A brave new world in capitalism's evolution

Reflecting on the 21 years since the 1987 stock market crash and the part played by governments around the globe leaves us assessing two differing policies. On one hand, the views of John Maynard Keynes, who advocated government intervention to mitigate the adverse effects of economic recessions, depressions and booms. On the other, Milton Friedman's theory (1962), which supported minimising government's role in a free market, as a means of creating political and social freedom.

The developed markets of the US and UK, during the leadership of Reagan and Thatcher, aligned their policies with Friedman's beliefs. In contrast, the emerging and developing nations, as we know them today, generally operate under the Keynesian philosophy of government intervention and control.

The role of financial institutions changed as a consequence of government regulation. In 1999, the Glass-Steagall Act of 1933, passed by US Congress in the wake of the 1929 crash to separate commercial banks and investment banks, was abolished. It was clear that commercial banks wanted to expand beyond their core competencies and compete with investment banks. In retaliation, investment banks became bigger. At the same time, the burden of financial regulation now sat in the hands of the newly-formed regulatory bodies while the central banks functioned primarily as the lenders of last resort.

The last decade has seen the development of complicated financial instruments from futures and options, swaps to credit default swaps. But some nations, (China, India and Saudi Arabia for example) have not permitted complicated instruments in their capital markets. This may have resulted in some econ-omic shelter from the global turmoil. At the beginning of this decade, the conventional "long-only" equity funds dominated the industry, but following their severe losses during the internet bubble, hedge funds took the lead by avoiding dramatic falls. At the start of the credit crisis in July 2007, hedge funds took a view on "long oil-short banks" - this trade lost them 57 per cent from July to October this year. It is estimated that $31-$43 billion (Dh114-Dh158 billion) was redeemed from hedge funds last month.

A new era awaits us - one of transparency and controls where risk can be measured and priced efficiently; not disseminated and restructured. Isolated incidents of rogue traders bringing down entire institutions, although treated as one-off events, have in fact pointed to the lack of controls in the financial system for many years.

Riding out the storm

The states of the Gulf Cooperation Council (GCC), Brazil and sub-Saharan Africa seem to be the only nations whose growth in 2009 will exceed estimates for 2008. This time around, the tables are reversed. The economic crisis started in the US, spread to the UK and developed markets before washing up on the shores of emerging markets. While none of us is immune to global sentiment and widespread panic, fundamentals in the GCC remain robust. Governments here have the ability to tap into surpluses and re-ignite their economies, a luxury which developed markets do not have. Herbert Spencer's reference to "survival of the fittest" (1851) begs the question: "What will this brave new world look like?" Perhaps a shift of economic power to emerging market nations; a return to government control...the next step in capitalism's evolution.

The writer is chief investment officer, ING Investment Management Middle East.