In his new book, Superpower, Eurasia Group’s Ian Bremmer suggests three strategic options for America to remain a global superpower. But while many lawmakers appear to be taking his preferred option of an “Independent America” to heart, we believe it’s the wrong choice. In fact, Bremmer leaves out a fourth approach that we feel is the best strategy for America to win not only on the current global chessboard, but on the next one as well.
With the US reluctantly being drawn back into putting out fires in the Middle East, warily watching Russian aggression, facing a stop-and-start “Asia pivot,” and on the sidelines the Greek crisis unfolds or Chinese stock markets go through turmoil, reviewing these options is timely for President Obama; they may be even more important for his successor.
The dramatic speed of financial transactions can be matched only by the intensity of the controversy surrounding it, especially when it comes to high-frequency trading.
In markets for stocks, futures and foreign exchange, transactions take place in milliseconds to microseconds (or even nanoseconds). Markets for fixed-income securities including corporate bonds and over-the-counter derivatives such as interest-rate swaps are also catching up quickly by adopting electronic trading.
To many, the “Flash Crash” of May 2010 was a wake-up call for reevaluating market structure. A series of technology glitches proved to be highly costly for some brokers, proprietary firms and marketplaces in terms of both profits and reputation. The SEC launched investigations into HFT firms and their strategies. French regulators introduced a financial transaction tax. Author Michael Lewis wrote “Flash Boys.” The list goes on.
With this fallout comes important economic questions: What are the costs and benefits to investors for speeding up trading? Is there an “optimal” trading frequency at which the financial market should operate? And does a faster market affect one group of investors more than another?
Financial shadows are dangerous. Even more dangerous are interactions between poorly understood shadows and essential financial intermediation activities. And most dangerous is when officials and private sector executives encourage a class of transactions that supposedly provide modest risk mitigation, while really building a disguised form of systemic risk on a grand scale.
It was not mounting losses at Countrywide, the failure of Lehman Brothers or the imminent collapse of AIG that spelt disaster in September 2008. It was the connections between those lightly regulated businesses and Citigroup, Bank of America, Goldman Sachs, Société Générale, Barclays, UBS and Deutsche Bank.
Where is the next generation of systemic risk hiding in plain sight? Look carefully at central clearing counterparties, or clearing houses, which are expanding due to the post-crisis requirement that standardised swaps – derivative transactions, including credit default swaps, that have standard terms along important dimensions – be cleared centrally.
What’s the one thing Pope Francis, Barack Obama, Marco Rubio, and Warren Buffett all agree on? America needs to change the way it sets wages to overcome its economically and politically unsustainable levels of income inequality.
The question is how? Let’s start with some lessons from history and see how we can apply them to today’s economy and society.
For 30 years after World War II, wages and productivity in the U.S. moved up in tandem, creating a growing middle class and ensuring baby boomers could realize their American Dream. We called that the “post-war Social Contract.” Then in the 1980s, the social contract fell apart, starting 30 years of stagnant wages, growing inequality, and political polarization.
The post-war Social Contract was possible because the New Deal established a floor on minimum wages and protected workers’ rights to organize and engage in collective bargaining. Then in the mid-1940s as the domestic economy grew on the basis of purchasing power pent up during the war, United Auto Workers’ President Walter Reuther and General Motors (GM) CEO Charles Wilson negotiated what was called the “Treaty of Detroit,” specifying that wage increases would be set to match growth in the cost of living and productivity. The strength of unions then helped spread this “pattern” bargain across American industry.
Benchmarks are heavily wired into modern financial markets. For example, trillions of dollars in bank loans and several hundred trillion dollars (notional) of derivatives transactions depend on daily announcements of LIBOR. The WM/Reuters foreign exchange fixings dominate the currency markets, in which there are over $5 trillion of transactions per day. Benchmarks are the basis for trade of a wide range of commodities such as gold, silver, oil, and natural gas. They have also been the focus of scandals (Brousseau et al. 2013).