In a shift that appears to have surprised
and dismayed U.S. experts, American
dominance in the world’s financial
system seems to be waning as foreign rivals—
including the Euro zone—win a
growing share of rapidly expanding
global capital markets and international
financial activity. The trend has shaken
many American business leaders as a
worrisome symptom of declining U.S.
power and influence, with negative consequences
for the economy and for asset
prices in New York and other U.S. markets.
Needless to say, in Europe and elsewhere,
the development is viewed as
long-overdue recognition that Manhattan,
however lively its trading zeitgeist
and reputation for financial power, had
no monopoly on skill at deal-making, innovative
financing, nose for new ventures—
or even the kind of greed that
drives people to succeed in the most
competitive markets.
For decades, the world has thought
of Wall Street as the uncontested leader
of global capital markets. Equities,
bonds, investment banking, M&A, IPO’s,
derivatives, private equity or hedge
funds, you name it, U.S. markets and financial
institutions were Number One
for decades. It was not just in the lead,
but actually far ahead of European,
Japanese and other rivals. But that lead
was perhaps not a permanent one. The
recent data suggests American dominance
is waning as other international financial
marketplaces, especially London
and to a lesser degree other European financial
centers, gain ground and clout.
Are we seeing a tectonic shift? The
question was debated by financial, corporate
and government rainmakers at this
year’s World Economic Forum in Davos on
the theme
Shaping the World Agenda: The
Shifting Power Equation. The mere fact of
the debate was symptomatic of spreading
concern amid mounting statistical and anecdotal
evidence. The Davos conclave concluded
that rapid globalization means “we
are living in an increasingly schizophrenic
world where economies are booming and
global signs are promising, but underneath
are economic, political and social risks as
well as imbalances and inconsistencies.”
In a geo-political sense, the Forum
participants agreed that “while the U.S. remains
the dominant world power, its position
is increasingly challenged or constrained
by new emerging players such as
China and resource-rich Russia, as well as
states with nuclear capabilities and ambitions
such as North Korea and Iran.”
The U.S. decline in global capital
markets was confirmed recently by two
authoritative groups of financial experts
who urged action to protect the competitiveness
of U.S. capital markets. The
first, the Committee on Capital Markets
Regulation (CCMR), was created last
summer at the urging of Treasury Secretary Henry
Paulson. Representing major
U.S. financial, investor, legal, accounting
and academic institutions, the CCMR
analyzed the reasons for and economic
consequences of the U.S. decline in
global capital markets.
1 Public capital
markets are the principal vehicle with
which companies raise and price capital,
and individuals and institutions invest.
So they play a “vital role in the U.S.
economy,” accounting for over eight percent
of GDP and five percent of private
sector employment, the CCMR said in
its initial report last November. Its findings
emphasized that U.S. economic vitality
depends on its financial markets
remaining competitive enough to finance
the U.S. economy’s ever-growing
appetite for capital and to ensure that
there is enough liquidity in the market
for buying and selling to grow unabated.
Now this level of performance seems
to be becoming more problematic for
U.S. capital markets—partly because of
increased U.S. regulatory constraints on
business and markets. The CCMR recommended
easing some of these rules in
order to facilitate business domestically
and reduce incentives for big capital
deals to migrate to rival financial centers
in Europe that are growing in scale and
sophistication.
Similar conclusions were reached by
McKinsey & Co., in a recent 145-page
report that concluded there is “urgent
need for concerted but balanced action
at the national, state and local levels to
maintain the competitiveness of U.S. financial
markets and New York’s role as a
global financial center.” The report, released in late January, was commissioned
by New York City Mayor Michael R.
Bloomberg, a Republican, and Democratic
Senator Charles E. Schumer. Entitled
Sustaining New York’s and the U.S.’s
Global Financial Services Leadership, it
was based on interviews with CEOs and
executives of financial services companies
and with investor, labor and consumer
groups. Like the CCMR, the report
recommended easing the regulatory
environment. And it urged that immigration
restrictions be eased for highly
skilled workers and that New York City
consider creating an international financial
services zone offering tax incentives
for clients who want to do their business
in Manhattan.
Urgent appeals to roll back regulatory
constraints on U.S. business and finance
highlighted a high-level conference
of financial and business leaders
convened by Treasury Secretary Paulson
and the Securities and Exchange Commission
in Washington on March 12 and
13. The CCMR and Schumer-Bloomberg
(McKinsey) reports, as well as a more recent
one by the United States Chamber
of Commerce, were cited as evidence
that burdensome regulations and accounting
transparency are causing U.S.
business and finance to lose global competitiveness.
It was noteworthy, however,
that former Federal Reserve Chairmen
Alan Greenspan and Paul Volcker joined
former SEC Chairman Arthur Levitt and
investor Warren Buffett to argue in favor
of maintaining requirements for corporate
accountability and transparency.
The CCMR and Schumer-Bloomberg
reports cited a deluge of evidence,
much of it linked with “equities” (essentially
shares in companies), demonstrating
the relative decline in U.S. domination
of global finance.
•
Equity market indices in Europe
and Asia out-performed (in local
currency terms) their rivals in comparable
U.S. equity markets since
2003. Appreciation of the euro and
the Chinese yuan (CNY) against the
dollar (USD) during this period
meant dollar investors would have
made even more investing in the
Euro zone or Chinese equity markets
than in dollars because of the exchange-
rate premium. (See Figure 1
—Major Equity Market Trends.)
•
The U.S. share of global equity
market activity was 50 percent in
2005, down from 60 percent in 2000
at the height of the “dot.com bubble.”
(See Figure 2—Share of Global
Stock Market by Region.)
•
Global equity Initial Public Offerings
(IPOs) are falling off sharply in
the U.S. In the late 1990s, 48 percent
of them originated on U.S. exchanges,
but only six percent in 2005 and an
estimated eight percent last year. Of
the largest global IPOs, 24 out of 25
were done outside the U.S. in 2005;
last year it was nine out of 10.
•
Companies issuing new equity outside
their home markets also shifted
away from U.S. exchanges. In 2000,
50 percent of the dollars in global
IPOs were raised on U.S. exchanges,
but only five percent in 2005.
•
Listing and trading of foreign securities
on U.S. exchanges have been
declining over the past five years as
major foreign markets attract a
growing share of those companies.
This helps explain why the New
York Stock Exchange (NYSE) moved
recently to take over Euronext, the
stock-market consortium of Paris, Amsterdam and Brussels exchanges,
and London’s LIFFE. NASDAQ is
trying to take control of the London
Stock Exchange (LSE), whose share
of global IPOs soared from five percent
in 2002 to 25 percent in 2005.
•
U.S.-domiciled companies doing
IPOs increasingly turn to London,
even though they must still comply
with the reporting requirements of
the Securities Exchange Act of 1934
and the Sarbanes-Oxley Act passed
in 2002 to enhance corporate governance
in the wake of the scandals
concerning Enron and some other
major U.S. companies. Even proponents
of the legislation now seem inclined
to view some of its provisions
as too harsh in terms of the costs of
reporting on compliance.
•
Foreign companies increasingly issued
equity to large U.S. institutional
investors under Rule 144A
allowing them to avoid the additional
Sarbanes-Oxley scrutiny associated
with publicly-listed equity
IPOs. Foreign firms used this technique
to raise $86 billion in 186 U.S.
equity issues, versus only $5.4 billion
in 34 public equity offerings in 2005.
•
IPOs on the London Stock Exchange
and its more loosely-regulated
AIM market for small growth
companies totaled $55 billion in
2005—exceeding, for the first time,
the $47 billion raised on the NYSE
and NASDAQ.
•
The U.S. ranked only No. 5 as the
best place for new business to raise
capital in 2006. The Milken Institute’s
Capital Access Index recently
put “Hong Kong, Singapore, Britain
and Canada ahead of the U.S., based
on 56 quantitative and qualitative indicators
used with 122 countries.”
•
Employment in London’s financial
services sector rose by 4.3 percent
between 2002 and 2005 while New York’s dropped 0.7 percent in the
same period.
•
Earnings growth of U.S. financial
groups, including Citigroup, Merrill
Lynch, Goldman Sachs, Morgan Stanley
and Lehman Brothers, was reported
better outside the U.S. in 2006 than in
the U.S. Much of the increased earnings
originated in London and Europe.
Investment banks generated more
revenues from bond issuance in
2006 than from equities (including
IPOs) for the first time, with much
of the increase outside the U.S.
•
Investment banks generated more
revenues from bond issuance in
2006 than from equities (including
IPOs) for the first time, with much
of the increase outside the U.S.
•
Outstanding debt securities issued
in the euro zone were worth the
equivalent of $4.83 trillion at the end
of 2006, compared with $3.89 trillion
for dollar debt.
•
New issuance of euro-denominated
debt accounted for 49 percent of
total global debt in 2006. As recently
as 2002, euro debt securities were
only 27 percent of the total vs. 51
percent for dollar debt.
•
Euro-denominated debt now accounts
for 45 percent of the international
(cross-border) market, compared
with 37 percent for the dollar.
•
The value of euro-denominated banknotes
in circulation overtook dollars
in circulation for the first time in 2006.
•
Of the $2.7 trillion in daily foreign exchange
transactions, about one third
passes through London almost
double the volume in 2001.
•
Central banks are diversifying foreign
exchange reserves away from
the dollar, principally toward the
euro as its credibility as a durable
value grows.
•
Investment banking revenues in
European Union (EU) countries are gaining on the U.S.,
notably in IPOs and securities trading. EU banks' revenues
from derivatives trading already exceed those of U.S. competitors.
•
Capital-market revenues in Europe,
the Middle East and Africa, are forecast
to soon overtake those in the
U.S., the McKinsey report said, with
London and the EU replacing the
U.S. as “the financial powerhouse in
terms of top-line numbers.”
•
Total U.S. financial assets, measured
as a share of GDP, were four
times U.S. GDP at end-2005. European
financial assets were three
times the region’s GDP, but the European
ratio had grown six percent a
year since 1996, double the growth
rate of U.S. assets.
Four causes of the U.S. decline were
identified by the CCMR (and endorsed
by the McKinsey study): 1) increased
trust in the integrity of major foreign
public markets as a result of more transparency
and better disclosure; 2) a relative
increase in the liquidity of these foreign
and private markets, making it less
necessary for foreign firms to tap the U.S.
public equity market for capital; 3) technological
improvements enabling U.S. investors to invest in foreign markets; and
4) restrictive changes in the governance
and regulation of U.S. public markets at a
time when foreign and private market alternatives
were gaining credibility.
While the CCMR and McKinsey reports
focused attention on U.S. markets’
loss of competitiveness and its potential
economic consequences, critics note that
they may also be self-serving. The
groups explicitly seek to roll back the increased
regulatory constraints imposed
on business following the epidemic of
U.S. corporate scandals that erupted in
2001. (In 2002, I wrote an analysis of the
economic and investment impact of
large-scale corporate corruption on U.S.
financial markets’ international standing
in an article entitled “Enronitis.”
2)
The post-Enron Sarbanes-Oxley Act
of 2002 significantly tightened accounting,
management and transparency requirements
for U.S. business, especially
those which are publicly traded. The act
set up the Public Company Accounting
Oversight Board to oversee, for the first
time, U.S. accounting firms. The CCMR
and McKinsey reports attribute part of
relative U.S. decline in global capital
markets to the dissuasive influence of
this tougher regulatory environment, including
the actual costs of compliance
with new standards.
Both the CCMR and McKinsey reports
urge that the regulatory environment
be relaxed to help preserve U.S.
competitiveness. But these reports fail to
take enough account of the possibility
that such newly-enhanced regulatory
vigilance may now be helping restore international
investor confidence in the integrity
of U.S. corporate governance, financial
reporting and market efficiency.
And that this restored confidence may
encourage capital flows to the U.S., helping
finance our external deficit and invest
in U.S. business.
Erosion of the U.S.’s preeminence in
global capital markets is also due to underlying
factors, some cyclical and some
long-term. Cyclical factors include the
exceptionally tough domestic competition
among U.S. financial institutions for
market share following the dot.com and
equity market bust in 2000-2002. A more
restrictive interest rate environment was
imposed by the Federal Reserve after
June 2004, resulting in higher capital
costs in the United States. The U.S. economic
cycle, which has benefited from a
booming residential housing market,
strong corporate profits and improving
labor-productivity growth, may also be
running out of steam. This is reflected in
stock markets’ performance (as measured
by the Wilshire 5000 index which represents about 97 percent of publicly traded
equities). The long, rising boom
in the U.S. stock market - which took blue-chip stocks from a 2003
low to a record high on February 20—
may be peaking, as evidenced by the
nasty correction in early March.
Cyclical interest rate and economic
factors in Europe, Japan and Asia currently
appear more attractive to international
investors. The European Central
Bank (ECB) has cautiously managed an
anti-inflationary monetary policy in the
13 countries of the single euro currency
zone, and that record—controversial
with some EU governments (notably
those outside the euro zone, especially
London)—has built up the ECB’s credibility
with international investors. The
Bank of Japan has been similarly prudent
in stimulating a significant economic recovery
without inflationary pressures.
The result is that euro zone and
Japanese short-term interest rates are
lower than those in the U.S. Because inflationary
expectations are also lower, 10-
year government bond yields are also
lower outside the U.S. These cyclical factors
explain why foreign firms’ cost of capital may
be lower than those in the U.S.
Other cyclical factors include: corporate
cost-cutting and restructuring; investment in technology to bring productivity
gains; and increased emphasis
on international marketing. Similar belt tightening
boosted gains in profits and
share prices in the U.S. since the mid-
1990s, but the relative benefits may be
fading for the U.S. today. Now the same
methods, applied in recent years in Europe
and Japan, have sharply boosted
growth in their profits and stock-market
levels, with the change relative to the
U.S. becoming evident since 2004.
These cyclical factors also contributed
to exchange-rate changes that,
since the dollar’s peak in 2002, have favored
the euro, sterling and yen over the
U.S. dollar. As a result, investors, especially
those with dollars, now are starting
to anticipate gains thanks to exchange rate
moves that increase their returns on
investments in the euro zone and Japan.
The same reasoning applies to China,
whose policy of slow yuan appreciation
against the dollar encourages foreign investment
in Chinese assets and markets
in anticipation of bonus returns based
on moves in the exchange rates against
the dollar. (Such cyclical factors, especially
monetary policy and equity market
performance, could change during the
next several years, or even months, to
the detriment of Europe and Japan, allowing
the U.S. to recover relative attractiveness.)
Perhaps more important for the
long-term outlook for the U.S.’s relative
position in global capital markets (as
well as the vanity of Wall Streeters accustomed
to being Masters of the Universe),
there seem to be sea changes in irreversible
macroeconomic and policy-related
areas in the global economy and
capital markets. These are already causing
a long-term relative decline for the
United States as the world’s single largest
economy and capital market.
These long-term changes include the
much faster economic growth of China,
India and other emerging markets, which
insures that the U.S. share of world GDP
is declining and will continue to over the
next decade or so. (See Figure 3—Global
GDP Share Trends 1999-2005.) The resulting
global competition for scarce energy
and mineral resources means more
U.S. resources must be diverted from
consumption, a shift liable to have the effect
of slowing overall growth.
The U.S. faces a structural shortfall of
savings for investment as a result of a
long-term trend of over-consumption and
declining savings. This leads to a large balance
of payments deficit that must be financed
with foreign capital. Foreign borrowing
by the U.S. has led to accumulating
foreign obligations to the point where,
once the world’s largest creditor nation,
the United States has become the largest
international debtor. (See Figure 4—U.S.
Net International Position at Yearend.)
Given the intractability of correcting
these structural imbalances in the U.S.,
international investors are increasingly
worried that the dollar will not be a
long-term store of value. Investment
preferences are thus shifting away from
dollar-denominated assets toward alternatives—
starting with euro-denominated
assets. The success of the euro as a
currency, due to its being backed by the
credible anti-inflationary monetary policy
of the Frankfurt-based European Central Bank, taken together with Europe’s
restructuring of its markets for
capital, labor and products, have made
Europe more competitive and the euro
an attractive alternative to dollars. Rapidly
growing emerging markets such as
China, India, Brazil and Russia also appear
to be viable destinations for global
savings even though they are clearly
riskier, as demonstrated by the equity
market sell-off in China in early March.
Another irreversible sea change is the
internationalization of investment flows
as financial assets are diversified among
many different countries and business
shifts direct investment to the most attractive
environments. The continuing
internationalization of capital flows and
growing concerns about the dollar seem
to make it inevitable that we will see further
erosion in the position of the U.S. as
the leader among global capital markets.
In the long run, it appears unlikely
that this trend toward a multi-polar
global capital system can be halted or reversed.
Today, this prospect of continued
relative decline appears disagreeable to
U.S. market participants, long accustomed
to being Number One. But they
may be overlooking the advantages of
the clearly-emerging pattern that might
be called, to borrow a French expression,
a “multi-polar system of global capital
markets.” This on-going shift from a
“unipolar” system, dominated by the
U.S., to one in which multiple capital
markets are large and liquid enough to
attract growing international investment
means global diversification. In principle,
that should reduce systemic risks.
At this juncture, the foreseeable risks
seem unlikely to do more than slow or
alter the process of globalizing financial
markets. Political turmoil in China or
India could impede shifts in gross domestic
product growth that currently
favor Asia. European markets could be
dealt a major blow by the emergence of
greater reluctance to continue the
painful process of restructuring labor
markets and fiscal imbalances, or of failures
to reform governance in the 27 EU
countries, or a loss of credibility for the
euro. At the outer edge of probability, the
American consumer might decide to cut
back spending and rebuild savings,
thereby reducing U.S. borrowing abroad.
This would lead, however, to a period of
slower economic growth and a reduced
rise in corporate profits, with hard-to forecast
consequences for U.S. and international
financial markets.
As an overall assessment, it seems
that today’s globalization of capital markets
is reaching a trajectory with its own
inertial force. If so, it will very likely continue
readjusting the relative importance
of national and institutional players, notably
by reducing U.S. predominance.
Underlying structural pressures may reemerge
at times to slow these changes
with cyclical developments. But such periods are likely to be temporary. Meanwhile,
although the United States may be
losing its Number One ranking in certain
markets or financial activities, it will remain,
for the foreseeable future, the only
single country with such large liquid capital
markets and competitive financial
and business institutions—a position of
strength underpinned by the world’s
largest and most dynamic economy.
One major caveat must hang over
any assessment of the internationalization
of capital markets. The absolute size
of the U.S. economy and its capital markets,
and the quantity of dollars invested
around the world, ensure that any major
U.S. economic or market downturn is
very likely to trigger similar problems in
Europe, Japan and Asia. That is what has
happened in the past, and it continues to
be highly probable in any foreseeable
partial redistribution of the cards in
terms of global capital markets. The U.S.
also has an asset confirmed by history:
Experience shows that in a crisis, investors
have a traditional reflex of seeking
refuge in stability and size, where the
U.S. is the leader and will remain so in
absolute terms for the foreseeable future.
A crisis could be expected to accelerate
foreign capital flows back to the U.S.
once again and, in the process, slow the
now-accelerating process of globalization
of capital markets.
1 The Committee on Capital Markets Regulation is an independent, bipartisan committee of 22 corporate and financial leaders representing
the investor community, business, finance, law, accounting and academia, announced on September 12, 2006. Co-Chaired by
Glenn Hubbard, Dean of Columbia School of Business, and John Thornton, Chairman of the Brookings Institution, the CCMR issued
an interim report on November 30, 2006 evaluating the competitiveness of U.S. capital markets.
2 “Does Enronitis Threaten the Dollar and the Economy? American
and French Views” by J. Paul Horne and Albert Merlin in
Business Economics (National Association for Business Economics)
in October 2002. See:
http://nabe.com/publib/be/c20024.html
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