Stephen King: Roquefort cheese dispute may be first whiff of a return to financial nationalism

As a symbol of the growing protectionist backlash, it’s hard to beat the protests in the UK last Friday. Repeating Gordon Brown’s pledge to create “British jobs for British workers,” the protesters demanded protection against foreign workers in the construction industry.



Protectionism comes in all shapes and sizes, ranging from the recent spat between the outgoing US administration and the French over the 300 per cent duty slapped on Roquefort cheese through to the sweeping trade barriers of the interwar period, triggered by the 1930 US Smoot-Hawley tariff. With the possible exception of the stink over Roquefort – which was presumably linked to the American image of the French as “cheese-eating surrender monkeys” during the second Gulf War – protectionism is typically connected with economic downturns. It’s also linked, of course, to crass nationalism and, ultimately, xenophobia.

Politicians can all too easily be seduced by the superficial appeal of protectionism. There are votes in it.

No one, though, wants to be accused on the international stage of being overtly protectionist. Smoot-Hawley probably won’t happen again: it’s too closely associated with the Great Depression and, in any case, we now have international bodies such as the World Trade Organisation designed to prevent the proliferation of trade barriers. Protectionism these days comes in stealthier, but no less invidious, forms.

The latest version is what I’d call “capital market protectionism” or, alternatively, “financial nationalism”.

The dismantling of trade barriers, which supported the first phase of post-war globalisation, took place under successive trade rounds from the 1950s through to the 1980s, and led to an enormous increase in world trade. Countries were able to specialise in their own “comparative advantages”, which, in turn, paved the way in the industrialised world for persistent increases in living standards. In some areas, though, protectionism persisted (agriculture is the most obvious example), leaving many of the world’s most impoverished countries unable to benefit from trade liberalisation.

The second phase, the one that’s under threat, has been all about capital markets. The UK led the way with the 1979 abolition of exchange controls.

Other countries followed suit, some with more enthusiasm than others. As capital controls have slowly disappeared, savers have no longer had to keep their money at home.

They’ve increasingly been able to invest almost anywhere in the world.

Borrowers, meanwhile, have been able to raise funds much more easily: no longer are their ambitions limited by the volume of domestic savings.

Of course, the removal of barriers on cross-border capital flows was only part of the story. Improved information technology linked countries together like never before, allowing the owners of capital to find out more easily how well their investments on foreign soil were developing.

And the political revolutions in China and the former Soviet Union changed the landscape for capital markets dramatically. Taken together, these developments paved the way for capital to be allocated around the world much more efficiently.

I’ve no doubt these changes have made a huge contribution to rising living standards over the last three decades, not just in the rich industrialised world but, more importantly, in countries like China and India, where per capita incomes have risen extraordinarily quickly in recent years. To turn our backs on cross-border capital flows would, then, be a serious mistake. Unfortunately, we may be heading in precisely that direction.

The credit crunch is now a global phenomenon. It may have started in the US, the UK and other over-borrowed economies, but its effects have spread far and wide. Banks, under pressure from their sponsoring governments, are showing a renewed “home bias” in their lending practices.

They’re short of funds, they can no longer support the lending volumes of yesteryear and taxpayers are, rightly, in no mood to fund risky operations in foreign climes.

The result of all this is that those countries particularly dependent on foreign bank lending are in trouble, through no fault of their own. Many of these are emerging economies.

Having built up large foreign exchange reserves in recent years, policymakers are suddenly discovering that their war chests are not offering the security they’d expected.

The reason is simple: rising foreign exchange reserves resulted from huge increases in foreign bank lending combined with a refusal to allow exchange rates to appreciate too far.

Now that bank lending is dropping off, foreign exchange reserves are fast disappearing and currencies are coming under downward pressure.

The rise in global capital flows should have been a collective good, benefiting everybody. Unfortunately, existing international financial arrangements have proved insufficiently robust to cope with the now-obvious downsides of cross-border capital flows, including the subprime crisis and the credit crunch.

There was too much saving in China and Russia, providing them with excessive current account surpluses, and too much borrowing in the US and the UK, leaving their households with excessive debts. There was too little knowledge of the precise sources of funds that banks were drawing upon to support rapid lending growth. There was too much trust in the skills of the ratings agencies which, for too long, had made their judgements on creditworthiness with the use of only a rear-view mirror.

And central banks, delighted with their inflation-targeting frameworks, ignored the rapid growth of credit, even though it was supporting ever-higher house prices and consumer debt.

Luckily, there’s an opportunity to address some of these shortcomings at the G20 meeting on 2 April. At the very least, a new global infrastructure needs to be created to deliver for the capital markets what the WTO has delivered for trade. That might include an enhanced role for the IMF, and perhaps a bigger say for the Bank for International Settlements.

Whether our leaders will be in the mood to grasp the opportunity is, though, another matter. The new US administration is pushing a “Buy American” policy and the new Treasury Secretary, Tim Geithner, has already rattled his “China is a currency manipulator” sabre. Meanwhile, the Russians were moaning last week at Davos about the effective abuse by the Americans of their reserve currency status.

If Barack Obama and Ben Bernanke turn on the printing press, the implied fall in the dollar’s value would leave emerging market holders of Treasuries nursing losses in domestic currency terms. The rest of the world is now waking up to the idea that, if push comes to shove, American policymakers will happily shift the burden of adjustment from domestic debtors on to foreign creditors.

How will the creditors react?

Will they regard the printing press as an instrument of default? If so, what happens to the dollar’s role as the world’s reserve currency?

In this uncertain new world, we may end up with a radically different series of economic and political relationships.

Whether we are richer or poorer as a result will depend critically, though, on the ability of policymakers to keep capital flowing across borders in spite of the ever-louder siren calls of the protectionists.

stephen.king@hsbcib.com

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