Welcome to Eureka Street

back to site

ECONOMICS

Can financial fictions survive reality?

  • 31 May 2022
As commodity prices and inflation soar in the ‘real’ world we may be witnessing a prelude to another 2008-style crisis triggered by the foreign exchange markets. The risks certainly look similar and can be described with a simple question. Can the fictions produced by out-of-control financial actors survive reality? 

The situation has been brought to a head by Western countries’ attempt to destroy the Russian economy by using sanctions, banning the country from the cross-border payments system (SWIFT) and stealing about two thirds of the nation’s central bank’s foreign exchange reserves. 

So far, it has completely backfired. It was supposed to force the rouble into free fall and bring the country to its knees, but the opposite happened: the currency is back higher than before the war in Ukraine began. 

Russia has turned the tables by asking European countries to buy gas in roubles. Those countries are absurdly crying foul – some are even calling it extortion – but they have little choice. It seems they are yet to understand that for a transaction to occur, two willing parties are essential. Who would have thought?

There are two major implications. First, it is a stark demonstration that national governments do not control the global financial markets. Nobody does. Most of the turnover comes from private actors but none of those players has control; they are all just gamblers at the biggest casino that has ever existed. Governments do not even mediate. If there are disputes they are solved informally by a group of lawyers. 

Second, it points to the unreality of financial markets that are bent on endlessly creating money out of money. Real things, such as traded goods, or oil, are actually quite a small component of the overall activity.

'It is a battle between a ‘real’ world of goods and services, and assets and liabilities, versus an ‘unreal’ financial world of algorithms and derivatives and swaps and forwards and options and spot prices. We saw a similar dynamic with the global financial crisis of 2007-08, when derivatives (financial instruments derived from real assets) nearly destroyed the global financial system.' 

According to the Bank for International Settlements, about $US6.5 trillion crosses borders every day, with about nine tenths involving the US dollar on one side. If we annualise that we get about $2,372 trillion a year. Total annual global trade is valued at $US28.5 trillion. That means trade represents only about 1.2 per cent of the total