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Capital Without a Conscience

Even the global economic crisis worsening, no hopeful solution was reached at last week's IMF annual meeting. Are ore controls the answer?

October 11, 1998|David Friedman | David Friedman, a contributing editor to Opinion, is an international consultant and fellow in the MIT Japan Program

The failure of last week's top-drawer financial meetings to produce a solution to the global economic crisis should not come as a big surprise. Economic orthodoxy is in full retreat amid fundamental disagreement over the causes of the problems, appropriate countermeasures and the institutions that should implement them. The world is fragmenting into combative, yet interdependent cliques, none of which trust or want to shoulder burdens for the others. There is even talk of controlling free-flowing capital, the cornerstone of the world's acclaimed "new order."

The consequences have been devastating. Decades of Asian growth and social advancement have been destroyed in a few months. Russia lacks a functioning economy. Latin America teeters near collapse. The mounting global insecurity and anxiety have reached the United States and Europe. As the grim toll mounts, the consensus that the United States worked so hard to build is giving way to nationalism and philosophical antagonisms many thought obsolete.

Not that long ago, free-market capitalism seemed everywhere triumphant. Led by such Wall Street alumni as U.S. Treasury Secretary Robert E. Rubin and backed by outfits like the International Monetary Fund, which specializes in forcing economically troubled nations to liberalize their financial markets, the United States championed unregulated global capital above all else. More than merchandise trade or copyright protection, fast-moving, profit-seeking capital opened the world to big-time investors as never before.

But most nation-states were totally unprepared for the age of borderless capital. Few foresaw the rapid growth and staggering power of "hedge funds," the invisible, mostly U.S.-based investment pools open only to ultrarich individuals and large institutions. By some estimates, hedge funds have $200 billion of "hot," extremely fluid capital that they can leverage into investments worth trillions of dollars.

Countries like Thailand or South Korea are no match for these kinds of resources. Critics contend that hedge funds make huge bets that certain currencies or stock prices will fall, then use their power to trigger panics by selling off local assets. Earlier this year, normally laissez-faire Hong Kong authorities, for the first time ever, pumped $15 billion worth of foreign reserves into local stocks to counter reputed hedge-fund attacks. Badly battered Malaysia simply checked out of the global economy, ended free currency convertibility altogether.

Investors also didn't behave as theory predicted. Once liberated from national controls, money didn't flow into low-cost nations, but instead crowded into a handful of U.S. blue-chip stocks and Treasury bonds.

Despite massive devaluation leading to bargain-basement local prices, multibillion-dollar IMF bailouts and extortionate interest rates, nothing appeased global capital. Emerging-market investments dropped from $308 billion in 1996 to an anticipated $160 billion this year. Even local banks in hard-hit Asia parked billions of dollars badly needed at home in U.S. Treasury bonds.

To deal with these unforeseen events, the United States turned to the IMF, which, it now admits, made matters worse by dictating austerity budgets at a time when reflation was crucial. At the IMF's annual meeting last week, Rubin even rebuked the fund and its sister organization, the World Bank, for squabbling over how to help troubled countries, assuming they could get funding from Congress to intervene at all.

Still, the official U.S. line that unregulated finance is the engine of global prosperity remains unamended. Problems like hedge funds or "hot" capital, officials say, are just excuses that nations make for their failure to adopt to the most-advanced (read: U.S.) practices. Regrettable though it may be, severe social and economic pain is the price profligate countries must pay to rejoin the ranks of the credit-worthy.

U.S. officials smugly raise America's prosperity as proof of their argument, but in much of the world, their claims smack of self-serving ideology. Of course Washington wants open capital markets. Wall Street and the U.S. Treasury dominate global finance and are sucking up world resources to finance the U.S. "bubble" economy and support politically critical stock indices.

Treasury officials browbeat other countries for propping up struggling companies and favoring friends. Yet, they cheered the rescue of Long-Term Capital Management, a multibillion-dollar hedge fund insiders call "friends of Alan" because of its close ties to Federal Reserve Chairman Alan Greenspan. "Right now, [U.S.] market fundamentalism is a greater threat to open society than any totalitarianism," says Wall Street icon George Soros, who pioneered speculative attacks on currencies and was widely blamed for triggering Asia's meltdown last year.

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