The GW Center for the Study of Globalization
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The past few years have witnessed the worst turmoil in the international financial system in the post-War era. The world economy has witnessed recurring financial crises, as well as a tremendous rise in speculation. How are the two related? Are speculators and financial trading responsible for market volatility?
Researchers have devoted much time and creativity to modeling and assessing market functioning and performance over extended time periods. The bulk of this research has addressed questions of how well financial markets function "on average," in part reflecting the widespread popularity of regression analysis. Professional consensus, as summarized in current textbooks, is that on average, these markets work reasonably well.
In contrast, policy makers tend to focus on the performance of markets during times of stress. For example, the fact that stock markets serve to allocate capital efficiently on average is likely to be of limited relevance during times, such as the October 1987 worldwide crash, when they appear to work poorly. Government officials are not only galvanized to deal with crises themselves, but also often wind up making broader proposals that affect markets on the basis of crisis response, for example the circuit-breaker provisions adopted in the USA following the 1987 crash.
Numerous claims have been made that financial markets in general, and speculators in particular, contributed to the collapse of the European Exchange Rate Mechanism (ERM) in the early 1990s, the Tequila crisis of the mid 1990s, the Asian financial crisis of the late 1990s, and the recent dramatic fluctuations in commodity prices, notably gold and petroleum.
The recurring crisis of the last few decades provide a natural laboratory for the study of international financial markets, enterprises, national governments, and international organizations in times of turmoil. This paper presents a study of the Gulf Crisis of the early 1990s, when the Iraqi invasion of Kuwait, and Operation Desert Shield (stationing of foreign troops in the Middle East under UN aegis) and Desert Storm (air attack on Iraq, and subsequent ground war, by the US and its allies) made front-page headline news and catapulted CNN from an obscure cable TV network to international prominence.
Over the course of the crisis, price volatility in the oil market reached unprecedented levels. Changes in underlying market fundamentals, in contrast, were not readily apparent. The "trading causes volatility theory" of financial markets was widely advanced, motivating U.S. Congressional investigation and proposals for shutting down the petroleum markets analogous to the wheat-market shutdown that followed the Soviet grain embargo in 1979.
Robert Weiner, Professor of International Business and International Affairs, Chairman, Department of International Business
The Gulf Crisis: Report from the Volatility Front
Occasional Paper, CSGOP-03-20
The GW Center for the Study of Globalization
2033 K Street, NW, Suite 230 • Washington, DC 20052 • Phone: (202) 994-5206 • Fax: (202) 994-5284
Email: gwcsg@gwu.edu • http://gstudynet.org/