The IMF may lend large amounts, create moral hazard in doing so, and still not be able to ward off the threat of financial crises. And faced with a run on their currency or banking system, countries may be forced to take unilateral action to suspend payments. So what to do? 4. The middle way  Given that neither purist approach is on the agenda, the international community has been trying to take some practical steps forward. The aim is to reduce the frequency and severity of financial crises. Some might describe this as muddling through. I prefer to call it the “middle way”. The difference is that the middle way is based on the principle that if the emergency services will be slow to arrive then whichever form of transport you care to think of, borrowing countries should drive slowly. How to encourage and enforce careful driving has been the subject of innumerable international meetings. Initially, the discussion took place in the G10, which, as you know, comprises eleven countries. Then last year the discussion was taken up by the G22. By the spring of this year that group had become the G33. Can you complete the sequence by guessing which international forum will take the lead next year? Suffice it to say that at the original Bretton Woods conference there were forty-four countries and it took place fifty-five years ago. In terms of practical steps forward, it is useful to distinguish between the prevention and resolution of crises.
If we cannot find a way to reconcile free movement of capital with prevention of financial crises, then many countries may draw the lesson that they are better off with capital controls – either explicit or implicit – than without. Over the past decade, the two-year swing in the current account among G7 countries has been of the order of 1-2% of GDP. The largest swing was less than 4% (3.7% for Italy over the period 1992-94). These are small compared with the swing of 17% for Korea, in 1996-98. 1  Stiglitz, J E, Financial Times, 25 March 1998. 2  Sakakibara, E (1999), “Reform of the International Financial System”, speech to the Manila Framework Meeting in Melbourne on 26 March 1999. BIS Review 95/1999  2  Two dimensions of the reversal of capital flows have been evident in recent experience. First, their intensity and scale. Second, the rapid contagion from one emerging market to other previously unaffected countries. Both phenomena are a product of the nature of the capital flows concerned. The problems arise from short-term flows of debt finance, not long-term equity flows or direct investment. Equity investment has a self-stabilising mechanism. When an investor wishes to withdraw from the equity market he or she has to find a buyer before they can head for the exit. The market price adjusts in order to attract a buyer to replace the seller. The physical investments financed by equity flows remain in place, even if their value on the market has fallen.