How Global Finance Defines Global Politics

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Note: This transcript was generated by an automated system and has been lightly edited for clarity. While we strive for accuracy, it may contain errors or omissions.

Kevin Cool: You probably know of the Medici family as a powerful force in the Italian Renaissance. But their rise started with a savvy investment in banking.

Paula Findlen: The first episode in the rise of the Medici has to do with the failure of all these other Florentine banks that have preceded them because they have unfortunately lent money to the King of England during the Hundred Years War.

Kevin Cool: That’s Paula Findlen, a professor of Italian history at Stanford.

Paula Findlen: And he defaults on the loans, you know, so they go under. Then you go from the Medici kind of emerging from the ruins of the Florentine finance market to the Medici who are establishing themselves in all sorts of key locations.

Kevin Cool: The Medici have so much power that people treat them with more respect than they do the actual rulers of the time.

Paula Findlen: The person that TV shows call ‘The Godfather of the Renaissance’

Cosimo I de’Medici, the first Cosimo, by the end of his life, he’s going to be an unofficial ruler of the city. He never holds office, nor do any of his family members, but they have a very attuned understanding, so everybody owes them something.

Kevin Cool: And that is one of the main sources of their power: just how much people are in their debt.

Paula Findlen: So that’s the brilliance of Cosimo, his ability to start with the economic principles of what does it mean to be a really great banker. But then he wants more. He becomes a great patron of arts and of faith, hence father of his country, right? The people locally see him as a great patron — unless you’re his enemy of course.

Kevin Cool: This idea of wielding power and influence based on how much other people depend on you for finance and credit is the case at least as early as the Medici. And Paula says it’s been true throughout history.

Paula Findlen: We tend to think that institutions like a bank were invented, oh, somewhere in the 19th century, that J.P. Morgan invented the bank. No, J.P. Morgan is the guy who in the Gilded age of America, thinks of himself explicitly as the new Medici, hence the Pierpont Morgan Library, which is filled with incredible medieval and Renaissance artifacts.

Kevin Cool: And we see that on a global scale today, according to Matteo Maggiori, a finance professor at Stanford Graduate School of Business.

Matteo Maggiori: I wouldn’t say it’s the definition, but it’s certainly one of the salient characteristics of a great power, is being able to exert this kind of economic statecraft.

Kevin Cool: That’s our focus today. How much a country’s power has to do with how it wields its financial muscle. It’s called geoeconomics. And Matteo’s research shows in many ways, it’s what makes the world go round.

This is If/Then, a podcast from Stanford Graduate School of Business where we examine research findings that can help us navigate the complex issues facing us in business, leadership, and society. I’m Kevin Kool, senior editor at Stanford GSB.

Let’s just start by getting some definitions. What is geoeconomics and why should we care about it?

Matteo Maggiori: So it’s a practice of governments, uh, that use their economic strength that comes from financial and trade linkages with the rest of the world to achieve either economic or, you know, geopolitical goals. So just to make it simple, think of the U.S. wants to achieve a particular outcome with a foreign country and might use the strength of its financial system, it might threaten, for example, kicking that country off from being able to transact in the dollar market. Uh, if they don’t comply with, uh, something the U.S. would like to get. That’s you know, it’s economic statecraft, and it’s a practice that has been going on for centuries, but particularly these days, if you watch the news, it’s, you know, everywhere in the news with China and the U.S., uh, competing on this.

Kevin Cool: Mm-hmm. So let’s get down to some real world examples if we can. So you use the U.S. trying to exert its influence in some way to get compliance or to get a country to do what, what they would like to do. What’s an example?

Matteo Maggiori: One that was in the news was the U.S. threatening banks in countries other than Russia, that if they help Russian banks, uh, evade the sanctions, uh, they will get sanctioned themselves. So it’s what is called a third party sanction. So you are a bank in Europe, but if you are, you know, dealing with Russia, you’re helping them, uh, bypass the sanctions, the U.S. might sanction you as a European entity, and that’s of course an extremely, uh, painful process if you’re a bank, because all of your business is dealing with the U.S. financial system. So if you cannot do it, that’s an extremely expensive proposition.

Kevin Cool: And does this usually work?

Matteo Maggiori: You know, the evidence is mixed. It certainly works in terms of the U.S. threatening European banks. It’s a very stark choice: stop doing business with U.S. financial institutions or help us sanction Russia, that one, I would say it’s, you know, probably closer to a no brainer for the target institution. Supposing the U.S. were to do it with Chinese banks, you know, much less likely that it would work. They have much less to lose. They have their own government with different incentives. You know, I think one of the things that we’re very keen to do in research is figure out when it works, when it doesn’t, and sort of reduce the range of possible options to a viable middle ground between it never works, this is useless, and the government can dictate whatever they want around the world and it will always work.

Kevin Cool: Right.

Matteo Maggiori: I think you need to have objectives that are commensurate to the threats that you’re making.

Kevin Cool: You said that this has been going on for hundreds of years. Can you give a couple of examples, historical examples of how this developed and how it maybe has evolved?

Matteo Maggiori: Sure. I’ll think of two. For example, the U.K. faced from the U.S. on the Suez Canal. The U.S. wanted a particular political outcome, which was a withdrawal of British troops. And what they threatened was to not assist the U.K. on a balance of payments crisis. So to make it simple, the U.K. wanted emergency loans in dollars, and the U.S. uh, sort of put some pressure on we’re gonna give them to you only if, uh, you do this particular military operation that we want: a withdrawal. And you know, if you’re thinking of the U.K. government, what are you facing? You’re facing the possibility of a crisis if you can’t get those emergency loans somewhere else, versus giving up on a political objective or a military objective you wanted. And in this particular case, the U.K. actually acquiesced to U.S. requests in order to avoid the potential of a financial crisis.

I’ll give you another example, which is much farther back in history. This is the Medici family in Florence. They were well known to exhort a lot of influence and allegedly one of the ways in which they did it was to use their bank to make every other sort of institution in Florence very dependent on Medici credit. So that if the Medici wanted a particular outcome, one thing that they could potentially threaten is to call back their credits and bankrupt you. And if there is no alternative for you, to the extent that you can’t get those loans from somewhere else, you get a lot of power. You know, it’s almost, I wouldn’t say it’s the definition, but it’s certainly one of the salient characteristics of a great power is being able to exert this kind of economic statecraft.

Kevin Cool: You talked about the U.S. economic strength. What is the source of that? What is it that allows them to exert this influence and, and potentially get the outcome that they want?

Matteo Maggiori: For the U.S. clearly the financial sector is a very big deal. If you think about the world financial system, it’s very U.S. centric and you know, particularly when it comes to the infrastructure like payment systems or the clearing of transactions and payments, there isn’t really a viable alternative that the U.S. doesn’t either own or indirectly control. So it’s something that is very difficult to build. Clearly countries like China are starting that process. They understand this and they will like to build their own infrastructure and system, but it’s a very slow process.

Kevin Cool: You mentioned China and one of the levers or one of the tools is currency. We had Darrell Duffie, who’s a finance professor at the GSB on in our first season, and he talked about the fact that he thinks the dollar will remain the global reserve standard for a long long time. Does China want to create an alternative for the dollar?

Matteo Maggiori: Uh, so the dollar is a mix of things like it’s a store of value, it’s a means of payment. But if I focus a little bit on, uh, the, the generic function of, uh, short term liabilities of a government, uh, China is certainly interested in doing this, but they’re at the very, very beginning. And historically we’ve seen many countries that have wanted to rival, uh, the U.S., uh, and the dollar has not been, uh, moved from, you know, its dominant position if anything in the last few years has become even more dominant. So, you know, it’s a very slow process. China will have to open up more and more to two ways capital flows with the rest of the world. And what is the main problem is, you know, imagine the promise that the U.S. makes to the rest of the world that you can buy the bonds, the government will not default to depreciate or in a crisis do anything to prevent you from liquidating and taking your money out.

And we’re not gonna block it unless, you know, in very specific circumstances, like with Russia, we get into a very specific, you know, political spat or situation for most countries that’s extremely difficult to have the institutional strength as a government, uh, to fulfill those promises. And so with China, the typical, uh, worry right now is you could probably bring your money in, but are you sure that in all circumstances you’re going to be able to get your money out of the country if you wanted to? And you know, China’s a long way to go to show the world that they can sustain, uh, that role.

Kevin Cool: So I wanna stay with China for a moment because I think for obvious reasons, China is the principal rival, certainly economically of the United States at this point. And I wanna look at this really with a global lens, not just from a sort of American kind of lens. What are the implications of a multipolar world to use a term that I’ve seen in your research compared to what we have now? What, what does that look like? And and is it good or bad? Is it both?

Matteo Maggiori: There are positive and negative aspects. So one that I will talk about from my research is, uh, coordinations on the store of value.

Kevin Cool: What do you mean by store of value?

Matteo Maggiori: Uh, let me, let me be clear. Store of value just simply means you’re putting your money into treasuries and you believe that tomorrow you can exchange those treasuries for the same amount of goods as today. You don’t think that this is the stock market where tomorrow that might be worth 20 or 30%.

Kevin Cool: There’s no volatility.

Matteo Maggiori: There’s no volatility. It’s something where, you know, it’s like a rainy day account. You put your money there and when you need it, it will be worth exactly the same or slightly more. So if, if you think of that world, uh, traditionally if you only had the U.S., there is nothing else. Like even if we get scared, uh, investors can’t fly to some other investment. Now suppose that you have two countries, the U.S. and China for example, both doing this. Now the coordination becomes more complicated. We could all get scared of the U.S. and try to park the money in China. Vice versa, we could get away from both. Uh, and that can generate some instability. So that’s one certain aspect where a multipolarity can generate some financial instability.

Kevin Cool: Instability in what respect?

Matteo Maggiori: Uh, instability financially in terms of the valuations. For example, you might get huge capital flows out of one country if everybody’s trying to think that the other country is gonna be the safe one.

Kevin Cool: I see.

Matteo Maggiori: Uh, it’s a little bit like a bank run. If we have multiple banks, I can run on one and park my money in the other.

Kevin Cool: Mm-hmm

Matteo Maggiori: And the fact that the other bank exists, uh, can create some trouble.

Kevin Cool: So the ‘flee to safety’ as they would say in a bank run.

Matteo Maggiori: Yes. That’s exactly right. The other aspects which are, you know, more to do with geoeconomics is clearly what we’re seeing right now is sphere of influence.

So China is doing a lot of the sort of exerting power the U.S. has traditionally done, is approaching countries and is offering them deals that have to do with building infrastructure, getting loans, or for example, getting access to uh, some markets and at the same time asking for either political, sort of concessions, or is asking for these countries to allow China to do things. For example, build a pipeline or uh, get a seaport.

And you know, again, this is nothing unusual. Many great powers have done this in the past, including the United States. Uh, but what you’re seeing is a little bit of the competition in terms of sphere of influence. And you see it in Africa, you see it in Latin America. So I think we’re gonna see more and more of that as these two countries compete.

Is it good or bad? Um, it depends. You know, at some level having these big hegemons is what makes the world go around. Uh, in international economics, you don’t have legal enforcements, you can’t take countries to court or at least it is extraordinarily difficult. So these big powers traditionally have had positive roles of exerting power and making, you know, in sometimes creating a world order, they’re making things work.

At the same time, though, they’re extracting value from the rest of the world. You know, we all like having uh, shipping lanes, uh, around the world that work and are safe. Uh, but at the same time, clearly the U.S. or whoever is enforcing the rule is going to try to shape the world economy in a way that is very advantageous to them.

Kevin Cool: So tell me if this is an imprecise analogy or description, but it sounds to me like what you’re describing is sort of a quid pro quo relationship where China will build you a superhighway and in return when China is in a conflict, say with the U.S., that you will lean toward China in terms of how you would respond.

Matteo Maggiori: I think that that’s exactly right. You know, it’s a little deeper than that. Lemme put it, uh, this way. For example, we might want to build, uh, a mine in a particular country, but we all know that the problem is the mine is gonna get expropriated the moment it gets built. So if there is no way to make this transaction go through, the world is worse off, there isn’t a production activity, the mine that should have been there and would’ve created value.

So sometimes these big powers can be, uh, a force for good because for example, you might expropriate Italy if they build a mine, but you might be a little bit more afraid of expropriating China or the U.S. Why? Because well you have a lot of other relationship with them. They might be lending to your government, they might be providing exports to you that are strictly necessary. They might be providing you energy or they might manage your ports. And so being able to threaten across many different activities, ‘cause you’re one of these big, uh, powers can be an enforcement tool and enforcements can be good because it makes economic activity go through.

Kevin Cool: A different example that I found interesting and in particular was reflecting on because I knew I was gonna have this conversation with you. So Vladimir Putin made a visit to Mongolia, and Mongolia is a signatory to the International Criminal Court that has actually issued an arrest warrant for Putin. There was no chance they were going to arrest Putin when he landed in Mongolia because they are so dependent on Russian oil. So in situations when you have an imbalance of power or when, when one country is reliant on the other one to such an extent, is geoeconomics in a situation like this useful to some degree? Or is it destructive?

Matteo Maggiori: So this is a good example and let me broaden it beyond sort of the purely arresting, you know, Putin or not, you know, as the U.S. and the Western allies have sanctioned Russia, uh, one of the limitations to the sanctions has been that China and India have allowed Russia, for example, to transact with them in oil, uh, in other exports that have made the Russian economy not suffer as much as if the sanctions were imposed with China and India included, uh, in the sanctioning countries. And, you know, why is this happening? Well, there’s a couple of reasons. One is, these countries would like to provide an alternative to the U.S. Two, it’s very attractive to buy some of these goods on the cheap because the other countries are not buying them. The western powers are not buying it. Uh, but it goes back to what we discussed about the power of substitution.

To the extent that Russia could find alternative buyers, uh, for its oil, uh, the sanctions aren’t that effective. So coordination is very important. The extent to which a power like the U.S. can coordinate a very large economic network, uh, to impose the sanctions really matters for the power.

And clearly as China’s becoming bigger and bigger in the world economy, or India’s coming up, uh, that ability to coordinate a very large part of the world economic activity is getting smaller and smaller for the U.S., certainly on the sort of trade manufacturing raw input side, that’s not true on the financial side, which is one of the reasons why the U.S. is so focused on the financial side. That’s still the part where you see the U.S. being able to really dominate the scene.

Going back to the power imbalance, really that really matters. Why? Because, well if I try to extort or coerce you into something, you can retaliate, or you might take measures ahead of time that make you less exposed to me. So you don’t want to be so dependent on me because you know you’re exposed, I might hold you up. The problem is, what you’re effectively doing is you’re making the world economy a little bit less integrated, and as you do it, everybody else starts doing it too. And so if we’re not careful and we do it in a very uncoordinated fashion, all we might end up doing is fragmenting the world economy inefficiently. And in some sense, each one of us tries to oversecure their own economy, not thinking about everybody else is doing the same, and we end up unwinding thirty years of gains from, you know, global trade and financial integration that, that I think is a very serious policy concern right now, um, around the world.

Kevin Cool: What’s important to avoid that scenario?

Matteo Maggiori: I think there’s several things. So I’m gonna mention first of all, uh, coordination. You know, clearly if we’re actually sitting down at the G20 level and thinking about, okay, Europe is gonna do a little bit of this, but so is Japan. If we take into account what other countries are doing, we’re gonna avoid each one of us overdoing it because we’re thinking that in isolation we’re gonna try to make ourselves really, really secure, but we’re not thinking that the country next door is doing the same and we end up not trading with each other, uh, sufficiently. So that’s one. The second thing is I think we actually need economic research. Part of sort of the problem right now is you can make anything strategic or international interest. So you need a quote that I quite like is from Khrushchev, the, uh, Soviet leader who at some point complained that you could make anything strategic in the national interest, even, you know, buttons because a soldier, if he doesn’t have a button on his trousers, will have to use one end to hold up the trousers, and then how could he possibly shoot, uh, with the other end.

So, you know, there’s some truth to this. There is a proliferation of the use of the word strategic or national security that can mask, you know, straightforward protectionism, or you know, political connections to some industry. So I think, you know, economic theory and measurement and empirics can really help by saying, okay, what exactly is a strategic sector?

Kevin Cool: And who is the we that you’re describing, when we scope out to a global level, and you’re talking about coordination, you mentioned the G20 –

Matteo Maggiori: Clearly there is a list of western coalition of countries that should be coordinating closely. I’m thinking about the usual suspects, you know, Europe, the U.K., Canada, the U.S., Australia, New Zealand, and so on. You’re right, what’s becoming much more difficult is coordination with China. Clearly the political tension with the U.S. uh, has escalated in the last four or five years, and a lot of cooperation and dialogue that used to be there, uh, seems to be breaking down. Um, hopefully that doesn’t deteriorate any farther, but, uh, I would have no idea whether that’s going to happen or not. But I think at least within the western space, uh, there should be a lot more coordination, uh, to avoid over-fragmenting for no reason financial or trade relationships. You know, Europe, for example, wasn’t necessarily too pleased with the U.S.-led sanctions on Iran. They tried to create their own payment system to trade with Iran. It was not successful, which goes back to the how difficult it is to create alternatives. But there was certainly some interest in doing that and having a, a separate voice from the U.S. when it comes to these policies.

Kevin Cool: Right. In our conversation that we had before we sat down to talk today, you talked about how moral persuasion sometimes is not an effective means of getting agreements and historically, often war has been the means by which one country dominated or got the outcome that it wanted in relationship with others. Does Geoeconomics offer a kind of middle ground there? I mean, does it actually create a means for peace and prosperity?

Matteo Maggiori: I think that’s right. I think of geoeconomics as essentially that middle ground between really expensive threats like the threats to invade a country or to start a war, and purely soft arguments. Uh, you know, here we’re threatening commercial relationships. We’re saying, I’m gonna kick your banks off a payment system or I will tell my Silicon Valley firms that they cannot export particular technology to you. You know, it’s painful. China, for example, has argued that it feels this is a policy of containment, uh, for its economic growth. And economic growth is, you know, welfare relevant. I mean, people suffer if you don’t grow enough. So it’s certainly not, uh, trivial in terms of costs.

Kevin Cool: We’ve cut off technology that helps them develop their own AI systems. Is that one example?

Matteo Maggiori: Yes, that’s one example. And you know, these things have real consequences for the welfare of countries and, and the people that live in them. But at the same time, it’s nowhere near an outright war, uh, or a military operation. And I think that’s what we’re seeing right now in the world is a lot of jostling around these economic relationships. Uh, and I think that that’s probably gonna keep happening, its been true through history. Uh, but certainly right now it’s on the rise and we should understand much better exactly how it works and how to limit the damage, uh, taking as a given that these things do exist and that abstracting away from them in our models is just not serving the world, in terms of research. I think we should take them as something that is happening and we should study them and figure out how to make it work, uh, for everybody.

Kevin Cool: Financial and trade relationships internationally are important, we know that. What we don’t know as well is how geoeconomics influences those relationships. If we want to navigate global power, then we need to understand exactly how countries wield their financial clout.

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