Controlling speculation in world financial markets
Progressive Christians Uniting
Gordon K Douglass
November 9 2002
Bretton Woods system
power of financial actors
of global financial flows
and ethical considerations
new financial architecture
Christians can do
to know more?
"During my whole career at Goldman Sachs - 1967 to 1991 - I never owned a foreign stock or
emerging market bonds. Now I have hundreds of millions of dollars in Russia, Brazil, Argentina
and Chile, and I worry constantly about the dollar-yen rate. Every night before I go to bed I
call in for the dollar-yen quote, and to find out what the Nikkei is doing and what the Hang Seng
Index is doing. We have bets in all these markets. Right now Paul [one of my traders] is long
[on] the Canadian dollar. We have bets all over the place. I would not have worried about any
of these twenty years ago. Now I have to worry about all of them."
Leon Coopermann, hedge fund manager1
Economic globalization is probably the most fundamental transformation of the world's political
and economic arrangements since the Industrial Revolution. Decisions made in one part of the world
more and more affect people and communities elsewhere in the world. Sometimes the consequences
of globalization are positive, liberating inventive and entrepreneurial talents and accelerating
the pace of sustainable development. But at other times they are negative, as when many people,
especially in less-developed countries, are left behind without a social safety net. Globalization
undermines the ability of the nation to tax and to regulate its own economy. This weakens the
power of sovereign nations relative to that of large transnational corporations and distorts how
social and economic priorities are chosen.
Economic globalization is most often associated with rapid growth in the flow of goods and
services across international borders. Indeed, the economic "openness" of a nation is often measured
by the value of its exports, imports, or their sum when compared to the size of its economy. Economic
globalization also involves large investments from outside each nation, often by transnational
corporations. These corporations often combine technology and know-how with their investments
that enhance the productive capacity of a nation. Previous position papers of the Mobilization,
contained in Speaking of Religion & Politics: The Progressive Church Tackles Hot Topics2,
have dealt with globalization primarily in these terms.
But international trade and investment are only part of the openness that has come to be called
globalization. Another part, and arguably the most important, is the quickening flow of financial
assets internationally. While a small portion of this flow is directly associated with the "real"
economy of production and exchange, its vast majority is composed of trades in the "paper" economy
of short-term financial markets. This paper economy is enormous: The value of global financial
securities greatly exceeds the value of annual world output of goods and services. Moreover, the
paper economy often contributes to crises in the real economy. Thus it is important to the well
being of humanity and the planet as a whole, yet it is little understood by most people. This
essay undertakes to provide a basic understanding of this paper economy, especially as its more
speculative features have multiplied during the last two or three decades, so that Christians
and others concerned about what is happening in our world can join in an intelligent discussion
of how the harmful consequences of financial markets can be controlled.
To better understand this paper economy, one first needs to know something about foreign exchange
markets, international money markets, and "external" financial markets.
In an open economy, domestic residents often engage in international transactions. American
car dealers, for example, buy Japanese Toyotas and Datsuns, while German computer companies sell
electronic notebooks to Mexican businessmen. Similarly, Australian mutual funds invest in the
shares of companies all over the world, while the treasurer of a Canadian transnational corporation
parks idle cash in 90-day Bank of England notes. Most of these transactions require one or more
participants to acquire a foreign currency. If an American buys a Toyota and pays the Japanese
Toyota dealer in dollars, for example, the latter will have to exchange the dollars for yens in
order to have the local currency with which to pay his workers and local suppliers.
The foreign exchange market is the market in which national currencies are traded. As in any
market, a price must exist at which trade can occur. An exchange rate is the price of a unit of
domestic currency in terms of a foreign currency. Thus, if the exchange rate of the dollar in
terms of the Japanese yen increases, we say the dollar has depreciated and the yen has appreciated.
Similarly, a decrease in the dollar/yen exchange rate would imply an appreciation of the dollar
and a depreciation of the yen.
Foreign exchange markets can be classified as spot markets and forward markets. In spot markets
currencies are bought and sold for immediate delivery and payment. In forward markets, currencies
are bought or sold for future delivery and payment. A U.S. music company, say, enters into a contract
to buy British records for delivery in 30 days. To guard against the possibility of the dollar/pound
exchange rate increasing in the meantime, the company buys pounds forward, for delivery in 30
days, at the corresponding forward exchange rate quoted today. This is called hedging.
Of course, there has to be a counterpart to the music company's forward purchase of pounds.
Who is the seller of those pounds? The immediate seller would be a commercial bank, as in the
spot market. But the bank only acts as an intermediary. The ultimate seller of forward pounds
may be another hedger, like the music company, but with a position just its opposite. Suppose,
for example, that an American firm or individual has invested in 30-day British securities that
it wants to convert back into dollars after the end of 30 days. The investor may decide to sell
the pound proceeds forward in order to assure itself of the rate at which the pounds are to be
converted back into dollars after 30 days.
Another type of investor may be providing the forward contract bought by the music company.
This is the speculator, who attempts to profit from changes in exchange rates. Depending on their
expectations, speculators may enter the forward market either as sellers or as buyers of forward
exchange. In this particular case, the speculator may have reason to believe that the dollar/pound
exchange rate will decrease in the next 30 days, permitting him to obtain the promised pounds
at a lower price in the spot market 30 days hence.
The main instruments of foreign exchange transactions include electronic bank deposit transfers
and bank drafts, bills of exchange, and a whole array of other short-term instruments expressed
in terms of foreign currency. Thus, foreign exchange transactions do not generally involve a physical
exchange of currencies across borders. They generally involve only changes in debits and credits
at different banks in different countries. Very large banks in the main financial centers such
as New York, London, Brussels and Zurich, account for most foreign exchange transactions. Local
banks can provide foreign exchange by purchasing it in turn from major banks.
Although the foreign exchange market is dispersed in many cities and countries, it is unified
by keen competition among the highly sophisticated market participants. A powerful force keeping
exchange rate quotations in different places in line with each other is the search on the part
of market participants for foreign exchange arbitrage opportunities. Arbitrage is the simultaneous
purchase and sale of a commodity or financial asset in different markets with the purpose of obtaining
a profit from the differential between the buying and selling price.
When foreign exchange is acquired in order to engage in international transactions involving
the purchase or sale of goods and services, it is said that international trade has taken place
in the real economy. When international transactions involve the purchase or sale of financial
assets, they are referred to as international financial transactions. They constitute the paper
Financial markets are commonly classified as capital markets or money markets. Capital markets
deal in financial claims that reach more than one year into the future. Such claims include shares
of stock, bonds, and long-term loans, among others. Money markets, on the other hand, deal in
short-term claims, with maturities of less than one year. These include marketable government
securities (like Treasury bills), large-denomination certificates of deposit issued by banks,
commercial paper (representing short-term corporate debt), money market funds, and many other
kinds of short-term, highly liquid (easily transferable) financial instruments. It is these short-term
money market securities that account for most of the instability in the global paper economy.
Buying or selling a money market security internationally involves the same kind of foreign
exchange risk that plagues buyers or sellers of merchandise internationally. If one wishes to
guard against the possibility of an increase or decrease in the foreign exchange rate, one can
insure against such fluctuations by "covering" in the forward market. By the same token, the decision
about whether to own domestic or foreign money market securities is not simply a comparison of
the rates of interest paid on otherwise comparable securities, because one must also take into
account the gain (or loss) from purchasing foreign currency spot and selling it forward. Thus,
choosing the security with the highest return does not necessarily imply the one with the highest
People who trade in international money markets, moreover, need to take into account many other
variables, including the costs of gathering and processing information, transaction costs, the
possibility of government intervention and regulation, other forms of political risk, and the
inability to make direct comparisons of alternative assets. Speculating in international money
markets is a risky proposition.
International money markets involve assets denominated in different currencies. External financial
markets involve assets denominated in the same currency but issued in different political jurisdictions.
Eurodollars, for example, are dollar deposits held outside the United States (offshore), such
as dollar deposits in London, Zurich, or even Singapore banks. The deposits may be in banks owned
locally or in the offshore banking subsidiaries of U.S. banks. Deutsche mark deposits in London
banks or pound sterling deposits in Amsterdam banks also are examples of external deposits. They
are referred to as eurocurrency deposits. (The advent of a new common currency in the European
Community - the Euro - will require the development of new nomenclature for external financial
External banking activities are a segment of the wholesale international money market. The
vast majority of eurocurrency transactions fall in the above $1 million value range, frequently
reaching the hundreds of millions (or even billion) dollar value. Accordingly, the customers of
eurobanks are almost exclusively large organizations, including multinational corporations, government
entities, hedge funds, and international organizations, as well as eurobanks themselves. Like
domestic banks, eurobanks that have excess reserves may make loans denominated in eurocurrencies,
expanding the supply of eurocurrency deposits. The eurocurrency market funnels funds from lending
countries to borrowing countries. Thus, it performs an important function as global financial
The origins of what Karl Polanyi3 called haute finance
can be traced to Renaissance Italy, where as early as 1422 there were seventy-two bankers or bill-brokers
in or near the Mecato Vecchio of Florence.4 Many combined
trade with purely financial business. By the middle of the fifteenth century, the Medici of Florence
had opened branches in Bruges, London and Avignon, both as a means of financing international
trade and as a way of marketing new kinds of financial assets. Many banking terms and practices
still in use today originated in the burgeoning financial centers of Renaissance Europe.
By the early seventeenth century, the Dutch and East India Companies began issuing shares to
the public in order to fund imperial enterprises closely linked to Holland and Britain. Their
shares were made freely transferable, permitting development of a secondary financial market for
claims to future income. Amsterdam opened a stock exchange in 1611, and shortly thereafter, the
British government began issuing lottery tickets, an early form of government bonds, to finance
colonial expansion, wars and other major areas of state expenditure. A lively secondary market
in these financial instruments also emerged.5
Throughout these early years, financial markets were anything but riskless and stable. Consider
the famous Dutch tulip mania of 1630, for example. This speculative bubble saw prices of tulip
bulbs reach what seemed like absurd levels, yet "the rage among the Dutch to possess them [tulips]
was so great that the ordinary industry of the country was neglected." Some investors in Britain
and France shared this "irrational exuberance," though it was centered mostly in Holland. Then,
not unlike speculative bubbles of more recent vintage, prices crashed6,
pushing the economy into a depression and leaving many investors angry and confused.
Paris developed into an early financial center in the eighteenth century, but the Revolution
of 1789 dissipated its power. The New York Stock Exchange was formally organized in 1792 and the
official London Stock Exchange opened in 1802. The expansion westward of the railroads in the
U.S. offered the financial community opportunity to sell railway shares and bonds that quickly
became dominant in the financial markets. Indeed, the bond markets of London, Paris, Berlin, and
Amsterdam were vehicles for collecting massive amounts of European savings and transferring it
at higher returns to the emerging markets of the U.S., Canada, Australia, Latin America and Russia
in the century preceding World War I.
Forward markets soon developed, especially in the U.S., in order to counter the impact of long
distances and unpredictable weather. As capital and money markets expanded, other new financial
instruments came into use. Joint stock companies were formed, enabled by legislation that clarified
the distinction between the owners and managers of corporations. This, in turn, helped stimulate
the growth of the American stock market in the late nineteenth century. To be sure, financial
markets did not grow continuously in the nineteenth century. Lending to the emerging markets was
interrupted by defaults in the 1820s, 1850s, 1870s and 1890s, but each wave of default was confined
to a relatively small number of countries, permitting growth of financial flows to resume.7
In the four decades leading up to World War I, a truly worldwide economy was forged for the
first time, extending from the core of Western Europe and the U.S. to latecomers in Eastern Europe
and Latin America and even to the countries supplying raw materials on the periphery. Central
to this expansion of trade and investment was an expanding system of finance that girded the globe.
The amount was enormous: between 1870 and 1914 something like $30 billion,8
the equivalent in 2002 dollars of $550 billion, was transferred to recipient countries, in a world
economy perhaps one-twelfth as large as today's.
During this "Gilded Age" of haute finance, the risks of participating in international trade
and investment were generously shared with governments and the banking system. The reason is that
foreign exchange rates were kept reasonably stable by the commitment of most governments to the
"high" gold standard. In this way, businesses and individuals engaging in international transactions
were reasonably certain that the value of their contracts was not going to change before they
matured. Their exchange risk was shared with government by its willingness to buy or sell gold
in order to keep the exchange rate constant. Because of this assurance, financial flows were reasonably
free of regulation.
They were not immune from crises, however. When the sources of financial capital temporarily
dried up, capital-importing countries occasionally found they could not expand export earnings
sufficiently to avoid suspending interest payments on their debts or abandoning gold parity. On
two occasions, the United States faced this possibility. The first was in 1893, when it switched
in a sharp economic downturn to bimetallism (which caused William Jennings Bryan to denounce the
"cross of gold"), and the second was in 1907, which led to the creation of the Federal Reserve
System, handing to the government the function of lender of last resort previously carried out
by Wall Street banks under the tutelage of J. Pierpont Morgan.
In his magisterial book The Great Transformation, Karl Polanyi reflected on the pervasive influence
of haute finance on the policies of nations even in this "Gilded Age." The globalising financial
markets and the gold standard, according to Polanyi, left very little room for states, especially
smaller ones, to adopt monetary and fiscal policies independent of the new international order.
"Loans, and the renewal of loans, hinged upon credit, and credit upon good behavior. Since, under
constitutional government ..., behavior is reflected in the budget and the external value of the
currency cannot be detached from the appreciation of the budget, debtor governments were well
advised to watch their exchanges carefully and to avoid policies which might reflect upon the
soundness of budget positions." Thus, even one hundred years ago the then-dominant world power,
Great Britain, speaking as it did so often through the voice of the City of London, "prevailed
by the timely pull of a thread in the international monetary network.9
Following World War I, the United States emerged not merely as a creditor country but as the
primary source of new international financial flows. At first, the principal borrowers were the
national governments of the stronger countries, but as the boom in security underwriting developed
in the U.S, numerous obscure provinces, departments and municipalities found it possible to sell
their bonds to American investors.10 Just as domestic
construction, land, and equity markets went through speculative rises in the 1920s, so too did
the U.S. experience a speculative surge in foreign investment. In the aftermath of successive
defaults by foreign debtors in 1932, the Senate Committee on Banking and Currency concluded:
The record of the activities of investment bankers in the flotation of foreign securities is
one of the most scandalous chapters in the history of American investment banking. The sale of
these foreign issues was characterized by practices and abuses that violated the most elementary
principles of business ethics.11
Speculation in the stock markets leading up to 1929 offers still another window on the instability
of short-term financial flows. A speculative market can be defined as one in which prices move
in response to the balance of opinion regarding the future movement of prices rather than responding
normally to changes in the demand for and supply of whatever is priced. Helped by the willingness
of Wall Street to allow people to buy stocks on margin, people were only too ready to bet prices
would rise as long as others thought so too. Day after day and month after month the price of
stocks went up in 1927. The gains by later standards were not large, but they had an aspect of
great reliability. Then in 1928, the nature of the boom changed. "The mass escape into make-believe,
so much a part of the true speculative orgy, started in earnest.12
Following World War I, the gold standard itself took on new form. Nations were allowed to hold
their international reserves in either gold or foreign exchange. This worked for a while in the
1920s, but as speculation mounted and balances of payments disequilibria grew, fears of devaluation
led central banks to try to replace their foreign-exchange holdings with specie in a "scramble
for gold." The worldwide result of these shifts in central bank portfolios was an overall contraction
of the supply of money and credit that sapped aggregate demand and forced prices to fall and output
levels to shrink. Thus, it can be argued - persuasively in our view - that the Great Depression
of the 1930s was as much, if not more, the result of mismanagement of money and credit as it was
the result of protectionist policies. Protectionist policies were more likely the result of slowed
growth and stalled trade. Countries that broke with the gold-exchange standard early, such as
Britain in 1931, and pursued more expansionary monetary policies fared somewhat better.
Bretton Woods system
During the darkest days of World War II, a radically new economic architecture was designed
for the postwar world at a New Hampshire ski resort called Bretton Woods. With the competitive
devaluation and protectionist policies of the 1930s still fresh in their minds, the mostly British
and American delegates to the conference wanted most of all to design a system with fixed exchange
rates that did not rely on national gold hoards to keep exchange rates stable. They decided to
depend instead on strict controls of international financial movements. In this way, they hoped
to allow countries to pursue full-employment policies through appropriate monetary (money and
credit) and fiscal (tax and spending) policies without some of the anxieties associated with open
financial markets. The role of monetary and financial stabilizer was given to the International
Monetary Fund (IMF), which was provided with modest funds to assist nations to adjust imbalances
in their external payments obligations. The International Bank for Reconstruction and Development
(IBRD, later the World Bank) assumed the task of helping to finance post-war reconstruction.13
The IMF as it emerged from Bretton Woods had inadequate reserves to advance money for the long
periods that many countries require for "soft-landings" from big current-account deficits. It
would make only short-term loans. To make sure that borrowing nations were constrained, "conditionality"
attached to IMF loans became standard practice, even in the early years of the Fund's operation.
Policy limitations and "performance targets" tied to credit lines advanced under "standby agreements"
began in the middle 1950s and were universal by the 1960s, long before the notions of "stabilization"
and "structural adjustment" came into common parlance.
The Bretton Woods agreement also imposed a foreign exchange standard by which exchange rates
between major currencies were fixed in terms of the dollar, and the value of the dollar was tied
to gold at a U.S. guaranteed price of thirty-five dollars per ounce. By devising a system that
controlled financial movements and assisted with the adjustment of countries' balances of payments,
the new system succeeded in keeping exchange rates remarkably stable. They were changed only very
occasionally, e.g., as when the value of sterling relative to the dollar was reduced in 1949 and
again in 1966. This meant that companies doing business abroad did not need to worry constantly
about the risk of exchanging one currency for another.
Among the reasons for this remarkable stability was the willingness of the central banks of
other countries to hold an increasing proportion of their official reserves in the form of U.S.
dollars. It was an essential part of the system that the dollars held by other countries would
be seen as IOUs backed by the U.S. offer to exchange them for gold at a fixed pre-war price. But
as the balance-of-payments of the U.S. moved more deeply into deficits in the 1960s, there were
more and more U.S. dollars held by other countries, and this so-called "dollar overhang" became
disturbingly large.15 General de Gaulle called it "the
exorbitant privilege," meaning that the Americans were paying their bills - for defense spending
to fight the Vietnam War among other things - with IOUs instead of real resources in the form
of exports of goods and services.
Strict control over financial movements began to weaken as early as the 1950s, when the first
eurodollar (later eurocurrency) deposits were made in London. At first a trickle, limited originally
to Europe, these offshore banking operations soon expanded worldwide. The American "Interest Equalization
Tax" (IET) instituted in 1963 raised the costs to banks of lending offshore from their domestic
branches.16 The higher external rates led dollar depositors
such as foreign corporations to switch their funds from onshore U.S. institutions to eurobanks.
Thus, the real effect of the IET was to encourage the dollar to follow the foreigners abroad,
rather than the other way around. Eurobanks paid higher interest rates on deposits and loaned
eurocurrencies at lower rates than U.S. banks could at home. Still another large inflow of eurodeposits
occurred in 1973-74 as the Organization of Petroleum Exporting Countries (OPEC) began "recycling"
their surplus dollar earnings through eurobanks. Because of their existence, a country such as
Brazil could arrange within a reasonably regulation-free environment to obtain multimillion-dollar
loans from a consortium of offshore American, German and Japanese banks and thereby finance its
oil imports. Net eurocurrency deposit liabilities that amounted to around $10 billion in the mid-1960s,
grew to $500 billion by 1980.
These eurocurrency transactions taught the players in financial markets how to shift their
deposits, loans, and investments from one currency to another whenever exchange rates or interest
rates were thought to be ready to change. Even the ability of central banks to regulate the supply
of money and credit was undermined by the readiness of commercial banks to borrow and lend offshore.
Hence, the effectiveness of regulatory mechanisms that had been put in place to implement the
Bretton Woods agreement - interest rate ceilings, lending limits, portfolio restrictions, reserve
and liquidity requirements - gradually eroded as offshore transactions started to balloon.
The world economy developed at unprecedented rates during the roughly twenty-five years immediately
following World War II. Growth and employment rates during these years were at historic highs
in most countries. Productivity also advanced rapidly in most developing countries as well as
in the technological leaders. These facts suggest that the system devised at Bretton Woods worked
reasonably well, despite occasional adjustments. To be sure, it helped to sow the seeds of its
own destruction by failing to retain operational control of international financial flows. But
the twenty-five years of its survival leading up to August 15, 1971, when President Nixon closed
the gold window, have nonetheless come to be called by some economic historians the "Golden Years."
Fixed exchange rates did not last long after the U.S. stopped exchanging gold for claims on
the dollar held by foreign central banks. The pound sterling was allowed to float against the
dollar in July, 1972. Japan set the yen free to float in February, 1973, and most European currencies
followed suit shortly thereafter. The Bretton Woods gold-dollar system was doomed.
The fact that exchange rates no longer were fixed meant that companies doing business in different
countries had to cope with the day-to-day shifts in the dollar's rate of exchange with other currencies.
The risks of unexpected changes in the value of international contracts suddenly had shifted from
the public to the private sector. Corporate finance officers now had to hedge against possible
exchange losses by buying a currency forward and investing the equivalent in the short-term money
market, or by investing in the eurocurrency market. The corporations' banks, in turn, tried to
match each foreign currency transaction with another contrary transaction in order not to leave
each of the banks exposed to foreign exchange risk overnight. Since no single bank was likely
to balance its foreign exchange positions exactly, the need arose to swap deposits in different
currencies in order to match corporate hedging transactions and to square the bank's books.
The price of this forward cover on inter-bank transactions - that is to say, the premium or
discount on a currency's spot value - has tended to accord with the differences between interest-rates
offered for eurocurrency deposits in different currencies. This is the connection between the
foreign exchange market and the short-term credit markets, between exchange rates and interest
rates. Whenever exchange rates move up or down, therefore, their influence is immediately transmitted
through the eurocurrency markets to the credit markets.
It is this scramble to avoid private risk that accounted for the dramatic rise in international
financial movements following the demise of the Bretton Woods system. By 1973, daily foreign exchange
trading around the world varied between $10 and $20 billion per day. This amount was approximately
twice the value of world trade at the time. Bank of International Settlements data suggests that
the daily average of foreign exchange trading had climbed by 1980 to about $80 billion, and that
the ratio between foreign exchange trading and international trade was more nearly ten to one.
The data for 1992 was $880 billion and fifty to one, respectively; for 1995, $l,260 billion and
seventy to one; and for 2000, almost $1,800 and ninety to one.
There is very little doubt, therefore, that the lion's share of international financial flows
is relatively short-run. Indeed, about eighty percent of foreign exchange transactions are reversed
in less than seven business days. Only a very small proportion is used to finance international
trade and direct foreign investment. The vast majority must be used with the expectation of gain
or to avoid losses that may result from changes in the value of financial assets. In general terms,
they are speculative, made in hope of capital gain or to hedge against potential capital loss,
or to seek the gains of arbitrage based on slight differences in rates of return in different
power of financial actors17
Foreign exchange markets and markets for money and credit seem remote and abstract to most
people. This section introduces the real institutions that operate these markets and assesses
the nature of their power.
They take deposits, lend money, and create credit to the extent their capitalization allows.
In Europe, they tend to combine commercial and investment banking services, but in the U.S. and
Japan they are still kept at least partially separate by regulation. The foreign exchange trading
facilities of the largest commercial banks, e.g. Citibank and J.P.Morgan/Chase in the U.S., tend
to dominate the market. The banking industry as a whole represents the largest pool of world financial
They facilitate international payments, manage new issues of stocks and bonds, advise on mergers
and acquisitions in all industries, and engage in securities and foreign exchange trading as allowed
by law. Investment banks (previously called merchant banks in the U.K.) have specialized in particular
kinds of derivative products. Derivatives are financial contracts whose value is based upon the
value of other underlying financial assets such as stocks, bonds, mortgages or foreign exchange.
They handle the bulk of stock exchange transactions and a major part of foreign exchange transactions.
Investment banks recently have acquired several of the main brokerage houses in the U.S. The development
of investor-friendly methods of buying and selling securities, e.g., over-the-counter markets
and electronic brokerage, also have diminished the role of independent brokerage houses.
They are pools of funds provided by clients that are run by professional investment managers.
These collective investments are held in portfolios with various mixes of money-market instruments,
bonds and equities. Mutual funds account for the second largest pool of global financial capital.
They resemble mutual funds, but they are much less restricted in investment activities and
techniques. Their customers are high net-worth individuals and large institutional investors.
They specialize in complex financial instruments and tend to take significant speculative positions,
especially on expected future changes in macroeconomic conditions. They exploit arbitrage opportunities
embedded in the relative prices of related securities. They frequent offshore centers and tax
Offshore centers and tax havens shelter perhaps $10 trillion of wealth from capital and income
taxation. The British Virgin Islands, the Bahamas, Bermuda, the Cayman Islands, Dublin and Luxembourg
are among the most important. Many hedge funds are registered there.
They are an important source of funds, as many of them invest their liquid funds in financial
markets. They account for about eighty percent of hedge fund investors.
Private pension funds
They function like annuities, receiving funds today in return for a promise to pay future benefits.
With large pools of funds to invest, they tend to depend on investment banks, mutual funds or
hedge funds to supervise placement of their assets in global financial markets.
They pool risks by selling protection against the loss of property, income, or life. Since
the risks they insure have various durations, they call for varied investment strategies. A portion
of their funds is invested in short-term financial instruments, often through mutual and hedge
They produce and sell goods and services in a number of countries. Their finance departments
seek the best ways to raise and transfer funds across borders, and administer the transfer prices18
of international trade conducted within the corporation. Some even have in-house corporate banks.
According to recent work by political scientists, the power of these financial actors is based
in part on a complicated "process of multiplication" of loans, assets and transactions. Many investors
in financial markets buy financial instruments on very thin margins, based on loans obtained by
pledging the assets as collateral. This is called "leverage" in the jargon of financial markets.
In turn, the borrowed funds are invested in other financial assets, multiplying the demand for
credit and financial assets. As demand rises, more sophisticated financial assets are invented,
including many forms of financial derivatives. A major portion of the accumulated debt remains
serviceable only as long as the prices of most assets will rise or at least remain relatively
stable. If prices turn down, they easily can lead to a chain-reaction. If investors respond instinctively
like a herd, they will bring a far-reaching collapse that constitutes a crisis.
As the flow of financial assets climbs, some bankers, brokers, and managers of financial institutions
become prominent players in the competition for investor dollars. Some become known for picking
profitable places to invest and for promoting their selections successfully. This can influence
markets if people have confidence in their advice. A notorious example of the influence of prominent
players was the attack on British sterling in 1992 by George Soros' Quantum Fund. Believing that
sterling was overvalued, the Fund quietly established credit lines that allowed it to borrow $15
billion worth of sterling and sell it for dollars at the then "overvalued" price. Its purpose,
of course, was to pay back the loan with cheaper pounds after they had depreciated. Having gone
long on dollars and short on sterling, Soros decided to speak up noisily. He publicized his short-selling
and made statements in newspapers that the pound would soon be devalued. It wasn't long before
sterling was devalued; he made $1 billion in profit.
The point can be made more generally: financial markets are subject to manipulation because
they have become socially structured. Market leaders and financial gurus are admired and followed
(at least until very recently). The heavyweights thus dominate the business. An obvious consequence
of this is that there is a strong tendency in financial markets for further concentration of resources.
Another source of the power of financial actors is their obvious affinity for the rampant free-market
philosophy of neo-liberalism. The freedom with which they move financial capital around depends,
of course, on the market-friendly policies of the so-called Washington Consensus.19
As long as they are seen as part of the governing coalition, they derive special powers to regulate
themselves rather than be controlled by an independent government agency or civil society. Their
power also is reinforced by the activities of several collective associations of financial actors,20
which lobby on their behalf.
One more source of power for the financial actors is their knowledge that if they are big enough
and sufficiently interlaced with other financial actors, then the "system" will keep them from
failing. Consider the case of Long-term Capital Management, a hedge fund partnership started in
1994. It was able to borrow from various banks the equivalent of forty times its capitalization
in order to make bets on changes in the relative prices of bonds in the U.S. and abroad. When
the Russian government announced a devaluation and debt moratorium in August, 1998, it produced
losses that the fund could not sustain. Nor could some of the banks that had loaned large amounts
to the fund. Accordingly, the Federal Reserve Bank of New York, fearful that the risk to the entire
system was too high, orchestrated a private rescue operation by fourteen banks and other financial
institutions, which re-capitalized the company for $3.5 billion.
Financial actors also have the power indirectly to influence non-financial actors such as firms
or states. By providing economic incentives to gamble and speculate on financial instruments,
global financial markets divert funds from long-term productive investments. In all probability,
they also encourage banks and financial institutions to maintain a regime of higher real interest
rates that reduce the ability of productive enterprises to obtain credit. The volatility of global
financial markets, moreover, brings uncertainty and volatility in interest rates and exchange
rates that are harmful to various sectors of the real economy, particularly international trade.
The above stories about George Soros and Long-term Capital Management are good illustrations
of the consequences for non-financial actors of actions by financial actors. Both episodes are
examples of games that are basically zero-sum, at least in the short-run. Nothing new was produced;
no new values were created. In the 1992 case about speculating against sterling, the Quantum Fund's
profits were at the expense of the British government, especially the Bank of England, and British
taxpayers. In 1998, the losses suffered by Long-term Capital Management came out of the pockets
of the stockholders of the banks that bailed it out, as the stock-market value of their shares
depreciated. Hence, the financial system tends to feed itself by drawing more resources from other
sectors of the economy, undermining the vitality of the real economy.
of global financial flows
The dominant economic ideology of the last twenty-five years has been embodied in the so-called
Washington Consensus. It is a "market-friendly" ideology that traces its roots to longstanding
policies of the IMF that encourage macroeconomic "stabilization;" to adoption by the World Bank
of ideas in vogue in Washington early in the Reagan period concerning deregulation and supply-side
economics; to the zeal of the Thatcher government in England for privatizing public enterprises;
and perhaps most of all to the neo-liberal tendencies of the business community and the economics
profession in the U.S. The implementation of these policies of economic "reform," by first "stabilizing"
the macro-economy and then "adjusting" the market so that it can perform more efficiently, are
supposed to pay off in the form of faster output growth and rising real incomes
Among these policy prescriptions is financial liberalization in both the developed and the
developing countries. Domestically it is achieved by weakening or removing controls on interest
and credit and by diluting the differences between banks, insurance and finance companies. International
financial liberation, on the other hand, demands removal of controls and regulations on both the
inflows and outflows of financial instruments that move through foreign exchange markets. It is
the implementation of these reforms that is perhaps the single most important cause of the surge
in global financial flows. To be sure, the influence of technological advances has broken the
natural barriers of space and time for financial markets as twenty-four hour electronic trading
has grown. The fact that throughout most of the 1980s and 1990s the developed countries suffered
from over-capacity and overproduction in manufacturing may also have led the owners of financial
capital to look for alternative profit opportunities.
It now is time to ask whether the implementation of all these reforms, on balance, has produced
good or bad results. The focus of this section will be mostly on the consequences of large and
expanding international financial flows. After all, they are the main concern of this essay. But
first, we should ask whether or not the policies of growth and rising real incomes promoted by
the Washington Consensus have borne fruit.
There is little doubt that the introduction of the Washington Consensus' policy mix expanded
the volume of international trade. As a result, trade in goods and services has grown at more
than twice the rate of global gross domestic product (GDP), and developing countries' share of
trade has risen from 23 to 29 percent. Increasing numbers of firms from developing countries,
like their industrial-country counterparts, engage in transnational production and adopt a global
perspective in structuring their operations. The flow of foreign direct investments and foreign
portfolio investments has multiplied even more rapidly than trade, despite the financial instability
experienced in Asia, Brazil, Russia, and elsewhere in recent years.
The effects of liberalization have not been uniformly favorable, however. After at least ten
full years of experience with the Washington Consensus, several recent studies have begun to assess
the consequences for developing countries of this experiment in more open markets.21
Except for the years of crisis in a number of the countries studied, most developing countries
achieved moderate growth rates of gross domestic product in the 1990s - considerably higher than
in the l980s in Africa and Latin America during the debt crisis, but remarkably unchanged in most
other regions. Moreover, average annual growth in the 1990s was slightly lower than in the twenty-five
years preceding the debt crisis when a strategy of substituting domestic production for imports
was in fullest use. When population growth rates are taken into consideration, the growth rate
of per capita income in the developing countries studied during the 1990s also was somewhat lower
than in the 1960s and 1970s. Toward the end of the 1990s, growth tapered off in many countries
due to emerging domestic financial crises or external events. There is little evidence in these
figures, therefore, to suggest the strategy of liberalization boosted growth rates appreciably.
Nor did the distribution of income improve in most developing countries in the 1990s. On the
contrary, virtually without exception the wage differentials between skilled and unskilled workers
rose with liberalization. The reasons for this varied widely among countries, but one of the most
important reasons was the fact that the number of relatively well-paid jobs in sectors of the
economy involved with international trade, though growing, was insufficient to absorb available
workers, forcing many workers into more precarious and poorly paid employment in the non-traded,
informal trade, and service sectors or where traditional agriculture served as a sponge for the
labor market. Between the mid-1960s and the late-1990s, the poorest 20 percent of the world population
saw its share of income fall from 2.3 to 1.4 percent. Meanwhile, the share of the wealthiest quintile
increased from 70 to 85 percent.22
While all markets are imperfect and subject to failure, financial markets are more prone than
others to fail because they are plagued with three particular shortcomings: asymmetric information,
herd behavior and self-fulfilling panics. Asymmetric information is a problem whenever one party
to an economic transaction has insufficient information to make rational and consistent decisions.
In most financial markets where borrowing and lending take place, borrowers usually have better
information about the potential returns and risks associated with the investments to be financed
by the loans than do the lenders. This becomes especially true as financial transactions disperse
across the globe, often between borrowers and lenders of widely different cultures.
Asymmetric information leads to adverse selection and moral hazard. Adverse selection occurs
when, say, lenders have too little information to choose from among potential borrowers those
who are most likely to use the loans wisely. The lenders' gullibility, therefore, attracts more
unworthy borrowers. Moral hazard occurs when borrowers engage in excessively risky activities
that were unanticipated by lenders and lead to significant losses for the lender. Yet another
form of moral hazard occurs when lenders indulge in lending indiscriminately because they assume
that the government or an international institution will bail them out if the loans go awry.
A good illustration of asymmetric information is the story of bank lending following OPEC's
large increase in oil prices following 1973. Awash in cash, the oil exporters deposited large
amounts in commercial banks that then perfected the Euro-currency loan for developing countries.
Eager to put excess reserves to use, the banks spent little time discriminating among potential
borrowers, in part because they believed host governments or international agencies would guarantee
the loans. At the same time, developing countries found they could readily borrow not only to
import oil, but also to increase other kinds of expenditures. This meant they could use borrowed
funds to maintain domestic spending rather than be forced to adjust to the new realities of higher
prices for necessary imports. There is considerable evidence that moral hazard also was present
in the Mexican crises in 1982 and 1994, and in the Southeast Asian crises in 1997-8.
Yet another illustration of asymmetric information is the tendency of financial firms, especially
on Wall Street and in the City of London, to invent ever more complex derivatives to shift risk
around the financial system. The market for these products is growing rapidly, both on futures
and options exchanges (two of the several places where derivatives are traded). A financial engineer,
for example, can take the risk in, say, a bond and break it down into a series of smaller risks,
such as that inflation will reduce its real value or that the borrower will default. These smaller
risks can then be priced and sold, using derivatives, so that the bondholder keeps only those
risks he wishes to bear. But this is not a simple task, particularly when it involves assets with
risk exposures far into the future and which are traded so rarely that there is no good market
benchmark for setting the price. Enron, for instance, sold a lot of these sorts of derivatives,
booking profits on them immediately even though there was a serious doubt about their long-term
profitability. Stories of huge losses incurred in derivative trading are legion. The real challenge
before central banks and regulatory bodies is to curb speculative behavior and bring discipline
in derivative markets.
A second source of risk in financial markets is the tendency of borrowers and lenders alike
to engage in herd behavior. John Maynard Keynes, writing in the 1930s, suggested that financial
markets are like "beauty contests." His analogy was to a game in the British Sunday newspapers
that asked readers to rank pictures of women according to their guess about the average choice
by other respondents. The winner, therefore, does not express his own preferences, but rather
anticipates "what average opinion expects average opinion to be." Accordingly, Keynes thought
that anyone who obtained information or signals that pointed to swings in average opinion and
to how it would react to changing events had the basis for substantial gain. Objective information
about economic data was not enough. Rather, simple slogans "like public expenditure is bad," "lower
unemployment leads to inflation," "larger deficits lead to higher interest rates," were then the
more likely sources of changes in public opinion. What mattered was that average opinion believed
them to be true, and that advance knowledge of, say, more public spending, lower unemployment,
or larger deficits, respectively, offered the speculator a special advantage.
A financial market that operates as a beauty contest is likely to be highly unstable and prone
to severe changes. One reason for this is that people trading in financial assets, even today,
know very little about them. People who hold stock know little about the companies that issued
them. Investors in mutual funds know little about the stocks their funds are invested in. Bondholders
know little about the companies or governments that issued the bonds. Even knowledgeable professionals
are often more concerned with judging how swings in conventional opinion might change market values
rather than with the long-term returns on investments. Indeed, since careful analysis of risks
and rewards is costly and time consuming, it often makes sense for fund managers and traders to
follow the herd. If they decide rationally not to follow the herd, their competence may be seriously
questioned. On the other hand, if fund managers follow the herd and the herd suffers losses, few
will question their competence because others too suffered losses. When financial markets are
operated like a beauty contest, everyone wants to sell at the same time and nobody wants to buy.
The financial markets behaved as predicted shortly after several industrial countries, including
the U.S. and Germany, abolished all restrictions on international capital movements in 1973. The
new system proved to be highly volatile, with exchange rates, interest rates, and financial asset-prices
subject to large short-term fluctuations. The markets also were susceptible to contagion when
financial tremors spread from their epicenter to other countries and markets that seemingly had
little connection with the initial problem. In less than five years, it already was clear that
both the surpluses and the deficits on the major countries' balance of payments were getting larger,
not smaller, despite significant changes in the exchange rates.
In some cases, a financial crisis can be self-fulfilling. A rumor can trigger a self-fulfilling
speculative attack, e.g. on a currency, that may be baseless and far removed from the economic
fundamentals (unlike the Soros story above). This can cause a sudden shift in the herd's intentions
and lead to unanticipated market movements that create severe financial crises. Consider, for
example, the succession of major financial crises that have pock-marked the recent history of
international financial markets, including Latin America's Southern Cone crisis of 1979-81, the
developing-country debt crisis of 1982, the Mexican crisis of 1994-95, the Asian crisis of 1997-98,
the Russian crisis of 1998, the Brazilian crisis of 1999, and the Argentine crisis of 2001-02.
Perhaps the Asian crisis of 1997-98 is the most interesting in this regard, for there were
relatively few signals beforehand of impending crisis. All the main East Asian economies displayed
in 1994-96 low inflation, fiscal surpluses or balanced budgets, limited public debt, high savings
and investment rates, substantial foreign exchange reserves and no signs of deterioration before
the crisis. This background has led many analysts to suppose that the crisis was a mere product
of the global financial system. But what could have triggered the herd to stampede out of Asian
currencies? No doubt several factors were at work. Before the crisis that started in the summer
of 1997, there was a rise in short-term lending to Asians by Western and Japanese banks with little
or no premiums, a fact that the Bank for International Settlement raised questions about. Alert
investors, especially hedge funds, also noticed that substantial portions of East and Southeast
Asian borrowings were going into non-productive assets and real estate that often were linked
to political connections. In fact, some of the funds pouring into non-productive assets were coming
out of the productive sector, mortgaging the longer-term viability of some real economies. Information
about the structure and policies of financial sectors was opaque. Thus, opinions began to change
among key lenders about the regulation of financial sectors in several Asian countries and their
destabilizing lack of transparency. Suddenly, several important hedge funds reduced their exposure
by shorting currency futures, followed quickly by Western mutual funds. The calling of loans led
quickly to deep depression in several Asian countries. It has been estimated that the Asian crisis
and its global repercussions cut global output by $2 trillion in 1998-2000.
of government autonomy
Both economic theory and the experience of managing the external financial affairs of nations
tell us that it is virtually impossible to maintain (1) full financial mobility, (2) a fixed exchange
rate, and (3) freedom to seek macro-economic balance (full employment with little inflation) with
appropriate monetary and fiscal policies. Only two of these policy objectives can be consistently
maintained. If the authorities try to pursue all three, they will sooner or later be punished
by destabilizing financial flows, as in the run up to the Great Depression around 1930 and in
the months before sterling's collapse 1992. If a government tries to stimulate its economy with
lax monetary policy, for example, and players with significant market power like George Soros
sense that at a fixed exchange rate, foreigners will be unwilling to lend enough to finance the
country's current account deficit, they will begin to flee the home currency in order to avoid
the capital losses they will suffer if and when there is a devaluation. If reserve losses accelerate
and more players follow suit, crisis ensues. The authorities are forced to devalue, interest rates
soar, and the successful attackers sit back to count their profits.
For nations wishing to retain reasonably independent monetary and fiscal authority in order
to cater to domestic needs, the solution is to allow the exchange rate to move up or down as conditions
in the foreign exchange markets dictate, or to establish some sort of control over the movement
of financial instruments in and out of the country, or to devise some combination of these two
adjustment mechanisms. The debate over whether fixed or flexible exchange rates is the wiser policy
continues to rage in academic quarters and in finance ministries all over the world. For the most
part, the international business community prefers reasonably fixed exchange rates in order to
minimize their costs of hedging foreign currency positions. Thus instituting some form of control
over speculative financial movements may be an appropriate solution to the "trilemma."
The capacity of a nation to levy enough taxes to finance needed public expenditures is another
important reason to retain independent authority. A central function of government has been to
insulate domestic groups from excessive market risks, particularly those originating in international
transactions. This is the way governments have maintained domestic political support for liberalizing
trade and finance throughout the postwar period. Yet many governments are less able today to help
citizens that are injured by freer markets with unemployment compensation, severance payments,
and adjustment assistance because the slightest hint of raising taxes to pay for these vital public
services leads to capital flight in a world of heightened financial mobility.
This is a dilemma. Increased integration into the world economy has raised the need of governments
to redistribute tax revenues or implement generous social programs in order to protect the vast
majority of the population that remains internationally immobile. At the same time, governments
find themselves less able to maintain the safety nets needed to preserve social stability. It
seems reasonable to suppose, therefore, that doing things that will bolster the ability of governments
to levy sufficient taxes - curbing tax avoidance by transnational corporations, controlling offshore
tax havens, regulating capital flight - would help make globalization slightly more democratic.
The people who benefit from speculative financial movements are, for the most part, better
educated and wealthier than the vast majority of fellow citizens. They are the elites, whatever
the country. As noted above, they have fewer connections to the real economy of production and
exchange than most people. And their purpose in trading financial assets, again for the most part,
is to make a profit quickly rather than wait for an investment project to mature.
People who do not participate directly in the buying and selling of short-term financial instruments
are nonetheless influenced indirectly by the macroeconomic instability and contagion that often
accompany interruptions in financial market flows. This is true for people both in developed and
developing countries. In developed countries, the voracious appetite of financial markets for
more and more resources saps the vitality of the real economy - the economy that most people depend
upon for their livelihood. It has been shown that real interest rates rise as a result of the
expansion of speculative financial markets. This rise in real interest rates, in turn, dampens
real investment and economic growth while serving to concentrate wealth and political power within
a growing worldwide rentier class (people who depend for their income on interest, dividends,
and rents).23 Rather, the long-term health of the economy
depends upon directing investable funds into productive investments rather than into speculation.
In developing countries, attracting global investors' attention is a mixed blessing. Capital
market inflows provide important support for building infrastructure and harnessing natural and
human resources. At the same time, surges in money market inflows may distort relative prices,
exacerbate weakness in a nation's financial sector, and feed bubbles. As the 1997 Asian crisis
attests, financial capital may just as easily flow out of as into a country. Unstable financial
flows often lead to one of three kinds of crises:
- Fiscal crises. The government abruptly loses the ability to roll over foreign debts and
attract new foreign loans, possibly forcing the government into rescheduling or default of
- Exchange crises. Market participants abruptly shift their demands from domestic currency
assets to foreign currency assets, depleting the foreign exchange reserves of the central bank
in the context of a pegged exchange rate system.
- Banking crises. Commercial banks abruptly lose the ability to roll over market instruments
(i.e., certificates-of-deposit) or meet a sudden withdrawal of funds from sight deposits, thereby
making the banks illiquid and possibly insolvent.
Although these three types of crises sometimes appear singly, they more often arrive in combination
because external shocks or changed market expectations are likely to occur simultaneously in the
market for government bonds, the foreign exchange market, and the markets for bank assets. Approximately
sixty developing countries have experienced extreme financial crises in the past decade.24
The vast majority of people in the developing world suffer from these convulsive changes. They
are tired of adjusting to changes over which they exercise absolutely no control. Most people
in these countries view Western capitalism as a private club, a discriminatory system that benefits
only the West and the elites who live inside "the bell jars" of poor countries. Even as they consume
the consumer goods of the West, they are quite aware that they still linger at the periphery of
the capitalist game. They have no stake in it, and they believe that they suffer its consequences.
As Hernando deSoto puts it, "Globalization should not be just about interconnecting the bell jars
of the privileged few."25
Karl Polanyi in The Great Transformation sought to explain how the "liberal creed" contributed
to the catastrophes of war and depression associated with the first half of the twentieth century.
Polanyi's central argument, which in fact can be traced back to Adam Smith, is that markets do
indeed promote efficiency and change, but that they achieve this through undermining social coherence
and solidarity. Markets must therefore be embedded within social institutions that mitigate their
The evidence of more recent times suggests that the global spread of free-market policies has
been accompanied by the decline of countervailing institutions of social solidarity. Indeed, a
main feature of the introduction of market-friendly policies has been to weaken local institutions
of social solidarity. Consider, for example, the top-down policy prescriptions of the IMF and
World Bank during the developing world's debt crisis in the 1980s. These policies evolved into
an intricate web of expected behaviors by developing countries. In order for developing countries
to expect private businesses and financial interests to invest funds within their borders and
to boost the growth potential of domestic economies, they needed to drop the "outdated and inefficient"
policies that dominated development strategies for most of the postwar period and adopt in their
place policies that are designed to encourage foreign trade and freer financial markets. Without
significant adjustments in the ways economies were managed, it was suggested, nations soon would
be left behind.
The list of Washington Consensus requirements was long and daunting:
- Make the private sector the primary engine of economic growth
- Maintain a low rate of inflation and price stability
- Shrink the size of the state bureaucracy
- Maintain as close to a balanced budget as possible, if not a surplus
- Eliminate or lower tariffs on imported goods
- Remove restrictions on foreign investment
- Get rid of quotas and domestic monopolies
- Increase exports
- Privatize state-owned industries and utilities
- Deregulate capital markets
- Make currency convertible
- Open industries, stock, and bond markets to direct foreign ownership
- Deregulate the economy to promote domestic competition
- Eliminate government corruption, subsidies and kickbacks
- Open the banking and telecommunications systems to private ownership and competition
- Allow citizens to choose from an array of competing pension options and foreign-run pension
and mutual funds.
In a provocative article, Ute Pieper and Lance Taylor point out that market outcomes often
conflict with other valuable social institutions. In addition, they emphasize that markets function
effectively only when they are "embedded" in society. The authors then look carefully at the experience
of a number of developing countries as they struggled to comply with the policy prescriptions
of the IMF and the Fund. In almost every case, they demonstrate conclusively that the impact of
these efforts was to make society an "adjunct to the market."26
An appropriate balance is not being struck between the economic and non-economic aspirations
of human beings and their communities. Indeed, the evidence is mounting that globalization's trajectory
can easily lead to social disintegration - to the splitting apart of nations along lines of economic
status, mobility, region, or social norms. Globalization not only highlights and exacerbates tensions
among groups; it also reduces the willingness of internationally mobile groups to cooperate with
others in resolving disagreements and conflicts.
History confirms that free-markets are inherently volatile institutions, prone to speculative
booms and busts. Overshooting, especially in financial markets, is their normal condition. To
work well, free markets need not only regulation, but active management. During the first half
of the post-war era, world markets were kept reasonably stable by national governments and by
a regime of international cooperation. Only lately has a much earlier idea been revived and made
an orthodoxy - the idea adopted by the Washington Consensus that, provided there are clear and
well-enforced rules-of-the-game, free markets can be self-regulating because they embody the rational
expectations that participants form about the future.
On the contrary, since markets are themselves shaped by human expectations, their behavior
cannot be rationally predicted. The forces that drive markets are not mechanical processes of
cause and effect, as assumed in most of economic theory. They are what George Soros has termed
"reflexive interactions."27 Because markets are governed
by highly combustible interactions among beliefs, they cannot be self-regulating.
The question before us then, is what could be done to better regulate financial markets and
to bring active management back into the task of "embedding" markets in society, rather than the
other way around? Monetary authorities such as the Federal Reserve System in the U.S. and the
central banks of other countries were formed long ago in order to dampen the inherent instabilities
of financial market in their home countries. But the evolution of an international regulatory
framework has not kept pace with the globalization of financial markets. The International Monetary
Fund was not designed to cope with the volume and instability of recent financial trends.
Given the problems outlined above about short-term speculative financial transactions, one
might wonder why national policy-makers have not insulated their financial markets by imposing
some sort of control over financial capital. The answer, of course, is that some have continued
trying to do so despite discouragement from the IMF. For example, some have put limitations on
the quantity, conditions, or destinations of financial flows. Others have tried to impose a tax
on short-term borrowing by national firms from foreign banks. This is said to be "market-based"
because it operates by altering the cost of foreign funds. If such transactions were absolutely
prohibited, they would be called "non-market" interventions.
A more extreme form of financial capital controls, one that controls movement of foreign exchange
across international borders, also has been tried in a number of countries. This form of control
requires that some if not all foreign currency inflows be surrendered to the central bank or a
government agency, often at a fixed price that differs from that which would be set in free market.
The receiving agency then determines the uses of foreign exchange. The absence of exchange controls
means that currencies are "convertible."
The neo-liberal argument opposing financial capital controls asserts that their removal will
enhance economic efficiency and reduce corruption. It is based on two basic propositions in economic
theory that depend for their proof on perfectly competitive markets in the real economy and perfectly
efficient gatherers and transmitters of information in financial markets. Neither assumption is
realistic in today's world. Indeed, a number of empirical studies have reported the effectiveness
of capital controls in controlling capital flight, curbing volatile capital flows and protecting
the domestic economy from negative external developments.
Developing countries have only recently abandoned, or still maintain, a variety of control
regimes. Latin American countries traditionally have used market-based controls, putting taxes
and surcharges on selected financial capital movements or tying them up in escrow accounts. Non-market
based restrictions were more common in Asia until the early 1990s. Many commentators believe that
their sudden removal in the early 1990s was a contributing cause to the Asian financial crises
in 1997-8. The experience of two countries, Malaysia and Chile, with capital controls is especially
Malaysia, unlike its Asian neighbors, was reluctant to remove its restrictions on external
borrowing by national firms unless they could show how they could earn enough foreign exchange
to service their debts. Then when the Asian crises hit, its government imposed exchange controls,
in effect making its local currency that was held outside the country inconvertible into foreign
exchange. After the ringget was devalued, exporters were required to surrender foreign currency
earnings to the central bank in exchange for local currency at the new pegged rate. The government
also limited the amount of cash nationals could take abroad, and it prohibited the repatriation
of earnings on foreign investments that had been held for less than one year. Thus, Malaysia's
capital controls were focused mostly on controlling the outflow of short-term financial transactions.
Happily, the authorities were able to stabilize the currency and reduce interest rates, leading
to a degree of domestic recovery.28
Chile, on the other hand, tried to limit the inflow of short-term financial transactions. It
did so by imposing a costly reserve requirement on foreign-owned capital held in the country for
less than one year. Despite attempts to stimulate foreign direct investment of the funds, most
of the reserve deposits were absorbed in the form of increased reserves at the central bank. In
turn, this created a potential for expanding the money supply, which the government feared would
lead to inflation. Rather than allow this to happen, the government "sterilized" the inflows by
selling government bonds from its portfolio. But this pushed down the prices of bonds and pushed
up the interest rates on them, discouraging business investment. Finally, when prices of copper
(Chile's primary export) fell sharply in 1998, the control regime was scrapped.29
A global tax on international currency movements was first proposed by James Tobin, a Yale
University economist, in 1972.30 He suggested that a
tax of one-quarter to one percent be levied on the value of all currency transactions that cross
national borders. He reasoned that such a tax on all spot transactions would fall most heavily
on transactions that involve very short round-trips across borders. In other words, it would be
speculators with very short time-horizons that the tax would deter, rather than longer-term investors
who can amortize the costs of the tax over many years. For example, the yearly cost of a 0.2 percent
round trip tax would amount to 48 percent of the value of the traded amount if the round trip
were daily, 10 percent if weekly and 2.4 percent if monthly. Since at least eighty percent of
spot transactions in the foreign exchange markets are reversed in seven business days or less,
the tax could have a profound effect on the costs of short-term speculators.
Of course, for those who believe in the efficiency of markets and the rationality of expectations,
a transactions tax would only hinder market efficiency. They argue that speculative sales and
purchases of foreign exchange are mostly the result of "wrong" national monetary and fiscal policies.
While we readily admit that national policies sometimes do not accord with desired objectives,
they nonetheless have little relevance for speculators focused on the next few seconds, minutes
Tobin did not intend for his proposal to involve a supranational taxation authority. Rather,
governments would levy the tax nationally. In order to make the tax rate uniform across countries,
however, an international agreement would have to be entered into by at least the principal financial
centers. The revenue obtained from the tax could be designated for each country's foreign exchange
reserve for use during periods of instability, or it could be directed into a common global fund
for uses like aid to the poorest nations. In the latter case, the feasibility of the tax also
would depend on an international political agreement. The revenue potential is sizeable, and could
run as high as $500 billion annually.
There are two other advantages often cited by proponents of the Tobin tax. Tobin's original
rationale for a foreign exchange transactions tax was to enhance policy autonomy in a world of
high financial capital mobility. He argued that currency fluctuations often have very significant
economic and political costs, especially for producers and consumers of traded goods. A Tobin
tax, by breaking the condition that domestic interest rates may differ from foreign interest rates
only to the extent that the exchange rate is expected to change (see p. 10), would allow authorities
to pursue different policies than those prevailing abroad without exposing them to large exchange
rate movements. More recent research suggests that this is only a very modest advantage.31
An additional advantage of the tax is that it could facilitate the monitoring of international
financial flows. The world needs a centralized data-base on all kinds of financial flows. Neither
the Bank for International Settlements nor the IMF has succeeded in providing enough information
to monitor them all. This information should be regularly shared among countries and international
institutions in order to collectively respond to emerging issues.
The feasibility issues raised by the Tobin tax are more political than technical. One of the
issues is about the likelihood of evasion. All taxes suffer some evasion, but that has rarely
been a reason for avoiding them. Ideally all jurisdictions should be a party to any agreement
about a common transactions tax, since the temptation to trade through non-participating jurisdictions
would be high. Failing that, one could levy a penalty on transactions with "Tobin tax havens"
of, say, double the normal tax rate. Moreover, one could limit the problem of substituting untaxed
assets for taxed assets by applying the tax to forwards, swaps and possibly other contracts.
Tobin and many others have assumed that the task of managing the tax should be assigned to
the IMF. Others argue that the design of the tax is incompatible with the structure of the IMF
and that the tax should be managed by a new supranational body. Which view will prevail depends
upon the resolution of other outstanding issues. The Tobin tax is an idea that deserves careful
consideration. It should not be dismissed as too idealistic or too impractical. It addresses with
precision the problems of excessive instability in the foreign exchange markets, and it yields
the additional advantage of providing a means to assist those in greater need.
The IMF was established in 1944 to provide temporary financing for member governments to help
them maintain pegged exchange rates during a period of internal adjustment. With the collapse
of the pegged exchange rate regime in 1971, that responsibility has been eclipsed by its role
as central arbiter of financial crises in developing countries. As noted above (p. 20), these
crises may be of three different kinds: fiscal crises, foreign exchange crises, and banking crises.
Under current institutional arrangements, a nation suffering a serious fiscal crisis that could
easily lead to default must seek temporary relief from its debts from three different (but interrelated)
institutions: the IMF, which is sometimes willing to renegotiate loans in return for promises
to adopt more stringent policies (see above); the so-called Paris Club that sometimes grants relief
on bilateral (country to country) credits; and the London Club that sometimes gives relief on
bank credits. This is an extremely cumbersome process that fails to provide debtor countries with
standstill protection from creditors, with adequate working capital while debts are being renegotiated,
or with ways to ensure an expeditious overall settlement. The existing process often takes several
years to complete.
There is a growing consensus that this problem is best resolved with creation of a new international
legal framework that provides for de facto sovereign bankruptcy. This could take the form of an
International Bankruptcy Code with an international bankruptcy court, or it could involve a less
formal functional equivalent to its mechanisms: automatic standstills, priority lending, and comprehensive
reorganization plans supported by rules that do not require unanimous consent. Jeffrey Sachs recommends,
for example, that the IMF issue a clear statement of operating principles covering all stages
of a debtor's progression through "bankruptcy" to solvency. A new system of emergency priority
lending from private capital markets could be developed, he suggests, under IMF supervision. He
also feels that the IMF and member governments should develop model covenants for inclusion in
future sovereign lending instruments that allow for priority lending and speedy renegotiation
of debt claims.32
At the Joint Meeting of the IMF and the World Bank in September, 2002, the policy committee
directed the IMF staff to develop by April, 2003, a "concrete proposal" for establishing an internationally
recognized legal process for restructuring the debts of governments in default. It also endorsed
efforts to include "collective action" clauses in future government bond issues to prevent one
or two holdout creditors from blocking a debt-restructuring plan approved by a majority of creditors.
The objective of both proposals is to resolve future debt crises quickly and before they threaten
to destabilize large regions, as happened in Southeast Asia in 1997-98.
Member countries rarely receive support from the IMF any longer to maintain a particular nominal
exchange rate. Because financial capital is so mobile now, pegged exchange rates probably are
unsupportable. But there are special times when the IMF still might give such support during a
foreign exchange crisis. International lending to support a given exchange rate is legitimate
if the government is trying to establish confidence in a new national currency, or if its currency
is recovering from a severe bout of hyperinflation. Ordinarily the foreign exchange should be
provided from an international stabilization fund supervised by the IMF.
National central banks usually supervise and regulate the domestic banking sector. Thus, banking
crises normally are handled by domestic institutions. This may not be possible, however, if the
nation's banks hold large short-term liabilities denominated in foreign currencies. If the nation's
central bank has insufficient reserves of foreign currencies to fund a large outflow of foreign
currencies, there may be circumstances when the IMF or other lenders may wish to act as lenders-of-last-resort
to a central bank under siege. Nations like Argentina that have engaged in "dollarization" are
learning about the downside risks of holding large liabilities denominated in foreign currencies.
The best way to avoid this problem is for governments and central banks to restrict the use of
foreign currency deposits or other kinds of short-term foreign liabilities at domestic banks.
Overall, what is most needed is the availability of more capital in developing countries and
much quicker responses, amply funded, to emerging financial crises.. George Soros has argued powerfully
that the IMF needs to establish a better balance between crisis prevention and intervention.33
The IMF has made some progress in prevention by introducing Contingency Credit Lines (CCLs). The
CCL rewards countries that follow sound policies by giving them access to IMF credit lines before
rather than after a crisis erupts. But CCL terms were set too high and there have been no takers.
Soros also has recommended the issuance of Special Drawing Rights (SDRs) that developed-countries
would donate for the purpose of providing international assistance. Its proceeds would be used
to finance "the provision of public goods on a global scale as well as to foster economic, social,
and political progress in individual countries."34
A growing number of civil society institutions, however, oppose giving more money to the IMF
unless it is basically reformed. They point out that it is a committed part of the Washington
Consensus, the application of whose policies have made societies adjuncts of the market. They
see the IMF as an instrument of the U.S. government and its corporate allies. The conditions it
attaches to loans for troubled countries often do more to protect the interests of first world
investors than to promote the long-term health of the developing countries. The needed chastening
of speculative investors does not occur under these circumstances. There is evidence that in several
major crises, IMF requirements for assisting nations have in fact worsened the situation and protracted
the crises. The IMF opposed the policies that enabled Malaysia to weather the crisis in Southeast
Asia, for example, while it urged the failed policies of other Southeast Asian nations. The vast
literature cited by Pieper and Taylor (p. 22) is a convincing chronicle of earlier missteps. For
such reasons as these, some civil society institutions argue that, unless IMF policies are changed,
giving the institution more money will do more harm than good.
Fortunately, the IMF's policies are beginning to change, partly as a result of criticisms by
civil society institutions, but more through recognition of the seriousness of the problems with
the present system. In the wake of recent financial crises, leaders in the IMF as well as the
World Bank are looking for ways to reform the international financial architecture. Arguably,
their emphasis is shifting away from slavish devotion to the prescriptions of the Washington Consensus
and toward more state intervention in financial markets. Joseph Stiglitz, the Nobel Laureate who
has been particularly critical of the IMF, nonetheless acknowledges that its policy stances are
The IMF has begun to recognize the importance of at least functional public interventions in
markets and the need to provide more supporting revenues. It has realized that controls on external
financial movements and prudent regulation can help contain financial crises. It has abandoned
the doctrine, long the backbone of structural adjustment policies, that raising the local interest
rate will stimulate saving and thereby growth. Both the IMF and the World Bank have rolled over
or forgiven the bulk of official debt owed by the poorest economies.
Whether these and other promising changes in IMF thinking and policy formation are sufficient
to assure that its future responses to crises will be benign still is not clear. While celebrating
what they view as belated improvements, many critics of the IMF among civil society institutions
are not convinced that they are sufficiently basic. Even if the IMF avoids repeating some of its
more egregious mistakes, some believe that it is likely to continue to function chiefly for the
benefit of the international financial community rather than the masses of people. Rather, they
believe that, at least in the long term, it would be much better for control over international
finance to reside in new institutions under a restructured United Nations. They favor the U.N.
because it has a broader mandate, is more open and democratic, and, in its practice, has given
much greater weight to human, social, and environmental priorities.
Many civil society institutions want the primary focus of reform to be on taming speculation,
restoring the control of their economies to nations, and embedding economies in the wider society.
They believe that if these policies are adopted there will be less need for large funding to deal
with financial crises. There remains, however, the fact that such crises are occurring and will
continue to occur for some time. The IMF is the only institution positioned to respond to these
crises. Hence, even for those who sympathize with the goals of the civil society institutions,
there is a strong argument for more financing for the IMF.
world financial authority
A variety of public and private citizens and institutions have recently proposed the establishment
of a World Financial Authority (WFA) to perform in the domain of world financial markets what
national regulators do in domestic markets. Some believe it should be built upon the foundation
of global financial surveillance and regulation that have already been laid by the Bank for International
Settlements in Basel, Switzerland. Others regard it as a natural extension of the activities of
the IMF. Still others are less interested in the precise institutional form it would take than
in the clear delineation of the tasks that need to be done by someone.
Its first task probably should be to provide sufficient and timely financial assistance during
crises to avert contagion and defaults. This requires a lender-of-last-resort with sufficient
resources and authority to disperse rescue money quickly. Perhaps the best example to date is
the bailout loan to Mexico by the U.S. Treasury and the IMF at the end of 1994. It supplied sufficient
liquidity for Mexico to make the transition back to stability and to pay back the loans ahead
of time. The management of the Asian crises in 1997-8, on the other hand, was badly handled. The
bailout packages offered by the IMF were not only significantly smaller than in the Mexico case;
they also were constrained with so many conditions that a year later only twenty percent of the
funds had been disbursed. This slow response to the crisis probably worsened the contagion. Surprisingly,
the error was repeated in the Russian crisis in 1998 and the Brazilian crisis in 1999.
A World Financial Authority also should provide the necessary regulatory framework within which
the IMF or a successor institution can develop as a lender-of-last-resort. As long as domestic
regulatory procedures function properly, there will be no need for a world authority to be involved,
any more than to certify that domestic regulatory procedures are effective. In countries where
domestic financial regulation is unsatisfactory, the WFA would assist with regulatory reform.
In this way, the WFA could aid financial reconstruction, reduce the likelihood of moral hazard,
and give confidence to backers of the operation.
There is little appetite today, especially in Washington, to create a new international bureaucracy.
This fact gives support to the idea of building the WFA from the existing infrastructure of the
Bank for International Settlements (BIS). The BIS is a meeting place for national central bankers
who have constructed an increasingly complicated set of norms, rules and decision-making procedures
for handling and preventing future crises. Its committees and cooperative cross-border regulatory
framework enjoy the confidence of governments and of the financial community. It may well be the
best place to govern an international regulatory authority at the present time.
and ethical considerations
While Christian theology cannot provide us with detailed recommendations on how to correct
the adverse consequences of speculative financial movements, it can provide us with an empowering
perspective or worldview. Our theological expressions of the faith describe the source of our
spiritual energy and hope. They betray our ultimate values and the source of our ethical norms.
They shape how we perceive and judge the "signs of the times."
world and human responsibilities
Nothing in creation is independent of God. "The earth is the Lord's and all that is in it,
the world, and all those who live in it." (Ps. 24:1 NRSV) Thus, no part of the creation - whether
human beings, other species, the elements of soil and water, even human-made things - is our property
to use as we wish. All is to be treated in accord with the values and ground rules of a loving
God, their ultimate owner, who is concerned for the good of the whole creation. All of God's creation
therefore deserves to be treated with appropriate care and concern, no matter how remote from
one's daily consciousness or existence.
The doctrine of creation reminds us that our ultimate allegiance is not to the nationalistic
and human-centered values of our culture, but rather to the values of the loving Maker of heaven
and earth. When we seek plenty obsessively, consume goods excessively, compete against others
compulsively, or commit ourselves to Economic Fate, we are worshiping false gods. Modern idolatries
are often encountered in economic forms, just as in the New Testament's warnings about the spiritual
perils of prosperity in the parables of the rich, hoarding fool (Luke 12:15-21) and the rich youth
(Matt. 19:16-24 and Luke 18:18-25).
The fact that so much of financial speculation is divorced from the real economy of production
and exchange suggests that its paper transactions are more like bets in a casino than an essential
component of God's real economy, which seeks the good of all creation. It is wrong to subject
people to the effects of wholesale gambling. The fact that the practice of financial speculation
is secretive, compulsively competitive, and frequented by lone rangers, moreover, hints at a cult
of false idols. Its practitioners, including especially day-traders, seem interested only in exceedingly
short-term personal financial advantage, unconcerned about the long-term consequences of their
actions or their impact on others. This also indicates a degree of idolatry that contradicts the
doctrine of creation.
The conviction that human beings have a God-given dignity and worth (Gen. 1:26-28) unites humanity
in a universal covenant of rights and responsibilities - the family of God. All humans are entitled
to the essential conditions for expressing their human dignity and for participation in defining
and shaping the common good. These rights include satisfaction of basic biophysical needs, environmental
safety, full participation in political and economic life, and the assurance of fair treatment
and equal protection of the laws. These rights define our responsibilities in justice to one another,
locally, nationally and - because they are human rights - internationally.
Financial speculation often leads to unmanageable floods of funds into and out of host societies,
creating unwanted bubbles and panics. Financial speculators normally ignore the human consequences
of their activities on the rights of people in host societies, where economic adjustments are
shared widely and painfully. Their primary interest is short-term personal financial gain. The
absence of a sense of covenantal unity with their brothers and sisters of the developing world
is a sad commentary on the governing ethic of speculators in the capital markets. Their arrogance
calls for some form of control over foreign exchange and financial capital markets.
The rights and responsibilities associated with the image of God are inextricably tied to the
stress on justice in Scripture and tradition. We render to others their due because of our loving
respect for their God-given dignity and value. The God portrayed in Scripture is the "lover of
justice" (Ps. 99:4, 33:5, 37:28, 11:7; Isa. 30:18, 61:8; Jer. 9:24). Justice is at the ethical
core of the biblical message. Faithfulness to covenant relationships, moreover, demands a justice
that recognizes special obligations, "a preferential option" to widows, orphans, the poor, and
aliens, which is to say the economically vulnerable and politically oppressed. Hence, the idea
of the Jubilee Year (Lev. 25) was meant to prevent unjust concentrations of power and poverty.
Jesus' ministry embodies concern for the rights and needs of the poor; He befriended and defended
the dispossessed and the outcasts.
The fact that the liberalization of trade and finance has failed to improve the distribution
of incomes, indeed, that it has widened the gap between rich and poor in virtually every country,
is not a sign of distributive justice but of its opposite. The standard of living for the least
skilled, least mobile, and poorest citizens of many developing countries has declined absolutely.
This, too, is an unjust result of a broken system. The fact that governments that wish to assist
the vulnerable and weak of their societies are less able to do so, in part because they no longer
can levy sufficient taxes on foreign interests, is a violation of justice in community.
Sin is a declaration of autonomy from God, a rebellion against the sovereign source of our
being. It makes the self and its values the center of one's existence, in defiance of God's care
for all. Sin tempts us to value things over people, measuring our worth by the size of our wealth
and the quantity of goods we consume, rather than by the quality of our relationships with God
and with others. Sin involves injustice because its self-centeredness defies God's covenant of
justice, grasping more than one's due and depriving others of their due.
Sin is manifested not only in individuals, but also in social institutions and cultural patterns.
These structural injustices are culturally acceptable ways of giving some individuals and groups
of people advantage over others. Because they are pervasive and generally invisible, they compel
our participation. They benefit some and harm many others. Whether or not we deserve blame as
individuals and churches for these social sins depends in part on whether we defend or resist
them, tolerate or reject them.
The fact that the freeing of financial markets has permitted financial speculators to engage
in high-risk gambles without regard to the consequences for others is abundant evidence of both
individual and institutional sin. The policies of the Washington Consensus frequently lead to
adverse consequences for the poor and the environment, even as its proponents gain advantages
from the implementation of such policies. They are another serious expression of social sin in
our time. These policies inevitably increase the concentration of economic power in fewer hands.
The fact that the global spread of free-market policies has led to the decline of countervailing
social solidarity means that it is easier for the centers of economic power to corrupt governments,
control markets, alienate neighbors, manipulate public opinion, and contribute to a sense of political
impotency in the public.
Church's mission and hope
The church is called to be an effective expression of the Reign of God, which Jesus embodied
and proclaimed. This ultimate hope is a judgment on our deficiencies
and a challenge to faithful service. God's goal of a just and reconciled world is not simply
our final destiny but an agenda for our earthly responsibilities. We are called to be a sign of
the Reign of God, on earth as it is in heaven, to reflect the coming consummation of God's new
covenant of shalom to the fullest extent possible.
new financial architecture
In her path-breaking book, Casino Capitalism,36 Susan
Strange likens the Western financial system to a vast casino. As in a casino,
"the world of high finance today offers the players a choice of games. Instead of roulette,
blackjack, or poker, there is dealing to be done - the foreign-exchange market and all its variations;
or in bonds, government securities or shares. In all these markets you may place bets on the future
by dealing forward and by buying or selling options and all sorts of other recondite financial
inventions. Some of the players - banks especially - play with very large stakes. There are also
many quite small operators. There are tipsters, too, selling advice, and peddlers of systems to
the gullible. And the croupiers in this global finance casino are the big bankers and brokers.
They play, as it were, "for the house.' It is they, in the long run, who make the best living."
She goes on to observe that the big difference between ordinary kinds of gambling and speculation
in financial markets is that one can choose not to gamble at roulette or poker, whereas everyone
is affected by "casino capitalism." What goes on in the back offices of banks and hedge funds
"is apt to have sudden, unpredictable and unavoidable consequences for individual lives."
It is this volatility, this instability in financial markets that has given rise to recurring
financial crises. They must be tamed. In the wake of recent financial crises, people are beginning
to look for ways to reform the international financial architecture. Although it is difficult
to move from general theological convictions to specific proposals, we offer the following suggestions
for consideration by Christians and other persons of good will.
- Capital controls should be an integral part of national strategies to tame the financial
system. They can be made an effective and meaningful tool to protect and insulate the domestic
economy from volatile capital flows and other negative external developments.
- Regulatory and supervisory measures should supplement capital controls when appropriate.
They should include regulation of financial derivatives and hedge funds. Regulation is a necessary
complement to domestic capital controls. Nations influenced by hedge funds and their complex
financial instruments should seek international cooperation, including the governments of host
countries, to regulate their practices.
- A new international legal framework should be created, which provides for de facto sovereign
bankruptcy. The existing international system for dealing with insolvent governments is woefully
inadequate. Provision must be made for automatic standstills, priority lending, and planned
- An international transactions tax (like the Tobin tax) should be designed and implemented
to discourage short-term speculative capital movements. It is neither "too idealistic" nor
"too impractical." It would reduce short-term trading and strengthen the defensibility of the
exchange rate regime.
- International cooperation should be sought to curb dubious activities of offshore financial
centers. Strict international regulation and supervision of offshore centers is essential to
curb tax and regulatory evasions. They also are a primary conduit for money laundering and
various criminal activities.
- The IMF's responsibilities as a lender-of-last-resort should be enhanced, expanding its
authority and resources to make possible quick action to avert financial crises. The IMF must
have effective and swift mechanisms to increase the Fund's access to official monies in times
of crisis, including authority to borrow directly from financial markets under those circumstances.
- A World Financial Authority based on the cross-border regulatory framework of the Bank
for International Settlements should be developed. It should provide the necessary regulatory
framework within which the IMF or a successor organization can develop as a lender-of-last-resort.
Of these recommendations, perhaps the most controversial is that more funds be given to the
IMF. We noted above that much of the criticism of the IMF is justified. We also acknowledged that
the IMF is improving its policies. We hope that these improvements will continue. Meanwhile, there
is no other viable candidate to serve as lender-of-last-resort - an absolutely essential feature
of any new financial architecture.
The major reason some civil society institutions resist funding the IMF further is its history
of misguided structural adjustment policies, policies that are now widely recognized to have caused
widespread suffering. We hope that recent changes will improve this situation as well and enable
the IMF to perform the important role we recommend for it.
Along with the World Bank, it is beginning to contextualize its performance criteria and conditionalities,
taking much more seriously the unique circumstances of particular economies. It is listening more
and nitpicking less. To be sure, the IMF is not likely to abandon its policy of making its loans
conditional on the adoption by borrowing countries of mutually agreed economic policies. Even
so, there is considerable evidence that when it has had more resources on hand, conditionality
has been correspondingly wiser and less draconian.
The IMF now recognizes that it can leave more decisions to developing countries partly because
these have better informed and more sophisticated employees than was once the case. Certainly
in Latin America and Asia and increasingly in Africa, country economic teams are better qualified
technically than the lower rung Ph.D.s from American and European universities to whom the IMF
and World Bank entrust their missions. Local economists can do financial programming and standard
macroeconomic modeling as well as or better than the people from Washington can; they also know
how to do investment project analysis. To be sure, decisions about financial and project plans
must include input from many other elements of a society.
We can encourage the IMF (and World Bank) to reverse the typical procedure in setting conditions
for multilateral loans. Instead of waiting for it to specify the policies that must be followed
to justify additional financing, country economic teams, in consultation with other agencies of
their government, should be allowed to propose economic programs to the IMF. Disagreements between
Washington staff assessments and the local teams could be resolved directly or by third-party
arbitration. The scope of economic conditionality could also be restricted, for example, just
to a balance-of-payments target, while the country could pursue its own agenda regarding inflation,
income distribution, and growth.
Christians can do
A primary part of the "principalities and powers" referred to in the Bible is composed of the
political-economic institutions and processes that govern how people relate economically to each
other and to God's whole creation. The church has a stake in their design. Yet many church members
feel powerless to change basic political-economic reality. They think either that the economic
conditions of society result "naturally" from the forces of markets that are only marginally within
the power of human control, or that economic conditions result from powerful interests that are
beyond the reach of ordinary citizens. Thus, there's nothing that can be done about it, or there's
nothing we can do about it.
On the contrary, Mobilization for the Human Family believes that the political economy is shaped
by deliberate social policy decisions; that conditions at any given time are the result of those
decisions; that conditions can be changed by human decisions; and that the will of a nation's
and the world's citizens about what the commitments and purposes of the nation and the world should
be can be expressed in the political economy through the framework of democratic process provided
in our national and transnational polity. Accordingly, we offer below some suggestions for action
that may be taken by individual Christians and by our churches and their denominations to correct
some correctable flaws of financial globalization.
by individual Christian
- Pray for persons working in governments, international organizations, institutions, and
non-governmental organizations who are trying to work toward a better world, including especially
a world financial architecture that better assures fairness in capital markets.
- In the management of personal and family investments, seek fuller understanding of the
uses to which the banks, companies, mutual funds, and investment counselors are putting your
money. Avoid speculative investments that are likely to be made without regard to their consequences
- Reflect upon decisions about work and career choices that are consistent with a Christ-like
commitment to economic justice for all.
- Organize Bible study in your local congregation, where possible together with people of
other backgrounds and life-styles, to learn and identify with God's continuing struggle to
seek economic justice in the world.
- Commit oneself to some voluntary organization that is trying to promote greater economic
justice in the local and/or global economy.
- Become involved politically in your area or nation, seeking political and economic change
in the direction of economic justice.
by churches and denominations
- Concern for economic justice must be fully reflected in the prayer life, worship, and educational
programs and mission outreach of all congregations.
- Seek assistance from members who work for banks, brokerage houses, and mutual funds to
help mould an educational program that will assist members of the congregation to become more
socially responsible investors.
- Seek collaborative programs among clusters of congregations, perhaps with the aid of local
Councils of Churches, to provide educational opportunities where Christians and other faith
groups can come to understand some of the complex economic issues amidst which they live and
work. Since virtually nothing is now available to explain the problems of financial speculation,
this paper could be used to assist study of this phenomenon.
- Over and beyond educational programs, local churches - again perhaps best working together
in the same neighborhood or town - can enter into a deliberate dialogue or partnership with
one or more voluntary bodies in the civic society, so as to put their energies into the health
of the wider society. Engagement with the International Forum on Globalization (l009 General
Kennedy Avenue #2, San Francisco, CA 94129) is a good way to explore the means of influencing
the debate on the globalization of trade and finance.
- At the denominational level, churches should review their investment criteria to reassure
themselves that social responsibility is a primary goal of their financial management.
- Also at the denominational level, agencies responsible for the formation of social witness
policies need to monitor global economic indicators on a continuing basis in order to assist
its programmatic agencies to form effective and timely social witness regarding the local and
national consequences of the globalization of trade and finance.
to know more?
Globalization is a vast topic. For a general introduction, see Sarah Anderson and John Cavanagh,
Field Guide to the Global Economy (New York: New Press, 2000) and Thomas Friedman, The Lexus and
the Olive Tree: Understanding Globalization (New York: Farrar Straus Giroux, 1999). A classic
introduction to the financial side of globalization is Susan Strange, Casino Capitalism, (New
York: Mnchester University Press, 1986). See also Kavaljit Singh, The Globalisation of Finance:
A Citizen's Guide (London: Zed Books, 1999) and John Eatwell and Lance Taylor, Global Finance
at Risk: The Case for International Regulation (New York: The New Press, 2000). The best introduction
to the Tobin Tax is Mahbub ul Haq et al (eds), The Tobin Tax: Coping with Financial Volatility
(New York: Oxford University Press, 1996). For how church people might react, see Pamela Brubaker,
Globalization at What Price? (Cleveland: Pilgrim Press, 2001).
- How have the linkages and interconnections of international finance impacted your life?
On balance, do you regard them as advantages or disadvantages for a healthy Christian life?
- The frequency and severity of recent financial crises have fueled calls for a radical redesign
of the rules of global finance. If you were the advisor to an international commission asked
to design "A New International Financial Architecture," what would you recommend?
- Do you favor allowing sovereign nations to declare bankruptcy? What Christian traditions
might be invoked to support or deny such an action?
- A growing number of civil society institutions oppose giving more money to the IMF. They
point out that it is part of the Washington Consensus, the application of whose policies have
made societies adjuncts of the market. Yet this paper suggests that the IMF needs more money.
As a committed Christian, which view do you favor?
- Is it too late to expect justice in a globalizing world? Since much of the direction the
global economy has taken is irreversible, how can a balance between market and society be negotiated?
How might Christians play a role in those negotiations?
1. Reported by Thomas L. Friedman, The Lexus and the Olive Tree
(New York: Farrar Staus Giroux, 1999) p.101.
2. John B. Cobb, Jr., (ed), (Claremont, CA: Mobilization for the
Human Family, 2000)
3. Karl Polanyi, The Great Transformation. The Political and Economic
Origins of Our Time (Boston: Beacon Press, 1957/1944)
4. Denys Hay (ed), The Age of the Renaissance (New York: McGraw-Hill,
5. Heikki Patomaki, Democratising Globalization (London: Zed Books,
6. Peter Garber, Famous First Bubbles: The Fundamentals of Early
Manias (Cambridge, MA: MIT Press, 2000). The quotation is from Charles Mackay, Memoirs of Extraordinary
Popular Delusions and the Madness of Crowds (London: Bentley, 1841) p.142.
7. For a summary of the vast literature on pre-World War I foreign
lending, see Albert Fishlow, "Lessons from the Past: Capital Markets in the 19th Century
and the Interwar Period," in M. Kahler (ed), The Politics of International Debt (Ithaca: Cornell,
8. Ibid, p.90.
9. Polanyi, op. cit. p.14.
10. J. T. Madden et al, America's Experience as a Creditor Nation
(Englewood Cliffs, N.J.: Prentice-Hall, 1937), p.74.
11. Reprinted in Madden et al, p.205.
12. John Kenneth Galbraith, The Great Crash, 1929 (Boston: Houghton
Mifflin, 1954), p.16.
13. For a helpful summary of the British and American plans at
Bretton Woods, see Raymond F. Mikesell, The Bretton Woods Debates: A Memoir (Princeton: IFC Essays
in International Finance no.192, 1994)
14. Jacques J. Polak, The Changing Nature of IMF Conditionality
(Princeton: IFS Essays in International Finance, no. 184, 1991.
15. Robert Triffin, Gold and the Dollar Crisis (New Haven: Yale
University Press, 1961.
16. The IET taxed foreign borrowings in the U.S. with the intention
of reducing the acquisition of dollars by foreigners; the U.S. government thought the dollar "overhang"
was getting too large.
17. This section draws upon Heikki Patomaki, Democratizing Globalization:
The Leverage of the Tobin Tax, (New York: Zed Books, 2001), chap. 2.
18. The prices a company charges itself for goods or services
purchased from one of its entities and sold by another. Multinational corporations with business
operations in many different countries try to charge prices that minimize their overall tax liabilities.
19. Roughly, a consensus between the U.S. Treasury, the IMF,
the World Bank, and the business community about the policies most likely to achieve free trade
and rapid growth: fiscal austerity, privatization, deregulation, and free movement of financial
20. International Organization of Securities Commissions, the
Joint Forum on Financial Conglomerates, the International Swaps and Derivatives Association, and
the Institute of International Finance..
21. See, for example, Amartya Sen, Development as Freedom. (New
York: Alfred A. Knopf, 1999); Lance Taylor (ed), External Liberalization, Economic Performance
and Social Policy.(New York: Oxford University Press, 2000); Dani Rodrik, The New Global Economy
and the Developing Countries: Making Openness Work. (Washington: Overseas Development Council,
1999); Enrique Ganuza, Lance Taylor, and Rob Vos (eds), Economic Liberalization and Income Distribution
in Latin America and the Caribbean. (New York: United Nations Development Programme, 2000).
22. United Nations Development Programme, Human Development Report.
New York: Oxford University Press, 2000.
23. David Felix, "Asia and the Crisis of Financial Globalization,"
in Dean Baker et al., (eds) Globalization and Progressive Economic Policy (Cambridge, U.K: Cambridge
University Press, 1998) pp.163-91.
24. Jeffrey D. Sachs, "Alternative Approaches to Financial Crises
in Emerging Markets," in Miles Kahler (ed), Capital Flows and Financial Crises (Ithaca, N.Y: Cornell
University Press, 1998)
25. The Mystery of Capital, (New York: Basic Books, 2000) p.207.
26. "The Revival of the Liberal Creed: the IMF, the World Bank,
and Inequality in a Globalized Economy," in Dean Baker op cit., pp. 37-63.
27. See his Underwriting Democracy (New York: The Free Press,
1991), part 3, and his On Globalization (New York: Public Affairs, 2002) ch. 4.
28. For additional details, see K. S. Jomo (ed), Malaysian Eclipse:
Economic Crisis and Recovery, (New York: Zed Books, 2001)
29. For more information, see Kavaljit Singh, Taming Global Financial
Flows New York: Zed Books, 2000) pp. 158-78. See also Carmen & Vincent Reinhart, "Some Lessons
for Policy Makers Who Deal with the Mixed Blessing of Capital Inflows," Miles Kahler (ed), Capital
Flows and Financial Crises (Ithaca: Cornell, 1998) pp. 93-124.
30. Given in 1972 at Princeton University and published subsequently
as "A Proposal for International Monetary Reform," Eastern Economic Journal 4 (July-October, 1978)
31. Mahbub ul Haq et al (eds), The Tobin Tax: Coping with Financial
Volatility (New York: Oxford University Press, 1996) passim.
32. Jeffrey Sachs, "Alternative Approaches to Financial Crises
in Emerging Markets," in Kahler, op. cit., pp. 256-59.
33. George Soros, On Globalization, op cit, ch. 4.
34. Ibid, appendix.
35. Joseph E. Stiglitz,, Globalization and Its Discontents (New
York: W.W. Norton, 2002)
36. (Manchester, U.K: Manchester University Press, 1986)