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Redesigning the International
Financial Architecture
Moderator:
Kenneth Clarke
Speakers:
Martin S. Feldstein
Stanley Fischer
Otmar Issing
Jean-Claude Trichet
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THERE was a general sense that the global capital markets have run a
little ahead of their regulators. Nobody disputed the idea that the
recent crises in emerging markets should be blamed primarily on the
countries concerned. But many people thought that the recent series
of dramatic upsets also seemed to highlight failings within the
international financial system. The regulators present insisted that
these failings were now being addressed. But many of the other
participants remained skeptical.
FIRST PANELLIST
The recent crises were different from previous ones. Capital
flows are both bigger and quicker than before. The current crises
tend to involve the Capital Account rather than the Current
Account. Such crises do not happen in more developed markets.
The basic response has thus been built around two ideas: to
strengthen domestic regulation in the countries concerned; and to
improve the monitoring of emerging markets.
In practice, that means six steps. The first is to create
standards of international behavior for countries: in most cases
(accounting is the obvious exception) these standards are easy to
create, but they have been hard to implement. The second Step
is the G7’s Financial Stability Forum which brings
together all the main regulators and international institutions: it
has set up committees to look at short-term capital flows, hedge
funds and offshore banking centres. The third push is for
greater transparency: more of the IMF’s dealings are
now being made public. The fourth is an attempt to "bail in’’
the private sector. The fifth is the establishment of
contingency credit lines.
The sixth is less a step than an observation: the spread of
flexi-
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ble exchange rate systems. Every crisis has involved a failed
attempt to defend a pegged exchange rate. However, flexible
countries have tended to do much better. Countries are now much more
likely to let their exchange rates float freely - though a few may
follow Argentina down the road to extremely firm
currency board systems. Either way, artificial pegs seem to be out
of fashion.
SECOND PANELLIST
It is worth noting that this is the first Bilderberg
meeting where the Euro is a fact rather than the topic of a
discussion. The redesign of the financial system, which is now under
way, also needs to be set in context. From 1944-73, there was a
system of fixed exchange rates. Since then, there has been only
piecemeal reform. In the 1970s there was good deal of talk about
whether the IMF should exist at all; in fact it has
increased and changed its role. But the basic trend has been very
unsystematic. Each crisis has called for a ``special facility’’ of
one set or another.
Why do we need to change? The globalization of capital markets has
happened much more quickly than the globalization of their
regulatory systems. The advances in electronic data processing
combined with financial liberalization have made capital flows much
swifter and also more uniform: all the big investors are following
the same benchmarks and being judged on the same quarterly
performance, so they tend to act in an even more herd-like than
usual.
The IMF should look at these flows, but it should be
aware of its limitations. It is very difficult to be right in a
world where money moves so quickly. The IMF should set
standards for transparency. But perhaps it should leave the job of
assessing them to the private sector. If the IMF says
that a country is in good shape, it gets into trouble if that
country crashes. But if it says that it the country is unhealthy, it
gets accused of starting the crash.
THIRD PANELLIST
There are grounds for being cynical about financial reform. Fear,
greed and ignorance remain as ever the main motors of markets. A
leading cen-
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tral banker has dismissed the attempts to rebuild the financial
architecture as a little interior decoration. There have always been
crises - and by many standards the 1980 debt crisis was much worse
than what we now face. But globalization and the advance of
information technology have upset the balance in financial markets.
What is needed is not so much one massive redesign as a process of
permanent adaptation.
Co-operation is the key. The world’s regulators are coming together
in more ways than most people realize. The Financial Stability
Forum is a good example. Transparency is also important as a way
of limiting the herd instinct of investors. What we need to do is to
encourage best practices on the regulatory side as well.
None of these things will happen without courage. The IMF
has actually exhibited quite a lot of bravery in telling governments
what to do. But we must find ways to introduce the private sector.
We cannot suppress risks, but we should make sure that the balance
between those risks and rewards is clear.
FOURTH PANELLIST
Most of the steps outlined so far make sense. But it is important to
realize the limits. Throughout history, people have imagined that
they have found the magic solution. But each system from the gold
standard to the ERM has run into trouble.
The existing system failed because it allowed enormous crises to
take place in emerging markets; and also because the regulatory
response to those crises was unsatisfactory. The main blame
certainly lies with the emerging countries themselves. They adopted
pegged exchange rate systems, they borrowed too much and they did
not reform their financial systems. But the IMF also
seems to have overstepped its responsibilities. It is not clear that
financial decisions about lending money should be tied to causes
like trying to reform corporate governance or trade union rules.
What should be the targets? First the IMF should not
try to refashion economies. Its lending should be based on
short-term, small packages, rather than big, long-term ones, tied to
broad
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reform proposals. Next the emerging countries should bear the main
responsibility for making their systems more transparent. And they
should find a way of increasing their liquidity. Back-up lines of
credit look good in theory; but may not pay out in practice. It is
vital that the emerging world feels more secure; otherwise it will
close off its markets.
DISCUSSION
The moderator began by throwing out a number of challenges that set
the tone for much of the subsequent discussion. Given the IMF’S
increased importance, is it a properly accountable body? What is the
G7’s role and is it the right shape? Given the introduction of the
Euro, is it really necessary for so many European countries to
attend G7 meetings? How can one begin to establish international
regulators when there are such conspicuous rivalries between
regulators within countries, especially America? And how do you
design a system that bails in the private sector?
Several participants returned to the basic theme that the markets
have globalized but the regulatory systems have not. Two European
speakers thought the answer is to give a greater role to regional
institutions, such as the European Union. One of the panellists was
sure that if the Euro worked, more regional currencies would emerge.
Others raised the question of dollarisation as a possible cure. One
of the panellists disagreed. Argentina and
Mexico both face a very difficult question. The only
possible reason for surrendering control of your monetary policy to
Washington (where nobody would ever make decisions on
the basis of what mattered in Buenos Aires) is the
fairly rotten financial records of the governments concerned. It
would thus be a sign of defeat. Another American participant agreed.
Mexico and Argentina both went through
recessions just to hold onto their pegs. It is to be hoped that they
can run their economies well enough themselves.
There was also a long discussion about how to give the private
sector a greater role. One European panellist stressed that
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bail-outs should not just be based around public-sector money. An
American participant said that there had been a clear progression
between South Korea and Brazil. In the
first instance, the private-sector banks had effectively been
strong-armed in; but with Brazil, they had come more
willingly. An American economist pushed this point a little harder:
what about changing bond contracts and introducing collective action
clauses for sovereign debt?
Several private-sector bankers rose to defend their profession. One
American banker pointed out that creditors have often been extremely
flexible, not least in the bail-out of Long Term Capital
Management. The public sector is simply behind: witness the
delays in changing the rules about investment banking in the United
States. A British banker believed that trust is key. Bankers will
"stay in’’ as along as they can be sure that their rivals have been
persuaded to do the same. Another European banker said that banks
simply do whatever makes it more likely to get their money back.
That is the point, agreed one panellist: co-operation is the
obvious way for everybody to gain.
Several people looked at the political side of international
regulation. An American participant pointed to the crucial position
of the big western economies in most negotiations. For instance the
recent rounds of discussion about bank supervision included 136
countries, but most of them were really backbenchers. One panellist
returned to the moderator’s questions about the composition of
G7 meetings. Europe, he stressed, is not a superstate. It
is thus correct for countries like France and
Germany to keep their individual seats at the table.
Nobody questioned the need for the IMF, but several
people questioned its abilities. One participant wanted to give a
greater role to ratings agencies. Another pointed out that the
IMF has no independent directors. A Briton accepted that
there is a good case for a lender of last resort, but only if it
lends money at a penal rate. Several people objected to the way that
financial reform has been put to the people. One Turkish participant
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pointed out that nobody explains to voters how, say, reforming
social security and taming inflation might be related.
One panellist reiterated his view that the IMF should
become a much narrower institution. Another wondered if it really is
the lender of last resort and not the subsidizer of last resort -
though he added that the tough medicine handed out to some Asian
countries had been justified. The third panellist wanted to see the
IMF become a catalyst for change; if not, capital
controls will be more likely. The first panellist admitted that the
IMF has not always explained its case well. But he
argued that the question of the power of a lender of last resort is
tied into that of how to bail in the private sector. Until a way is
found to keep the private sector involved, it will be very difficult
to have an effective lender of last resort.
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