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Clear Thinking on the Financial New World Order

The International Monetary Fund asked the economist Barry Eichengreen to come up with some out-of-the-box ideas for reforming the global financial architecture. The Wall Street Journal calls the result "Eight Ways to Radically Remake the World," and that's not far from the truth. The most significant -- indeed, the idea that a lot of the other recommendations seem to depend on in practice -- argues for the creation of a global financial regulator:

An alternative would be to create a World Financial Organization analogous to the already-existing World Trade Organization (WTO). In the same way that the WTO establishes a principles for trade policy (nondiscrimination, reciprocity, transparency, binding and enforceable commitments) without specifying outcomes, the WFO would establish principles for prudential supervision (capital and liquidity requirements, limits on portfolio concentrations and connected lending, adequacy of risk measurement systems and internal controls) and without attempting to prescribe the structure of regulation in detail. The WFO would define obligations for its members; the latter would be obliged to meet international standards for supervision and regulation of their financial markets and institutions.

Membership would be obligatory for all countries seeking freedom of access to foreign markets for domestically-chartered financial institutions. The WFO would appoint independent panels of experts to determine whether countries were in compliance with those obligations. Importantly, it would authorize the imposition of sanctions against countries that failed to comply. Other members would be within their rights to restrict the ability of banks and nonbank financial institutions chartered in the offending country to do business in their markets. This would provide a real incentive to comply.

It will be objected that national governments would never let an international organization dictate their domestic regulatory policies. The rebuttal is that the WFO would not dictate. The specifics of implementation would be left to the individual country. Members would still be able to tailor supervision and regulation to the particularities of their financial markets. But those regulatory specifics would have to comply with the broad principles set down in the WFO charter and associated obligations.

We already do the equivalent for trade. Dispute settlement panels already determine whether, inter alia, U.S. tariffs on timber imports from Canada are in compliance with U.S. WTO obligations. If not, we have the choice of whether to change those laws or face sanctions and retaliation. If the U.S. and other countries accept this in the case of trade, why should they not accept it for finance?

Not sure if that would remake the world, but it would definitely set some new rules for everyone operating within it. As a meta-point, I'd like to see more of this kind of paper: Experts spend a lot of time trying to do the work of politicians. They offer up ideas that are built in response to the imagined demands of the most powerful opponents. That sort of thing has value, but so does throwing off the shackles of votes and circumstances and thinking through a whole new order. Not only are those papers interesting, but it's useful for laymen and political hacks alike to know what the experts really think, as opposed to what the experts really think politicians can realistically achieve.

You can download Eichengreen's paper here.

By Ezra Klein  |  June 4, 2009; 5:31 PM ET
Categories:  Financial Crisis , Solutions  
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WFO is unlikely to see any light and it is not clear whether that is bad or good.

But a single thing like FDIC on global scale which guarantees deposits in other countries or other currencies to certain extent for the premiums paid by all participating sovereign states is another 'dart in the dark'.

The 2 biggest global financial challenges of today are:
- Merkel's of the world finding a mechanism to tame Fed (or tomorrow RBI or Chinese Central Bank); and
- China today getting some assured return for boat load of Treasury bonds it is buying (at least to the extent China is ready to remove the peg of Yuan with Dollar).

Will WFO address these problems? Not clear how.

Any serious global financial reforms will have 3 components:
- some sort of global currency or at least a stable conversion mechanism so that the global balance is neither hitched to prevailing artificial currency pegs or beholden to currency printing presses of few country (USA, UK for example); and
- some 'deep' bond market where sovereign and corporate debts denominated in this global currency or stable global currency exchange mechanism are traded. Both things are linked or rather two sides of the same coin.
- what French and many Europeans demanded in last G22 meeting: transparency of money flow. In any globally regulated financial regime, things like secret Swiss Bank accounts, Macau Banks flushing money to North Korea should simply be not possible.

Any reform on the global scale should be judged on account of how far we are able to achieve these objectives.

Posted by: umesh409 | June 4, 2009 11:49 PM | Report abuse

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