Global Policy Forum

With Asia's deepening crisis still rattling the world economy, the finger of blame has started to shift. And it's pointing right at countries like Canada, which, in the name of efficiency, have so deregulated their financial sectors that they have created a monster -- an unstable system that allows capital to slosh back and forth across the globe leaving havoc in its path.

"We're encouraging banks to expand their speculative activities and it's at the expense of the rest of us," says Roy Culpeper, an economist who heads the North-South Institute in Ottawa. Culpeper argues that Canada's proposed bank mergers can only make matters worse. Royal Bank chief economist John McCallum, while stoutly defending bank mergers, agrees that financial liberalization has gotten out of hand. "One impact (of the Asian crisis) is that people are more aware of the potential danger of volatile short-term capital flows," McCallum said. Until recently, this kind of argument has been relegated to the margins of political and economic debate.

Conventional wisdom put it that the crisis was brought on by a combination of corrupt Asian governments and cronyism. Even now, both the U.S. government and the International Monetary Fund (IMF) are urging troubled countries such as Japan to liberalize their financial markets further in order to solve the crisis. Indeed, since the 1980s, financial liberalization has been assumed by Western governments to be a good thing. Under pressure from Canadian bankers, Ottawa dismantled the system of rules which until 1991 had kept banks, insurance companies, brokerage houses and trust companies operating in separate spheres. Bank mergers may aggravate problems that led to crisis The banks argued that they had to be allowed to operate in non-banking lines of finance in order to compete internationally. Once they won that, they began to argue that they had to be allowed to merge in order to compete internationally.

In the U.S., under similar pressure, Washington began to dismantle financial regulations that had been in place since the depression of the 1930s. With Western governments as their sponsors, European and North American banks pushed other nations to deregulate their financial systems. Agencies controlled by the big industrial countries, such as the IMF, were enlisted in the battle to open the world to the freewheeling capital movement.

Indeed, those arguing for financial liberalization made what appeared to be compelling arguments. Capital, they said, was a useful tool for development. Some countries, such as the U.S. or Japan had lots of capital. Some, such as Indonesia needed it. Why not then break down the barriers that hindered the free flow of money? If this free flow required mergers and megabanks -- so what? Efficiency could only benefit everyone. Both bank mergers and financial liberalization moved apace, flip sides of the same coin. Countries in the developing world were urged to remove restrictions on capital flows. Banks in the U.S. and Europe merged partly to take advantage of that liberalization. Here at home, with four of the nation's biggest banks lobbying hard for the right to merge, it seemed as if Canada too would accede to the trend.

But Culpeper and others argue bank mergers actually aggravate the problems that led to the Asian crisis. Larger banks, he says, are more likely to make risky loans to dubious foreign ventures. Having once made them, they are then too big to be allowed to fail. He points to the fact that Japanese banks, some of the biggest in the world, were disproportionally involved in dodgy loans to Southeast Asia. In a paper published last month by his North-South Institute, Culpeper says that both the 1994-95 Mexican crisis and ongoing Asian problems were caused by the haste in which financial markets opened themselves to foreign money. In the Asian case, he writes, lenders flooded developing countries with short-term capital. Sometimes known as hot money, this kind of investment is not anchored in permanent structures such as factories. Rather it comes in forms that are liquid and fickle, such as loans that must be renegotiated every three months or money that is parked in a country literally overnight. Larger banks are much more likely to make risky loans. As long as the economies of Southeast Asia were performing well, the hot money stayed. But when lenders got a whiff of trouble, as they did in Thailand last summer, they became frightened, pulling their hot money out of the entire region. What some economists dubbed an "irrational exuberance" turned into an equally irrational panic. Currencies collapsed; unemployment and interest rates skyrocketed and the region fell into chaos. The crisis spread to South Korea and then Japan. South America, particularly Chile, has also been seriously hit.

Now, an already weakened Russia is on the verge of collapse. Nesbitt Burns, the Bank of Montreal's investment arm, says the contagion is beginning to spread into Italy, Germany and France. As Western governments tried to stem panic they resorted to different explanations.
The first was that the crisis would be contained to Southeast Asia. When that was proven untrue, Western governments and experts focused on the corruption of nations such as Indonesia and the dubious lending practices of Japanese banks. But now some mainstream economists are warning that the root problems lie not in the banks and governments of Asia but in the banks and governments of the West. In the U.S. journal Foreign Affairs, trade economist Jagdish Bhagwati has attacked what he calls the "Wall Street-Treasury complex," a mixture of self-interest and ideology that has promoted unfettered free trade in capital. Ideologues at the U.S. treasury department and self-interested Wall Street bankers, he writes, have bamboozled the public into accepting worldwide financial liberalization. "The weight of evidence and the force of logic point in the opposite direction towards restraints on capital flows."

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