[IWAR] FINANCE on market panic

From: 7Pillars Partners (partnersat_private)
Date: Thu Apr 09 1998 - 20:30:50 PDT

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    When markets panic
    Copyright  1998 Nando.net
    Copyright  1998 Reuters News Service 
    PARIS (April 9, 1998 10:31 p.m. EDT http://www.nando.net) - Investors panicked,
    markets plummeted and interest rates soared as government struggled to stem the
    flow of
    money. Fortunes were lost and life savings evaporated in hours, even minutes.
    The nightmare scenario could be a flashback to the great Wall Street stock
    market crash of
    1929, or the Mexico crashes in 1982 and again in 1994. It could also be applied
    to the worst
    days of the Asian financial crisis in late 1997 and early 1998.
    There was little new about the way investors took fright at the Asian meltdown.
    What is new is a growing sense among the world's economic policy makers that
    free flows of
    capital around the world, hailed by current doctrine as the life force of the
    world's globalizing
    economy, may be getting out of hand.
    "I believe that what is being referred to as the architecture of the
    international financial system
    will need to be thoroughly reviewed and altered as necessary to fit the needs
    of the new global
    environment," U.S. Federal Reserve Chairman Alan Greenspan said earlier this
    Pieter Bottelier, senior economic adviser at the World Bank, went further at a
    conference in
    "The sudden withdrawal of capital can have social consequences that are perhaps
    as cruel as
    war, and in some senses even worse than war. Millions of people in Thailand,
    Indonesia, in the
    Philippines, Malaysia and also Korea, are being thrown out of work," he said.
    "Very large numbers of people who had gained some degree of confidence in their
    class status have suddenly been robbed of their lifetime savings and social
    security," he said.
    Only last September, the International Monetary Fund won backing from its
    members for a
    statement that free capital flows, supported by sound economic policies, were
    key to the
    world's economic health.
    Its chairman Michel Camdessus has since said, however, that the Asia crisis was
    not triggered
    by too much liberalization, but rather by "perverse liberalization."
    Even the Organization for Economic Co-Operation and Development, a bastion of
    free-market orthodoxy, said in a report this month that "legitimate questions
    exist as to whether
    the Asia crisis could have become so severe" if institutions had respected the
    risks inherent in
    lending to emerging market economies.
    The issue is expected to come up at a meeting of the IMF and World Bank in
    Washington on
    April 13 to 17 of finance ministers and central bankers from developed and
    But despite the will to do something, there is little agreement on what the
    problem actually is,
    let alone on how to fix it.
    "There is no consensus emerging that the system needs to be fundamentally
    changed, although
    probably a majority now feel some change is necessary," said Adam Posen of the
    Institute for
    International Economics in Washington.
    "More importantly, among those interested in change there is no consensus
    whatsoever, with
    definitions of the problem, let alone the solution, varying widely," he said.
    Money makes the world go round
    Each day, more than a trillion dollars worth of capital changes hands, in
    anything from foreign
    exchange trading to long-term loans for road building to cash deposited
    overseas by
    corporations planning to build factories.
    The transfers have spurred economic growth by lowering the cost of capital,
    domestic savings and boosting investment.
    They also offer savers in developed economies investment opportunities,
    allowing them higher
    yields in countries with better growth potential than their own.
    In 1996 net private capital flows into the developing world totaled $234
    billion, a huge jump
    from $160.9 billion the year before, according to data from the OECD.
    The private flows make up the vast majority of the total net resource flows in
    1996, which
    totaled $303.1 billion.
    'Animal spirits'
    With such huge amounts of money washing through the world's economic system
    each day, a
    shift in investor sentiment like the one that clobbered Asian financial markets
    may have been
    inevitable because of the unpredictable factors at work.
    John Maynard Keynes said these factors could not be explained and called them
    spirits" to highlight their volatility.
    In a recent speech in Manila, World Bank Chief Economist Joseph Stiglitz drew a
    between Keynes's theories and Greenspan's comment that "irrational exuberance"
    had infected
    stock markets.
    Irrational or animal, individual investment decisions that collectively affect
    the flows of billions
    of dollars can have immensely damaging effects on unprepared economies.
    "There can be collective irrationality even when individuals are acting
    rationally because there
    are external factors," said Stephany Griffiths-Jones, professor of economics at
    the University
    of Sussex's Institute of Development Studies.
    "What makes sense for you and me individually could be irrational if everybody
    does the same
    thing at once."
    Excessive capital flows can lead to overvalued exchange rates, growing current
    deficits and inflation.
    But Griffiths-Jones argues that an even greater risk than the amount of capital
    on the move is
    the possibility that the money can flow out just as quickly as it rushed in and
    lead to a currency
    crisis with catastrophic effects.
    What can be done?
    No one is suggesting going back to protectionism. A summit this month of
    European and Asian
    leaders, while specifically blaming currency speculators for aggravating the
    crisis, reiterated
    their commitment to open markets.
    One former central banker suggested that the international community should
    perhaps consider
    liberalizing only capital outflows initially in some developing countries
    rather than opening them
    up to capital inflows which might become excessive.
    Other experts have suggested that encouraging long term inflows instead of so
    called "hot
    money" would help enormously.
    Camdessus, for example, said Asia had started the wrong way by opening up to
    capital flows first, describing these as the "most explosive."
    Others are discussing the imposition of some sort of reserve requirements on
    lenders investing
    in emerging economies. The loss of earnings from the reserves would be
    compensated by
    higher investor confidence that would attract more money.
    Another idea making the rounds is for the IMF to be granted the power to go
    public with
    negative assessments of a country.
    But some say such publicity could serve to spark exactly the kind of panic
    regulators are trying
    to avoid.
    "Public disclosure is certainly dangerous, but talking privately to regulators
    in lender countries
    may be an answer," said Stephen Harris of the Paris-based OECD.
    A small tax on transactions, proposed by economist James Tobin, is considered
    impractical by
    almost everyone.
    "Governments couldn't introduce a tax of the sort that Tobin advocates, there
    would be
    leakages," Harris said. "It would be a giant sieve."
    Main problem lies in the country, not the flows
    If there is consensus on anything, it is on the need for more transparency and
    better regulation,
    particularly of the financial sector, in emerging economies that open
    themselves to capital
    "The Asia crisis is not a reflection simply of capital flows," said Harris. "It
    is a reflection of bad
    economic flows and bad regulation."
    Harris also faults authorities in the west who failed to notice the rash of
    suspect lending.
    "National authorities don't have to be involved in tracking capital flows but
    if their banks are
    loading up with debt from badly regulated countries, they have a responsibility
    to intervene," he
    While some reject outright the idea of any intervention in the market and say
    the authorities
    could never get the right balance between freedom and regulation, others warn
    that failure to
    act could have serious consequences.
    "If the creditor countries don't put some constraints on their lenders we're
    going to face more
    crises," said Jerome Levinson, professor of international law at American
    University in
    In the meantime, he said, "We're living in a fool's paradise."

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