The Boston Globe, December 21, 1998
Capital markets need stabilizing
By George Soros, 12/21/98
Neither macroeconomic errors nor Asian governments' policy missteps can explain today's global financial crisis; rather, the operation of free financial markets is the culprit. Thus it is time for a radical reconsideration of the dominant role that deregulated financial markets play in the world.
The global capitalist system is characterized not just by free trade but more specifically by the free movement of capital. Like a gigantic circulatory system, it sucks capital into the financial markets and institutions at the center, then pumps it out to the periphery, either directly in the form of credits and portfolio investments or indirectly through multinational corporations.
Until the 1997 Thai crisis, financial markets were growing in size and importance. Countries at the periphery were obtaining an ample supply of capital from the center by opening up their markets. During this boom, the emerging markets fared especially well. But the Asian crisis reversed the direction of the flow. Capital started fleeing the periphery. At first, the reversal benefited the financial markets at the center. But in the aftermath of the Russian default in August 1998, the global financial markets themselves came dangerously close to a meltdown. The underlying cause of this threat is the inherent instability of deregulated markets.
The financial markets are playing a role very different from the one assigned to them by economic theory and the prevailing ideology of market fundamentalism, which says that competitive markets are always right - or at least they produce results that cannot be improved on through the intervention of nonmarket institutions and politicians. If left to their own devices, financial markets are supposed to act in the long run like a pendulum, always swinging back toward equilibrium.
The current crisis has shown this ideology to be irredeemably flawed and the very notion of equilibrium to be inapplicable. Instead of acting like a pendulum, financial markets can act like a wrecking ball, swinging from country to country and destroying everything that stands in their way.
Current international mechanisms for managing the crisis are grossly inadequate. Most policy makers in Europe and the United States worry whether their countries can be protected from the global financial contagion. But the issue at the global level is much broader and historically more important. Even if the Western economies and banking systems do survive the present crisis without too much harm, those in the periphery have been significantly damaged. Proposed solutions such as regulation and other mechanisms that simply improve the efficiency of free markets do not get at the heart of the problem. The flow of capital - and most importantly of private capital - from the center to the periphery must be revived and stabilized.
I propose establishing an international credit insurance authority, managed by the International Monetary Fund, to explicitly guarantee the loans that private lenders make to countries. If a country defaults, the IMF would pay the lenders and then work out a repayment process with the debtor country. The borrowing countries would be obliged to provide data on all borrowings, public or private, insured or not. This information would enable the authority to set a ceiling on the amounts it was willing to insure. Up to those amounts, the countries concerned would be able to access international capital markets at prime rates plus a modest fee. Beyond these limits, the creditors would be at risk. The new institution would function, in effect, as a kind of international central bank.
The thorniest problem raised by this proposal is how the credit guarantees to an individual country would be distributed among the country's borrowers. The guarantees should be channeled through closely supervised international banks that would compete with each other.
This kind of reform will require a change of mentality to get governments, parliaments, and market participants to recognize that they have a stake in the survival of the system - and that this stake is far more valuable than any short-term gains they may make from exploiting the flaws in the existing deregulated markets.
George Soros is chairman of Soros Fund Management.
This story ran on page A19 of the Boston Globe on 12/21/98.
© Copyright 1998 Globe Newspaper Company.