The continuing turmoil in the financial markets has displayed some dramatic moments over the last few weeks.

A Chinese American professor at Princeton has likened it to a Jackie Chan movie in which the spectator has hardly the chance to settle down after watching an awe-inspiring maneuver before being dazzled by a more stunning feat.

It would have been fun to continue to watch this global drama as make-believe had it not involved trillions of dollars of public money and the fate of the lives of billions of people and that started innocuously enough as an effort to fulfill the American dream of home ownership.

What is on display is the 21st century’s first crisis of globalisation and what is needed is a rebuilding of the international financial architecture imperfectly put-together decades ago, which has become totally dysfunctional.

Economists seem to have suddenly realised that they had been barking up the wrong tree in analysing the financial crises that have afflicted the world since late 1980s in the various parts of the world. Until now the received wisdom was that the main driver of globalisation was international trade and investment whose movement was greatly facilitated by the process of economic reforms attributed to the Washington consensus.

The ongoing global financial crisis has, however, shown that global capital movements, which have become increasingly unfettered, have assumed far greater importance in the shaping of the global economy. The phenomenal growth of global capital markets, which face far less restrictions than those on the movement of commodities and labour services, have made the developing countries much more vulnerable to their spasmodic and unregulated movements than in the past.

As is well-known, prior to the Wall Street meltdown, the world had witnessed a number of financial crises since the golden era of post World War II growth, especially in Latin America and East Asia. A common characteristic of these crises was that they resulted in abrupt and massive capital flights from the affected countries and a run on their currencies and bringing in its wake prolonged recession and deepening of poverty incidence in most countries. What was even more salient, especially in the East Asian financial crisis of 1998, were the contagion and domino effects which caused it to spread rapidly across inter-linked economies.

However, the unique thing about the current financial crisis is that it has occurred not in a developing country, but in the bastion of world capitalism, the United States, which was lately considered by some to be immune to such crises and as having the ability to ride out and contain the storm without widespread contagion and domino effects in its economy.

While the US was – often with the help of international financial institutions under its control –preaching the doctrines of sound economic management and chastising and punishing countries that departed from fiscal prudence, it was borrowing on a colossal scale to finance private consumption and fund its over-stretched military commitments all over the globe, largely from extensive domestic and foreign borrowing.

It may give some perverse pleasure to some in the developing countries to see the US having lost its immunity to financial crises and to have to admit, in the words of Paul Krugman, this year’s Nobel prize winner, that “we are all Brazilians now.” However, the rest of the world is unlikely to be spared of at least a flu, if the US catches pneumonia ,as seems likely to be the case.

Many of the less fortunate economies, which are more closely tied to the US, such as Pakistan, are even likely to catch typhoid, if nothing more serious.

There has been a surrealistic faith in the ability of the US financial system to defer its day of reckoning indefinitely. This unwarranted belief has stemmed largely from the assurance that America could always bail itself out of any fiscal or trade deficit, however large, by virtue of its ability to finance through the printing of its own currency which would remain universally acceptable to its trading partners, without being seriously discounted. (Indeed a paradox of the current crisis was that as it deepened, the value of the dollar rose, as many investors continued to treat it as a “safe haven”.) Its burgeoning current account deficit was readily financed by a world eager to export to a huge and affluent American market.

Most analysts of the genesis of the present financial crisis in the American economy relate it to the sub-prime crisis associated with the US housing boom, which started soon after the collapse of the dot com boom in the 1990s.

At least three significant events, viz the demise of the Soviet Union and the end of the cold war, the rise of Reagan-Thatcher onslaught towards deregulation and unbridled laissez faire capitalism and finally – and most importantly – the explosive growth of international capital movements as the principal driver of globalisation, have contributed significantly to the current crisis.

Powerful forces, including the forced pace of economic liberalisation and the relocation of low-wage and polluting industries to developing countries, combined to transform, the US economy from being a major net exporter of capital to an increasingly large net importer of capital from the rest of the world.

The global current account deficit of the United States in 2007 is estimated at $731.2 billion,almost as large as the Treasury’s bail-out plan for troubled assets (TARP) finally approved by the US Congress.

To finance this large current account deficit and its own sizable foreign investments, the United States requires about $1 trillion of foreign capital every year or more than $4 billion every working day.

Such a large current account deficit has been financed by 70 per cent of the rest of the world’s surplus capital or savings (China’s current account surplus for the same year is estimated at $371.8 billion, financing half of US current deficit; Germany and Japan post the next largest current account surpluses of $254.5 billion and $210.5 billion, respectively, while 60 other countries with current account surpluses – mostly developing countries, including Bangladesh – also help finance the US deficit).

Thus the United States became increasingly dependent on the excess savings of the more prudently managed, not necessarily rich, countries.

The situation was unsustainable in both international financial and domestic political (i.e., trade policy) terms. However, the United States policy makers, especially the current Fed Chairman, Ben Bernanke, were in denial that the present situation was of their own making. Instead they attributed it to be the result of a “savings glut” in the world economy.

In this view, the rise of China, the vast wealth of the petro-powers and high savings rates of China and East Asia, created an ocean of excess savings that had no obvious place to go, but the United States. According to the “savings glut” hypothesis, the emerging markets and oil producing countries became net current account surplus countries because of their inability to use their domestic savings for their own development and for reasons of protecting themselves from the volatility in capital markets experienced during the Asian Financial Crisis of 1998 and “forced” the US to absorb the world excess savings.

The contrarion “monetary glut” view, on the other hand, blames the reckless deregulation of the financial sector as the main culprit of the burgeoning US current account deficit. As a result of such unchecked deregulation, the US financial sector became highly bloated and risk-prone and created a culture of debt addiction which spread from individuals to institutions. This trend accentuated during the 12-year reign as chairman of the Federal Reserve of Alan Greenspan, who presided over the creation of two financial bubbles.

During the Greenspan era, the financial sector grew much more rapidly than any other sector of the economy. In particular, the financial derivatives sector grew at a phenomenal rate, rising five fold between 2002 to 2008 from $106 trillion to $ 531 trillion, while they were non-existent two decades earlier.

With the sub-prime mortgage crisis many other toxic credit instruments were created by non-bank financial institutions, which had largely unregulated by any agency of the government, unlike the commercial banks. It was the attraction of these high return high risk and high leverage instruments propelled by unhindered cross-border capital flows that became the Achilles’ heels of the US financial system and which has made the current crisis the worst since the Great Depression.

While the economic and social consequences of the present crisis will be far reaching, prolonged and largely adverse, some good may result from it by way of demolishing some of the myths and extravagant claims about the efficiency and the superiority of financial capitalism, compared to all other economic systems. In particular, it is likely that the shibboleths about financial liberalisation and uncontrolled capital movements will be revisited and will not be forced down the throats of developing countries.

On the other hand, with the necessity to nationalise and take over the control of many banks and financial institutions in the US and many European countries, the dogma of market fundamentalism will suffer a severe set-back. It has also highlighted the need for a greater policy co-ordination among major developed countries, as well as the creation of a more flexible, equitable and sustainable global financial architecture than exists now.

syed.naseem@aya.yale.edu