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Wednesday, 10 May, 2000, 16:53 GMT 17:53 UK
Can we trust the market?
by BBC News Online's Steve Schifferes
Nearly three years after the Asian currency crisis, which nearly triggered a global financial meltdown, policy makers are fiercely debating how to reform the world's financial institutions to prevent the next financial meltdown.
But despite pledges by the major industrial countries at various summit meetings, the political impetus for substantial reform is fading.
The disagreements were evident at a closed conference held at the Bank of England last week to discuss "reforming the architecture of the global economic institutions," the culmination of a five-year research programme sponsored by the Centre for Economic Policy Research and the UK's Economic and Social Council.
IMF under attack
One one side were many central bankers and American academics, who argue that it is the existance of International Monetary Fund (IMF) bail-outs themselves that have caused the excessive private sector lending and financial instability of the last few years.
On the other side were those who argued that the uncertainty and irrationality of markets, especially currency markets, meant that more international intervention than ever was needed.
The controversy centres over the role of the IMF, which is charged with preventing international financial crisis from spreading by aiding countries that run into trouble with their currencies.
Many critics charged that the IMF failed to work effectively during the Asian crisis, when one Asian currency after another came under pressure and eventually collapsed, causing severe financial losses and economic contractions across Asia.
The most notable critic is the former Chief Economist of the World Bank, Joseph Stiglitz, who resigned his position earlier this year.
World Bank v. IMF
Mr Stiglitz told the BBC on the sidelines of the conference that it was clear that the IMF's advice - to cut budgets and raise interest rates - had made the situation worse in countries that had followed its advice.
As the result of his experiences, he is now backing calls from a US commission established by Congress to scale back the role of the IMF to limited crisis intervention, without giving it the power to enforce a set of economic targets as a pre-condition for any help.
The commission, chaired by Allan Meltzer, is also calling for a more limited role for the World Bank, which it argues should stop lending to the richer developing countries.
Mr Meltzer argues that only countries which agree to undertake economic reforms in advance should get help in a crisis, and he worries that the current system encourages too much borrowing because of the "moral hazard" - the believe of big banks that they will be bailed out by the IMF if there is a crisis.
Can markets do it?
But other conference participants warned that in the uncertain world of financial markets, there needed to be a credible lender of last resort.
They argued that international capital markets were subject to panics and herd instincts, and could not be relied on to act rationally.
And they said that capital markets for developing countries could dry up if lenders were punished too severely.
Among the most vocal critics of Mr Meltzer's approach was the international financier George Soros, who warned that "market fundamentalism" was an illusion. The markets acted irrationally at times, and needed to be regulated at an international level.
He was broadly supported in this by Andrew Crockett, the general manager of the Bank for International Settlements, which sets the international standards for regulating banks to ensure they do not fail.
Mr Crockett argued that "although there was no alternative to a system based on decentralised market forces," this would not mean that "market forces can be left to themselves, either nationally or internationally".
The system needed to be more robust to deal with highly volatile capital flows, unsustainable exchange rates, weaknesses in domestic financial systems, and the danger of contagion, he said.
So far most energy spent on financial reforms has focused on strengthening the regulation of domestic banks in developing countries, and providing more information to lenders.
Less has been done to regulate the non-bank sector internationally and provide more resources to prevent another international financial panic.
Some other central bankers argued that crises were both inevitable and in some ways desirable, as they provided the only real impetus to reform the international financial system.
Unsustainable exchange rates
The conference experts also disagreed on whether the crisis had shown that "pegged" exchange rates, where countries try and maintain a particular value of their currency (usually to the US dollar) are still viable.
While many participants argued that countries should abandon such pegs - which proved extremely problematic for the Asian countries - others argued that smaller countries would be better off to stick to them.
There was also disagreement as to whether a complete opening of capital markets and an abolition of exchange controls was an essential condition for avoiding future crises.
Opening up the banking sector
While people like Allan Meltzer would make financial liberalisation a precondition for any help from the IMF in a crisis, others argued that many countries were not ready to be exposed to the full blast of world capital markets - and it would be unfair to impose that condition on them.
Underlying the controversy was the question of whether financial markets work efficiently, and require the minimum of intervention internationally; or whether the development of modern capitalism has made markets more irrational, and more in need of regulation than ever before.
Professor Meltzer said that only countries which had agreed to open their banking and financial sector to international competition should be eligible for aid.
In contrast, Joseph Stiglitz, although critical of IMF intervention, strongly argued that developing countries should have the right to limit the degree to which they are integrated in world capital markets until those capital markets are better regulated.
The philosophical differences among policy makers remain deep.
But what is clear is that the legitimacy of the world financial institutions is under unprecedented questioning, both among the public and policy elites.
For Mr Stiglitz at least, that is a very welcome development.
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