"The global financial crisis is now officially over," George Soros, the billionaire currency trader and financier, declared at a recent conference in New York. "So now we can look for the next one."
A cynical assessment, perhaps--but an understandable one, for in a world where money zips relatively freely across national borders, financial crises may rival death and taxes in inevitability. While stock, bond and currency markets around the globe have recovered smartly in recent months from the panic sell-offs that devastated Russia, Brazil and much of Asia over the past couple of years, it is presumably just a matter of time before some new trouble spot erupts and threatens to destabilize the global economy.
After all, the world hasn't suddenly become less vulnerable to such fits and seizures than it was before speculators began dumping the Thai currency, the baht, in mid-1997. Despite all the grand talk about building a "new global architecture" to replace the international financial system whose foundations were laid at the famous 1944 conference in Bretton Woods, N.H., and despite all the calls a few months ago for a "Bretton Woods II," there are no plans in sight for such a radical overhaul.
Yet in myriad ways, change is underway for the rules governing global finance--not a root-and-branch transformation, but modifications of some significance. And if those changes produce the desired effects, the system could become at least somewhat less prone to stampedes by international investors that menace the world's economic health.
"You might put it this way: The architects are essentially renovating a house, not razing an old one and building a new one," said Peter Kenen, an international economist at Princeton University. "It doesn't amount to a revolution. But it does amount to a significant change in the rules of the game."
An important step toward such change came in the past couple of days when a report on the new architecture was ceremonially welcomed by the leaders of the Group of Seven major industrial nations at their annual summit in Cologne, Germany. Prepared by Treasury Secretary Robert E. Rubin, top economic officials from other G-7 countries and senior policymakers at the International Monetary Fund after much debate, the report crystallized a new consensus among the elite that controls the levers of international economic policy. The report's recommendations are to go to the 182-nation IMF for approval this fall--and although sovereign nations have the right to ignore them, they would do so at the risk of cutting themselves off from global financial markets.
The issues involved can be fiendishly arcane, but at bottom they boil down to this, according to Jacob Frenkel, the governor of Israel's central bank: "You can try to eliminate two out of three crises. Or you can try to eliminate three out of two crises."
In other words, the system might be made super-stable by, say, severely restricting cross-border flows of capital. But it's better to accept the risk that some crises will occur, Frenkel argues, because otherwise the potential would be lost for the dynamism and rapid growth in living standards that many developing countries can enjoy by remaining open to international lenders and investors.
Accordingly, the order of the day among the G-7 and other architects is "robust incrementalism," a term coined by Barry Eichengreen, an economist at the University of California at Berkeley, for non-flashy but useful steps to temper excess volatility in global markets.
A few leading illustrations of the genre:
Let it all hang out. Remember the stories about how Thailand and South Korea withheld vital data about their governments' financial positions, causing investor panic to worsen when the gory details started leaking out? Some of the proposed new rules are designed to reduce the chances that countries will behave similarly in the future.
The new rules would offer incentives--not just finger-wagging--to disclose more. For example, under recently proposed international banking regulations, loans to countries that fail to comply with IMF disclosure standards would be classified as riskier than loans to countries that do comply--making it more expensive for non-compliers to borrow.
Avoid the fixity fix. Other rules are designed to discourage countries from getting into the sort of trouble that befell Russia and Brazil. The Russian and Brazilian governments pledged to maintain fixed exchange rates for their currencies but found themselves unable to maintain those rates when massive numbers of investors--having all determined at roughly the same time that a devaluation was likely--sought to exchange their rubles and reals for dollars.
The G-7 has concluded, along with much of the economics profession, that for most countries fixed exchange rates are a lot more crisis-inducing than floating rates, which allow currency values to fluctuate according to market forces. So the G-7 report declares that with rare exceptions, large IMF rescue loans should not go to "a country intervening heavily [in currency markets] to support a particular exchange rate level." One exception: Hong Kong-style "currency boards," where countries rigidly fix exchange rates by keeping enough dollars in reserve to back each unit of the local currency.
Caveat investor. Still other proposals are aimed at discouraging banks and investment firms from pouring money recklessly into emerging markets as they did in the mid-1990s.
The G-7 report seeks to admonish global money managers that they'd better not count on getting bailed out if a country they invest in runs into trouble. International rescues led by the IMF may be linked "to the country's efforts to restructure or refinance outstanding obligations." Translation: The IMF may refuse to rescue such a country unless its private creditors agree to take a financial hit and accept easier terms for repayment.
All this incrementalism--however robust it may be--seems a far cry from the rhetoric that prevailed during the darkest days of the crisis last autumn, when financial markets fell into virtual paralysis after Russia's default on much of its debts.
Back then, British Prime Minister Tony Blair, declaring that "we should not be afraid to think radically and fundamentally," called in a speech for "a new Bretton Woods for the next millennium." For his part, President Clinton summoned world finance chiefs for an urgent meeting to consider changes in the global architecture, stating: "The central economic challenge we face is to harness the positive power of an open international economy while avoiding the cycle of boom and bust that diminishes hope and destroys wealth."
Proposals abounded for sweeping revisions of the financial system. The German government advanced a plan to stabilize global currencies by establishing "target zones" for the dollar, yen and euro to minimize fluctuations in their values. British officials suggested creating a global super-regulator combining the functions of several international institutions, including the IMF and the World Bank. Soros touted a plan for a new international agency with far greater powers than the IMF, which would insure loans, up to a limit, to countries.
Most of those ideas were swatted down by Rubin and his Treasury team, who considered them impractical and likely to create more problems than they solved. So now the big question is, will incrementalism work?
"The honest answer is, nobody knows," said Morris Goldstein, a former IMF official who is now a scholar at the Institute for International Economics, a Washington think tank. "We won't know until we give these measures a trial whether they're going to be adequate.
"Most of us [economists and policymakers] reject the more radical ideas that have been proposed in favor of seeing whether moderate steps do the job," he added. "If not, well, more people will be radicalized."
Even some incrementalists fear that the system isn't being changed enough.
One of the hottest controversies involves the question of whether countries should impose limited taxes on inflows of short-term capital, as Chile did earlier in this decade, to keep from being overloaded with foreign money that can be pulled out at the touch of a computer button.
The G-7 report says "there is a strong case for further studying" such controls, and some countries "may be justified" in adopting them, but they "may carry costs"--wording that is far too grudging for some experts. Berkeley's Eichengreen, for one, contends that the IMF ought to be actively prodding developing countries to use controls, especially nations with fragile banking systems that make them susceptible to crises. He accuses the U.S. Treasury of having a "Wall Street complex" that makes it reluctant to accept any restrictions on international investment.
In any event, no one claims that the measures being proposed will cure the system of all its ills--not even the Architects themselves, who admit that the next crisis could arise from some wholly unanticipated source of instability, as the last one did.
"I think we can claim that if these things are done, there would be less risk," said Timothy F. Geithner, undersecretary of the Treasury for international affairs. "But there will probably be new sources of risk we haven't confronted yet."
CAPTION: GEORGE SOROS
CAPTION: ROBERT E. RUBIN