Crisis waiting to happen
LAST MONTH the derivatives dealer Nick Leeson was set up as the fall guy for an event that is inherent in the banking system. Although on this occasion it did not lead to a major crisis, more and bigger troubles are on the way.
Dealing in derivatives is a form of gambling. As long as the bookie hedges his bets, taking a small percentage for profit, he will never lose; in fact this is no different from the actions of insurance companies. Of course insurance companies - and even bookies - do go broke if they try to take more than a small percentage, but the system as a whole does not necessarily lose as a result.
The question is, why do financial institutions end up taking bigger risks? The real problem is that if they do not get a rate of return on their capital of about 20% they will be forced out of the market, either by capital being withdrawn from them or by being taken over by other institutions. In any gambling game those with the larger stake in the first place have an advantage over the others. The tendency is for the banks to become even larger. So it is better for small players to take risks, rather than face the certainty of failure.
The Financial Times has predicted that by the end of the century there may be as few as six to a dozen banks controlling the vast majority of the world’s capital. This process of capital concentration goes on even in the very stable conditions enjoyed by the world monetary system since 1945, based on the US dollar. The dollar still maintains its world role but, as the US government has continued to finance its deficits by printing dollars, the deutschemark and the yen are gaining strength. As the institutions move out of the dollar, they threaten the stability of the other currencies. This has been very true for Mexico and Spain, but the other non-DM based currencies of the EU are also under threat.
In addition the globalisation of the world economy is leading to huge currency switches, causing further instabilities in the banking system.
These problems are a combination of the uneven development of the world economy and the political struggles between the various capitalist states and blocs. One likely product is to accelerate the arrival of the common EU currency.
In the financial crisis at the Crédit Lyonnais Bank (the largest bank in the world outside Japan) losses were sustained that are probably ten times those of Barings. The French government has agreed to refinance the bank at a cost of anything up to £100 per French citizen. This is probably illegal under EU law, but there is general political agreement that this is necessary. The alternative - a political and financial crisis caused by such a collapse - would probably have precipitated events similar to those seen in the 1930s.