Fletcher Features

Turbulent times? Political Instability? The One Key to Weathering It All: Financial Liquidity.

It’s no great secret that with turbulent financial markets comes political instability. Just look at the number of Western governments that collapsed or changed control within a year of the 2008 financial crisis.  So how do you ensure stability in uncertain times?

Paul Schulte, MALD ’88, may have the answer:

“Financial liquidity – that’s the key,” Schulte told student and faculty earlier this month in a presentation hosted by The Fletcher School’s Institute for Business in the Global Context. The 1997 East Asian economic crisis? Liquidity crunch. The Soviet collapse? It may very well have been brought about by a massive credit crunch in 1987.

“Liquidity offers ‘elbow room’ for political mistakes. Without credit, your country’s politics are going to be toxic and unstable,” Schulte said.

Years of experience consulting companies, advising governments and weathering turbulent times has given Schulte valuable insight into how the still-unfinished Great Recession might continue to play out. 

An adjunct associate professor of finance at the Hong Kong University of Science and Technology, Schulte is also CEO of SGI Emerging Markets Research based out of Rio de Janeiro and Hong Kong. He’s associated with Fletcher’s Center for Emerging Market Enterprises as a Senior Fellow. He’s worked for the White House, advised the Indonesian Ministry of Finance, led Lehman Brother’s Asia Banks’ Research group and offered strategic guidance for the China Construction Bank.

Liquidity is often assumed as a given, Schulte said. “Most introductory courses to economics gloss over the role of credit as one of the key driving forces behind shifts in the demand curve.”

It’s extremely important to have a synergy between politics, business and finance, Schulte said: “Banking cycles affect political outcomes and it is important if you’re a politician running the country, that you know how they work.”

Schulte explained that the age of the free market is over. Walk into a meeting with officials from Brazil, Russia, India, China or South Africa (the so-called BRICS countries) and try to convince them of the virtues of a laissez-faire economy, “they will look at you as if you’re making some grand joke.”

For all the predictions that China is on the verge of political instability, Schulte argued that the political and technocratic elite know exactly what they are doing.

“They have sufficient liquidity, and more importantly, have the room to navigate through tough austerity measures if the need arises.”

On the other hand, Brazil, a commodity-driven country often touted as one of the next big economic powers, is in trouble, he said. “Brazil’s case is not helped by the gigantic deficits it is running up to finance new stadiums for the 2016 FIFA World Cup and Summer Olympics.”

In Europe, Schulte said, central banks in some countries have deprived the middle class of wealth through currency devaluations.

 “More is better than less’: this dictum is in fashion now and a worrying concern when banks are leveraging way beyond their means,” he predicted. “Many countries in the Eurozone will find it tough to recover from the downturn precisely because of this.”

Bhaskar Chakravorti, director of Fletcher’s Institute for Business in the Global Context, meanwhile challenged Schulte’s assertion that political risk was mitigated by financial liquidity.

“The history of revolutions shows that political turmoil is anything but linear, and it’s not enough to assume stability as a given if financial liquidity is present,” Chakravorti offered.

Schulte responded, highlighting the cases of the Arab Spring protests where countries that have faced the brunt of rebellion have also been those affected by a liquidity crunch.

In any case, the recent economic trajectory and political landscape call for action, whether the answer is liquidity or otherwise.

“Here we are today, facing the first instance since the Great Depression when aggregate credit has shrunk,” Schulte said. “For politicians and political risk analysts, it is time to wake up and smell the coffee.”

-- A student correspondent