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Should There Be Five Currencies or One Hundred and Five?
Author/s: Ricardo Hausmann
Issue: Fall, 1999 It was not supposed to turn out this way. The collapse of communism in the former Soviet Union and the abandonment of the interventionist and populist state in Latin America more than a decade ago were supposed to usher in a period of unparalleled prosperity. The invisible and efficient hand of the market, now made more powerful through globalization, would succeed where the incompetent and often bloody hand of government had failed. But more than a decade after the annunciation of this "end of history," country after country among the new emerging-market economies has fallen into financial crisis, the likes of which have not been seen since the Great Depression of the 1930s or the Latin American debt crisis of the 1980s. Economic turmoil has afflicted not only those countries with poor policy records, but also those held up as models (such as Mexico before 1994 and the East Asian Tigers until 1997), destroying livelihoods, crushing hopes, and increasing human suffering. This cataclysm has also shattered the consensus among bankers, policymakers, academics, and ideologues about appropriate economic policy in emerging markets. As economic professionals now return to the drawing board, one question is generating particularly fierce debate: Should emerging-market countries allow their currencies to float freely, or should they abandon them altogether in favor of strong international or supranational currencies such as the U.S. dollar or the euro? Interestingly, the debate has quickly become polarized: Both sides seem to accept that there can be no middle ground, no halfway arrangement between allowing a currency to float freely and bolting it down completely. MORAL HAZARD VERSUS ORIGINAL SIN The debate between "floaters" and "dollarizers" reflects the broader debate over the precise causes of the recent financial turmoil. Two opposing explanations have emerged: a dominant view based on what economists call "moral hazard" and an alternative theory based on what might be called "original sin." Just about anyone who has read about the financial crises in Asia, Latin America, and Russia has become familiar with the concept of moral hazard: the increase in recklessness that takes place when people are somehow protected against the consequences of their risky behavior. For example, car insurance may make people more likely to drive faster or to park their cars in neighborhoods where the chances of vandalism or theft are higher. By the same logic, the readiness of governments and international institutions to provide bailouts in times of emerging-market (and other) financial crises may make investors less vigilant about weighing all the risks involved. The view that moral hazard is to blame for the recent financial turmoil has inspired an ambitious roster of reforms for the international financial architecture. This agenda includes moves to upgrade the financial supervision and regulation of individual countries, to eliminate or reduce the provision of international bailouts by the International Monetary Fund (IMF), and to develop "bailing in" procedures to ensure that the investors themselves play a role in resolving future crises [See: "Think Again: The International Financial System," on page 16].
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