The response of private-sector financial institutions, central banks, regulators and governments to the murderous attacks on New York and Washington has been one of remarkable resilience and impressive solidarity. Governments have forged their diplomatic coalition against terrorists, central banks have coordinated injections of liquidity and interest rate cuts to prevent systemic crisis, regulators have been flexible enough to relax – temporarily – certain capital standards, banks have lent each other space and carefully rebooted the financial markets.
The danger now is that governments may be tempted to extend the extraordinary war-time powers they are granting themselves into an unwarranted and counterproductive degree of intervention in free markets.
The bankers who briefly cooperated so closely in the aftermath of the attacks did so out of pure and simple self-interest. They all make their living from a financial system that had been attacked. They all rallied to help fix it so they could go back to making money again as quickly as possible. They’re now happy to be beating the living daylights out of each other in the markets once more. And that’s as it should be.
The most unhelpful thing now would be for governments to throw sand in the works. But that’s the direction in which we are drifting.
It is in the nature of governments to seek to exercise power. That breeds a very different and sometimes hostile view of free capital markets, which are so merciless in exposing and punishing government mistakes. In their hearts, even western governments fear and dislike free markets. They now see a chance to rein them in, as the world still reels from those awful images in Manhattan. They will be all the more inclined to try to do this now as the world heads into a synchronized slowdown and voters fret.
Clearly the instinct of the US government is now to direct every force it can to its aim of obliterating terrorist organizations. President Bush signs an executive order and claims for his government sweeping powers to freeze assets and retaliate against international banks that deal with terrorists. Bankers are scrambling to understand the practical and legal implications. The US is right to follow the terrorists’ money and to threaten those who handle it for them. But there are limits to its ability to corral markets. Calls for patriotic buying of stocks are hopelessly misguided and naïve and betray a lack of understanding of what free markets are about. Worse they are bad advice for those tempted to buy when markets are clearly going to sell off.
Demonizing short selling and hedge funds is equally misguided. There is no difference between selling a stock in the expectation it will fall and buying one in the expectation it will rise. The ability to sell securities short encourages truly efficient markets in which capital is delivered with low friction costs to those best able to use it productively.
Of course markets make mistakes, they can get carried away, as in the tech stock boom. It is not the job of governments to correct these excesses, nor is it the job of governments to bail out mismanaged industries stricken by overcapacity, such as airlines.
Those opportunistic European politicians who have raised the corpse of the Tobin tax on foreign exchange turnover are simply pandering to voters’ unease about economic downturn in the west and their guilt about poverty in the third world. The politicians know it won’t work but they know by being seen to consider it, they can distance themselves from the downside of globalization and free markets. They should hang their heads in shame.
Didier Reynders, finance minister of Belgium, has predicted significant changes to global economic governance following the attacks, with more regulation and international organizations to manage enhanced coordination in specific policy areas. Nicholas Stern, chief economist at the World Bank, has pressed for coordinated increases in public expenditure. What a shame then that last month’s annual IMF and World Bank meetings were cancelled. For once the jamboree would have had a real purpose, being the ideal forum for such policy discussions. Cancelling it was well-meaning but mistaken. Yes, the police and emergency services of the northeastern US are overstretched. But the rock-throwers would not have turned up. Their parents would have kept them in Vermont and Surrey and threatened to cancel their Amex cards.
Governments and countries will cope with recession in their own ways. Few will cope better than the US. Think back to the recession at the start of the 1990s when corporations sacked workers in their tens of thousands, executives ended up flipping burgers, banks teetered on the brink and a populist isolationist called Ross Perot briefly built a huge lead in the polls for the 1992 presidential election. America’s dynamism, its people’s entrepreneurial instincts, its well-developed capital markets – its venture capitalists, angel investors, distressed asset buyers – saw it through and paved the way for a new technology revolution and a 10-year boom. None of this was coordinated by government, which barely understood it. Clinton briefly tried to reform healthcare, then sat back and let the markets work.
He was good at the international stuff, though. And that’s what the US government and its allies should attend to. First, they should punish the culprits. Then the US must consider a more even-handed approach to dealing with the Arab-Israeli conflict. Somehow Arab rulers need to be encouraged to move towards democratic principles, public accountability and transparency. Dictators in certain Arab Muslim countries have cynically used extreme religious doctrine as an instrument of political oppression over their impoverished populations, invoking injunctions from the Hadith (the reported sayings of the Prophet Muhammad) to obey the ruler even if he be cruel or unjust. Criticizing this and encouraging change is not an attack on Islam.
Federal Reserve chairman Alan Greenspan hopes that world governments coming together in response to the attacks might usher in new agreements on free trade. Let’s hope so. Global trade grew from 18% of world GDP in 1990 to 26% in 2000 and the world prospered, albeit very unevenly. Taxing capital flows and snarling up international commerce will impoverish us all and hand a victory to the terrorists.
