September, 1998

IMF and market deregulation under

fire as world domino effect continues

by Brian Jenkins

Washington’s Economic Policy Institute has warned that the devastating economic crises plaguing Russia, Asia and Latin America show that deregulated capital markets and current International Monetary Fund lending practices are dangerously outdated and must be reconsidered.

Economists John Eatwell and Lance Taylor have proposed establishment of a new "World Financial Authority" as an antidote to the IMF's liberalization of capital markets, and as a means to manage international financial regulation, increase levels of employment and promote steady economic growth around the globe.

Others including Jeffrey Sachs, director of the Harvard Institute for International Development, are calling for the resignation of IMF executive director Mr Michele Camdessus and a denial of further resources to the Fund. They argue that IMF bailouts have encouraged banks to make riskier loans while the costs of their excesses are ‘socialised’ and picked up by taxpayers at large.

The domino effect works through several channels: countries in recession demand fewer imports, so business in exporting countries falls off. Countries whose investors have invested in businesses in foreign countries which have entered a recession are hurt.

These foreign investors may not be able to repay their loans from domestic banks. This is what is happening to Japanese investors who have invested in Indonesia, so the nonperforming loan portfolios of Japanese banks are increasing.

Alan Greenspan, Chairman of the US Federal Reserve Board, says that 'excessive leverage' and short-term bank lending 'may turn out to be the Achilles' heel of an international financial system that is subject to wide variations in financial confidence'.

The effect has spread from the financial sector to the multinational sector of the productive economy. US giants General Motors and General Electric, for example, both make more profits from their financial subsidiaries lending credit money at compound interest than they do from all of their production of automotive and electrical manufactures put together. This practice now forms a typical pattern

In Perth, Chamber of Commerce and Industry president Mr Lyndon Rowe rejected the suggestion that short-term foreign direct investment (FDI) was potentially harmful and should be restricted or taxed.

"There is no such thing as 'harmful' investment. Rather, excess short-term capital can be attracted to a country which has underlying weaknesses in its financial structure such that it earns a rate of return that is not commensurate with the level of risk

"The domestic financial system should be liberalised, but under strong prudential regulation," Mr Rowe said

"It should adopt a flexible exchange rate regime which responds to changes in international capital flows; and encourage systems which provide reliable and timely market information," he added.

"The key is not to close the door on foreign capital, but to make sure that the domestic economy is capable of handling international capital flows without the sharp adjustments which can occur in an inflexible and under-developed economy," Mr Rowe said

But US economist Paul Krugman is less confident and has warned that danger signals must be heeded.

"In the end, a global slump is quite an easy thing to prevent. The only way it can happen is if the people who have the power to prevent it fail to take the risk of such a slump seriously, and continue to cling to ideologies inherited from a more benign era", Mr Krugman said.

Ends