Global Crisis -- Made in America

By Joseph E. Stiglitz
Spiegel on line
November 12, 2008,1518,590028,00.html

It should come as no surprise in a world of
globalization that it's not just the good things that
move more easily across borders, but the bad things as
well. Now, America has exported its downturn to the

A global financial crisis requires a global solution.
Uncoordinated macro-economic policies, for instance,
have contributed to Europe's problems. When the
European Central Bank refused to lower interest rates
earlier this year, focused as it was on the threat of
inflation, while America's did, focused on the
impending downturn, it led to a stronger euro. This in
turn contributed to Europe's downturn, though it made
America's GDP numbers look better for a while. Now,
Europe's downturn is ricocheting back on America:
Europe's weaknesses are contributing to America's.

The same has happened when it comes to regulation. To
too great extent, there has been a race to the bottom
in accordance with the myth that deregulation breeds
innovation. Instead, the innovation was greatest when
it came to getting around the regulations designed to
ensure good information and a safe and sound financial

Financial markets are supposed to be a means to an end
-- a more prosperous and stable economy as a result of
good allocation of resources and better management of
risk. But instead, financial markets didn't manage
risk, they created it. They didn't enable America's
families to manage the risk of volatile interest rates,
and now millions are losing their homes. Furthermore,
they misallocated hundreds of billions of dollar.

The Human Toll

The consequences of these mistakes will run into the
trillions -- not just the money that is being spent on
the bailouts, but the shortfall between global economic
potential growth and actual performance.

Beyond this, of course, is the human toll -- families
whose life dreams are destroyed as they lose their
homes, their jobs, and their life savings. If we are to
maintain global financial liberalization, with
financial products moving easily across borders, we
must be sure that these products are safe and that the
financial institutions who are selling them can stand
behind the products they create.

Financial market regulators, at both the national and
international level, have failed. To a large extent,
Basel II, the new framework of bank regulation, was
based on self-regulation, itself an oxymoron. Banks
have shown that they are not up to the task of managing
their own risk. But even if they had, there is the more
fundamental problem of systemic risk.

The current global financial architecture hasn't been
working well. But more than that, it is unfair,
especially to the developing countries. They will be
among the innocent victims of this global crisis that
wears the 'made in America' label. Even countries which
have done everything right -- those which have managed
their economy with far better regulation and better
macro-economic prudence than the US -- will suffer as a
result of America's mistakes. Worse, the International
Monetary Fund has -- at least in the past -- demanded
pro-cyclical policies (raising interest rates and
taxes, lowering expenditures when an economy goes into
a recession), while Europe and America do just the
opposite. The result is that capital flees developing
countries in times of crisis, reinforcing the vicious

Flawed Governance Structure

There is mounting evidence that the developing
countries may require massive amounts of money, amounts
that are beyond the capacity of the IMF. The sources of
liquid funds are in Asia and the Middle East. But why
should they turn their hard earned money over to an
institution with a failed track record; one which
pushed the deregulatory policies that have gotten the
world into the mess where are in now; one which
continues to advocate the asymmetric policies which
contribute to global instability; and one whose
governance structure is so flawed?

We need a new financial facility to help the developing
countries, one whose governance reflects the realities
of today. Going forward, this new facility might lead
to deeper reforms at the IMF. Such a facility needs to
be created quickly, but if experts from the finance
ministries and central banks are loaned out to this new
institution, it could be up and running in short order.

There are further reforms that need to be undertaken.
The dollar-based global reserve system is already
fraying -- the dollar has proven not to be a good store
of value. But moving to a dollar-euro, or a dollar-
euro-yen system could be even more unstable. We need a
global reserve system, for a global financial system.
Keynes wrote about this at the time of the last big
downturn, but the need today is even greater. His hope
was that the IMF would create a new global reserve
currency. He called his Bancor, much akin to the IMF's
SDR (special drawing rights). This is an idea whose
time may have finally come.

It is inconceivable that America would have prospered
had it left the management of its financial system to
the 50 separate states. They have a role, but that of
the national government is essential. We now have a
global financial system, but we are leaving its
management to that of the individual countries. This
system simply cannot work.

We will never achieve perfect stability of our
financial markets, or of our economy. Markets are not
self-correcting. But we can do a lot better. Hopefully,
at the summit in Washington, the leaders of Europe and
Asia will lead the way, beginning the task of creating
the global financial architecture that the world needs
if we are to have a stable and prosperous 21st century.

Joseph E. Stiglitz, 65, won the Nobel Prize in
economics in 2001 for his contribution to analyses of
the relationship between markets and information
uncertainties. He is widely cited and writes a popular
column for the New Yorker.

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