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New Rules for Global Finance
Randall Dodd
Director, Directives Study Center
Department of Economics,
American University
April, 2001
Very
little has changed since the East Asian financial crisis nearly derailed the
world economy several years ago. Trillions of dollars continue to flow through
global financial markets, with little or no regulation, almost as if nothing
had happened. So it is welcome news that President Bush has appointed new
economic advisors who want to refocus attention on the need for “new global
financial architecture.”
Senior U.S. officials like Treasury Secretary Paul O’Neill and chief
presidential economic adviser, Lawrence Lindsey, have joined the growing
international circle of policy analysts and street protestors who have been
demanding the reform of international financial institutions, particularly the
International Monetary Fund (IMF). Unfortunately, the Bush team's definition of
the problem is too narrow and its single solution impractical.
According to the Bush team, the financial crises in developing countries
were caused by "moral hazard"--a situation in which investors, who
expect to be bailed-out by governments or international financial institutions,
take greater risks than they would otherwise. The Bush solution is to announce that, henceforth, there
will be no bailouts. For developing countries feeling the heat of a financial
meltdown, this approach gives new meaning to the term benign neglect. More
likely, however, this is an empty threat. Most economists believe that the Bush
Administration, faced with the likelihood of serious harm to U.S. interests,
would take whatever rescue measures were necessary.
The financial markets, understanding this, will not act more responsibly.
This is a textbook case of how faulty analysis leads to bad policy. Almost all observers now agree that the
financial crises of the past decade were caused by a combination of problems
including over-valued fixed exchange rates, large trade deficits, "hot
money" flowing into the small emerging capital markets, poorly regulated
financial markets and various forms of local corruption or
"cronyism." Developing
country financial crises were not caused by any one factor and will not be
prevented by any single policy change.
Benign neglect will not fix these problems. And unfortunately a lack of preventive measures is exactly
what got us where we are today. No
real changes were made after the Mexican peso crisis in December of 1994, or
the East Asia crisis in the summer of 1997. The Russian and Brazilian crises followed in 1998. And although the IMF and World Bank
have created new departments--the World Bank promises to focus more on
Although the critical posture of the Bush team is appropriate, its
passivity is not. New and more
severe crises cannot be prevented or mitigated unless new measures are adopted
to reduce the disruptive shifts of financial flows. The Bush team should start
by insisting that the IMF stop pressuring developing countries to deregulate
their financial markets. Many ardent free traders now observe—after near
meltdowns in Mexico, Thailand and Turkey—that financial “liberalization” often
precedes financial crashes, and fails to deliver the promised higher rates of
economic growth. Some have even embraced an idea first suggested three decades
ago by Nobel Laureate economist James Tobin: slow down the rate at which “hot
money” moves in and out of countries by levying a modest financial transaction
tax.
The Administration should then discourage some of the riskiest
activities, the ones that have financial panic written all over them: establish
and enforce adequate capital and collateral requirements for all investors so
that their losses do not undermine the financial system; eliminate off-shore
money laundering and the use of tax havens that assist the evasion of national
financial market regulations; and rein in hedge funds which pool the money of
wealthy investors for high stakes betting on the direction of currency
fluctuations.
The Bush Administration wasted no time establishing its “get tough”
foreign policy bona fides, but on the most pressing international
financial problems it is pointing an empty gun at the wrong target.
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