Financial Crises, Global Capital Flows and the International
Financial Architecture
The recent upheavals in the world financial markets were
quelled by the immediate intervention of both international
financial institutions such as the IMF and of domestic ones in
the developed countries, such as the Federal Reserve in the USA.
The danger seems to have passed, though recent tremors in South
Korea, Brazil and Taiwan do not augur well. We may face yet
another crisis of the same or a larger magnitude momentarily.
What are the lessons that we can derive from the last crisis
to avoid the next?
The first lesson, it would seem, is that short term and long
term capital flows are two disparate phenomena with very little
in common. The former is speculative and technical in nature and
has very little to do with fundamental realities. The latter is
investment oriented and committed to the increasing of the
welfare and wealth of its new domicile. It is, therefore, wrong
to talk about "global capital flows". There are investments
(including even long term portfolio investments and venture
capital) - and there is speculative, "hot" money. While "hot
money" is very useful as a lubricant on the wheels of liquid
capital markets in rich countries - it can be destructive in less
liquid, immature economies or in economies in transition.
The two phenomena should be accorded a different treatment.
While long term capital flows should be completely liberalized,
encouraged and welcomed - the short term, "hot money" type should
be controlled and even discouraged. The introduction of
fiscally-oriented capital controls (as Chile has implemented) is
one possibility. The less attractive Malaysian model springs to
mind. It is less attractive because it penalizes both the short
term and the long term financial players. But it is clear that an
important and integral part of the new International Financial
Architecture MUST be the control of speculative money in pursuit
of ever higher yields. There is nothing inherently wrong with
high yields - but the capital markets provide yields connected to
economic depression and to price collapses through the mechanism
of short selling and through the usage of certain derivatives.
This aspect of things must be neutered or at least countered.
The second lesson is the important role that central banks and
other financial authorities play in the precipitation of
financial crises - or in their prolongation. Financial bubbles
and asset price inflation are the result of euphoric and
irrational exuberance - said the Chairman of the Federal Reserve
Bank of the United States, the legendary Mr. Greenspun and who
can dispute this? But the question that was delicately
side-stepped was: WHO is responsible for financial bubbles?
Expansive monetary policies, well timed signals in the interest
rates markets, liquidity injections, currency interventions,
international salvage operations - are all co-ordinated by
central banks and by other central or international institutions.
Official INACTION is as conducive to the inflation of financial
bubbles as is official ACTION. By refusing to restructure the
banking system, to introduce appropriate bankruptcy procedures,
corporate transparency and good corporate governance, by engaging
in protectionism and isolationism, by avoiding the implementation
of anti competition legislation - many countries have fostered
the vacuum within which financial crises breed.
The third lesson is that international financial institutions
can be of some help - when not driven by political or
geopolitical considerations and when not married to a dogma.
Unfortunately, these are the rare cases. Most IFIs - notably the
IMF and, to a lesser extent, the World Bank - are both
politicized and doctrinaire. It is only lately and following the
recent mega-crisis in Asia, that IFIs began to "reinvent"
themselves, their doctrines and their recipes. This added
conceptual and theoretical flexibility led to better results. It
is always better to tailor a solution to the needs of the client.
Perhaps this should be the biggest evolutionary step:
That IFIs will cease to regard the countries and governments
within their remit as inefficient and corrupt beggars, in
constant need of financial infusions. Rather they should regard
these countries as CLIENTS, customers in need of service. After
all, this, exactly, is the essence of the free market - and it is
from IFIs that such countries should learn the ways of the free
market.
In broad outline, there are two types of emerging solutions.
One type is market oriented - and the other, interventionist. The
first type calls for free markets, specially designed financial
instruments (see the example of the Brady bonds) and a global
"laissez faire" environment to solve the issue of financial
crises. The second approach regards the free markets as the
SOURCE of the problem, rather than its solution. It calls for
domestic and where necessary international intervention and
assistance in resolving financial crises.
Both approaches have their merits and both should be applied
in varying combinations on a case by case basis.
Indeed, this is the greatest lesson of all:
There are NO magic bullets, final solutions, right ways and
only recipes. This is a a trial and error process and in war one
should not limit one's arsenal. Let us employ all the weapons at
our disposal to achieve the best results for everyone
involved.
About The Author
Sam Vaknin is the author of "Malignant Self Love - Narcissism
Revisited" and "After the Rain - How the West Lost the East". He
is a columnist in "Central Europe Review", United Press
International (UPI) and ebookweb.org and the editor of mental
health and Central East Europe categories in The Open Directory,
Suite101 and searcheurope.com. Until recently, he served as the
Economic Advisor to the Government of Macedonia.
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