Banking and Financial Reform at the Crossroads of the Neoliberal Contagion

Abstract

At the time of publication, this article provided the most in-depth critique of capital account liberalization in any U.S. law journal. The article stemmed from a paper presented by the author to the Seventh Annual Conference of the United States-Mexico Law Institute in Santa Fe, New Mexico on October 3, 1998, during the climax of one of the most volatile periods in the global financial markets. The Russian ruble was in free fall, and so was Long-Term Capital Management, a hedge fund that was threatening to bring down its own large creditors. The crisis was averted only by an emergency multi-billion dollar bailout brokered at the offices of the New York Federal Reserve Bank. This article situates that financial volatility within the context of the 1990's global currency contagion that had spread from Mexico and Latin America to East Asia. Canova identified a recurring pattern associated with the liberalization of portfolio capital. The initial dependence on short-term foreign investment requires a restrictive monetary policy and higher interest rates to maintain the inflow. The inflow, however, contributes to overvalued exchange rates that in turn contribute to unsustainable trade and current account deficits. What follows is an inevitable panic sell-off and flight to foreign-denominated assets. The sudden outflow of capital then leads to fiscal austerity and other disciplines imposed as conditions for International Monetary Fund (IMF) assistance. After describing the dynamics of contagion, Canova inventories the range of legal instruments and institutions prematurely pushing capital account liberalization on developing countries. From the IMF Articles of Agreement to IMF loan conditions, from Bilateral Investment Treaties (BITs) to provisions of the North American Free Trade Agreement (NAFTA), Canova demonstrates that the program of capital account liberalization is part of a Wall Street agenda. The symbiotic relationship between regulators and private financial actors raises fundamental constitutional questions about accountability in a representative democracy. The article concludes by proposing several reforms of the international monetary system, including various restrictions on short-term capital flows, the recycling of surpluses through foreign aid flows, and the issuance of global currency in the form of Special Drawing Rights. The analysis synthesizes various methodological approaches, including comparative, historical and institutional approaches: prudential restrictions on portfolio inflows (such as the Chilean ?encage?); a global turnover tax on currency transactions (such as the Tobin Tax proposal, named after former Nobel economist, the late James Tobin); reform of the burdens of adjustment (modeled on the Marshall Plan); and use of the dormant Scarce Currency clause in the IMF Articles of Agreement. The article deals with obscure and often technical matters in an easy-to-read conversational style that is accessible to non-experts.