Why, in the era of Wall Street hegemony, do close to half of global financial transactions still flow through territories linked to Britain? New Left Project's Jamie Stern-Weiner spoke to Ronen Palan, Professor of International Political Economy at City University London and co-author of Tax Havens: How Globalisation Really Works, to find out.
What has London's preeminent international financial position got to do with British empire?
Historically there is a strong interlink between the rise of the City of London and the rise of the British empire. Usually, large financial centres emerged in the world's large trading centres. In 1850 Britain was the largest manufacturing centre—about 50% of all global manufacturing was produced in the UK—and so, not surprisingly, it was serviced by the largest financial centre. So the City of London was at the core of the British economy and the British empire.
How was Britain's imperial decline after WWII reflected in the financial sphere?
This was an interesting period and a challenge to the City of London. The City's power and success during the twentieth century had been in servicing not only the 'formal' British empire, but also the 'informal' empire: areas, for example in Latin and Central America, which were under the informal tutelage of Britain without being formally part of the empire.
To understand the success and function of the City of London you have to recall that this was a period before the internet and before faxes. At a time when information was relatively immobile and inaccessible, it was very difficult to maintain investment overseas. But in the City of London there emerged all sorts of middle- and small-sized commercial institutions that were really specialists on different countries: they had specialists on Nicaragua, on Peru, on Colombia, on Ghana, and so on. This was the bedrock of the City's success: highly specialised knowledge of various areas in the world.
With the decline of the British empire after WWII this specialised knowledge was still required, and so the commercial institutions in the City continued to be the main vehicle for investment in what were then called 'developing' countries (i.e. decolonising countries). But that was a shrinking business, and the City of London was, in terms of its importance within the British state as a whole, in decline. It was still a very important financial centre, but in relative terms it was in decline.
That said, we should recall something that most people have forgotten: after WWII the British state re-established what was called the sterling area, which ensured that trade between certain countries was conducted in sterling. It was initially established in 1932, but was broken up at U.S. insistence. However it was then re-established in 1946. As a result, until the early 1960s about 40% of all international trade was denominated in sterling, and the City of London of course played an important role because of that.
What was the Euromarket?
The Euromarket was essentially an informal agreement between the Bank of England and the commercial banks in the City of London that any transaction through London between two non-residents and in a foreign currency—at the time, mainly dollars—would not be subject to British regulations.
The agreement arose out of the run on the pound of 1956-7 and a subsequent desire to avoid harmful effects on the British balance of payments. Rumours at the time suggested that the currency crisis was partly engineered by U.S., which was unhappy about the British and French invasion of Egypt to reverse Nasser's nationalisation of the Suez Canal. In response to the run on the pound, the Treasury raised interest rates from 5 to 7% and imposed a moratorium on lending to non-British borrowers. The two policies aimed to strengthen the pound. The moratorium cut many commercial banks, which specialised in lending to ex-colonies or the ‘informal empire’, off from their business. It appears that they reached an agreement with the Bank of England—through the services of John Bolton, former CEO of BOLSA (the Bank of London and South America, which was acquired in 1971 by Lloyds Bank) and at the time the deputy director at the Bank of England—that they could continue lending as long as they interacted in dollars (or any other non-sterling currency) and intermediated between non-British clients. Such transactions—in foreign currency, between non-British clients—would not affect the British balance of payments. But the agreement seems to have yielded an unintended consequence: such transactions were 'deemed' by the Bank not to be taking place in London. This liberated them from the regulatory regime not only of the UK, but also of any other country. This was the origin of 'offshore'.
Effectively it created a new market. That wasn't the intended impact: indeed, some eminent bankers felt sure it was only a temporary market that was likely to decline and disappear fairly quickly. But sure enough, once British banking institutions began to understand that by organising banking transactions in such a way they could sidestep key regulations, like capital reserve requirements, they quickly realised that they had here an opportunity. And from that point, in the early 1960s, the market grew rapidly.
If the proximate cause of the emergence of the Euromarket was the 1956-7 sterling crisis, was there also a broader context of attempting to compensate for imperial decline?
That's a very good question, and I don't think we have a definitive answer. It's a matter of interpretation. There is no doubt that successive British governments understood the importance of the City of London and wanted it to remain the global financial centre. There's no doubt that there was the political will to support the City of London, and there's no doubt that the City was always powerful politically, regardless of whether Labour or the Conservatives were in power. But the circumstances that gave rise to the Euromarket are so specific that it appears more like a series of accidents, an unforeseen result of decisions taken in response to very local issues, rather than an intentional strategy to revive the City.
Were there particular political forces that pushed for the development Euromarket and others that were resistant?
I don't know of any resistance. We know that some of the people who pushed for it had previously worked in the commercial banks, like the John Bolton I mentioned above. He understood the interest of the commercial banks and many of us believe he acted on their behalf. But I don't know of any resistance.
Did the development of the Euromarket have implications for the sustainability of the Bretton Woods financial order?
Yes, it punched a hole in the whole Bretton Woods system. Bretton Woods was based on financial regulations and restrictions on capital movements: that was the whole basis of the Bretton Woods agreement. But now you had a whole market with no regulations, a market that was truly global because it existed nowhere. It had no boundaries. It's a bit like the World Wide Web: initially it was everywhere and nowhere. It simply created a new space. That space attracted a lot of funds and basically undermined the entire system of national regulation that was the basis of Bretton Woods.
Has the Euromarket persisted in the decades since the 1960s?
Yes. It grew enormously during and after the 1973 oil crisis. Today basically the entire wholesale global financial market is effectively an expansion of the Euromarket: it's effectively offshore. It was for a long time completely unregulated, until it became subject to 'voluntary' regulation: Basel I and Basel II. These are sets of voluntary agreements agreed at the Bank for International Settlements (BIS) in which banks agreed to abide by certain rules of capital requirements and so on. So it's no longer true to say that international financial markets are unregulated, but until recently they were subjected to largely voluntary regulation.
Presumably the existence of this market facilitates tax evasion, and enabled sidestepping of national regulations which contributed to the 2007-8 financial crisis?
Absolutely. People talk about financial deregulation as one of the causes of the crisis, but in fact financial deregulation followed rather than constituted deregulated financial markets. Governments essentially found themselves in a position whereby so much of international finance was already operating through this non-regulated parallel market, that they had no choice but to try and deregulate their own domestic markets in order to compete. They rationalised this ideologically—we call it neoliberalism—but the main cause was that there was already a non-regulated global financial market sucking in most of the funds in any case.
Would any attempt to impose regulations on that parallel market require concerted state action?
It would require concerted state action. The attempt that I know of to do this was made in 1978 by the United States. The U.S. came with a proposal at the BIS to effectively re-regulate the Euromarket, to renationalise it. They were resisted primarily by the UK, but also Switzerland and a few others. As a result the U.S. decided to change tack and instead of fighting the Euromarket they set up their own version of it, called the International Banking Facilities (IBF). This was initially established in New York, but now operates in L.A. and Chicago too, and about one-third to one-half of U.S. financial markets now effectively operate offshore. (The Japanese, incidentally, followed suit in 1986.)
In a journal article [£] you discussed the odd situation whereby, even at the height of what is conventionally seen as an era of U.S. and Wall St. financial hegemony, the leading international financial centres appear to be former British colonies and protectorates. How has Britain been able to sustain its leading position in global finance?
What really pricked my interest was simply looking at the data of international lending and deposits, and where they are located. On the face of it London is the largest international financial centre, followed by New York. But this data tends to treat British jurisdictions like Jersey, Guernsey, the Cayman Islands, and so on as entirely separate, independent territories. They are not: they are part of the British state. And if you add them all together, you find that at the moment roughly one-third of all international deposits and investments are going through these jurisdictions, which are remnants of the British empire and which remain part of the British state. And if you add ex-colonies whose independence was relatively recent, like Singapore, then you reach a figure of 40%. This compared to roughly 10% going through the US.
That data raises a question: why are these jurisdictions, many of which are still controlled by the British state and some of which only recently gained independence, playing such a prominent role in global financial markets? I came to the conclusion that in fact we have, to put it provocatively, a second British empire which is at the very core of global financial markets today.
There are broadly speaking two views about the City of London. One is that the City of London refers to those activities and transactions taking place in London itself. The other is that the City of London is the core of a whole network of other financial centres which are linked to it, particularly places like Guernsey, Jersey, the Isle of Man, Bermuda, Cayman Islands, and also Switzerland and Luxemburg. This second view is more useful if you want to understand how international finance operates. In many cases financial transactions are being decided and agreed upon in London, but are being registered for various reasons (mainly tax-related) in, say, the Cayman Islands. As a result the Cayman Islands appears statistically as the fourth largest financial centre in the world, about the size of Frankfurt and much larger than Tokyo. But it's only a paper centre: most of the activities attributed to it in fact take place in London.
Within field of International Relations there is a strong theory: hegemonies (i.e. large, powerful states) emerge as manufacturing centres, develop into commercial centres, eventually become financial centres and then decline. That cycle seems to represent very well the rise and decline of the Netherlands, then London and now the United States. But the picture that emerges if you look at the role of the 'second British empire' described above is much more complex: whereas the old British empire declined, it re-emerged again in different guises. The second empire is not as big and doesn't incorporate as many territories, but in financial terms it's very significant. So while the whole notion of cycles of hegemonies, which is very seductive and simple, contains an element of truth, the world out there is, as usual, much more complex than our theories tend to allow for.
Does the story you've been telling of the development of deregulated global financial markets have implications for how we should understand economic globalisation in relation to state power?
Yes, it has many conceptual, theoretical and also practical implications about how we understand globalisation. A very simple view of globalisation sees it as an expansion of market forces that will eventually undermine the anachronistic state system. If you look more carefully at processes like the expansion of financial markets, however, you find that even the most unregulated market is in fact an aspect of state regulation: it survives only as long as there are states and state regulation to sustain it. It's a difficult idea to understand, but the two go hand-in-hand.
That doesn't mean that outcomes are always intentional: that a group of states or governments sat together as a committee and decided to develop an unregulated financial market. For the most part they didn't understand what they were doing. Most governments cannot see five or ten years ahead and cannot plan. Nevertheless their policies, collectively, created the structures that are determining our lives, whether they intended these structures or not.
Has the City's role as the centre of an international network of financial centres had an impact on the balance of power between the UK and other states?
Britain is very good at not advertising its position. It's a great coup for the British state that the Cayman Islands etc. are presented in the data as independent states. Because if other states were to notice how much funds are effectively going through the British state they'd be a lot more cautious.
My view is that the British state plays a much more central role in international regulation than is attributed to it. But the British government has a continuing interest in playing down this role.
Do states like the U.S. look at Britain's position enviously? Have they tried to claw back some influence?
They tried to claw it back by introducing their own offshore financial centre through the IBF, and by offering, or at least tolerating, secrecy jurisdictions (i.e. tax havens) in places like Delaware, New Jersey, Vermont and Nevada. American financial centres very much see themselves as being in competition with London.
Is it worth talking here about the City of London's weird jurisdictional status as a city within a city?
It's very interesting, the role of the Corporation of London as a unique political entity within the British state. However, you'll be surprised to hear that, in spite of the success of the City of London and the importance of the Corporation of London, I could find no academic study of its politics and influence in the British state. Perhaps there is one, but I couldn't find it. We don't understand the Corporation of London.
Which itself illustrates what appears to be a theme here, namely the affinity between finance and protection from scrutiny.
It seems like there is a certain logic that pervades the whole system there: the logic of discretion, secrecy, and informality. That's at the very heart of the financial markets worldwide, and the City of London is a paradigm.
Since the 2007-8 crisis have you noticed any shifts in Britain's position in international finance?
Like everyone else I've noticed that there is an ongoing debate about financial regulation. Clearly the Europeans are in favour of much more stringent regulations and there is also an ongoing debate within the British state. The Financial Services Authority (FSA), now run by Lord Turner, has taken a much more radical view about the need to regulate the City of London. But I don't know how much success he's having.
However what we don't hear in the discussion—and I'm simply puzzled by this—is the fact that much of the market exists in non-regulated spaces. Some of it is basically the old Euromarket, some of it is over-the-counter exchanges. So when people talk about introducing new regulations, I'm not sure the extent to which they will be universally applied. And I don't get an answer to that question. If only the onshore, official banking system will be regulated, with the offshore component—including various aspects of shadow banking, which according to some estimates amounts to nearly half the global financial markets—remaining as it is, then we achieve nothing.
Jamie Stern-Weiner co-edits New Left Project.
Front image from the New Statesman