Redesigning World Markets
This week political and financial leaders work on new ways to make the world safe for massive capital flows.
This has not been a good week for Michael Mussa, the economic counselor for the International Monetary Fund.Skip to next paragraph
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Critics have repeatedly accused Mr. Mussa and his colleagues at the IMF's annual meeting of fueling rather than halting the firestorm in world financial markets.
"We are virtually in depression in much of the emerging world," said Jeffrey Sachs, director of the Harvard Institute for International Development, before a gathering here of economists and officials, including Mussa. "This was a predictable consequence of Draconian [IMF] measures that increase panic rather than reduce panic."
A look at the obstacles to restoring world financial order suggests, however, that Mussa and other IMF technocrats are not scoundrels but scapegoats.
IMF officials admit they were caught flatfooted and that the "international financial architecture" needs an overhaul, but first governments must repair the political foundation for global finance. Ultimately, the world financial system is shaky because it cannot cope with the surge in capital flows.
Investment and private loans in emerging markets exploded more than fivefold between 1990 and 1996 to roughly $300 billion. World institutions sped the flood of capital, helping to bring to both wealthy and developing nations unprecedented free market riches. Those same institutions, though, have proven incapable of containing free-market risks. In East Asia especially, poorly supervised banks went on a spree of lending to unprofitable companies. Mounting business losses and debt helped trigger the financial tumult last year.
The resulting costs today in well-being and social order are high; the possible future costs are enormous. Financial-market mayhem has spread within 15 months from several countries in East Asia, to Russia, and to the doorstep of Latin America.
Now, one-fourth of the world economy is in recession. The IMF estimates lost output has so far equaled the annual gross domestic product of Canada. The monetary fund last week warned of global recession, drastically cutting its forecast for economic growth this year to 2 percent.
Of more historical weight, the laissez faire ethos that sprouted in Britain in the late 1970s and took root in the United States and much of the world is in retreat. Several governments in the past several weeks have either proposed or instituted capital controls. Thailand and South Korea, have made the most progress in strengthening their currencies by following IMF remedies, but at a great cost of lost jobs and bankruptcies.
The crisis has prompted the major industrialized countries to pitch a cacophony of solutions. The clashing proposals underscore how the leaders, pulled apart by pressing domestic needs, have failed to hatch a decisive, unified plan to calm financial markets.
"At the end of the day, all of the world's problems are individual problems," says Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y. Governments "will be hard pressed to come up with any coordinated" solutions, he says.
Billionaire financier George Soros on Oct. 5 criticized financial leaders from industrial nations for not overcoming their differences and devising a concrete plan for calming markets. Referring to a meeting of finance officials from major economies, Mr. Soros said, "Those people should have been shut into a room and hammered this thing out and come out with a decision."
Japan's leaders exemplify how politicians put domestic concerns before the need to make sacrifices for a multilateral campaign to restore financial order. Tokyo has been paralyzed for years by factionalism and fiscal conservatism. It has shrugged off foreign pressure to spur its flagging economy and shake up its debt-strapped banks, thereby denying East Asia a vibrant importer and source of capital. Tokyo's political gridlock is seen as the biggest unresolved issue threatening investor confidence.