To what extent can monetary and financial crises and cycles be explained through economic

theories? This paper is aimed at highlighting why a reliance on economic theories may be necessary

given certain flaws which have been revealed from the recent Financial Crisis. Namely, that

economic and legal foundations of financial stability cannot always be considered to be credible.

Further, the paper aims to accentuate on why despite the valid argument (that a reference to

economic theories may be required to explain causalities of financial and monetary crises),

causalities could also be explained from other perspectives – even though these perspectives may

sometimes, not be as accurate

Ojo, Mariane.B.

English

Covenant University Repository

Electronic copy available at: http://ssrn.com/abstract=22637601ABSTRACTTo  what  extent  can  monetary  and  financial  crises  and  cycles  be  explained  through  economic theories? This paper is aimed at highlighting why a reliance on economic theories may be necessary given  certain  flaws  which  have  been  revealed  from  the  recent  Financial  Crisis.  Namely,  that economic and legal foundations of financial stability cannot always be considered to be credible. Further,  the  paper  aims  to  accentuate  on  why despite  the  valid  argument  (that  a  reference  to economic  theories  may  be  required  to  explain  causalities  of  financial  and  monetary  crises), causalities could also be explained from other perspectives – even though these perspectives may sometimes, not be as accurate.Key Words: Theory of Economic Time (TET), Efficient Markets Hypothesis, financial stability, Currency Theory, Euro crisis,  Austrian, Keynesian or Quantitativist-monetarist, Random Walk TheoryElectronic copy available at: http://ssrn.com/abstract=22637602Restoring the Credibility of the Legal and Economic Foundations of Financial Stability: The Need for Incorporation of Economic Theories? Marianne OjoA. IntroductionThe first lines of the communication I had with an incredibly strong supporter and advocate of economic theories is that “When studying monetary and financial crises, the first thing you should look at is economic theories.” The message also had the following bold print:CAUSALITY OF ECONOMIC CYCLES   (THEORIES)  I then responded by adding that:“  Immense thanks for the message. I also have something to add: when studying monetary and financial  crises,  one  should  also  not  solely attribute  these  to  the  Efficient  Markets  Hypothesis (EMH) or ECMH.” Thereafter I kindly referred him to a recent publication.Even though I had openly declared in a most recent book publication, “Recovering from the Global Financial Crisis: Achieving Financial Stability in Times of Uncertainty “1 that I was not an advocate of the Efficient Markets Hypothesis or the Efficient Capital Markets Hypothesis – for many reasons which were highlighted in the publication, I was compelled to visit the website referred to by this advocate of economic theories, to gain some insight into the contributory factors responsible for the driving force (behind his conviction). Hence I visited Carlos Bondone's website to read his kindly (referred to) publication on the “Currency Theory”.2 On the website, other theories were also listed: Theories such as:- Theory of Money1 Business Express Press,  ISBN 978-1-60649-700-5, June 2013  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=22452082  See C Bondones, „Currency Theory: The Crisis of Currency Financial Theories“ Chapter IV Currency Financial Institutions, page 35 http://www.carlosbondone.com/en/theory-of-economic-time/aplication/currency-theory.html (last accessed 11 May 2013)3- Theory of Economics- Theory of Interest (Interest theory)- Theory of Capital (Capital Theory)- Macro Economic Theory- Theory of Monetary (Currency) Crisis(amongst other theories).Before embarking on reading his publication, I still wasn't convinced that there could or should be such a dominant focus on an economic theory perspective. In my opinion, there is, to a greater extent, a dual or tripartite perspective in viewing or explaining many events more accurately – for example a legal, financial, economic or accounting perspective. Naturally other perspectives also exist. Furthermore, close linkages usually exist between many of these perspectives.B. Can one also make reference to the study of monetary and global crises without some reference to some of the legal foundations of financial stability?Bondones interestingly also adds that contrary to the view that legal foundations are pivotal  to financial  and economic stability,  that  „it is precisely postulated that  existing legislation are the consequence of the crisis - however such legislation is based on poor economic fundamentals.“Such criticisms are definitely valid. Many firms (for example Northern Rock) were operating within the stipulated and recommended capital requirements of the Basel capital adequacy requirements but still crashed whilst other factors such as maturity mismatches (particularly relating to liquidity requirements) had not previously been accorded adequate focus. Hence the need for the introduction of the two new Basel liquidity requirements, namely the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).Even with the two new liquidity standards, although some progress has been made in relation to the re-dress  of  liquidity  risks,  more  efforts  are  still  required  -  hence  Bondones  is  justified  in highlighting the fact that inadequate regulations and rules, also in respect of focus of such rules, were also contributory to the recent crisis. However, this also highlights the importance of enacting the most appropriate legal and regulatory requirements - thereby underlining the importance of rules and  legal  requirements  in  averting  financial  crises,  as  well  as  the  fundamental  role  of  legal foundations in fostering financial stability.4Hence the present rules and regulations aimed at ensuring financial stability are not only criticised for having weak based economic foundations, but a lack of adequate theoretical basis  in attributing more precisely, the causes and consequences of monetary and financial crises in relation to studies on these.In judging the effectiveness of stress testing techniques as well as other economic indicators used by various federal regulators and supervisors, could such techniques be considered to be credible enough in averting another financial crisis? Are the current stress testing techniques really based on more credible foundations than those capital adequacy rules which firms such as Northern Rock were relying on (and complying with) but neverthelesss, still crashed?Further Carlos Bondone argues that „ the currency and financial institutions that govern our daily life have a close relation with the theories derived from the dichotomies of Böhm-Bawerk and Wicksell  which TET (Theory of Economic Time) so often refers to. When humans act  without previous theories we say they apply “techniques”, if the opposite is true, we say their actions are based on science.  But  acting according to science does not  necessarily mean it  is  an adequate science, and when a science cannot explain facts and events it is necessary to revise it.“3The following section attempts to illustrate how the Theory of Economic Time relates to financial occurrences that have recently taken place: more specifically, to the ongoing Euro-zone crisis.C. The Theory of Economic Time (TET)Bondone  “presents as proof of what TET teaches”, extracts from the book :4Considering  the  theories  presented  in  this  work,  one  should  anticipate  serious  difficulties in the attempt to unify currencies among states acting according to current  theories, i.e. with irregular monetary systems. This is so because, as we have shown, it  is impossible to have central banks really independent from political government in  irregular currency systems. In other words, adopting a single currency with irregular  currency systems means the countries forming the currency union must have identical  political systems. If this reality is not considered, there will be very serious political  3  See C Bondones, „Currency Theory: The Crisis of Currency Financial Theories“ Chapter IV Currency Financial Institutions, page 35 http://www.carlosbondone.com/en/theory-of-economic-time/aplication/currency-theory.html (last accessed 11 May 2013)4   See  The Theory of Economic Relativity – Solution to CURRENCY CRISES – A CRITIQUE OF CURRENT ECONOMIC THEORIES – Austrians, Keynesians, and Quantitativists, chapter XIX, last paragraph under the subtitle One Currency ibid  at page 51 of 735and economic conflicts among those countries in a very short time, which will be more  or less important for each country and the union as a whole according to the relative  weight of each country.He adds that this text which “clearly explains political events in Europe in the search for a leading nation, is even more relevant considering it was written between 2004 and 2005, years in which  the  Euro  was  considered  an  exemplary currency,  the  currency institution  of  reference.” Further he highlights the importance of “stressing that the Euro crisis confirms the idea derived from TET that not all countries can use a currency of the same quality. Just as different types of motors require different lubricants, the same occurs with currencies.”5Even though the Theory of Economic Time is also considered to be consistent with such economic theories as Adam Smith's invisible hand6 in confirming the importance of such a theory, it conflicts with certain other economic theories.7 Hence the Theory of Economic Time certainly has its merits as well as its criticisms. This is however, not a peculiar and isolated case given the fact that many economic theories often conflict with each other.In highlighting and accentuating the importance of the Theory of Economic Time (in explaining the causes  and  consequences  of  monetary  and  financial  crises),  Bondone  draws  attention  to  three different types of crises, namely, currency-financial crises:8• Currency crisis: currency crisis without a financial crisis• Financial crisis: financial crisis without a currency crisis• Currency-financial crisis: currency crisis and financial crisisHe makes reference to  twin asymmetries, which in his view, “guarantee inevitable and recurring currency-financial  crises,  as  long  as  economic  democracy  can  survive  them;  that  the  world  is immersed  in  recurring  and  inevitable  currency-financial  crises  that  capitalism  suffers  as  a consequence of the twin asymmetries.”5 „A circumstance that ratifies that first you must establish the common characteristics of the motors to use the same lubricant, if not the use of a “common” lubricant will be more painful, because several motors will “break down”, until the right lubricant for each motor is found. Any similarity between motors and countries, and lubricants and currencies, is not a mere coincidence.“ibid6 See ibid at page 617 For example, Bondone adds that conclusions derived from (Theory of Economic Time) TET contradict the Keynesian idea of a “barbarous relic”. See ibid at page 45 of 738 See ibid at page 44 of 736D. ConclusionWhat can be concluded from all that has been discussed is that whilst economic theories certainly have the capacity to explain causes and consequences of monetary and financial crises, gaps still remain in certain respects – particularly with regards to inconsistencies which still exist between certain economic theories. It is certainly true that monetary and financial crises and cycles cannot be explained  solely  from  one  perspective.  It  is  also  true  that  fundamentals  relating  to  legal  and economic, as well as financial foundations have proven to be flawed – as evidenced from the recent Financial Crisis. Fiscal, monetary policies as well as financial regulation (amongst other factors) are crucial in addressing required responses as well as a consideration of legal and economic aspects – be they foundational principles or economic theories. As re-iterated previously, I'm not a strong proponent of economic theories such as the Efficient Markets Hypothesis (even though I consider the Random Walk Hypothesis to be more credible) – given the fact that markets are certainly and absolutely not perfect. Furthermore, a combination of numerous factors have also contributed to the recent Financial Crises. It would therefore be unjustified to attribute the cause of the recent Crisis entirely to the Efficient Markets Hypothesis or the proposition that an undermining of the need for regulation (owing to the assumption that markets are efficient) solely contributed to the Crisis.Collaboration between financial regulators and supervisors, standard setters and external auditors would  greatly  improve  market  efficiency  through  an  allocation  of  responsibilities  in  matters regarding the obtaining of information and channels through which such information should be distributed. In relation to cost reduction of the monitoring process – as well as agency costs, it could be  said  that  an  enhancement  of  the  value  of  information  which  is  accessed  in  markets  would automatically result in a reduction of costs involved in monitoring certain channels through which such information is distributed.7ReferencesBasel  Committe on Banking Supervision, „Principles For Sound Stress Testing Practices and Supervision  http://www.bis.org/publ/bcbs155.pdfCentral Banking. Com, „Basel Committee Highlights Resource Challenges in Stress Testing“ http://www.centralbanking.com/central-banking/news/2167763/basel-committee-highlights- resource-challenges-stress-testingC Bondones, „Currency Theory: The Crisis of Currency Financial Theories“ Chapter IV Currency Financial Institutions,  http://www.carlosbondone.com/en/theory-of-economic-           time/aplication/currency-theory.html  ( last accessed 11 May 2013)E Financial News.Com, “Basel committee Slams Banks' Stress Testing” http://www.efinancialnews.com/story/2009-05-21/basel-committee-slams-banks-stress- testing-1Ojo M,Recovering from the Global Financial Crisis: Achieving Financial Stability in Times of Uncertainty, Business Express Press,  ISBN 978-1-60649-700-5, June 2013  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2245208

Restoring the Credibility of the Legal and Economic Foundations of Financial

Stability: The Need for Incorporation of Economic Theories?

To what extent can monetary and financial crises and cycles be explained through economic theories? This paper is aimed at highlighting why a reliance on economic theories may be necessary given certain flaws which have been revealed from the recent Financial Crisis. Namely, that economic and legal foundations of financial stability cannot always be considered to be credible. 



Further, the paper aims to accentuate on why despite the valid argument (that a reference to economic theories may be required to explain causalities of financial and monetary crises), causalities could also be explained from other perspectives – even though these perspectives may sometimes, not be as accurate

Ojo, Marianne

Munich RePEc Personal Archive

MPRAMunich Personal RePEc ArchiveRestoring the credibility of the legal andeconomic foundations of financialstability: The need for incorporation ofeconomic theories?Marianne Ojo11. May 2013Online at http://mpra.ub.uni-muenchen.de/46911/MPRA Paper No. 46911, posted 12. May 2013 04:04 UTC1ABSTRACTTo  what  extent  can  monetary  and  financial  crises  and  cycles  be  explained  through  economic theories? This paper is aimed at highlighting why a reliance on economic theories may be necessary given  certain  flaws  which  have  been  revealed  from  the  recent  Financial  Crisis.  Namely,  that economic and legal foundations of financial stability cannot always be considered to be credible. Further,  the  paper  aims  to  accentuate  on  why despite  the  valid  argument  (that  a  reference  to economic  theories  may  be  required  to  explain  causalities  of  financial  and  monetary  crises), causalities could also be explained from other perspectives – even though these perspectives may sometimes, not be as accurate.Key Words: Theory of Economic Time (TET), Efficient Markets Hypothesis, financial stability, Currency Theory, Euro crisis,  Austrian, Keynesian or Quantitativist-monetarist, Random Walk Theory2Restoring the Credibility of the Legal and Economic Foundations of Financial Stability: The Need for Incorporation of Economic Theories? Marianne OjoA. IntroductionThe first lines of the communication I had with an incredibly strong supporter and advocate of economic theories is that “When studying monetary and financial crises, the first thing you should look at is economic theories.” The message also had the following bold print:CAUSALITY OF ECONOMIC CYCLES   (THEORIES)  I then responded by adding that:“ Immense thanks for the message. I also have something to add: when studying monetary and financial  crises,  one  should  also  not  solely attribute  these  to  the  Efficient  Markets  Hypothesis (EMH) or ECMH.” Thereafter I kindly referred him to a recent publication.Even though I had openly declared in a most recent book publication, “Recovering from the Global Financial Crisis: Achieving Financial Stability in Times of Uncertainty “1 that I was not an advocate of the Efficient Markets Hypothesis or the Efficient Capital Markets Hypothesis – for many reasons which were highlighted in the publication, I was compelled to visit the website referred to by this advocate of economic theories, to gain some insight into the contributory factors responsible for the driving force (behind his conviction). Hence I visited Carlos Bondone's website to read his kindly (referred to) publication on the “Currency Theory”.2 On the website, other theories were also listed: Theories such as:- Theory of Money1 Business Express Press,  ISBN 978-1-60649-700-5, June 2013  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=22452082  See C Bondones, „Currency Theory: The Crisis of Currency Financial Theories“ Chapter IV Currency Financial Institutions, page 35 http://www.carlosbondone.com/en/theory-of-economic-time/aplication/currency-theory.html (last accessed 11 May 2013)3- Theory of Economics- Theory of Interest (Interest theory)- Theory of Capital (Capital Theory)- Macro Economic Theory- Theory of Monetary (Currency) Crisis(amongst other theories).Before embarking on reading his publication, I still wasn't convinced that there could or should be such a dominant focus on an economic theory perspective. In my opinion, there is, to a greater extent, a dual or tripartite perspective in viewing or explaining many events more accurately – for example a legal, financial, economic or accounting perspective. Naturally other perspectives also exist. Furthermore, close linkages usually exist between many of these perspectives.B. Can one also make reference to the study of monetary and global crises without some reference to some of the legal foundations of financial stability?Bondones interestingly also adds that contrary to the view that legal foundations are pivotal  to financial  and economic stability,  that  „it is precisely postulated that  existing legislation are the consequence of the crisis - however such legislation is based on poor economic fundamentals.“Such criticisms are definitely valid. Many firms (for example Northern Rock) were operating within the stipulated and recommended capital requirements of the Basel capital adequacy requirements but still crashed whilst other factors such as maturity mismatches (particularly relating to liquidity requirements) had not previously been accorded adequate focus. Hence the need for the introduction of the two new Basel liquidity requirements, namely the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).Even with the two new liquidity standards, although some progress has been made in relation to the re-dress  of  liquidity  risks,  more  efforts  are  still  required  -  hence  Bondones  is  justified  in highlighting the fact that inadequate regulations and rules, also in respect of focus of such rules, were also contributory to the recent crisis. However, this also highlights the importance of enacting the most appropriate legal and regulatory requirements - thereby underlining the importance of rules and  legal  requirements  in  averting  financial  crises,  as  well  as  the  fundamental  role  of  legal foundations in fostering financial stability.4Hence the present rules and regulations aimed at ensuring financial stability are not only criticised for having weak based economic foundations, but a lack of adequate theoretical basis  in attributing more precisely, the causes and consequences of monetary and financial crises in relation to studies on these.In judging the effectiveness of stress testing techniques as well as other economic indicators used by various federal regulators and supervisors, could such techniques be considered to be credible enough in averting another financial crisis? Are the current stress testing techniques really based on more credible foundations than those capital adequacy rules which firms such as Northern Rock were relying on (and complying with) but neverthess, still crashed?Further Carlos Bondone argues that „ the currency and financial institutions that govern our daily life have a close relation with the theories derived from the dichotomies of Böhm-Bawerk and Wicksell  which TET (Theory of  Economic  Time) so often refers  to.When humans act  without previous theories we say they apply “techniques”, if the opposite is true, we say their actions are based on science.  But  acting according to science does not  necessarily mean it  is  an adequate science, and when a science cannot explain facts and events it is necessary to revise it.“3The following section attempts to illustrate how the Theory of Economic Time relates to financial occurrences that have recently taken place: more specifically, to the ongoing Euro-zone crisis.C. The Theory of Economic Time (TET)Bondone  “presents as proof of what TET teaches”, extracts from the book :4Considering  the  theories  presented  in  this  work,  one  should  anticipate  serious  difficulties in the attempt to unify currencies among states acting according to current  theories, i.e. with irregular monetary systems. This is so because, as we have shown, it  is impossible to have central banks really independent from political government in  irregular currency systems. In other words, adopting a single currency with irregular  currency systems means the countries forming the currency union must have identical  political systems. If this reality is not considered, there will be very serious political  3  See C Bondones, „Currency Theory: The Crisis of Currency Financial Theories“ Chapter IV Currency Financial Institutions, page 35 http://www.carlosbondone.com/en/theory-of-economic-time/aplication/currency-theory.html (last accessed 11 May 2013)4   See  The Theory of Economic Relativity – Solution to CURRENCY CRISES – A CRITIQUE OF CURRENT ECONOMIC THEORIES – Austrians, Keynesians, and Quantitativists, chapter XIX, last paragraph under the subtitle One Currency ibid  at page 51 of 735and economic conflicts among those countries in a very short time, which will be more  or less important for each country and the union as a whole according to the relative  weight of each country.He adds that this text which “clearly explains political events in Europe in the search for a leading nation, is even more relevant considering it was written between 2004 and 2005, years in which  the  Euro  was  considered  an  exemplary currency,  the  currency institution  of  reference.” Further he highlights the importance of “stressing that the Euro crisis confirms the idea derived from TET that not all countries can use a currency of the same quality. Just as different types of motors require different lubricants, the same occurs with currencies.”5Even though the Theory of Economic Time is also considered to be consistent with such economic theories as Adam Smith's invisible hand6 in confirming the importance of such a theory, it conflicts with certain other economic theories.7 Hence the Theory of Economic Time certainly has its merits as well as its criticisms. This is however, not a peculiar and isolated case given the fact that many economic theories often conflict with each other.In highlighting and accentuating the importance of the Theory of Economic Time (in explaining the causes  and  consequences  of  monetary  and  financial  crises),  Bondone  draws  attention  to  three different types of crises, namely, currency-financial crises:8• Currency crisis: currency crisis without a financial crisis• Financial crisis: financial crisis without a currency crisis• Currency-financial crisis: currency crisis and financial crisisHe makes reference to  twin asymmetries, which in his view, “guarantee inevitable and recurring currency-financial  crises,  as  long  as  economic  democracy  can  survive  them;  that  the  world  is immersed  in  recurring  and  inevitable  currency-financial  crises  that  capitalism  suffers  as  a consequence of the twin asymmetries.”5 „A circumstance that ratifies that first you must establish the common characteristics of the motors to use the same lubricant, if not the use of a “common” lubricant will be more painful, because several motors will “break down”, until the right lubricant for each motor is found. Any similarity between motors and countries, and lubricants and currencies, is not a mere coincidence.“ibid6 See ibid at page 617 For example, Bondone adds that conclusions derived from (Theory of Economic Time) TET contradict the Keynesian idea of a “barbarous relic”. See ibid at page 45 of 738 See ibid at page 44 of 736D. ConclusionWhat can be concluded from all that has been discussed is that whilst economic theories certainly have the capacity to explain causes and consequences of monetary and financial crises, gaps still remain in certain respects – particularly with regards to inconsistencies which still exist between certain economic theories. It is certainly true that monetary and financial crises and cycles cannot be explained  solely  from  one  perspective.  It  is  also  true  that  fundamentals  relating  to  legal  and economic, as well as financial foundations have proven to be flawed – as evidenced from the recent Financial Crisis. Fiscal, monetary policies as well as financial regulation (amongst other factors) are crucial in addressing required responses as well as a consideration of legal and economic aspects – be they foundational principles or economic theories. As re-iterated previously, I'm not a strong proponent of economic theories such as the Efficient Markets Hypothesis (even though I consider the Random Walk Hypothesis to be more credible) – given the fact that markets are certainly and absolutely not perfect. Furthermore, a combination of numerous factors have also contributed to the recent Financial Crises. It would therefore be unjustified to attribute the cause of the recent Crisis entirely to the Efficient Markets Hypothesis or the proposition that an undermining of the need for regulation (owing to the assumption that markets are efficient) solely contributed to the Crisis.Collaboration between financial regulators and supervisors, standard setters and external auditors would  greatly  improve  market  efficiency  through  an  allocation  of  responsibilities  in  matters regarding the obtaining of information and channels through which such information should be distributed. In relation to cost reduction of the monitoring process – as well as agency costs, it could be  said  that  an  enhancement  of  the  value  of  information  which  is  accessed  in  markets  would automatically result in a reduction of costs involved in monitoring certain channels through which such information is distributed.7ReferencesBasel  Committe on Banking Supervision, „Principles For Sound Stress Testing Practices and Supervision  http://www.bis.org/publ/bcbs155.pdfCentral Banking. Com, „Basel Committee Highlights Resource Challenges in Stress Testing“ http://www.centralbanking.com/central-banking/news/2167763/basel-committee-highlights- resource-challenges-stress-testingC Bondones, „Currency Theory: The Crisis of Currency Financial Theories“ Chapter IV Currency Financial Institutions,  http://www.carlosbondone.com/en/theory-of-economic-time/aplication/currency-theory.html   (last accessed 11 May 2013)E Financial News.Com, “Basel committee Slams Banks' Stress Testing” http://www.efinancialnews.com/story/2009-05-21/basel-committee-slams-banks-stress- testing-1Ojo M,Recovering from the Global Financial Crisis: Achieving Financial Stability in Times of Uncertainty, Business Express Press,  ISBN 978-1-60649-700-5, June 2013  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2245208

Restoring the credibility of the legal and economic foundations of financial stability: The need for incorporation of economic theories?

http://mpra.ub.uni-muenchen.de/46911/1/MPRA_paper_46911.pdf

Restoring the Credibility of the Legal and Economic Foundations of Financial Stability: The Need for Incorporation of Economic Theories?

Abstract

Similar works

Full text

Available Versions

Covenant University Repository

Munich RePEc Personal Archive