Money Reform.

Position:International economic policy

New international crises are just over the horizon without some dramatic money and banking reforms.

Currency and banking crises gave hell to emerging market economies in the 1990s. They have also placed heavy burdens on taxpayers around the world who have been forced to finance ever-larger bailouts of crisis-ridden banking systems. But to listen to conventional wisdom these days, one might think the crises of the type recently encountered in Mexico, Southeast Asia, and Russia are a thing of the past.

Indeed, most cognoscente aren't losing sleep over the possibility of new eruptions. These fair weather folks believe the world has somehow changed since 1997-98. For a close of reality, however, they should crack the Bank for International Settlements (BIS) recently released Annual Report.

The BIS folks in Basle aren't sleeping soundly. As they see it, the prospects for a hard landing in the United States are now real, and the liquidity in many of the emerging markets has dried up, causing market volatility (risks) to soar. If that isn't bad enough, the money and banking crisis-proofing needed in these emerging economies has not occurred since 1998, leaving the countries exposed to bad weather.

As long as emerging market countries retain their own national currencies and fractional reserve banking practices, and as long as the prospect of bailouts exists, trouble is certain. In fact, policymakers' attempts to safely maneuver their economies will be about as successful "as a one-armed blind man in a dark room trying to shove a pound of melted butter into a wild cat's left ear with a red-hot needle," as a P.G. Wodehouse's character Ukridge put it.

The failure of the bailout therapy -- a fact carefully documented by Michael Bordo and Anna J. Schwartz -- has brought forth a flood of proposals to reform the international financial architecture. The International Financial Institutions Advisory Commission, for example, has proposed that the International Monetary Fund (IMF) restrict its lending to rescues, rather than bailouts. This would transform the IMF into a pseudo-international lender of last resort along classical lines.

The classical lender-of-last-resort idea was first proposed in the nineteenth century by Henry Thomton and Walter Bagehot. The classical theory held that banking panics could be averted if central banks stood ready to supply liquidity (base or high-powered money) at rates above those prevailing in the market to solvent, but...

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