OCIO Y TIEMPO LIBRE

Jacob Frenkel remarked that it isn’t possible to prevent all crises. Indeed, the expectation of future crises—some of which we will be familiar with and some of which we won’t—is a logical corollary of the creativity of markets.

The proper perspective to adopt is that of risk management rather than risk avoidance. As a practical matter, this means that we should focus on elimi-nating distortions in the pricing of risk, thereby moving away from volatil-ity suppression and toward volatilvolatil-ity reduction. Returning to the issue of desirable exchange rate regimes, he emphasized that as a rule speculative at-tacks on currencies came when governments tried to peg the exchange rate.

In current conditions it is wrong to think of international reserves as the mechanism for insuring against a crisis. “[I]n the new world, the self-insurance mechanism is the development of financial markets that create the instruments to enable you to deal with [exchange rate] changes, and these markets will not develop if you insist on pegging the exchange rate,”

he said. On the issue of transparency, he said that “transparency about transparency”—that is, making it clear which countries publish informa-tion about the condiinforma-tion of the financial system—is one of the ways to en-courage the development of self-insuring mechanisms.

Domingo F. Cavallo sought to clarify his statement from the session on exchange rate regimes, fearing that it was being misinterpreted. He said,

“The currency system of Argentina is perfectly sustainable,” and he pointed

to the size of reserves, the ability of nationals to make deposits in foreign currencies, and the ability of banks to lend in foreign currencies as impor-tant elements in this sustainability. He went on, however, to say that we can’t be sure that the current system is the final version. If Mexico had adopted the Argentine or Hong Kong system, he said, they would be converging to some kind of monetary association with the United States. He is not so sure that the Argentine system is converging to a monetary association, given that the euro and the yen are moving so much against the dollar. With Ar-gentina’s trade so diversified, at some time, possibly more than twenty years into the future, and when the Argentine exchange rate appreciates rather than depreciating, the country will move from a super-fixed to a floating regime, he said.

Regarding the problems being experienced by the Argentine economy, he said that they are not problems of overvaluation. Exports are actually grow-ing faster than GDP. Rather, the problems are the result of destructive tax increases that have been closing off investment opportunities. This, he con-cluded, is not a situation you can come out of by devaluing the currency.

Andrew Crockett disagreed with Robert Rubin’s pessimistic assessment that crises are inevitable and will probably become more common, finding it “profoundly gloomy in some respects.” As interpreted by Crockett, Ru-bin’s view is that this cycle of crises is inevitable because of the way markets

“reach for yield and have excesses.” He believes that one of the reasons for this reaching for yield is the way risk management is undertaken by institu-tions and reinforced by supervisors. The current practice assumes that risk falls in a boom and rises in a recession. However, it is more accurate to say that underlying risk rises in a boom and “crystallizes” in a recession. If risk management models could be made to reflect this, Crockett thought we might be able to break the trend of ever worsening crises.

Michael P. Dooley warned that he was going to be even gloomier. He said the discussion thus far had been based on the assumption that the real costs of crises come from the panic-induced breakdown of financial intermedia-tion. He thinks that investors are smarter than that. Investors design con-tracts so that if they are not paid the renegotiation of the contract interferes with financial intermediation in the country. This, in turn, leads to output loss. This cost is what leads people to repay international debt, and so it is an important part of the system. If this interpretation is correct, Dooley said, involving the private sector is going to be much more difficult than sug-gested in models where its simply panic or bad luck that is driving the out-comes. Unless there is an alternative “enforcement mechanism,” and he does not see what this might be, the threat of output loss is the one thing that makes international debt possible in the first place.

Dooley added that the ones to pay the price in the country are not the ones who have made the decisions. Residents of debtor countries suffer the loss in output while private debtors and creditors are bailed out. Referring

to Richard Cooper’s famous 1971 paper on devaluation, Sebastian Edwards interjected that the evidence is that government officials do pay the price. In the vast majority of crisis episodes Cooper studied, the finance minister or central bank governor was either fired or imprisoned, or maybe even exe-cuted. Stanley Fischer offered another calculation: of the six big recent crises the IMF has dealt with—Mexico, the three Asian cases, Russia, and Brazil—only two out of the twelve finance ministers and Central Bank gov-ernors involved survived in office following the crisis.

Edwards asked what mechanisms for preclassifying countries for prefer-ential access to funds in times of crisis make sense. Based on the thinking of the Meltzer commission, he identified (without necessarily supporting) five:

fiscal solvency, bank strength and supervision, participation of foreign banks, transparency, and avoiding pegged exchange rates.

Fischer responded to George Soros’s call to reward countries with good policies in some way. He said that the recent changes to the IMF’s Contin-gent Credit Line (CCL) bring it closer to what Soros suggests. However, Fischer thinks that standards and other reforms will only be effective if they affect spreads in the markets, and it is an open question how best to per-suade market players to pay attention.

Arminio Fraga said that in designing any new facilities it has to be kept in mind that markets do not like discontinuities. It is fine to label countries when things are going well. But what, he asked, will be the response when a downturn comes? He favors something along the line of what Robert Rubin suggested—“some degree of ambiguity while the work is being done.” He said this is not like the exchange rate regime debate, in which he supports the idea of extremes. The corner solutions are not practical when it comes to labeling countries. Fraga suggested that trade issues should receive more treatment in the Frankel and Roubini paper. He said the best thing that de-veloped countries could do is to continue to work for global free trade, adding, “they should also practice what they preach.”

Morris Goldstein said that Mervyn King had noted “with a tinge of pride” that the IMF now monitors sixty-six standards and codes. Recalling that in 1995 the number was zero, he said that if you want financial market participants to watch what countries are doing, they are not going to be able to watch sixty-six areas. A positive recent development is the decision by the G7 and the IMF to identify twelve as having some priority. It would have been even better, he thinks, if they had chosen six.

Yung Chul Park questioned the assertion in the paper that American cap-italism has won and that the Japanese or Asian model has lost. He queried what faults they are referring to in the Japanese-Asian system. Do they mean, he asked, that relationship banking has deteriorated into crony cap-italism? But this raises the question of whether the system is inherently de-fective or has been mismanaged by corrupt governments. He fears that “this game [of picking the superior system] will be played every four years like the

Olympic games.” He added that trying to compare the Asian model with the Anglo-Saxon model is not very productive because all the East Asian economies have market-based systems. They do have bank-oriented finan-cial systems, but Park recalled that just a few years ago the academic com-munity recommended this system of developing and emerging market economies. He also complained that the East Asian economies feel that they are being left out of discussions relating to reform of the international financial system. And he noted that there is considerable support among East Asian countries—including China—for the idea of some sort of Asian Monetary Fund.

Nouriel Roubini raised the issue of how more internationally mobile cap-ital and greater derivative-driven leverage have lead to greater systemic risk.

We live in a world, he said, where everyone is a mark-to-market investor, there isn’t the forbearance that existed in the 1980s, and everyone is using the same value-at-risk models. With everyone acting the same way, Roubini said, we must think about the systemic effects of another liquidity shock.

Continuing on the leverage theme, he said it is not obvious that greater leverage is necessarily bad. Overall leverage has contracted along with the hedge funds. But the absence of leverage—or, more importantly, the ab-sence of these market participants—might mean that liquidity is reduced.

These and other issues that have a bearing on systemic risk need to receive much more attention, Roubini said.

Jeffrey Sachs said he wanted to come back to what he saw as a shared theme in King’s, Rubin’s, and Soros’s presentations: that incentive problems existed on both sides of the market. Yet in the final analysis, he said, the sys-tem is run by (borrowing Soros’s term) the core. “This is not an interna-tional system; this is a creditor-run system,” he complained. The core has a fear that any standstill will break the system. Sachs said that he has always advised countries just to stop paying when they are in a crisis—and to do so unilaterally, without waiting for permission from the U.S. Treasury.

“When that happens,” he said, “the crisis eases.” Moreover, when we don’t allow countries to do it, they often break into pieces, like Yugoslavia did when it was told that it wouldn’t get a Paris agreement back in 1990. He added that there is no real lender of last resort in the world, and “there is very little money around.” As an example he pointed to Africa, where net transfers are practically zero. U.S. aid to the least developed countries is now about $600 million, or less than six-tenths of 1 percent. Sachs ended by saying that the illusion has been created that there is little risk for the rich countries due to the fact that the imbalanced approach is being followed.

But that illusion, and the bubble it may have given rise to, “is going to leave us most vulnerable ourselves.”