The age of big bailouts appears to be over. And so, too, the era of pegged foreign-exchange rates. In what appears to be a major change of policy, Treasury Secretary Robert E. Rubin has announced that the U.S. will no longer encourage the global financial community to provide money to help countries defend currencies rigidly pegged to the dollar. Furthermore, it will strongly push for a "bail-in" from banks and bondholders to share in the burden of rescuing countries in deep trouble. Although they are described as modest proposals to fix the international financial system, the sum of these changes amounts to a dramatically new policy direction. We welcome the change.
Chalk it up to expensive lessons learned. In Asia and Russia hundreds of billions of dollars in public money was sent in by the U.S. Treasury, the International Monetary Fund, and other Western nations to stem a deep financial crisis. Much of the money then flowed out to foreign bondholders and banks. They had lent recklessly but escaped whole, while entire economies were plunged into recession and millions of middle-class people were pushed back down into poverty. Asia is only now, two years later, beginning to dig out of the ruin, and Russia has hardly begun. The Rubin initiatives would force lenders to price their credits to account for real-world risk, and allow the markets to truly discipline capital flows into emerging countries.
Under the new rules, the U.S. would also encourage countries to either float or fix--that is, either let the currency markets shape their domestic financial performance or mold their domestic policies to conform to those of a stronger currency. For countries who decide to fix, the Treasury now appears more open to accepting an Argentine-style currency board. The next step, total dollarization, now appears to be an option as well. The Treasury, of course, insists that either choice of foreign-exchange regime still requires countries to institute the kind of policy mix and financial-reform regulations that generate stable economic growth.
Rubin, Deputy Treasury Secretary Lawrence H. Summers, and Federal Reserve Chairman Alan Greenspan are united in saying that the Fed would not alter policy or act as lender of last resort to countries contemplating dollarization. But they are now open to countries adopting the dollar because, combined with the right policies, it could curb inflation and promote growth and trade. This is big news.
The Treasury is also supporting a new international banking code out of Basel, Switzerland, that would put pressure on banks to be more prudent in lending to hedge funds and other big leveraged global investors. And the Treasury will soon propose its own plan to require disclosure by U.S. banks lending to highly leveraged market participants, allowing both regulators and investors to monitor banks' exposure to risk.
Rubin is even opening the door--under emergency conditions--to accepting Chilean-style taxes on short-term capital inflows. While not a substitute for fundamental financial reforms, temporary controls on hot-money inflows are now seen as useful. Again, this is a big change in policy.
It has taken two years for the U.S. to formulate a policy to deal with the kind of crises that can arise out of a closely integrated global financial system. It isn't fancy "architecture" and it doesn't break new theoretical ground, but the new Rubin policy initiative is a step forward in taming the wild surges of capital around the world. By showing himself willing to take remedial action, Rubin helps the cause of globalization everywhere. Henry Kissinger said recently that new, fragile democracies could not be expected to withstand the withering blast of continued financial crisis and economic ruin. He was right. Rubin's plan is a start toward making the world safe for globalization again.