Time to Rein in Global Finance
The financial crisis that collapsed Asian economies in mid-1997 and then bounced around the world was a distant sideshow to most Americans until it reached Wall Street. One year later, when Russia defaulted and Brazil was engulfed by the investor panic, US financial markets plunged too, and some major American banks and brokerages were at risk (as a result of lending billions to such magical schemes as Long-Term Capital Management, the wildly overleveraged hedge fund that went bust). The Federal Reserve rushed to the fire, supervised a forgiving bailout for Long-Term Capital and swiftly cut interest rates three times to restore confidence. The giddy boom resumed, but the US establishment was rattled. Led by the President, important voices from financial and academic circles began to talk earnestly about the need to reform the global financial system. "A new international financial architecture," they called it.
Nothing has been reformed. Three years after the turmoil and destruction began, the world's unstable financial system remains unchanged and, therefore, still vulnerable to all the excesses of unregulated capitalism that nearly brought it down. Another savage crisis is very likely to occur, somewhere or another, and millions of innocent bystanders will, once again, find themselves wiped out by the blind force of global finance, with its reckless, manic appetite for greater returns. For instance, because global flows of capital are now freed of any moderating controls by national governments, they can surge into a promising "emerging market" like Mexico or Indonesia, overwhelm it with easy money lent short-term for quick profits, then rush out overnight, collapsing the currency and economy. Major speculators, meanwhile, operating from unregulated offshore banking centers, gang up to attack vulnerable currencies from Britain to Malaysia and reap enormous windfalls by forcing them into costly, often exaggerated devaluations. An embattled country like Brazil is compelled to seek the protection of the International Monetary Fund, which will demand an austerity policy to restore the confidence of global investors (the very people whose panicky flight triggered the crisis). These and other destabilizing features of the free-market "architecture" are among the problems that have not been fixed. When another crisis does occur (perhaps closer to home), it will confirm the dereliction of the "responsibles."
So the burden of reform devolves to others--those diverse voices around the world who are uniting now in a movement to challenge the corporate-capitalist version of globalization. These active citizens, of course, have very little power to change things themselves, except their intelligence and spirit, plus an ability to arouse the broader public. This new international movement understands that the maladies of global finance go deeper than recurring crises and the danger of a total breakdown. For decades, the poorer countries have lived with harsh dictation from global capital about what economic plans their governments may or may not pursue in behalf of citizens, with brutal discipline if they stray. The cheerleaders describe this as globalization's "golden straitjacket"--follow our orders, and we will make you rich (someday)--but people in most societies are learning that the consequences for humanity are often quite leaden. Some people do get rich, of course, or gain wage incomes. But as millions learned in Southeast Asia, their escape from poverty was a temporary thing, hostage to the anxieties of distant investors who are oblivious to their individual efforts and aspirations.
The financial realm constitutes the commanding citadel of the global system--the benefactor that provides essential capital, the enforcer that disciplines multinational corporations as well as nations. Its imperious attitudes and amoral operating assumptions are embedded in every aspect of globalization and implicated in every complaint, from inhumane working conditions to environmental wreckage, from the erosion of national sovereignty to the gross and growing inequalities. Reforming global finance is, likewise, the most formidable challenge, since many people who can grasp the immorality of exploited labor or wanton destruction of nature are intimidated by the dense abstractions of high finance.
An essential starting point is to remember that this out-of-control global financial system is a man-made artifact, a political regime devised over many years by interested parties to serve their ends. Nothing in nature or, for that matter, in economics requires the rest of us to accept a system that is so unjust and mindlessly destructive. What follows is intended to help people think more clearly about the possibilities for reform (two previous articles, on January 31 and April 10, focused on rules to impose social-moral values on globalization and the deep economic imbalances in production and trade that drive the "race to the bottom"). Some plausible, immediate steps will be described that could impose more order and equity on global finance, also a grander vision of how the world's divergent economic interests might someday come together in a new institutional relationship that disarms the overbearing power of capital while it also reconciles tensions between rich and poor countries. We begin, however, on the narrow ground where the elite debate is located because some of its "solutions" may actually make things worse, especially for poorer countries.
The public dialogue among establishment figures started on a hopeful note, with sober pleas for "a new architecture" from Bill Clinton, Treasury Secretary Robert Rubin, Tony Blair of Britain and many other influentials. Since then, the discussion has steadily narrowed and is now reduced to a single question: how to reform the International Monetary Fund and the World Bank, as if those international financial institutions (the so-called IFIs) are the only problems to fix. What's left aside is the private, deregulated marketplace of global investing, lending and speculation that actually generates the instabilities and gross injustices. There are a couple of significant exceptions I will mention, but the general drift of respectable opinion is toward doing as little as possible--and doing nothing that might upset the bankers and financiers.
In Washington, the reform debate has been hijacked by the free-market right-wingers in Congress and elsewhere, who propose to eviscerate the IMF and the World Bank, severely reducing the scope of their lending and their authority to intervene in crises. The loan windows would be effectively closed to most poor nations, and discretionary decision-making would be replaced with fixed and very conservative rules. The right portrays the fund and the bank as out-of-control bureaucracies that have stealthily accumulated functions far beyond the original purposes of the Bretton Woods agreement that created them a half-century ago. In the reconstruction following World War II, the IMF's initial role was to be the mediating agency that insured stable, fixed currencies. The World Bank did investment lending to rebuild war-devastated economies and to help poor countries begin development. It is certainly true that in recent decades, both institutions have been transformed and both often make things worse for countries they are supposedly helping, imposing on them the conservative economic dogma known as the "Washington consensus."
But the right-wingers make an additional complaint: The IMF actually causes financial crises--by encouraging investors to take imprudent risks in the belief that the IMF will come to their rescue with a bailout--and its functions must be sharply limited. Among their fanciful claims, the right-wingers promise that if another major financial collapse does occur, the IMF will be prohibited from executing the kind of big-package bailouts employed for Mexico in 1995 and Southeast Asia in 1997.
The right-wingers' anti-IFI message appeals to many social activists on the left, and some have signed on to the conservative agenda on the assumption that anything that weakens the IMF and the World Bank is a big step in the right direction. I share their critique of the IFIs, but their logic seems to me quite naïve about the actual power relationships in the global system. I suspect they may come to regret making common cause with the likes of Senator Phil Gramm, who, as conservative chairman of the Senate banking committee, can do great damage under the banner of reform.
The right wing's prescriptions are contained in the recent report from the International Financial Institution Advisory Commission, created by Congress in 1998 to critique the IFIs and recommend changes (the chairman is Professor Allan Meltzer of Carnegie Mellon, a hard-money disciple of Milton Friedman who regularly scolds the Federal Reserve for being too lax). Treasury Secretary Lawrence Summers, perhaps anticipating the right's line of attack, has called for a moderate scaling back, but Harvard economist Jeffrey Sachs is providing liberal cover for the right-wingers. A leading IMF critic and Democratic appointee to the IFI commission, Sachs enthusiastically endorsed the conservative recommendations (while privately assuring friends that he disagrees with the more odious elements).
At the risk of sounding soft on the IFIs, I observe that the right has grossly rewritten recent history in order to blame them and absolve private capital. The IMF and the World Bank have indeed expanded and contorted their purpose enormously over the past two decades, but in every important instance they've done so at the behest of the US Treasury, responding to urgent demands from private banking and finance, mainly the major US banks and brokerages. In the Third World debt crisis of the eighties, IFI lending assisted the massive, silent bailout of leading banks like Chase and Citicorp (now Citigroup), which allowed private banks to back out of huge portfolios of failed loans yet left the indebted countries of Latin America in even worse shape (a negative wealth transfer, from poor to rich, totaling $116 billion). In the nineties the $50 billion bailout of Mexico was engineered by Rubin and Summers, not the IMF, which as always followed Treasury's orders (a rescue for the customers at Merrill Lynch and Goldman Sachs, among other firms). The Asia and Russia bailouts were likewise driven by US policy-makers and financiers. The IFIs are agents of global capital, not the masters.
If the two Bretton Woods institutions were abolished tomorrow, the punishing chaos and inequities in global finance would continue--and might be amplified by panicky investors--since these disorders originate in financial markets, driven by powerful private interests and their self-serving doctrine of lawless free markets. The right-wingers, along with Jeffrey Sachs, are being cute when they pretend to recommend no more bailouts. As they well know, if the next crisis is large and threatening enough, the IMF, World Bank, Fed and other major central banks will again intervene as lenders of last resort--regardless of anybody's promises--since "letting nature take its course" might risk a total meltdown.
Developing countries, meanwhile, will find themselves in a new straitjacket, probably harsher than the present one, if the right's agenda prevails. The Meltzer-Sachs commission's majority insists, for instance, that the IMF lend only to "prequalified" nations that pass certain tests of soundness--that is, adopt conservative economic policies and deregulate domestic financial systems so that foreign banks and brokerages are free to enter and dominate them. Thus the US financial industry might accomplish through this back door what it has long sought in formal trade negotiations, like the controversial Multilateral Agreement on Investment, which was stymied only by vigorous grassroots opposition from many nations. The Meltzer-Sachs proposals contain other neocolonial features that are most unfriendly to the poor.
The political plans of the right may also threaten--even derail--the energetic global campaign under way to win debt relief for the very poorest nations. Senator Gramm and allies intend to attach the Meltzer-Sachs prescriptions to upcoming legislation needed to approve debt relief. If they succeed, Jubilee 2000 could be held hostage, even stalemated, by Congressional right-wingers insisting on their version of reform.
The global financial marketplace resembles a Wild West territory where bankers and big ranchers try to establish law and order among the populace while exempting themselves (since they write the laws in the first place). In this metaphor, the IMF plays sheriff and hanging judge, dispensing commandments and punishment on behalf of wealthy patrons while absorbing the wrath of angry citizens. Reforming the IFIs, including attempts to insert labor and environmental rights into their lending conditions, may be a noble project, but it will almost surely fail unless this underlying contradiction is confronted and altered. What this territory needs is new laws that regulate the behavior of the powerful, that extend due process and equal protection to the weak as well as the mighty.
The great fiction promoted by the free-market gurus--that national governments are powerless to assert themselves in this new world--has always been nonsense but widely believed. The myth is now being refuted, concretely, by legislation introduced by a respected establishment Republican. Representative Jim Leach, the moderately conservative chairman of the House banking committee, has proposed a measure to assert the influence of US banking regulation over the galaxy of offshore banking centers--the secretive, unregulated outposts where "dirty money" from drugs and crime mingles with respectable capital from hedge funds, major banks and wealthy investors. Leach's proposal is the most meaningful step toward genuine reform that I've observed (actually the only one) and ought to inspire reform activists to explore the broader implications.
Last year Leach was powerfully offended by the scandalous money traffic through the Cayman Islands and other offshore havens that allowed Russian oligarchs to spirit away many billions and deposit the loot in the Bank of New York (possibly the same billions the IMF had lent to the Russian government, though that's not yet proved). Leach discovered that in one year some $70 billion was transferred from Russian accounts through a tiny island in the Pacific Ocean called Nauru, population 11,000. Last fall Leach drafted regulatory legislation that could put a stop to these financial games, or at least force them into the daylight. The so-called brass-plate banks, typically existing only as computers set up in obscure locations, are more than an arcane gimmick, because they channel huge volumes of global capital, especially from the major speculators, outside official scrutiny from any government.
Banks in the United States, Leach asserted, should be prohibited from accepting any of these blind transfers from money shops if they cannot establish that the money originated from a truly regulated institution that is, in fact, a real bank (the Clinton Administration introduced a competing version after the financial industry complained about Leach's). The issue exposes a central hypocrisy of international finance--a system that demands "transparency" and "due diligence" from banks in developing nations while all the best names in international finance use these irregular outposts. The offshore money, whether clean or dirty, enjoys the same benefits: avoidance of national laws and regulation as well as avoidance of taxes (global tax-avoidance schemes may cost hundreds of billions in lost revenues; no one really knows).
Despite the complexities of global finance, the operating cortex is relatively small and easily accessible to government regulators--five dozen or so international banks that handle the foreign-exchange transfers for everyone else. Nearly all are based in the wealthiest economies, supervised and regulated by their national governments. The politics is straightforward: Write tough new rules for these leading banks and everyone else must observe them (unless they choose not to do any banking with the world's principal centers of financial wealth).
New rules are needed to create more financial stability and equity, but, ultimately, banking regulation can also be a discreet instrument for upholding social values--public needs for housing, healthcare, education--since the regulation implicitly influences access to credit (which borrowers are preferred, which shut out). Not all of the issues can be reached by national legislation alone, but much of the disorder will be swiftly remedied if the wealthiest nations, especially the United States, abandon the crumbling dogma of laissez-faire and accept the obligation to restore fairness. Here is a brief sampling of some possibilities proposed by various reformers:
§ Shut off or shut down the offshore banking centers, both to curb speculation and recapture lost revenues for national governments. Leach's proposal is a modest first step toward establishing the standard of law. Tax-dodging and money-laundering are financial issues that every citizen can understand.
§ Allow nations to impose their own controls on short-term capital flows in order to disarm the "hot money," those frantic capital surges in and out of countries that have triggered so many crises. The Council on Foreign Relations, an old establishment outpost, recommended as much in a study group co-chaired by two other Republican notables, Peter Peterson, Richard Nixon's Commerce Secretary, and Carla Hills, George Bush's US Trade Representative. Their recommendation departs from orthodoxy but is not as radical as it sounds. Chile, after all, has been allowed to do this. It successfully discourages short-term lending from abroad with a stiff holding-period tax that severely penalizes early withdrawals (shorter than a year's duration). The United States and other powers simply have to tell the IMF to back off and let emerging economies use such insulating devices, perhaps even incentives like Chile's that direct longer-term capital to the nation's own priorities. One wonders, in passing, why the Clinton Administration is so shy about the issue of capital controls when the Council on Foreign Relations has provided establishment cover.
§ Create a quasi-public international investment fund that directs major volumes of long-term capital to developing countries and thus allows them to escape the dictates of investors and economic doctrines imposed by the IMF. A broadly diversified fund, including private and public investors, professionally managed to produce healthy returns, would bring patience to the process of globalization--stable capital that is not beholden to the quarterly earnings of multinational corporations or the feverish mood swings of financial markets. Governments might set forth the broad principles, but the fund would have to establish that patient capital can compete profitably (precisely why private capital loathes the idea). Jane D'Arista of the Financial Markets Center (her work is available at www.fmcenter.org) has proposed a closed-end international fund that would function like a giant mutual fund, but with a sense of history. An alternative version would raise its capital from a modest tax on global financial transactions and might gradually displace the World Bank as the leading development lender. Either way, the goal is to give aspiring nations more freedom from the fickle financial markets, while assuring the capital inflows they need to develop.
In the meantime, governments should prohibit the World Bank from financing any more oil, gas or mining projects--40 percent of the World Bank Group's loan portfolio last year, according to Friends of the Earth and other environmental groups. These generate environmental destruction and social upheaval in developing countries while often propping up corrupt regimes. Private capital should take these risks, not taxpayers.
§ Create a new international bankruptcy court to arbitrate claims between creditors and defaulting nations and provide protective workouts so indebted countries aren't destroyed in the process. The present system, loosely supervised by the IMF, central banks and various clubs of private bankers, is utterly one-sided. The fallen nations are steadily bled, their remaining assets picked over by scavenging investors, while foreign creditors walk away with no responsibility for their own mistakes. A global bankruptcy system for nations would develop equitable principles for settlements and terms of lending that could be incorporated in every debt instrument of global finance, the legal language that establishes the obligations of bankers and bondholders as well as their borrowers. This reform is a more reliable response to the problem of "moral hazard"--investors who take irresponsible gambles because they believe governments will bail them out--than anything the free-marketeers have suggested. Professor Kunibert Raff of the University of Vienna has proposed that nongovernmental organizations, trade unions and civic groups participate to speak for the affected citizens in bankrupt nations.
§ Confront and engage the long, difficult task of constructing a new international system that assures stable relationships among national currencies. The present system of floating exchange rates, with its exaggerated swings in currency values, is a central source of global instability as well as a movable feast for speculators. With everyone linked to the continuing gyrations of major currencies, the damage is randomly transmitted: US interest rates rise and trigger a collapse of the peso in Mexico or the baht in Thailand. Unpredictable exchange rates lead multinationals to disperse factories so they can hedge currency shifts by bumping their output from one country to another. This rudderless free market--$1.5 trillion a day in foreign-exchange transactions--wastes enormous amounts of capital in unproductive games, while the intimidating instability also retards growth rates in the advanced industrial nations.
These are not radical complaints, but points that conservative authorities like Paul Volcker have made in calling for reforms to stabilize the world's currency relationships. Unlike previous examples, this problem cannot be easily fixed, and certainly not by a single nation. Managing the international stability of currencies was the original purpose of the IMF, but that function was wiped out three decades ago when Nixon unilaterally discarded the Bretton Woods system and accepted Milton Friedman's idea of floating exchange rates--money values determined, every day, in the marketplace. The triumph of laissez-faire produced the present turmoil. The IMF ought to be phased out, but that's unlikely until a new, more democratic institution is created to replace it. Big players can hedge against unpredictable losses, but people can't hedge their lives, their societies. Global finance needs a supervisory governor that everyone can trust.
Set aside current realities and imagine a different future: Every nation, rich or poor, conducts foreign trade in its own currency and, therefore, gains greater ability to steer its own national economic policies. The dollar and the euro, perhaps joined by the yen, serve as the most reliable anchors but no longer swing wildly in value against one another, damaging producers and workers on one end or the other. Poorer nations, exporting and importing in their own currencies, are no longer compelled to raise "hard currency" reserves to pay back foreign loans; thus they are free to move away from the model of export-led growth and concentrate more on domestic development. Exchange rates among the currencies still fluctuate in value, actively influenced by market forces, but the speculators have lost their best game. The extraordinary volumes of currency trading subside; the "hot money" finds less opportunity to panic. The rhythms of globalization become less volatile and randomly destructive, as investors discover that the best returns require investing with a longer perspective. Finance capital no longer acts like an imperious master, but only as one important agent in capitalism's processes of wealth creation.
All this is entirely plausible, but to reach this future one has to accept the need to create some kind of new governing authority for global finance. The most ambitious and persuasive plan I have encountered was designed by financial economist Jane D'Arista. The improvements described above are what D'Arista foresees as possible if the world undertakes a fundamental reordering. Someday, I predict, political leaders will be compelled to consider something like this, though I fear it may require a bloody catastrophe to get their attention.
Many reformers will object that this subject is wildly premature, too abstract for citizens to grasp, too distant from present politics to engage their scarce energies. Besides, they will say, does anyone really want a new, more powerful IMF? I disagree. Thinking ahead in larger terms can give self-confidence to this new movement. Asking hard questions about the future forces people to clarify their vision. Besides, governing elites are much too timid to think big for us.
D'Arista's concept borrows from John Maynard Keynes and Harry Dexter White, co-architects of the original Bretton Woods arrangement, but the operating principles are adapted to the greater, faster complexities of today. She calls this new institution an "International Clearing Agency" because it would act as the currency clearinghouse for payments in international trade (the place where exporters and importers exchange one nation's currency for another's). Banks would do the exchanges for them, much the way they use the Federal Reserve as a clearinghouse for all US banking transactions. The ICA would not be a true central bank, since it wouldn't have the power to create money, but many features and functions would be similar. Like a central bank, it would hold the world's reserves, backed by marketable financial assets deposited by the participating nations. This financial base would give it the power to act as lender of last resort in major emergencies and provide temporary liquidity loans to countries in difficulty (just as the Fed routinely lends to commercial banks).
The ICA's central function, however, would be a balancing act among nations and their currencies--keeping the exchange values of currencies within agreed-upon ratios. If a nation tried to capture artificial advantage by letting its currency stray, it would be nudged back in line by its shrinking reserves at the ICA and eventually compelled, more or less automatically, to correct its economic imbalances or face a formal devaluation. Thus the ICA would adjust and stabilize the flows much as the original IMF did. Other times, it would help a country deal with unexpected shocks like commodity-price gyrations or natural disasters. Overall, the agency could discreetly counter the runaway surges in financial activity, just as the Fed is supposed to do. Defending the safety and soundness of the system is in everyone's interest, not just private investors. It's an alternative to the Wild West.
Such an institution would have awesome power, no question about it, but less awesome and arbitrary, I think, than the unaccountable powers that private capital randomly asserts, for self-interested profit, over the affairs of nations. Smaller countries, ironically, might find D'Arista's scheme more attractive because it promises them more sovereign space to pursue their own ideas of economic development. The centers of financial wealth--especially the United States--would likely be the skeptics, since it requires them to surrender much of their ability to manipulate and dominate others. When the United States developed into a truly national economy in the late nineteenth century, it suffered repeated, disastrous financial upheavals that eventually persuaded politicians, albeit reluctantly, to accept the need for a central bank. The question now is whether the world has yet had enough of the chaos and profiteering to accept something similar.
The toughest challenge concerns democratic governance, not financial design. Who would run and control this institution? Wouldn't the same old crowd take over and use it to bully others, as with the IMF? D'Arista has some tentative answers. She proposes a rotating executive committee whose members must insure representation on two levels--population and economic output--so that at least half the world's population would be represented at the table, as would nations that, combined, account for at least half the world's economic output. I suggest two additional levels of representation--the world's regions and the people at large themselves. It's not practical, obviously, to have a popular assembly supervising the global financial system, but here's a radical thought: Why not elections? I can imagine a regular worldwide referendum in which people everywhere vote directly to express themselves--thumbs-up or thumbs-down--on the ICA's performance. A negative vote would force a change in the leadership, much as in parliamentary systems. The same principles might be useful for restructuring control of the IMF and the World Bank (while they exist) or, for that matter, the United Nations and other international forums that lack credibility and power because they do not truly reflect world realities.
These are just ideas, of course. But if nations are serious about the notion that globalization can lead to worldwide democracy, we ought to look at distant horizons and begin asking ourselves how this new democracy might work. The vision is simple: putting people first, instead of behind capital.