Time to Reweave the World's Financial Safety Net

NEW YORK — Imagine a map of the world. In mid-1997, when Thailand's economy became the first in Asia to collapse, we could have colored that country red. Now, only 14 months later, the entire developing world would be crimson. The worst international economic crisis in 50 years, which no one foresaw, has ravaged two-thirds of the globe. Standards of living, so painfully raised, are falling. The U.S. economy and financial markets, initially expected to escape unscathed, are also damaged.

Stunned observers are asking whether the international economic and financial system is broken. Several larger developing nations that were pursuing open-market policies for years, including Hong Kong, Malaysia and Russia, are reversing course. They are, in effect, dropping out of the global economy. There are increasing calls for curtailing the worldwide system of floating exchange rates and free flows of capital. Previously, these were icons of global economic progress.

But our international economic system, based on open and competitive markets for goods and capital, is the right one. It is the safety net underneath that is torn and needs repair. Resources for the International Monetary Fund, emergency lender to governments, must be vastly expanded. An early-warning system on financial and economic weaknesses and individual nations is long overdue. The United States and Europe should engineer a lowering of worldwide interest rates now to cushion against global recession and deflation.

It is important to understand how a collapse of this magnitude could have happened and whether its spread can be stopped, as well as the flaws in the international system that have been exposed. These are the crucial questions that must be answered--and fast.

Let's begin by understanding the illness. First, a part of the problem is the classic tendency of financial markets to overshoot, both on the upside and the downside. As Federal Reserve Chairman Alan Greenspan observed last week, they are usually too euphoric or too pessimistic. The current, wholesale investor boycott of all developing countries is a prime example.

Second, a group of Asian economies is sicker than anyone realized. A combination of complacent global investors and poor data issued by these countries enabled them to appear healthier than they were.