Capital Without a Conscience

The failure of last week’s top-drawer financial meetings to produce a solution to the global economic crisis should not come as a big surprise. Economic orthodoxy is in full retreat amid fundamental disagreement over the causes of the problems, appropriate countermeasures and the institutions that should implement them. The world is fragmenting into combative, yet interdependent cliques, none of which trust or want to shoulder burdens for the others. There is even talk of controlling free-flowing capital, the cornerstone of the world’s acclaimed “new order.�

The consequences have been devastating. Decades of Asian growth and social advancement have been destroyed in a few months. Russia lacks a functioning economy. Latin America teeters near collapse. The mounting global insecurity and anxiety have reached the United States and Europe. As the grim toll mounts, the consensus that the United States worked so hard to build is giving way to nationalism and philosophical antagonisms many thought obsolete.

Not that long ago, free-market capitalism seemed everywhere triumphant. Led by such Wall Street alumni as U.S. Treasury Secretary Robert E. Rubin and backed by outfits like the International Monetary Fund, which specializes in forcing economically troubled nations to liberalize their financial markets, the United States championed unregulated global capital above all else. More than merchandise trade or copyright protection, fast-moving, profit-seeking capital opened the world to big-time investors as never before.

But most nation-states were totally unprepared for the age of borderless capital. Few foresaw the rapid growth and staggering power of “hedge funds,� the invisible, mostly U.S.-based investment pools open only to ultrarich individuals and large institutions. By some estimates, hedge funds have $200 billion of “hot,� extremely fluid capital that they can leverage into investments worth trillions of dollars.

Countries like Thailand or South Korea are no match for these kinds of resources. Critics contend that hedge funds make huge bets that certain currencies or stock prices will fall, then use their power to trigger panics by selling off local assets. Earlier this year, normally laissez-faire Hong Kong authorities, for the first time ever, pumped $15 billion worth of foreign reserves into local stocks to counter reputed hedge-fund attacks. Badly battered Malaysia simply checked out of the global economy, ended free currency convertibility altogether.

Investors also didn’t behave as theory predicted. Once liberated from national controls, money didn’t flow into low-cost nations, but instead crowded into a handful of U.S. blue-chip stocks and Treasury bonds.

Despite massive devaluation leading to bargain-basement local prices, multibillion-dollar IMF bailouts and extortionate interest rates, nothing appeased global capital. Emerging-market investments dropped from $308 billion in 1996 to an anticipated $160 billion this year. Even local banks in hard-hit Asia parked billions of dollars badly needed at home in U.S. Treasury bonds.

To deal with these unforeseen events, the United States turned to the IMF, which, it now admits, made matters worse by dictating austerity budgets at a time when reflation was crucial. At the IMF’s annual meeting last week, Rubin even rebuked the fund and its sister organization, the World Bank, for squabbling over how to help troubled countries, assuming they could get funding from Congress to intervene at all.

Still, the official U.S. line that unregulated finance is the engine of global prosperity remains unamended. Problems like hedge funds or “hot� capital, officials say, are just excuses that nations make for their failure to adopt to the most-advanced (read: U.S.) practices. Regrettable though it may be, severe social and economic pain is the price profligate countries must pay to rejoin the ranks of the credit-worthy.

U.S. officials smugly raise America’s prosperity as proof of their argument, but in much of the world, their claims smack of self-serving ideology. Of course Washington wants open capital markets. Wall Street and the U.S. Treasury dominate global finance and are sucking up world resources to finance the U.S. “bubble� economy and support politically critical stock indices.

Treasury officials browbeat other countries for propping up struggling companies and favoring friends. Yet, they cheered the rescue of Long-Term Capital Management, a multibillion-dollar hedge fund insiders call “friends of Alan� because of its close ties to Federal Reserve Chairman Alan Greenspan. “Right now, [U.S.] market fundamentalism is a greater threat to open society than any totalitarianism,� says Wall Street icon George Soros, who pioneered speculative attacks on currencies and was widely blamed for triggering Asia’s meltdown last year.

Small wonder Asians see matters in a totally different light. Most advocate curbing short-term investment volatility caused by borderless capital and using regional funds to stabilize their economies and permit gradual, less socially disruptive growth. U.S. demands for wholesale business closures and public spending to stimulate growth are anathema to them.

Led by Japan, Asia is gambling that export growth will compensate for runaway capital and eventually generate enough wealth to rescue failing companies and trigger new growth. Restraining imports, buying time to keep manufacturers afloat and exporting goods priced at devalued local currencies to earn inflated dollars are the keys to its thinking. Asian currencies may gyrate wildly because of hedge-fund activity, as they did last week when the yen suddenly appreciated against the dollar. But given the importance of exports to the region, few expect sustained upward movement.

Newly minted center-left governments in Europe have their own agenda. After years of inaction, Germany and France are increasingly critical of U.S. leadership, voicing support for capital controls and sympathy for Asian and emerging-market complaints. France is backing efforts to vastly expand the IMF, which is headed by a former French bureaucrat, and create a global economic oversight entity independent of U.S. control.

Europe’s rhetoric is tempered, however, by its planned Jan. 1, 1999, launch of a regional currency, the euro, which it hopes will compete with the dollar as the world’s reserve (safest) currency. Despite signs of slowdown, especially in Britain, Europeans are unlikely to do much to help hard-hit countries by cutting interest rates, absorbing imports, or expanding public budgets, all of which would undermine the euro.

All this makes for some frightening possibilities.

Asia’s export-led recovery effort, for instance, depends on America’s continued tolerance of massive trade imbalances. Today, U.S. policymakers are under little pressure to protect domestic jobs and inbound capital flows make it possible to pay for record trade deficits that would otherwise drive up interest rates and slow growth. This delicate balance may quickly unravel, however, if Asians continue to spurn reforms demanded by free-trade-oriented U.S. officials, the U.S. economy worsens, or sensitive manufacturing sectors, like computers, nose-dive.

Then there’s the high-stakes poker game being played over who pays for global stimulus measures amid impending reserve-currency competition. During last week’s meetings, French officials challenged the United States to lower its domestic interest rates far more than the recent quarter-point cut made by the Federal Reserve, even though their German economic allies scuttled a coordinated international rate cut.

Behind this appeal is the reality that U.S. rate cuts will make the dollar less attractive and boost demand for the euro. Many experts believe that when the euro is launched, investors will shift billions out of dollars and into Europe, severely destabilizing the U.S. economy. The Federal Reserve has to weigh making money cheaper in the short term against the possibility of much greater setbacks if it departs from a cautious, deflationary approach.

Despite hopes for an enduring consensus, the world is approaching the 21st century with the antagonism and self-aggrandizement that has marked this one. The United States wages ideological battle against an Asia and other emerging economies that view its philosophies with outright contempt. Europeans exploit global unrest for their own narrow interests. Worldwide recovery depends in too many cases on U.S. willingness to bear costs and suffer risks--massively unbalanced trade and interest-rate whipsaws, for example--no one else will share.

In such circumstances, what’s needed is compromise and pragmatism. U.S. ideologues have to concede that capital liberalization did foster real abuses and victimize nations for less than compelling reasons. Agreeing to curb extremely short-term capital with little purpose other than speculation, such as minimum investment time limits or taxing in-and-out fund movement, would appease skeptical nations without seriously harming the global economy. For their part, Asian and emerging markets can’t expect the United States to import them back to health at the expense of domestic industries and without meaningful reforms equalizing international trade relations. Europeans must share fiscal burdens in ways that don’t opportunistically take advantage of U.S. policies.

Achieving these goals requires that U.S. policymakers, even at the risk of retreating from their Wall Street dogma, moderate their hubris and seek common ground with the rest of the world. If they’re unwilling to deal more flexibly, however, they may be trading away our future.*