The 2008 global financial crisis has fueled reforms to the international financial governance system and posed challenges to the US-led liberal international order. It has been more than a decade since the crisis broke out. Significant changes have taken place in the theories and practices behind global financial governance, involving different fields such as the monetary systems, financial regulation, international financial institutions, accounting standards, financial infrastructure and macroeconomic policy. However, have these changes resulted in a more secure and stable international financial system than the pre-crisis one?

Causes of the crisis

Opinions have varied on what caused the financial crisis in 2008. Economists pay more attention to national or international economic and financial factors, such as problems in macroeconomic development, financial liberalization, regulatory arbitrage, financial securitization, the China-US trade “imbalance,” wealth gaps between countries, and unreasonable payment systems on the national and international levels.

Based on theoretical paradigms in economics, other researchers place more emphasis on political factors. For example, neoliberals attribute the crisis to inherent defects in financial departments, such as procyclicality and systemic risks, rather than the implementation of neoliberal thought and policy centered around economic liberalization. 

Therefore, realists criticize the proliferation of neoliberalism in economics and the economic system, and they blame it for generating a domino effect across countries. Constructivists maintain that the above material factors are inadequate to explain the economic or financial crisis, stressing such human factors as identity, ideas and culture. They agree that neoliberalism played a crucial role in shaping the behaviors of market entities that eventually gave rise to the crisis.

From the perspective of financial governance, the 2008 financial crisis can be traced to the flawed international monetary system, the failure of domestic monetary policy and financial deregulation in the US, and weak international financial supervision, which represent the three different stages leading to the crisis. 

It was because of flaws in the international monetary system that large amounts of liquidity entered the American market and brought about the so-called macroeconomic imbalance between China and the US: the huge current-account deficits and rising foreign debt of the US versus China’s huge current-account surpluses and foreign-exchange reserves.

Inappropriate monetary policy and loose financial regulation in the US bred and encouraged real estate bubbles, the securitization of housing mortgages and other unregulated financial innovations, finally triggering the sub-prime mortgage crisis in the property market.

The international financial regulatory system was unable to forecast, guard against or prevent the US sub-prime crisis from spreading to the financial sector and real economy. They failed to stop its spread from the US to the global market.

Compared with macroscopic theory, the explanation from the perspective of financial governance has pointed out a clearer direction for financial system reforms in the post-crisis era. 

Uneven reform progress

In the wake of the financial crisis, national and international financial regulators quickly took action to solve or ease the three major problems mentioned above.

First, all sectors of society proposed various plans for reforming the international monetary system to address macroeconomic imbalances between China and the US. 

The US, where the crisis started, adopted expansionary monetary policy featuring quantitative easing and launched a reform to financial regulation, in particular the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Moreover, global financial governance structures changed remarkably, as a new network governance system was in the making and international financial supervision was strengthened to a certain degree. 

Through the lens of economics and finance, the reforms that aimed to make up for the deficiencies of the old system have been fruitful. Related reports show that after reform, the leverage ratio of large banks has dropped with better liquidity; “too-big-to-fail” risks have been effectively controlled by building resolution mechanisms; the over-the-counter derivative market has become simpler and more transparent; and risky non-bank financial intermediaries have decreased dramatically.

Since the outbreak of the crisis, the banking industry has seen structural changes in its market capacity and structure and its business model and profitability, indicating that the sector has become more robust and the international financial regulatory framework has been repaired and improved in the post-crisis era.

The current international financial system has appeared more secure than the old one prior to the crisis. However, the progress of reforms in different fields is quite uneven. First, the international monetary system reform has gotten into trouble. Problems that had existed before the crisis have still not been effectively solved. Second, much attention has been paid to global macroeconomic imbalances in the post-crisis era, but major countries have divided views on the causes of the imbalances. The division has further hindered sustainable adjustments to the imbalances. 

For instance, emerging countries including China hold that the defects in the international monetary system, especially the dollar hegemony, are the primary cause for global economic imbalances, so internationalizing the RMB and revamping the international monetary system are their major appeal.

The US, on the other side, puts the blame on emerging countries’ interventions in the foreign exchange market. The Trump administration has attempted to make adjustments unilaterally with such frictional means as trade protection. 

Third, international financial regulation has evolved from micro-prudential to macro-prudential regulation. Rules for regulation of the banking, insurance and securities fields have been reinforced, exemplified by the revision and implementation of such international rules as Basel III, the Insurance Core Principles, and the IOSCO Objectives and Principles of Securities Regulation.

Fourth, reforms to international financial institutions have yielded some results, such as the upgrade of the G20 from a ministerial conference to a state leaders’ summit, the incorporation of more emerging countries into the membership of the Bank for International Settlement, and adjustments to voting power and shares of the IMF. 

Financial risks escalate

However, the above analysis from economic and financial perspectives has overlooked financial power, the core factor in international financial cooperation and competition. Reforms since the outbreak of the 2008 financial crisis have improved the operational model and effect of global financial governance, but the basic form of international financial power struggles, the decisive factor in international financial security, has remained unchanged. In this regard, current international financial security has not been enhanced yet. Instead, intensifying financial power competition and friction between major countries has added further risks.

In the context of the changing international order, the contention for currency hegemony will be fiercer, and the outlook for reforms to the international monetary system is bleak. The dollar-based post-WWII international monetary system is a manifestation of the dollar hegemony. Considered to be caught in the Triffin Dilemma, the hegemony has been sustained for more than half a century. Even after the collapse of the Bretton Woods system, the dollar has maintained its hegemony in the international monetary system. 

Therefore, in the foreseeable future, it will be extremely difficult to carry out substantive reforms to the international monetary system. Major countries will strive to promote the internationalization of their own currencies to offset the negative impacts of the hegemony of the dollar.

Moreover, financial games between major countries and corresponding policy adjustments will invite direct financial friction. Under the above international monetary system, China-US financial and economic relations have been seriously imbalanced. While the US has been debt-ridden, China and other emerging countries have accumulated large foreign-exchange reserves. Internal structure and policy adjustments should be the main approach to tackling the imbalances. 

Yet the Trump administration has resorted to trade friction in an attempt to pass on the large costs of adjusting imbalances, which has not only increased latent risks, but also undermined the security of the international financial system, and even the international system.

Institutional path dependence and obstructions instigated by major countries with vested interests have hampered reforms to major international financial institutions. Reforms to major international financial institutions, the IMF in particular, have a direct bearing on the stability of the international financial system. 

From the reform to the WTO to the establishment of the G20, from changes in the IMF’s SDR basket to the revolution of major financial rulemaking institutions, every change has been characterized by rivalry between major countries. Power competition between them in international financial organizations will make the pace of reform lag far behind real changes in international political and economic landscapes.

Lagging reforms to the international financial system, China-US bilateral relations and international financial organizations have trapped the international financial system in a crisis cycle. Although the tremendous impacts of the 2008 crisis have driven reforms to existing institutions, relations and systems, institutional path dependence and vested interests have confined the scope of the reforms, so the reforms will not be thorough enough. 

Less thorough reforms are likely to result in the global financial governance system lagging behind international financial development. In the lagging global governance system, crises might break out again and continue the history of crises in international finance.

Zhang Falin is an associate professor from the Zhou Enlai School of Government at Nankai University.

(Edited by CHEN MIRONG)