The Group of 30 is a secretive assemblage of some of the most powerful people in the world of finance, most of them current or former central bankers, finance ministers, chiefs of mega-banks or all three. Monday morning they released a new report arguing for how they think the financial system needs changes to ensure a more prosperous global economy.
The assemblage of 30 men, led by former European Central Bank president Jean-Claude Trichet, sees a particular dearth of long-term capital. Not enough global savings is channeled toward making long-lasting investments in countries that need it, and too much is “hot money,” or in the Group of 30’s language, “cross-border capital flows have been driven by short-term, volatile lending.”
The report, "Long-term Finance and Economic Growth," was produced by a working group led by Guillermo Ortiz, former head of Mexico’s central bank; Tharman Shanmugaratnam, Singapore’s finance minister; Adair Turner, the top British bank regulator; and Axel Weber, former head of the German central bank and now chairman of Swiss bank UBS. It paints a portrait of a global economy increasingly constrained by a financial system that encourages short-term investment rather than long, making the system vulnerable to crisis in the process.
The job of finance is to channel funds from global savers to global investment — but a number of rules and practices have made that system of allocating capital less resilient than it ought to be — and potentially inadequate to the task.
“To sustain growth, economies must build and continually renew the physical and intangible capital that fuels productivity growth and innovation,” the report says. “The ability to develop modern infrastructure will determine whether emerging nations can fulfill their economic potential. It will take an enormous infusion of capital to build transportation networks and deliver education, health care, water, housing, and electricity to growing populations. Advanced economies, too, need long-term investment, since it is one of the few ways to boost economic growth during a time of deleveraging and necessary fiscal consolidation.”
To do that, they need investment dollars (and euros, and yen, and renminbi) that have long investment time horizons. It is hard to build a water purification plant or power grid with money that could be pulled away at a moment’s notice.
Indeed, the attempt to turn long-lasting mortgage investments into ultra-liquid securities that could be traded at a moment’s notice was a major factor behind the 2008 crisis, the report argues. “Before the crisis, financial innovation attempted to bestow an artificial liquidity on long-term instruments. But when long-term investment rests on the shaky foundation of short-term financing, the resulting maturity mismatch increases risk — for borrowers, for investors and for the financial system as a whole.”
Ironically, given that the report comes from a group that includes many leading bankers, it describes an over-reliance on bank lending, instead of corporate debt and equity markets, as part of the problem. Bank lending accounts for up to 71 percent of long-term finance in Western Europe and 75 percent in China, compared with only 19 percent in the United States. Yet bank loans tend to have shorter maturities than corporate debt and other instruments perhaps better suited to funding long-lasting investments. For example, in emerging markets, commercial bank loans average a 2.8-year maturity, compared with an average six-year maturity for investment grade debt.
In other words, if the report's recommendations were followed, bond markets would do more of the work of financing global investment, at the expense of major global banks — something that may be doubly important as those banks pare themselves down to comply with new Basel III regulations aiming to cut down on their degree of risk.
To help fill the gap created by the contraction of giant banks, the Group of 30 report calls on national and international financial regulators to “promote long-term horizons in the governance and portfolio management of public pension funds and sovereign wealth funds.”
Other specific recommendations include creating new lending institutions with explicitly long-term goals, promoting corporate debt and equity markets in Europe and emerging markets, and to gradually, carefully liberalize the ability of capital to flow across borders so that emerging markets can better benefit from global investment dollars without becoming unduly exposed to the risk of investors all pulling their money out at once.
Given the prominence of many members of the Group of 30, the new report is a sign of where the conversation among some of the most powerful men in the financial world is going — and what changes leading central bankers and regulators will be pushing for in the years ahead.