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The
Need to Regulate Cross-Border
Flow of Speculative Funds
By
Henry C.K. Liu
This article appeared in AToL
and NewDeal2.0 on
November 24, 2009
In this season of debate on regulatory reform, a rather obvious area
that has been crying out for reform seems to be overlooked by
government officials and market participants.
The root of much of past and
current global financial crises lies in the unrestricted cross-border
flow of speculative funds and the ability of market participants to
deploy cross-border speculative financial and regulatory arbitrage for
risky profit at the expense of central banks and local market
fundamentals. The reason low dollar interest rates do not help
the US
economy is because hot money will respond by flowing into China and
other high interest rate economies to profit from carry trade and
exchange rate arbitrage, leaving the US with a persistent credit
crunch. The only way a low Fed funds rate will help the US economy is
if the US regulates cross-border flow of speculative funds, thus
forcing the bailout and stimulus money to stay within US border to
create jobs locally. It is a simple measure that can be easily
implemented by administrative order. After the 1997 Asian
Financial
Crisis, Malaysia imposed currency control and was widely criticized at
first but later widely acknowledged as the correct and effective
measure to adopt. Germany after 1933 also imposed currency control and
its economy recovered faster than any other in the world. There is no
way to effectively regulate OTC financial derivative trading against
global systemic risk without first stopping cross-border financial
arbitrage. Anyone who has studied the and understood problem would
know that the path of reinforcing capital reserve adequacy leads to a
dead-end
against astronomical notional values.
Ever since the end of the Cold War,
which actually began winding down with President Nixon’s policy of
Détente,
international trade has overwhelmed domestic development in the global
economy, as
superpower
competition to win the hearts and minds of the world in the form of aid
subsided and development was channeled solely through global trade. Persistent US fiscal and trade deficits
had forced the
abandonment in 1971 of the Bretton Woods regime of fixed exchange rates
linked
to a gold-back dollar. The flawed
international finance architecture that resulted has since limited the
global
growth engine to operating with only the one cylinder of international
trade,
leaving all other cylinders of domestic development in a state of
permanent
stagnation.
Drawing lessons from the 1930s Great
Depression, economics thinking prevalent immediately after WWII had
deemed
international capital flow undesirable and unnecessary for national
development. Trade, a relatively small
aspect of most national
economies, was to be mediated through fixed exchange rates pegged to a
gold-backed dollar. These fixed exchange rates were to be adjusted only
gradually and periodically to reflect the relative strength of the
economies participating
in international trade, which was expected to augment but not overwhelm
the
development of national economies. The
impact
of
exchange rates was limited to the financing of international trade. Exchange rate considerations were not expected
to dictate domestic monetary and fiscal policies, the chief function of
which
was to support domestic development and regarded as the inviolable
province of
national sovereignty.
Recurring global financial crises will continue to occur until
cross-border flow of speculative funds is regulated.
November 22, 2009
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