The financial crisis has gone global. Stock indexes have fallen and credit markets are seizing up around the world. In recent days, as most Americans focused on the political drama of the rescue package, a number of European banks have failed or been taken over. Several in Russia and Eastern Europe are teetering on the verge of insolvency. Many Latin American countries are newly vulnerable because foreign banks are big players there. Few nations can escape the financial contagion.
Also looming is an even more virulent form of contagion: decreased levels of economic activity because of contracting trade flows. Japan and several European countries are already in recession. If the United States and the entire European Union sink further, as looks increasingly possible, emerging markets and developing countries will face lower exports and less growth. Even China will experience a sharp slowdown because of its heavy reliance on overseas markets. Unemployment will soar almost everywhere.
Globalization of the crisis requires a globalized response. While the consequences of financial crises are clearly international, the regulation of finance remains almost wholly national. And national efforts, including the U.S. rescue plan and European governments' remedies for their nations' bank problems, will continue to be the first responses.
Yet an internationally coordinated strategy, ranging far beyond the heroic efforts of the world's leading central banks, is essential now that the U.S. rescue plan is in place. When finance ministers convene in Washington this week for the annual International Monetary Fund meeting, they should adopt several initial components of such a strategy. Not doing so would be almost as serious as if Congress had adjourned without passing the rescue legislation.
First, heading off a precipitous decline in world economic activity requires a global stimulus program. Different governments can use different policy tools. China has room for fiscal expansion, while Europe could ease monetary policy. The United States can combine the two. A coordinated effort should boost confidence and would deter individual countries from attempting to escape the downturn via trade controls and other beggar-thy-neighbor policies.
Second, coordination of the parallel national efforts to recapitalize tottering banking systems would pack a powerful psychological punch. The United States, European Union and some others are moving rapidly to shore up their financial institutions. But countries need both to do more and to avoid gaps in their rescue programs by agreeing on how to handle cross-border loans and financial institutions that operate across jurisdictions. Widespread international participation in the recapitalization effort, including by the highly liquid sovereign wealth funds, could be of substantial help.
Third, as the United States and some Europeans are already doing, many countries will need to expand coverage of their deposit insurance programs to discourage bank runs. Parallel or uniform policy steps through which unlimited insurance is provided for at least a temporary period, as Germany and Ireland have done for their banks and the Treasury has for U.S. money market funds, will be mutually reinforcing and help prevent panic.
Beyond the short term, countries will need to develop a cooperative framework to prevent and resolve such crises, most urgently within Europe. There is inherent tension as finance becomes global but its regulation remains national. The current crisis originated in the United States but was importantly affected by massive savings surpluses in some countries and the resulting surfeit of liquidity, which drove down interest rates and encouraged irresponsible lending here. Those international imbalances were in turn partly caused by misaligned exchange rates. Global oversight of both financial regulation and currencies can no longer be neglected.
Our policy responses must reflect the interdependent vulnerability of the world economy. Although the Europeans rebuffed a recent U.S. initiative for a cooperative strategy and are having trouble getting their region-wide act together, it is too late to assign blame over responsibility for the crisis, within or among countries. The traditional Group of Seven industrial countries have mounted coordinated economic programs of this type in the past, with considerable success; now they must be joined by the chief emerging markets, particularly China. The G-7 finance ministers should fully include the five or six main emerging markets in their upcoming meeting and seek to forge a global strategy. This week's IMF conclave offers a unique opportunity to add a critical international dimension to the crisis response.
C. Fred Bergsten, director of the Peterson Institute for International Economics, was assistant Treasury secretary for international affairs from 1977 to 1981. Arvind Subramanian is a senior fellow at the Peterson Institute.
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