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Saturday, Feb. 9, 2008
U.S. resists its own medicine
CAMBRIDGE, Mass. — As the United States' epic financial crisis continues to unfold, one can only wish that U.S. policymakers were half as good at listening to advice from developing countries as they are at giving it.
Americans don't seem to realize that their "subprime" mortgage meltdown has all too much in common with many previous post-1945 banking crises throughout the world.
The silver lining is that there are many highly distinguished current and former policymakers out there, particularly from emerging market countries, who have seen this movie before.
If U.S. policymakers would only listen, they might get an idea or two about how to deal with financial crises from experts who have lived through them and come out safely on the other side.
The parallel between today's U.S. crisis and previous financial crises is not mere hyperbole. The qualitative parallels are obvious: banks using off-balance loans to finance highly risky ventures, exotic new financial instruments, and excessive exuberance over the promise of new markets. There are strong quantitative parallels as well.
Professor Carmen Reinhart of the University of Maryland and I systematically compared the runup to the U.S. subprime crisis with the runup to the 19 worst financial crises in the industrialized world over the past 60 years.
These include epic crises in the Scandinavian countries, Spain and Japan, along with lesser events such as the U.S. savings and loan crises of the 1980s.
Across virtually all the major indicators — including equity and housing price run-ups, trade balance deficits, surges in government and household indebtedness, and precrisis growth trajectories — red lights are blinking for the U.S. Simply put, surging capital flows into the U.S. artificially held down interest rates and inflated asset prices, leading to laxity in banking and regulatory standards and, ultimately, to a meltdown.
When Asia and Latin America had their financial meltdowns in the 1990s and early 2000s, they took advice not only from the International Monetary Fund, but also from a number of small panels composed of eminent people representing diverse backgrounds and experiences. The U.S. should do the same.
The head of the IMF, Frenchman Dominique Strauss-Kahn, could easily select a superb panel from any range of former crisis countries, including Mexico, Brazil, Korea, Turkey, Japan, and Sweden, not to mention Argentina, Russia, Chile and many others.
Admittedly, the IMF's panel would have to look past America's current hypocrisy. The U.S. Treasury strongly encouraged Asia to tighten fiscal policy during its 1990s' crisis. But today the U.S. Congress and president are tripping over themselves to adopt an ill-advised giant fiscal stimulus package, whose main effects will be to tie the hands of the next president in simplifying the U.S. tax code and closing the budget deficit.
Americans firmly told Japan that the only way to clean up its economy was to purge insolvent banks and regenerate the financial system through Schumpeterian "creative destruction."
Today, however, U.S. authorities appear willing to contemplate any measure, no matter how inflationary, to ensure that none of its major banks and investment houses fails.
For years, foreign governments complained about American hedge funds, arguing that their nontransparent behavior posed unacceptable risks to stability. Now, many U.S. politicians are complaining about the transparency of sovereign wealth funds (big government investors mainly from Asia and the Middle East), which are taking shares in trophy American assets such as Citibank and Merrill Lynch.
In fact, having countries like Russia and China more vested in the well-being of the U.S. economy would not be a bad thing. Yes, the IMF ought to develop a voluntary code of conduct for sovereign wealth funds, but it should not be used as a weapon to enforce financial protectionism.
For years, I, along with many others, have complained that emerging markets need greater representation in global financial governance. Today, the issue goes far beyond symbolism. The U.S. economy is in trouble, and the problems it spins off are unlikely to stop at the U.S. border.
Experts from emerging markets and elsewhere have much to say about dealing with financial crises. America should start to listen before it is too late.
Kenneth Rogoff is professor of economics and public policy at Harvard University, and was formerly chief economist at the IMF. Copyright 2008 Project Syndicate (www.project-syndicate.org)