Markets

The 7 Major Flaws of the Global Financial System

Published

4 years ago

February 13, 2019

Jeff Desjardins

Part 1 Part 2 Part 3

The 7 Major Flaws of the Global Financial System

Since the invention of banking, the global financial system has become increasingly centralized.

In the modern system, central banks now control everything from interest rates to the issuance of currency, while government regulators, corporations, and intergovernmental organizations wield unparalleled influence at the top of this crucial food chain.

There is no doubt that this centralization has led to the creation of massive amounts of wealth, especially to those properly connected to the financial system. However, the same centralization has also arguably contributed to many global challenges and risks we face today.

Flaws of the Global Financial System

Today’s infographic comes to us from investment app Abra, and it highlights the seven major flaws of the global financial system, ranging from the lack of basic access to financial services to growing inequality.

1. Billions of people globally remain unbanked
To participate in the global financial sector, whether it is to make a digital payment or manage one’s wealth, one must have access to a bank account. However, 1.7 billion adults worldwide remain unbanked, having zero access to an account with a financial institution or a mobile money provider.

2. Global financial literacy remains low
For people to successfully use financial services and markets, they must have some degree of financial literacy. According to a recent global survey, just 1-in-3 people show an understanding of basic financial concepts, with most of these people living in high income economies.

Without an understanding of key concepts in finance, it makes it difficult for the majority of the population to make the right decisions – and to build wealth.

3. High intermediary costs and slow transactions
Once a person has access to financial services, sending and storing money should be inexpensive and fast.

However, just the opposite is true. Around the globe, the average cost of a remittance is 7.01% in fees per transaction – and when using banks, that rises to 10.53%. Even worse, these transactions can take days at a time, which seems quite unnecessary in today’s digital era.

4. Low trust in financial institutions and governments
The financial sector is the least trusted business sector globally, with only a 57% level of trust according to Edelman. Meanwhile, trust in governments is even lower, with only 40% trusting the U.S. government, and the global country average sitting at 47%.

5. Rising global inequality
In a centralized system, financial markets tend to be dominated by those who are best connected to them.

These are people who have:

Access to many financial opportunities and asset classes
Capital to deploy
Informational advantages
Access to financial expertise

In fact, according to recent data on global wealth concentration, the top 1% own 47% of all household wealth, while the top 10% hold roughly 85%.

On the other end of the spectrum, the vast majority of people have little to no financial assets to even start building wealth. Not only are many people living paycheck to paycheck – but they also don’t have access to assets that can create wealth, like stocks, bonds, mutual funds, or ETFs.

6. Currency manipulation and censorship
In a centralized system, countries have the power to manipulate and devalue fiat currencies, and this can have a devastating effect on markets and the lives of citizens.

In Venezuela, for example, the government has continually devalued its currency, creating runaway hyperinflation as a result. The last major currency manipulation in 2018 increased the price of a cup of coffee by over 772,400% in six months.

Further, centralized power also gives governments and financial institutions the ability to financially censor citizens, by taking actions such as freezing accounts, denying access to payment systems, removing funds from accounts, and denying the retrieval of funds during bank runs.

7. The build-up of systemic risk
Finally, centralization creates one final and important drawback.

With financial power concentrated with just a select few institutions, such as central banks and “too big too fail” companies, it means that one abject failure can decimate an entire system.

This happened in 2008 as U.S. subprime mortgages turned out to be an Achilles Heel for bank balance sheets, creating a ripple effect throughout the globe. Centralization means all eggs in one basket – and if that basket breaks it can possibly lead to the destruction of wealth on a large scale.

The Future of the Global Financial System?

The risks and drawbacks of centralization to the global financial system are well known, however there has never been much of a real alternative – until now.

With the proliferation of mobile phones and internet access, as well as the development of decentralization technologies like the blockchain, it may be possible to build an entirely new financial system.

But is the world ready?

Related Topics:currency money banking global financial system

Up Next

Where Investors Put Their Money in 2018

Don't Miss

5 Lessons About Volatility to Learn From the History of Markets

Click for Comments

Markets

Which Countries Hold the Most U.S. Debt?

Foreign investors hold $7.3 trillion of the national U.S. debt. These holdings declined 6% in 2022 amid a strong U.S. dollar and rising rates.

Published

1 week ago

March 24, 2023

Dorothy Neufeld

Which Countries Hold the Most U.S. Debt in 2022?

Today, America owes foreign investors of its national debt $7.3 trillion.

These are in the form of Treasury securities, some of the most liquid assets worldwide. Central banks use them for foreign exchange reserves and private investors flock to them during flights to safety thanks to their perceived low default risk.

Beyond these reasons, foreign investors may buy Treasuries as a store of value. They are often used as collateral during certain international trade transactions, or countries can use them to help manage exchange rate policy. For example, countries may buy Treasuries to protect their currency’s exchange rate from speculation.

In the above graphic, we show the foreign holders of the U.S. national debt using data from the U.S. Department of the Treasury.

Top Foreign Holders of U.S. Debt

With $1.1 trillion in Treasury holdings, Japan is the largest foreign holder of U.S. debt.

Japan surpassed China as the top holder in 2019 as China shed over $250 billion, or 30% of its holdings in four years.

This bond offloading by China is the one way the country can manage the yuan’s exchange rate. This is because if it sells dollars, it can buy the yuan when the currency falls. At the same time, China doesn’t solely use the dollar to manage its currency—it now uses a basket of currencies.

Here are the countries that hold the most U.S. debt:

Rank	Country	U.S. Treasury Holdings	Share of Total
1	🇯🇵 Japan	$1,076B	14.7%
2	🇨🇳 China	$867B	11.9%
3	🇬🇧 United Kingdom	$655B	8.9%
4	🇧🇪 Belgium	$354B	4.8%
5	🇱🇺 Luxembourg	$329B	4.5%
6	🇰🇾 Cayman Islands	$284B	3.9%
7	🇨🇭 Switzerland	$270B	3.7%
8	🇮🇪 Ireland	$255B	3.5%
9	🇹🇼 Taiwan	$226B	3.1%
10	🇮🇳 India	$224B	3.1%
11	🇭🇰 Hong Kong	$221B	3.0%
12	🇧🇷 Brazil	$217B	3.0%
13	🇨🇦 Canada	$215B	2.9%
14	🇫🇷 France	$189B	2.6%
15	🇸🇬 Singapore	$179B	2.4%
16	🇸🇦 Saudi Arabia	$120B	1.6%
17	🇰🇷 South Korea	$103B	1.4%
18	🇩🇪 Germany	$101B	1.4%
19	🇳🇴 Norway	$92B	1.3%
20	🇧🇲 Bermuda	$82B	1.1%
21	🇳🇱 Netherlands	$67B	0.9%
22	🇲🇽 Mexico	$59B	0.8%
23	🇦🇪 UAE	$59B	0.8%
24	🇦🇺 Australia	$57B	0.8%
25	🇰🇼 Kuwait	$49B	0.7%
26	🇵🇭 Philippines	$48B	0.7%
27	🇮🇱 Israel	$48B	0.7%
28	🇧🇸 Bahamas	$46B	0.6%
29	🇹🇭 Thailand	$46B	0.6%
30	🇸🇪 Sweden	$42B	0.6%
31	🇮🇶 Iraq	$41B	0.6%
32	🇨🇴 Colombia	$40B	0.5%
33	🇮🇹 Italy	$39B	0.5%
34	🇵🇱 Poland	$38B	0.5%
35	🇪🇸 Spain	$37B	0.5%
36	🇻🇳 Vietnam	$37B	0.5%
37	🇨🇱 Chile	$34B	0.5%
38	🇵🇪 Peru	$32B	0.4%
	All Other	$439B	6.0%

As the above table shows, the United Kingdom is the third highest holder, at over $655 billion in Treasuries. Across Europe, 13 countries are notable holders of these securities, the highest in any region, followed by Asia-Pacific at 11 different holders.

A handful of small nations own a surprising amount of U.S. debt. With a population of 70,000, the Cayman Islands own a towering amount of Treasury bonds to the tune of $284 billion. There are more hedge funds domiciled in the Cayman Islands per capita than any other nation worldwide.

In fact, the four smallest nations in the visualization above—Cayman Islands, Bermuda, Bahamas, and Luxembourg—have a combined population of just 1.2 million people, but own a staggering $741 billion in Treasuries.

Interest Rates and Treasury Market Dynamics

Over 2022, foreign demand for Treasuries sank 6% as higher interest rates and a strong U.S. dollar made owning these bonds less profitable.

This is because rising interest rates on U.S. debt makes the present value of their future income payments lower. Meanwhile, their prices also fall.

As the chart below shows, this drop in demand is a sharp reversal from 2018-2020, when demand jumped as interest rates hovered at historic lows. A similar trend took place in the decade after the 2008-09 financial crisis when U.S. debt holdings effectively tripled from $2 to $6 trillion.

Foreign Holdings of U.S. Debt

Driving this trend was China’s rapid purchase of Treasuries, which ballooned from $100 billion in 2002 to a peak of $1.3 trillion in 2013. As the country’s exports and output expanded, it sold yuan and bought dollars to help alleviate exchange rate pressure on its currency.

Fast-forward to today, and global interest-rate uncertainty—which in turn can impact national currency valuations and therefore demand for Treasuries—continues to be a factor impacting the future direction of foreign U.S. debt holdings.