The currency meltdown in Asia has now entered a new and dangerous phase. Like a nuclear disaster, its fallout is spreading indiscriminately around the world, damaging countries with both poor and solid economic fundamentals. The virtuous countries of Canada, Australia, New Zealand, Latin America, and Eastern Europe have all been hard hit recently by the financial turmoil. Even the seemingly immune U.S. economy has shown signs of slowdown from the Asian fallout. The risks of a global recession are rising.

The social and economic costs of this meltdown are staggering. Many currencies have plunged 50% or more. Unemployment has soared in hard hit economies. Many years of economic progress have been reversed and hundreds of millions of people are falling below the poverty line. The economic and political backlash has prompted several countries to take matters into their own hands, with Malaysia imposing capital controls, Russia defaulting on its foreign debt, and Hong Kong directly intervening in the stock market. Protectionism is also on the rise as a result of economic hardship and trade imbalance. The global capitalist system based on free capital flow and free trade is in great danger.

The international rescue efforts led by International Monetary Fund have so far failed to contain the fallout. While the IMF has provided sizable financial packages to help the crisis countries avoid financial default, it is rather poorly equipped to stem investor panic and increase market confidence. Its call for long-term economic reform often amplifies those economic problems that causes market panic. As Harvard economist Jeffery Sachs put it, "the arrival of IMF gives all the confidence of seeing an ambulance outside one’s door". Thus, alternative approaches are needed to boost market confidence and to stabilize currencies. One possibility that deserves discussion is the establishment of an international stability fund for limited and coordinated currency market intervention.

The idea of coordinated currency market intervention may sounds radical, but the G-7 governments have often engaged in precisely the same action. Emerging market governments, such as Korea, Mexico, and Thailand, have also used intervention to stabilize their currencies. But such inventions have often been ineffective. First, unlike the G-7 countries, emerging markets have limited reserves and thus are prime targets for speculation, since once the reserves are exhausted, currency devaluation is the only alternative. Second, rising unemployment associated with currency defense often exerts too high a political cost for the government. Finally, the lack of financial expertise and coordination often render intervention ineffective.

An international stability fund, with the single objective of currency market stabilization, would help overcome these disadvantages by pooling the resources of member countries. It could provide liquidity to or take it away from the currency market depending on international capital flow to a country. Like a reservoir, it could sell emerging market currency when foreign capital inflow is strong while buying the currency when panic outflow occurs. With its large pool of capital and coordinated action with member governments, the fund could increase dramatically the potential loss for currency speculators. Thus, it would be in a much better position than a single government to deter speculation and dampen currency market volatility. It could also help bear some of the political cost should intervention become unsuccessful. While it is often difficult to determine how to intervene, there are times when intervention could be highly desirable, such as the recent joint action by the U.S. and Japanese governments to stabilize the yen.

Currency market interventions are justified for several reasons. First, foreign capital flows are prone to investor panic. Private capital flows to the five crisis economies changed from a huge $93 billion inflow in 1996 to a $12 billion net outflow in 1997, exceeding 10% of the countries’ GDP. The resulted sharp currency adjustment has wrecked havoc of the economies and the contagion has hurt many innocent bystanders. Second, currency market may not reflect fundamental economic equilibrium when the currency is under strong attack by international speculators. At such times, a few big players with strong market power and influence could dominate the market or trigger investor panic. While speculators often argue that attacks only happen against countries with overvalued currencies, panic often sets in and market can wildly overreact. Moreover, currency attacks often occur near a country’s election, as is currently the case in Brazil, when the government is most vulnerable and can least afford to implement tough economic measures for currency defense.

Our proposal could lead to problem of moral hazard, which could prolong inappropriate and unsustainable government policies. To avoid the problem, the extent of the intervention would be based on a country’s contribution to the fund, its financial health, and the willingness of its government to pursue appropriate stabilization policies. Moreover, the country involved would be required to buy back its currency at cost within a reasonable amount of time. Thus, if intervention is triggered mostly when a country’s currency is undervalued due to market panic, then the country and the fund would profit from such an intervention. Otherwise, the country would have to bear most of the intervention loss.

Such an international stability fund would supplement the role of IMF, not replace it. We still believe congress should approve the additional funding for IMF. We believe a mixture of limited market intervention, together with an orderly debt workout and IMF funding packages would provide a much better chance for market stabilization and avoiding moves toward market isolation and protectionism.

This is not the time for complacency and inaction. The global capitalist system based on free flow of capital and trade has generated tremendous improvements in productivity and living conditions for people all over the world. Unfortunately, the system is inherently unstable. Like a nuclear reactor, if the strong forces of instability are not contained, a meltdown could have devastating impact both on emerging economies and developed countries. New international mechanisms are desperately needed to keep the world economy on the path of growth and prosperity in the 21^st century.