Eight Steps to a New Financial Order
Article Summary and Author Biography
The economic conflagrations that lit up the world throughout the last half decade sent a very clear message: There are fatal flaws in the global financial architecture. The Bretton Woods system was designed for a very different world. The IMF, part schoolmarm and part firefighter, no longer plays either role well. Too often, it ignores the real victims and makes crises worse. The system must be redrawn to stabilize markets and head off panics before they spin out of control. Herewith a simple, eight-point plan for such reforms that uses existing institutions and respects current notions of national sovereignty.
Alan S. Blinder is Gordon S. Rentschler Memorial Professor of Economics at Princeton University and Director of Princeton's Center for Economic Policy Studies. He served on the Council of Economic Advisers from 1993-94 and as Vice Chairman of the Board of Governors of the Federal Reserve from 1994-96.
BACK TO BRETTON WOODS
Financial crises once made most people's eyes glaze over; they were subjects of intense interest to only a limited clientele, many of whom wore green eyeshades. Not any longer. The topic has unfortunately acquired a mass audience in the second half of the 1990s. Stunning currency collapses in Mexico (1995), southeast Asia (1997), Russia (1998), and Brazil (1999) have pushed the subject to the front page. Financial conflagrations have become too frequent, too devastating, and too contagious to be ignored.
As the World Bank's chief economist Joseph Stiglitz has put it, when so many cars run off the road, you start wondering whether the road itself might be the problem. And indeed, many questions are now being raised about the global financial architecture. Much of the discussion centers around the concept of "moral hazard," an awkward phrase that economists borrowed years ago from the world of insurance. In the financial context, it means that people (or banks, or governments) who are shielded from the consequences of their actions may take imprudent risks -- hoping they will be bailed out if things go wrong.
But there is a vastly more important hazard of much greater moral urgency: the fact that financial crises afflict literally hundreds of millions of innocent bystanders who play no part in the speculative excesses but nonetheless suffer when the bubbles burst. The present global financial system manifestly fails to protect these poor people from extreme hazards. This failure is the chief reason to seek reform. Those who bet wrongly in financial markets should suffer losses. And borrowers should repay their debts, even when they are onerous. But citizens who take no part in the game should be shielded from the consequences of financial collapse to the maximum extent possible. This is plainly not happening now. How did we get into such an awful mess?
The story starts back in 1944, when the major Allied nations met at Bretton Woods, New Hampshire, to design a mechanism for restoring the shattered world economy to health. They created a new international financial architecture based on fixed exchange rates and the convertibility of the U.S. dollar into gold. And they established a new multilateral institution, the International Monetary Fund, to police the system.
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