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Shoring up the Global Financial Safety Net: International Trade Implications

By Karen Lynch

Many articles in the financial press unavoidably use a phrase that has begun to wear thin: "Since the global financial crisis of 2008…" Ten years later, though, global policymakers are not looking in the rearview mirror; they're looking ahead to avert the next potential international trade crisis by strengthening what they call the global financial safety net.

Their work could be important to small and midsize enterprises (SMEs), which the U.S. Small Business Administration has said were especially hard hit by the crisis,1 and to import-export traders, which suffered through what the Federal Reserve System has called a collapse of international trade finance.2

 

During the global financial crisis, "international coordination and collaboration on financial stability was limited, and there was a shortage of detailed and standardized information about financial conditions and vulnerabilities in different countries," according to Randal K. Quarles, a Federal Reserve Governor.3 By mid-2018, coordination had improved but new risks to international trade had also arisen, such as virtual currencies and ever-faster and more automated digital transactions, according to speakers at the 2018 G20 Global Financial Stability Conference.4

 

"The actions of G20 countries in response to the crisis increased the size of the safety net significantly," according to a recent paper from the Brookings Institution. "But the G20's success may be producing a false sense of security." 5

 

The G20 and International Monetary Fund (IMF) are working to further strengthen what is currently in place.

 

What is the Global Financial Safety Net?

 

The global financial safety net is a framework of international organizations and arrangements designated to help economies facing crisis. More specifically, it is intended "to provide precautionary insurance against a crisis; to supply liquidity when crises hit; and to incentivize sound macroeconomic policies."6

 

How the G20 Enhanced the Safety Net

 

G20 countries have already taken numerous steps to shore up the global financial safety net since the financial crisis. For example:

 

  • The IMF's lending capacity was tripled, as a global financial backstop.
  • The Federal Reserve and other central banks have entered into a multitude of bilateral currency swap agreements. (These allow a central bank in one country to exchange its domestic currency for a certain amount of foreign currency to lend to its domestic banks, which can be particularly important in alleviating dollar funding problems among non-U.S. banks.7)
  • And the Financial Stability Board was created as a multilateral body for reforming international financial regulation.

 

Now, the Brookings paper estimates that, "Adding together the global, regional and bilateral components finds that the global financial safety net is $4.6 trillion in size."

 

Before the 2008 financial crisis, however, some had argued that this safety net was no longer needed. "This view, of course, proved to be incorrect," according to the Brookings paper. "The consequences of neglecting the safety net for many years were on display for all to see, threatening the stability of the global economy and the global financial system."

 

The crisis that unfolded is vividly described in the paper: "Whole economies, one after the other, went into crisis. Each of these economies required an amount of external assistance that was multiples of the meagre funds that the IMF had to offer. Global liquidity evaporated. Major economies faced shortages of U.S. dollars with no means through which to access more. … Credit froze, global trade seized, and it was left to the newly-minted G20 leaders' forum to fix it."

 

Observers say that the global economy is still picking itself up from the crisis.8

 

Implications for Business and International Trade

 

Economic crises tend to affect international trade in several ways: lowering consumer demand, reducing the number of markets for expansion, reducing credit, triggering currency fluctuations, and contributing to the rise of protectionist policies.9 At one extreme, a country can experience a "sudden stop," in which foreign capital stops flowing into its economy, imperiling its ability to pay for external trade.10

 

Rules of thumb for SMEs to prepare for a crisis include understanding their industry and its performance in previous crises, diversifying their customer base, and developing an emergency plan that includes targeted budget cuts.11

 

In the 2008 crisis, "one of the most salient features was the decline in international trade relative to gross domestic product (GDP), which was unusually abrupt compared with past recessions for most economies," according to the Federal Reserve. Causes included the steep reduction in global demand and significant tightening of financing, which reduced companies' operating capital and ability to satisfy demand for their products.12 In the wake of the 2008 crisis, international trade finance was said to fall short of demand by $1.6 trillion.

 

Averting Financial Crises

 

Despite efforts to shore up the global financial safety net, gaps remain, according to the IMF. For example, coverage is uneven and the high cost of maintaining the safety net can be a disincentive.13

 

Since now is a time of global economic strength, "we must use the current window of opportunity to prepare for the challenges ahead," IMF Managing Director Christine Lagarde said in April 2018. "Most importantly, we want a strong global financial safety net."14 The IMF has proposed enhancing its "toolkit" for crisis prevention, for example, and is developing various reforms to its lending practices.15

 

Recommendations in the Brookings paper also include strengthening the IMF as well as mitigating the fragmentation of various regional and bilateral arrangements. "The G20 is increasingly seen as the premier forum for global governance reform. With … increasing risks in many economies, strengthening the global financial safety net should represent one of its top priorities," the paper said.

 

Further consideration of the global financial safety net is on the agenda for the G20 meeting of finance ministers and central bank governors in October 2018.16

 

The

Takeaway:

In the business world, companies involved in international trade were particularly hard hit by the 2008 financial crisis. International policymakers are now at work on improving the global financial safety net that is currently in place to mitigate such economic crises. The G20 meeting in November 2018 is expected to weigh in on the way forward.

Karen Lynch - The Author

The Author

Karen Lynch

Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.

Sources

1. “How Did the Financial Crisis Affect Small Business Lending in the United States?” U.S. Small Business Administration; https://www.sba.gov/advocacy/how-did-financial-crisis-affect-small-business-lending-united-states
2. “The Role of Financing in International Trade during Good Times and Bad,” Federal Reserve Bank of St. Louis; https://www.stlouisfed.org/publications/regional-economist/january-2012/the-role-of-financing-in-international-trade-during-good-times-and-bad
3. “America’s Vital Interest in Global Efforts to Promote Financial Stability,” Federal Reserve System; https://www.federalreserve.gov/newsevents/speech/quarles20180627a.htm
4. “G20 Urges Global Cooperation to Maintain Financial Stability,” Aju Business Daily;http://www.ajudaily.com/view/20180615113457983
5. “The Dangerous Inadequacies of the World’s Crisis-Response Mechanisms,” Brookings Institution; https://www.brookings.edu/wp-content/uploads/2018/05/working-paper-116_world-crisis-response_adam-triggs.pdf
6. “What exactly is the Global Financial Safety Net?” European Stability Mechanism; https://www.esm.europa.eu/content/what-exactly-global-financial-safety-net-gfsn
7. “The Spread of Central Bank Currency Swaps Since the Financial Crisis,” Council on Foreign Relations; https://www.cfr.org/interactives/central-bank-currency-swaps-since-financial-crisis#!/
8. “Tit-for-tat Tariff Battle Could Spark Downturn in Global Economy,” The Guardian;https://www.theguardian.com/business/2018/jun/24/tit-for-tat-tariff-battle-could-spark-downturn-in-global-economy-bis
9. “Effects of the Economic Crisis on Free Trade,” Small Business Chronicle;http://smallbusiness.chron.com/effects-economic-crisis-trade-1667.html
10. “In Economics, What Does ‘Sudden Stop’ Mean?” The Hindu;https://www.thehindu.com/opinion/op-ed/in-economics-what-does-sudden-stop-mean/article22271429.ece
11. “How to Prepare Your Small Business for an Economic Crisis,” allBusiness; https://www.allbusiness.com/prepare-business-economic-crisis-108931-1.html
12. “Trade Credit and International Trade during the 2008-09 Global Financial Crisis,” Federal Reserve; https://www.federalreserve.gov/pubs/ifdp/2011/1020/ifdp1020.pdf
13. “Strength in Numbers: A Safety Net to Prevent Crises in the Global Economy,” IMFBlog; https://blogs.imf.org/2017/12/19/strength-in-numbers-a-safety-net-to-prevent-crises-in-the-global-economy/
14. “Fix the Roof While the Window of Opportunity is Open: Three Priorities for the Global Economy,” International Monetary Fund; https://www.imf.org/en/News/Articles/2018/04/09/spring-meetings-curtain-raiser-speech
15. “Adequacy of the Global Financial Safety Net – Considerations for Fund Toolkit Reform,” International Monetary Fund; https://www.imf.org/en/Publications/Policy-Papers/Issues/2017/12/19/pp121917-AdequacyOfTheGFSN
16. “Update for the G20 Meeting of Finance Ministers and Central Bank Governors,” Eminent Persons Group on Global Financial Governance; https://www.bundesfinanzministerium.de/Content/EN/Downloads/G20-Wash-okt-International-Financial-Architecture.pdf?__blob=publicationFile&v=1

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