Financial Crises, Global Capital Flows and the International Financial Architecture

The recent upheavals in the world financial markets were quelled by the immediate intervention of both international financial institutions such as the IMF and of domestic ones in the developed countries, such as the Federal Reserve in the USA. The danger seems to have passed, though recent tremors in South Korea, Brazil and Taiwan do not augur well. We may face yet another crisis of the same or a larger magnitude momentarily.

What are the lessons that we can derive from the last crisis to avoid the next?

The first lesson, it would seem, is that short term and long term capital flows are two disparate phenomena with very little in common. The former is speculative and technical in nature and has very little to do with fundamental realities. The latter is investment oriented and committed to the increasing of the welfare and wealth of its new domicile. It is, therefore, wrong to talk about "global capital flows". There are investments (including even long term portfolio investments and venture capital) ? and there is speculative, "hot" money. While "hot money" is very useful as a lubricant on the wheels of liquid capital markets in rich countries ? it can be destructive in less liquid, immature economies or in economies in transition.

The two phenomena should be accorded a different treatment. While long term capital flows should be completely liberalized, encouraged and welcomed ? the short term, "hot money" type should be controlled and even discouraged. The introduction of fiscally-oriented capital controls (as Chile has implemented) is one possibility. The less attractive Malaysian model springs to mind. It is less attractive because it penalizes both the short term and the long term financial players. But it is clear that an important and integral part of the new International Financial Architecture MUST be the control of speculative money in pursuit of ever higher yields. There is nothing inherently wrong with high yields ? but the capital markets provide yields connected to economic depression and to price collapses through the mechanism of short selling and through the usage of certain derivatives. This aspect of things must be neutered or at least countered.

The second lesson is the important role that central banks and other financial authorities play in the precipitation of financial crises ? or in their prolongation. Financial bubbles and asset price inflation are the result of euphoric and irrational exuberance ? said the Chairman of the Federal Reserve Bank of the United States, the legendary Mr. Greenspun and who can dispute this? But the question that was delicately side-stepped was: WHO is responsible for financial bubbles? Expansive monetary policies, well timed signals in the interest rates markets, liquidity injections, currency interventions, international salvage operations ? are all co-ordinated by central banks and by other central or international institutions. Official INACTION is as conducive to the inflation of financial bubbles as is official ACTION. By refusing to restructure the banking system, to introduce appropriate bankruptcy procedures, corporate transparency and good corporate governance, by engaging in protectionism and isolationism, by avoiding the implementation of anti competition legislation ? many countries have fostered the vacuum within which financial crises breed.

The third lesson is that international financial institutions can be of some help ? when not driven by political or geopolitical considerations and when not married to a dogma. Unfortunately, these are the rare cases. Most IFIs ? notably the IMF and, to a lesser extent, the World Bank ? are both politicized and doctrinaire. It is only lately and following the recent mega-crisis in Asia, that IFIs began to "reinvent" themselves, their doctrines and their recipes. This added conceptual and theoretical flexibility led to better results. It is always better to tailor a solution to the needs of the client. Perhaps this should be the biggest evolutionary step:

That IFIs will cease to regard the countries and governments within their remit as inefficient and corrupt beggars, in constant need of financial infusions. Rather they should regard these countries as CLIENTS, customers in need of service. After all, this, exactly, is the essence of the free market ? and it is from IFIs that such countries should learn the ways of the free market.

In broad outline, there are two types of emerging solutions. One type is market oriented ? and the other, interventionist. The first type calls for free markets, specially designed financial instruments (see the example of the Brady bonds) and a global "laissez faire" environment to solve the issue of financial crises. The second approach regards the free markets as the SOURCE of the problem, rather than its solution. It calls for domestic and where necessary international intervention and assistance in resolving financial crises.

Both approaches have their merits and both should be applied in varying combinations on a case by case basis.

Indeed, this is the greatest lesson of all:

There are NO magic bullets, final solutions, right ways and only recipes. This is a a trial and error process and in war one should not limit one's arsenal. Let us employ all the weapons at our disposal to achieve the best results for everyone involved.

About The Author

Sam Vaknin is the author of "Malignant Self Love - Narcissism Revisited" and "After the Rain - How the West Lost the East". He is a columnist in "Central Europe Review", United Press International (UPI) and ebookweb.org and the editor of mental health and Central East Europe categories in The Open Directory, Suite101 and searcheurope.com. Until recently, he served as the Economic Advisor to the Government of Macedonia.

His web site: http://samvak.tripod.com

---

Stocks Trading - Advantages and Disadvantages

What is Stocks Trading?Companies throughout the world issue new stock... Read More

Welcome to the World of Currency Trading

Indeed large multinational and individual banks and other major financial... Read More

Choosing A Forex Broker

With currency trading becoming ever more popular, the number of... Read More

E-currency Exchange Trading

If you are reading this article you are probably one... Read More

Psychology Of Trading

The psychological aspect of trading is usually underestimated by those... Read More

Forex Training: Follow Your Gut or Your Broker

Which way will the forex market move? Do you just... Read More

Forex2u Forex Strategy On Successful Forex Trading

The essence of the FX2u Forex strategy is that it... Read More

Trading Profitably on the Foreign Exchange Market

You may be asking yourself "how does one begin to... Read More

Experience

Throughout our course on futures trading, we have tried to... Read More

Writing A Trading Plan

All professional traders have a trading plan. Trading futures is... Read More

Two Timeless Rules in FOREX Investing

RULE #1) ~ Cut your losers; let your winners ride.One... Read More

How To Choose Wisely A FOREX Broker

Most traders use a FOREX broker to handle their transactions.... Read More

Forex Signal Services

What are Forex signals? Forex signals are paid services offered... Read More

Stopping Yourself

I read on a bulletin board a traders comment that... Read More

Hedging Foreign Exchange Risks

The exchange rate of the Macedonian Denar against the major... Read More

Online Forex Trading

Foreign exchange currency trading is also known as Forex trading,... Read More

The Yin and the Yang of Markets

I am reading a fantastic book on trading, first published... Read More

FOREX - Where Fortunes Are Made Everyday

The Foreign Exchange Market ? better known as FOREX -... Read More

Mechanical or Discretionary Trading - Which is Best?

Discretionary TradingPure discretionary trading will rely solely on the traders... Read More

Day Trading the Index Futures - How to Judge Good Entries

QUESTION: If the SP futures fall through support and go... Read More

Forex Trading

Foreign exchange market, or better known as FOREX, is the... Read More

The Nature of the Trading Business

Consider the following: As a trader you are in a... Read More

Learn Forex Trading - a Guide for Beginners

One can learn forex trading as easily as one would... Read More

Sending Signals for Trading in Forex

Forex signals are sent by a forex firm to their... Read More

Reality of Online Forex Trading

Foreign exchange trading is the trading of currencies. Most currencies... Read More

Exploring the World of Day Trading

Are you looking into a career in day trading? In... Read More

The Secret of Reduced Margin Spreads

One of the best kept secrets in trading is that... Read More

Trading Tips No 1: Learn How to Trade The Moment of Truth

So you have learned how to trade the markets by... Read More

Ways to Acquire Discipline in Trading

One way to acquire discipline in trading..."Hey Joe! When you... Read More

Stock Market Report: Day Trading or Swing Trading Online? Stock Investing Information

Profitable day traders recognize that momentum trading is among the... Read More

Forex Trading Can Be Like Day-trading

Forex trading, or foreign currency trading, has become a bit... Read More

Online Stock Trading: Freedom of Trade

I remember the first time I started to trade online.... Read More

What are Your Options Regarding Forex Options Brokers?

Forex option brokers can generally be divided into two separate... Read More