Political Economy
Adam Smith, David Riccardo and Alfred Marshall believed they were studying not economics but political economy. To understand what happened to Glass-Steagall requires not abstracting economics from its political context. Banks arguing about competitive pressures and policy makers who believe in a minimal role for the state in the economy joined forces to dilute the government-imposed restrictions.
The calls for repealing Glass-Steagall seemed to ignore the political history of this economic regulation. What guarantees that a new Glass-Steagall would not share the same fate?
Some observers note that there is precedent for breaking up large combines. Standard Oil is the favorite example, but Standard Oil of New York (Exxon Mobil) is now the fourth-largest company globally, and Standard Oil of California (Chevron) is the ninth-largest company in the world today. AT&T was broken up in the 1980s, but today it is the seventh-largest company, according to Forbes. E.F. Schumacher's book Small is Beautiful (1973) makes for a nice treatise, but competitive pressures and the logic of the market provide powerful incentives for consolidation and concentration.
Just like special investment vehicles (SIVs) seem to be an evolutionary dead-end, the financial crisis demonstrated the weakness of the investment-bank model. Typically, investment banks do not take deposits. They depend on the capital markets, of the money-market component. This is its strength in good times, but when the capital markets freeze up, they are left high and dry.
Lastly, consider the competitive climate. Several European banks are being broken up. By market capitalization, Chinese banks hold the top three places. In 2006, China did not have a bank in the top 20 - at that time, there were seven U.S. banks in the top 20 including the top two. Today, the U.S. has just three in the top 20, and the highest holds fifth place.
Europe may be unilaterally disarming in the financial battlefield just as Chinese banks begin to flex their muscles. Breaking up U.S. banks now would risk eviscerating them at an important competitive moment vis-a-vis both Europe and China. Some observers already see the demise of U.S. banks and the rise of Chinese banks as yet another sign of the decline of America and the rise of China. It is precisely this sentiment that contributes to the undermining of the dollar.
At the G20 meeting, the moral hazards of "too big to fail" likely will be discussed. If for the sake of coordination the U.S. bows to pressure to break up its largest banks, look for the dollar to sell off, potentially in a destabilizing fashion. It may very well be understood by friend and foe alike as an abdication of global leadership. |
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