FIGHTING THE ASIAN FLU
Like death and taxes, international economic crises cannot be avoided. They will continue to occur as they have for centuries past. But the alarmingly rapid spread of the 1997 Asian crisis showed how shifting perceptions alone can disrupt even fundamentally stable countries. In the wake of Russia's default, skyrocketing interest rates in emerging markets underlined these economies' vulnerability to investor skittishness. Unfortunately, there is no international "911" that emerging markets can dial when facing economic collapse. Neither the International Monetary Fund (IMF) nor a new global financial architecture will make the world less dangerous. Instead, countries that want to avoid a devastating rerun of the 1997-98 crisis must learn to protect themselves. And self-protection requires more than avoiding bad policies that make a currency crisis inevitable, for the threat of contagion makes even the virtuous vulnerable to currency runs.
Liquidity is the key to financial self-help. A country that has substantial international liquidity -- large foreign currency reserves and a ready source of foreign currency loans -- is less likely to be the object of a currency attack. Substantial liquidity also enables a country already under a speculative siege to defend itself better and make more orderly financial adjustments. The challenge is to find ways to increase liquidity at reasonable cost.
The need for enhanced liquidity stems from the inevitable absence of an international lender of last resort -- a dependable source of credit when a country needs additional foreign currency. This is not the case within a national economy, where the central bank provides liquidity to the banking system. A solvent commercial bank -- one with assets that exceed its liabilities -- does not have enough liquid assets to pay depositors if they were all to demand their funds at once. But a central bank can prevent a run of depositors on the bank by following the advice provided more than a century ago by British economist Walter Bagehot: to lend "freely, at penalty interest rates, on appropriate