For Americans, the stakes in improving the stability of the global financial system are
enormous. The freer flow of private capital across national borders has facilitated a boom
in international investement and the 15-fold expansion in global trade since 1945. But the
growing interdependence of global financial markets has not been without downside risk.
Although freer cross-border flows of capital can facilitate the more efficient allocation
of savings and investment - increasing global economic growth and welfare - they can also
speed the transmission of financial disturbances from country to country and expose
individual countries to massive dislocations caused by large, unanticipated, and
self-reinforcing flights of capital.
Although the current financial crisis has had it origins and has done most of its
damage offshore, the United States has suffered from declining export markets, greater
financial market volatility, and reduced risk capital availability. As we move into the
21st century, the problems of emerging market economies can quickly become the problems of
American workers, businesses, and investors.
Either we find ways to make markets work better or others will rewrite the rules,
undermine the international financial system, and weaken the benefits it can provide. In
short, if for no other reason than economic and political self-interest, the United States
must lead the world in efforts to achieve sustained growth and stability in the
international system and to prevent similar crises from erupting in the future.
We believe that U.S. leadership in the creation of a more stable and prosperous global
economic order is indispensable. In the aftermath of World War II, the United States
generously devoted both its resources and its leadership to rebuilding its war-devastated
allies and enemies in Europe and Asia. We led in the creation of multilateral economic
institutions - including the General Agreement on Trade and Tariffs, the World Bank, and
the International Monetary Fund - that have provided the foundation for 50 years of
unprecedented global growth and stability.
In the ensuing years, the global economic system has changed profoundly as a result of
technological breakthroughs in transportation and communication, successive rounds of
trade liberalization, the end of the Cold War, and the embrace of markets by a growing
number of nations. In responce to these profound changes, the world community, led once
again by the United States, has embarked on the task of modernizing the multilateral
system to reflect the new dynamics of the global economy. Substantial progress has been
achieved on the trade front with the completion of the Uruguay Round, the introduction of
the World Trade Organization, and regional groups such as NAFTA and APEC.
The challenge facing individual countries and the global system now is to design
policies and institutions that maintain the immense growth benefits provided to all
participants by broad, active, and open financial markets while at the same time
mitigating the negative effects on growth and employment of their recurrent - and, to a
significant extent, inevitable - volatility. The American economy is the envy of the world
in part because it has designed the regulatory structures - including laws, accounting and
reporting practices, supervisory guidelines for financial institutions, and an independent
central bank - that are essential to the smooth operation of an open, transparent market
system. The question now before us is: What lessons can the United States and the other
advanced market economies share with the emerging market economies and the global system
as a whole?
In this present moment of global uncertainty, some have been quick to advocate a
"global New Deal" - the formation of a whole new set of multilateral
institutions patterned on the key financial, regulatory, and legal institutions that have
improved made domestic economic stability in the United States and other advanced
industrial countries. But a careful examination of these institutions suggests that they
are not likely to be replicated internationally in the foreseeable future. Even if it were
economically desirable to do so, which is highly debatable, the idea of creating a global
central bank - an international version of the Federal Reserve - is hardly likely to
receive political support from the United States or the other G-7 nations any time soon. A
worldwide Securities and Exchange Commission or a common international bankruptcy law is
also impractical given the huge disparities in national legal, accounting, and regulatory
standards.
At the same time, others argue that international markets should be left alone, to fail
or succeed as they will. Indeed, some have even gone so far as to argue that the existing
multilateral institutions, especially the International Monetary Fund (IMF), have actually
made the global system more crisis-prone. There is no factual basis for such an assertion.
Indeed, the empirical evidence strongly supports the conclusion that these institutions -
despite their imperfections - have helped to contain the adverse effects of macroeconomic
and financial shocks on economic growth in individual countries to the benefit of the
global system during the last 50 years.
Neither creating broad new multilateral institutions nor returning to the laissez-faire
policies that characterized the global economy during the first half of this century will
increase growth and stability in the global financial system. What is needed is a set of
"third way" reforms that expand market opportunities, build on peer review and
the free exchange of information, and encourage national entities to monitor one another.
In lieu of top-down regulatory strategies, these market-driven reforms would rely
heavily on cooperation among national authorities and institutions to solve particualr
cross-border problems while continuing to reflect diverse national interests. Such
transgovernmental cooperation would be enhanced by new communications technologies that
allow groups of experts to exchange detailed information and evaluate one anothers'
performance, without leaving their home offices.
The market-driven approach we propose rests on four fundamental principles:
- The United States should take a leadership role in creating new forums for
transgovernmental cooperation to address global needs. As the most successful economy in
the world, the U.S. should provide both money and manpower to promote such efforts.
- Although we believe that the United States must lead, we do not believe that American
leadership involves imposing a uniform "American" model on other countries.
Positive adjustments in the international economic system can be achieved in ways that
respect national sovereignty and regional cultural differences.
- Without sound domestic economic policies, robust banking systems, effective regulation
and supervision, and well-functioning legal systems in nations around the world, sweeping
changes in the structure of international institutions will do little good. With sound
domestic policies and practices, a few well designed modifications of the international
system can produce important benefits.
- With appropriate modifications, the International Monetary Fund and the World Bank
should continue to play critical roles in fostering global economic stability, capital
flows, adequate liquidity, and prosperity. As part of its leadership responsibility, the
United States must continue to support these institutions and to cooperate with other
members in reforming and modernizing them.
We believe that proposed reforms of the global economic system should be judged
on the basis of four major tests:
- Do they strengthen the domestic capabilities of countries to foster stable growth while
coping with dramatic and ongoing changes in the international economy?
- Are they proactive, anticipating and averting the kinds of rapid withdrawal of capital
and confidence that we have seen recently, or are they reactive, thereby rendering
countries more vulnerable to such crises?
- Do they incorporate the private sector to a greater degree in helping to fashion the
policies and arrangements that will ensure steady flows of productive capital and avoid
the losses of confidence that render countries vulnerable to capital market turbulence?
- Do they take full advantage of cooperation among national authorities in industrialized
and emerging economies to improve domestic practices, limiting the role of global economic
institutions to those functions that other groups cannot perform?
To lay the groundwork for a new century of robust global economic growth and
prosperity, America should lead the world in undertaking six basic institutional and
policy changes in industrial and emerging economies and in the global economic system.
- creating a regularized dialogue between emerging and industrialized countries in which
financial and central bank officials critique one another's policies; and
- creating a set of common standards for participation in the highly sensitive global
financial system.
Establish a forum that would bring emerging and industrialized countries together
to promote sound domestic macroeconomic policies.
Maintaining a sound macroeconomic environment is the joint responsibility of fiscal policy
(typically controlled by the executive and legislative branches of government) and
monetary policy (the responsibility of the central banks). Except in rare instances in
which nations have created common institutions like the European Central Bank, national
parliaments and central banks have jealously guarded control over macroeconomic policies.
But a great deal can be done internationally to reinforce the right kinds of macro-polices
or at least to point out the dangers of the wrong ones. The IMF has a Code of Good
Practices on Fiscal Transparency and is working on a Code of Conduct on Monetary and
Financial Policy. Missing is a regularized policy dialogue between emerging and
industrialized countries in which financial and central bank officials could critique one
another's policies. Industrialized countries currently do this through the Organization
for Economic Cooperation and Development. Now a broader forum is necessary to tackle
critically important topics such as avoiding misalignments and excessive volatility in
exchange rates and ways for national currency regimes to reinforce - and be reinforced by
- sound macroeconomic policies.
Create regularized country-by-country dialogues between officials of emerging
market economies and representatives of the private financial community.
In these countries, financial stability and growth depend on the resources and the
confidence of international investors. Governments can receive valuable feedback from the
financial community through dialogue with key private participants: banks, investors,
hedge funds, and mutual funds. Governments would hear about market concerns over problems
(such as widening budget deficits or growing short-term debt exposure) before they lead to
massive private sector withdrawal of funds. And governments could receive suggestions on
ways to attract more stable flows. As a result of regular dialogue, investors would become
more familiar with government policies and less likely to base decisions on false
information.
Develop common standards and best practices of disclosure and reporting by
governments, banks, and corporations that would make financial information more reliable,
easier to interpret, and more timely.
Such standards of participation should include those relating to supervision, regulation,
accounting, and reporting of private as well as public economic entities. Over time
countries should see the competitive advantages of conveying timely and credible
information. And the global system would benefit from collective improvements. Peer
pressure coupled with institutional encouragement and technical support could make an
enormous difference in advancing greater economic transparency.
- establishing a system of peer review among national and international financial
supervisors; and
- strengthening disincentives to high risk short-term lending and borrowing.
Good macro-policies are necessary but not sufficient to produce economic growth and to
avoid vulnerability to financial crisis. Before the onset of the global financial crisis,
macroeconomic policy was in good order in much of Asia, but banks, regulations, and
supervision were generally weak. In the summer of 1997, the central bank of Thailand was
discouraged from raising interest rates to avert a currency collapse by private banks that
feared higher rates would damage their already weak balance sheets. Weak banking systems
can both create and exacerbate financial shocks that dry up credit to sound companies,
greatly damaging economies otherwise following reasonable policies.
Introduce a peer review process among national and international banking
supervisors.
In October of 1998, the Group of Seven finance ministers agreed on the necessity of better
surveillance of national financial systems and their regulatory and supervisory regimes.
Canadian Finance Minister Paul Martin proposed peer reviews by national and international
supervisors. This innovative idea avoids the elaborate process of establishing an
overarching international supervisory bureaucracy. Instead, international institutions and
government authorities would work together to avert instability in national financial
systems and to avoid systemic risk of cross-border contagion among nations. Possibilities
for carefully structured supervisory measures to temper buildups in short-term currency
debt should be a prime topic.
Strengthen the Bank for International Settlements' disincentives to high risk
short-term lending by applying a higher "risk weighting" factor to such loans.
Currently, the Bank for International Settlements' standards provide an incentive for
short-term versus long-term loans. These should be revised. New standards should be
produced to create disincentives for banks in emerging economics to become vulnerable to
mismatches in the maturity and currency exposure of their assets and liabilities.
Provide international guidance and support for emerging economies to create
deposit insurance schemes that could help restore confidence in their banking systems.
Deposit insurance is an important component of banking sector stability in industrialized
economies. Clearly defined depositor guarantees have been critical in avoiding the runs on
banks that the United States experienced in earlier times and that plague many emerging
economies today. The types of claims covered by deposit insurance must be clearly
demarcated to avoid moral hazard and confusion during crisis situations.
- establishing common international principles for securities regulation and a core set of
accounting standards for cross-border securities offerings.
One reason the banking crisis has hit many emerging economies so hard is that their
capital markets are relatively underdeveloped; hence, these economies rely mostly on banks
as the major source of credit. Better developed long-term bond and equity markets can be a
stabilizing factor - channeling savings into longer-term financial instruments and more
productive uses. Such markets, however, require a sound legal and regulatory underpinning
plus high accounting standards.
Encourage and promote the work already under way to establish common
international principles for securities regulation and a core set of accounting standards
for cross-border securities offerings.
In both cases, the task is to help emerging economies establish or strengthen their own
systems and practices consistent with the requirements of a more demanding global
financial market. Both efforts would be enhanced by encouraging more companies in emerging
economies to list their shares on the capital markets of the advanced industrial
countries. This in turn would require these companies to meet the tough listing
regulations and accounting requirements of such markets and give them positive feedback on
how to enhance the use of such standards at home. In the United States, the Securities and
Exchange Commission (SEC) has contributed enormously to the quality and expansion of
capital markets, permitting them to serve as the major source of capital for growth and to
foster improvements in corporate governance. The SEC and its sister organizations in other
industrialized countries could play a mentor role to their counterparts around the world.
- establishing a system of peer review of national corporate and bankruptcy laws.
A comprehensive and clearly understood system of corporate law is vital to a
well-functioning economy and to integration into the international financial system.
Without well-defined personal, corporate, and intellectual property rights, stable flows
of capital will be hard to attract and hold. Peer review of national corporate and
bankruptcy laws by transgovernmental groups of experts can avoid the fruitless process of
trying to develop a common international body of law, while still fostering a higher level
and quality of national convergence.
Reform national bankruptcy laws so that they avoid premature dismemberment of a
debtor's assets and provide adequate time for a debtor to determine alternatives, while
assuring fair treatment to various categories of creditors.
If national bankruptcy laws were more effective, financial problems in a few banks and
corporations would be less likely to cause a sharp drop in market confidence in an entire
country. Insolvent banks or companies could be dealt with one-by-one in a pre-established
legal framework. A sound bankruptcy law regime should also permit debtors to realize as
much of the value of their assets as possible by sale or reorganization, thereby avoiding
closure of entire companies or banks unless absolutely necessary.
Mobilize a "Workout Peace Corps" of public and private experts to
assist in debt workouts in affected countries and to build local institutional expertise
in those countries.
These experts - perhaps culled in part from the ranks of those who gained
experience during the U.S. savings and loan crisis - could be mobilized by the U.S.
Treasury. They would assist the many countries in which sufficient expertise does not
exist to process huge numbers of bankruptcy cases or to dispose of the tens of thousands
of bad loans now on the books of banks or of governments that have assumed such loans from
private actors.
- helping individual countries create effective safety net policies; and
- creating contingency pools of funds and stocks of essential items like foodstuffs that
could bolster national safety nets in times of crisis.
Establish safety net programs in the emerging market economies to help those
citizens most adversely affected by cyclical downturns.
Safety nets barely exist in many emerging countries. In the absence of
unemployment insurance, food assistance or other kinds of welfare, extended families have
supported jobless or displaced workers. In a world more prone to crisis, the World Bank
has assigned high priority to making sure nations are equipped to meet the basic needs of
citizens affected by economic downturns. Such programs can also help sustain political
support for the restrictive fiscal and monetary policies sometimes needed to cope with a
financial crisis and to reduce political pressure for trade or capital restrictions during
difficult times.
Create contingency pools of funds and stocks of essential food for humanitarian
assistance to bolster domestic safety nets in times of crisis.
This effort should be lead by the World Bank and IMF, along with groups like the World
Food Organization and World Health Organization. To some extent, such temporary crisis
assistance is available now on an ad hoc basis, but a more comprehensive, systematic, and
reliable approach to provide funds, foods, and medicine would strengthen the world's
ability to address the human needs of people harmed by a global financial crisis.
Central banks play a critical stabilizing role as lenders of last resort to their
banking system. No such capability exists internationally as there is no global central
bank, and the IMF currently does not have the funds or the mandate to perform this role.
At the moment, the IMF doles out its financial support gradually, but this approach is not
the formula for stemming a panic withdrawal of funds from a country. A true lender of last
resort needs large sums of money to dispense promptly in time of crisis and a process of
pre-certification so that a country in need can have access to such funds quickly.
The G-7 has recently proposed a step in this direction by giving the IMF some new tools
to provide liquidity and head off a crisis. The G-7 proposal calls for the
"establishment of an enhanced IMF facility which would provide a contingent
short-term line of credit for countries pursuing strong IMF approved polices. The facility
could be drawn upon in times of need and would entail appropriate interest rates along
with shorter maturities." This proposal has the attributes of being proactive -
aiming to anticipate problems before they occur - and of strengthening domestic policies
that avoid vulnerability to crisis. In addition, the proposal calls for "appropriate
private sector involvement." This should provide the private sector with a say in
determining the criteria for country eligibility to draw on the facility and will involve
it more actively with the IMF and potentially eligible countries in shaping and analyzing
policy.
But this proposal also raises many critical questions including: which nations should
get these funds, when they should receive them, what criteria would be considered for
qualification, and what effects such decisions would have on economic stability. The IMF,
working with the G-7, will have to quickly come up with explicit criteria for implementing
the contingency fund proposal quickly, or the proposal will raise a number of fresh
concerns about the IMF having too much authority and too little transparency in its
exercise.
We believe these steps can be taken with U.S. leadership. By working to develop best
practices, common understandings, and contingency policies, individual countries can
cooperate to build a solid institutional and policy foundation for greater stability in
global financial markets. As the undisputed global economic and political power, the
United States has both the responsibility and the self-interest to lead this process and
pave the way for another half century of growing economic interdependence and prosperity.
