In Defense of Free Capital Markets: The Case Against a New International Financial Architecture by David F. DeRosa

From the Publisher

Because of the remarkable number of currency and emerging-market meltdowns during the 1990s--from the Mexican peso crisis to the collapse of the Asian markets to the Russian devaluation of the ruble--the free market system faces the prospect of tighter global regulation. Bloomberg News columnist and Yale School of Management adjunct professor David DeRosa makes a compelling case that markets are smarter than ministries and that tighter regulation will only distort economic development.

A common claim of reformers is that changes must be made to the international monetary system to prevent fresh waves of financial devastation. Yet a great deal of these claims are built on the belief that fluctuations in exchange rates serve almost no useful economic function and benefit only currency traders. When confronted with a financial crisis, many leaders prefer to indict the international financial system rather than to admit policy blunders that may be of their own making.

This book analyses the economic conditions that produced a number of recent financial crises. It also investigates the responses made to each crisis, to uncover whether government policies directed at these episodes of turmoil made matters better or worse.

Before constructing new regulations, economists should carefully examine the results of past policy. Many fixed-exchange-rate regimes have failed in their intended purpose of maintaining stability in the currency markets. Those attempts at control, instead, have caused violent macroeconomic fluctuations and have had far-reaching, often destructive, effects--ironically, just the opposite of what their creators intended. The future economic well-being of both developed and developing nations depends upon an honest look at the irrefutable lessons of these recent financial disasters--before they are repeated.

Milton Friedman

[A]n impressive survey and analysis of the crises of the 1990s.

Nassim N. Taleb

[E]loquently shows how governments can use pseudoscience to disrupt markets and create additional financial risk and volatility.

Thomas S. Coleman

Important reading for all those interested in world economic issues and the future path of economic growth.

Product Details

• ISBN: 157660036X
  
• ISBN-13: 9781576600368
• Format: Hardcover, 240pp
• Publisher: Bloomberg Press
• Pub. Date: January 2001
• Edition Description: 1 ED

• Table of Contents
• Read an Excerpt

Table of Contents

Read an Excerpt

These positions must be tempered by the study of the countries that have suffered the sharpest reversals of fortune in the 1990s. These same nations had dangerous domestic financial policies in place for a significant time before they descended into crisis. Moreover, when crisis did erupt, the government's response often exacerbated their problems.

The picture of history that is being told by most, but not all, of the would-be reformers lacks the essential recognition that financial crisis is mostly homegrown, not imported, and that it is usually preventable with modification of bad financial policies. By analogy, one could imagine a large, complex telephone network that is subject to intermittent failures. The reformers have concluded that the problem must be with the master switching circuitry, the analogue of the international capital market, before having taken a close look at the subscriber's kitchen wall phone, the parallel for domestic financial policies.

The common denominator in practically every crisis in the 1990s was an experiment with a fixed foreign exchange rate regime. Fixed foreign exchange regimes are founded on the promise of currency stability. Some of them have survived for years and have basked in their apparent success. Yet so many have ended in spectacular turmoil that one has to wonder if there isn't an inevitable day of reckoning for all pegged exchange rate currencies. What is often misunderstood is that fixed exchange rate systems, in and of themselves, have the power to attract foreign capital, provided that they reflect an appearance of permanence. They incubate the buildup of massive disequilibrium positions in the foreign exchange and fixed income markets. The famous carry trade, in which investors have taken leveraged positions in stabilized, high-yielding foreign currencies, is one example. Another is the phenomenon of foreign currency denominated debt accumulation in countries with fixed exchange rates. Both are motivated by the illusion that the fixed exchange rate regime will be permanent. If the day comes when the market suspects otherwise, a ferocious adjustment process can take place at a moment's notice when practically everyone inside and outside of the country tries to dump their exposure to the local currency.

The '90s, far from being an indictment of the international financial system, are a striking reminder of how potentially destructive fixed exchange rate regimes can be. Equally striking is the fact that once broken fixed exchange rate systems were replaced with floating regimes, no further disruptions occurred.