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Monday, 5 October, 1998, 14:09 GMT 15:09 UK
Curbing global turmoil
Vast flows of short-term private capital have been at the heart of the Asian financial crisis which is now affecting the world economy.
Foreign investors who had bought stocks and bonds, and Western financial institutions who lent money to companies and banks, fled the region after the currency collapse in 1997.
Within a year, a capital inflow of $93bn turned into a global dis-investment of $12bn for the five key Asian countries (South Korea, Thailand, Malaysia, Philippines and Indonesia). This $105bn turnaround was equal to 10% of their combined GNP.
Now many experts, and some countries are beginning to question the 'Washington consensus' - that further global financial liberalisation is both inevitable and desirable.
The main alternative to allowing the free flow of capital is to re-introduce some form of exchange controls on capital movements.
Up until the 1970s, when the Bretton Woods system of fixed exchange rates broke down, these were common. The UK only abandoned them in 1979, and France and Italy in the 1980s.
But today the volume of foreign exchange trading is staggering.
Currency traders buy and sell $1.5 trillion dollars every day, of which $637bn is traded in London, the world's largest foreign exchange centre.
Although initially rejected by policy-makers and economists alike, this alternative - at least as a temporary measure - is back on the agenda.
Respected US economist Paul Krugman argued recently that exchange controls might be the lesser of two evils, saying "as the slump gets deeper, that price is starting to look more and more worth paying."
China and India, two countries with exchange controls, have been largely isolated from the crisis - although China has been struggling to control illegal capital flight.
Hong Kong, one of the few Asian countries to maintain a fixed parity to the dollar, spent the summer intervening in its stock market to defend its currency link. The government bought a reported $12.9bn worth of stock to prevent speculators profiting from the link between its currency and stock market.
Prime Minister Mahathir has said he was taking action to prevent speculators from damaging his country's economic achievements.
But international financial markets have reacted by downgrading Malaysia's rating and effectively ruling out new investment in the country.
Some economists, like Nobel laureate James Tobin, have advocated a worldwide turnover tax on currency transactions to damp down the speculative fever.
New financial architecture
But the main players in the global financial system, including the IMF and the US Treasury, reject exchange controls and taxes on speculation as both harmful and useless.
IMF Managing Director Michel Camdessus said that capital controls "were not desirable, or even feasible, in today's globalised economy."
And UK Prime Minister Tony Blair added his voice to the sceptics when he called such moves "futile" in his speech to the Labour Party Conference in Blackpool.
Instead, world leaders want to redesign the international financial system to give early warning of any potential trouble spots.
And they want to require countries to operate tougher controls on their banking systems.
This would mean tighter controls on foreign borrowing, more information on off-balance sheet exposure, and possibly higher capital adequacy requirements for banks.
The international organisation that regulates standards in banking, the Bank for International Settlements, would be brought more closely into the international financial system.
And perhaps countries would be required to adhere to tougher standards before they became eligible for IMF bail-outs.
In one version, countries which accepted these standards would have easier access to IMF and World Bank funds if a crisis hit.
But even the international institutions are beginning to recognise that some limits on capital movement may be inevitable.
The World Bank's chief economist, Joseph Stiglitz, has argued that international flows of short-term capital may expose developing countries "to unacceptable risks without commensurate returns."
And the IMF's Asia-Pacific region head, Hubert Neiss, has said that he was discussing the possibility of limited controls "to protect countries from the over-volatility of short-term flows of capital."
The argument is that financial liberalistion should be limited initially to long-term investments, with short-term bank lending restricted until developing countries have more sophisticated banking systems.
One model is Chile, otherwise a model free market country, which imposes a tax on capital inflows but not outflows.
Whatever the outcome of the debate, there is no doubt that the unexpected severity of the crisis has shaken the orthodoxy to its roots.
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