GDP in Japan; 200 percent in the UK; and 150 percent in France, Germany and Italy. In fact, quite a few countries may find themselves in a situation like that of Greece, which is incapable of overcoming its debt burden without restructuring the terms and conditions of payment.

That is why the leading countries declared their intention in Toronto to halve their budget deficits with regard to GDP by 2013, and to stabilize their government debt to GDP ratio by 2016.

Meanwhile, the finance ministries of those countries are not prepared to abandon low interest rates and the buying up of government bonds by their central banks (i.e. the policy of quantitative easing). Almost all financial analysts admit that such policies lead to higher inflation both in the dollar zone of the global economy and the eurozone. Given the present-day volatility of the financial system and deflation trends, inflation is being considered as a positive scenario for the future.


Moving from shrinking global GDP to a gradual recovery is a very uneven process that depends on the country and region. The recovery has provided new evidence to the fact that the world cycle is split, as developing market economies – such as China, India and Brazil – continue to show positive growth rates against the decline and ensuing stagnation in developed nations.

There is a fundamental connection between the Russian economy and the economies of the European Union in commodity exchange and the movement of capital. Russia is passing through the crisis, replicating the trajectory typical of its East European neighbors.

Russian analysts, business people and civil servants have been passive observers of global financial processes. Domestic players do not do business in these markets and are not fit for them, although the Russian Trading System Stock Exchange occupies a noticeable place in commodity derivatives markets. Only remote and indirect consequences, such as a slowdown in economic growth and the resulting lower demand for oil and gas on the European market, are believed to be of practical interest for the Russian economy. This factor is of special importance for Russia, but macroeconomic balances do not lead to the restructuring of financial markets. Developed and emerging markets are changing at different rates and the resulting split of the world cycle of economic growth is a no less significant factor than the curbing and simplification of financial markets.

However, there are more direct consequences for the Russian economy that promise to cause headaches in the near future. This is regulation of futures and forward contracts on commodities markets that cover practically all Russian exports. The spot markets for oil, grain and non-ferrous metals (including gold and palladium metals) are functional only with derivatives trading.

The above-described streamlining of financial operations with the entire set of derivatives may result in an outflow of liquidity from commodity derivatives trading markets. If, for instance, commercial banks or investment funds are no longer allowed to assume naked positions in these instruments, or if they are ordered to create massive reserve positions against commodity derivatives, then the liquidity of these markets will shrink and prices will go down.

The crisis has revealed a picture of the world much more complex than has ever been seen before. The orientation towards previously effective market techniques encouraging competitiveness has proven to be insufficient. National egoism has put economic ties between the countries to severe tests. For example, the protection of domestic jobs and trade positions in the U.S. and the EU have invariably provoked demands to revalue the Chinese yuan and protect copyrighted products from unauthorized copying.
Summit meetings have until now been helpful in curbing protectionism, supporting concerted action and avoiding confrontation. However, they have been unable to build a new architecture either in finances, trade or ecology.

China has successfully used the opportunities offered by free international trade and capital flow, which opened up within the framework of the Washington Consensus. This factor promoted an unprecedented rise of the national economy. However, the crisis demanded that it be restructured and this process is continuing vigorously. Whereas in the pre-crisis year of 2006, the ratio of China’s exports to its GDP stood at 69 percent, in post-crisis 2010 the figure has barely reached 50 percent. Domestic consumption rose to 35 percent of GDP. Thus, China’s balance of payments surplus in 2010 has fallen from 11 percent of GDP to 6.1 percent, while its imports are rapidly growing.

China is seeking a new strategy and a new place in the world. Several years ago Niall Fergusson declared the birth of a “G2,” or Chimerica, as a new reality on the global stage, in the belief that China and the U.S. would closely cooperate in various spheres besides the economy. However, a long-term balancing of economic interests cannot be achieved bilaterally, especially as it involves the broad range of domestic and foreign policy strategies. The already-existing multilateral formats for coordinating global ties fit the scale of the problems better, although they, too, cannot offer a complete and rapid solution.

The developing economies are prepared to join the ranks of key players on the financial markets by strengthening their national market infrastructures; that is, by setting up new financial centers on the basis of their banking systems and stock exchanges, and by diversifying debt securities markets. Shanghai, Dubai and Moscow are new generation centers, to name just a few.

A set of new technologies is required to develop an infrastructure of this kind, including information systems of a potential financial center linked to the global network and a huge resource of free data channels. But this is not sufficient either. Legal support for the deals is of critical importance: a favorable investment climate requires legislation that is comfortable for business. Macroeconomic stability and the business community’s trust in the established rules of business regulation are likewise important. Finally, one more compulsory requirement is the continuous development and diversification of instruments offered for trading. These include markets for stocks, bonds, repo deals, and such derivatives as options, forwards, etc.

There have been instances of financial centers making deals in foreign rather than in national currencies. In London, for example, finance operations are often done in U.S. dollars and euros. Yet the free exchange of these currencies into pounds sterling undoubtedly strengthens the position of this center. At the same time, financial centers in Shanghai and Dubai are developing without the free exchange of national currencies.
However, free currency exchange is a must for effective inclusion into the global links of the world financial market. If this is achieved, national currencies could be used as a currency for financial deals. For instance, the Chinese yuan may become a reserve currency (as well as the Russian ruble), but this is hardly possible as long as the two countries have a balance of payments surplus, because in such circumstances the inflow of national currencies into international circulation channels continues to be limited. This is an issue of economic feasibility rather than political prestige. “Reserve” assets will eventually be chosen by the financial market on the basis of risk assessment and investment appeal.