george soros is an unusual animal. Indeed, in my experience he is unique. Not just for his ability to make money in a wide range of volatile markets. (Although that ability may now-by his own admission-be a thing of the past). Nor even because he is engaged in a huge philanthropic exercise, redistributing $500m a year through his Open Society Foundations in eastern Europe and elsewhere. That is unusual, but there are others who have similarly endowed foundations in their image.
Soros's unique contribution rests rather on his personal engagement with the main policy issues in international financial markets today: the purpose and nature of regulation, the case for and against market interventions and-most important-the appropriate structure and role of the international financial institutions.
Relatively few bankers and fund managers engage in these debates: "too busy making money," is one explanation. More generously, one might point to the complexity of the issues, and a natural reluctance on the part of market professionals to chance their arm on subjects in which their expertise is bound to be partial. Soros is not deterred by such considerations. His books are punctuated by apologies for his lack of theoretical understanding. But it is clear that he has little time for some of the theories and arguments he claims not to understand. The efficient markets hypothesis is dismissed with some homespun wisdom, backed by his own record: "my performance exceeded what would be permitted by the random-walk hypothesis by a wide margin." Rational expectations theory fares no better: "I dismiss it out of hand." What he calls classical economics, or equilibrium theory, is tried and found wanting. Again, it is at variance with his plain-man observation of real markets.
These blanket condemnations of those he describes as "market fundamentalists" have not gone down well with mainstream economists and policymakers. Soros's last book, The Crisis of Global Capitalism, was widely dismissed as wrong-headed. Some of the reviews will make it into the "great pannings of our time" anthology.
His latest opus, Open Society: Reforming Global Capitalism, is in many respects the same book. Soros has revised parts of The Crisis, reprinted other sections as they were, some with new commentary on recent events and added some wholly new material, too. As he recognises: "this has made the structure of the book more cumbersome."
The main new element is a modest proposal for what he calls an "Open Society Alliance," with "the dual purpose of, first, promoting the development of open societies within individual countries, and second, strengthening international law and the institutions needed for a global open society." The alliance would, in effect, be a form of world government, using the UN as its legislative body.
We can assume, I think, that the Open Society Alliance is not a "tomorrow morning" kind of thing. As George W takes over the White House, strengthening the UN or committing the US to sharing sovereignty in new multilateral organisations is not high on the political agenda.
And yet, and yet. Although the prescriptions Dr Soros writes out for our ailments may not be available at any currently functioning pharmacy, his journey down the diagnostic pathways is not without interest. He starts with the platitude that "the global capitalist system is far from stable." Prone to shocks, it lurches from crisis to crisis which the IMF and the World Bank are powerless to prevent. "Under the prevailing rules," he argues, "the IMF does not have much say in the internal affairs of member countries except in a crisis." Furthermore, the IMF "does not have enough resources to act as a lender of last resort. It needs the co-operation of the financial markets to make its programmes successful, and the banks and investment banks know how to exploit their position. In addition, the IMF is controlled by the countries at the centre of the capitalist system; it would go against the national interests of the controlling shareholders if the IMF penalised the lenders."
The outcome, Soros says, is that the likelihood of IMF intervention in a crisis creates conditions of "moral hazard" in which private sector lenders advance funds to states without proper discipline, knowing they will get their money back. And the post-crisis burden of adjustment falls mainly on the borrowing countries, not on the lenders. Furthermore, the move away from bank lending towards the bond markets as the prime source of finance for developing countries makes the position worse, because bondholders are much less susceptible than commercial banks to pressure from the authorities to share the pain.
Soros wants the IMF to be better resourced in order to provide "contingency credit lines," with access open to countries which follow sound policies, plus: "better banking supervision, better IMF supervision of macroeconomic and structural policies, greater transparency, and the like." This would increase the Fund's pre-crisis leverage. And he wants stronger mechanisms for bailing commercial banks into IMF rescue packages.
The World Bank would become a World Development Agency. Such a change of name was recommended by last year's Meltzer Commission, set up by the US Congress. But Meltzer favoured a smaller institution, devoted to grant aid to the poorest states. Soros wants something far more ambitious: an agency providing credit for small and medium-sized enterprises in all developing and transition economies.
There is something very 1999 about all this. After the Asian crisis, debate about global financial architecture was all the rage. For a time it seemed that a kind of global design competition had been announced, as the creative department of every finance ministry in the developed world put forward its own ideas for a new architecture.
At the same time, controversy raged over the validity of IMF policy prescriptions in Asia. Joe Stiglitz, then of the World Bank, argued that the IMF's medicine would kill, not cure the patient. But under Michel Camdessus and Stan Fischer the IMF stuck-largely-to its guns, and recovery in Asia was more robust then expected.
So is Soros right? Has nothing changed and is the world's financial system as vulnerable as it was in 1997? Certainly, there has been no significant institutional redesign. But there has been more change-below the parapet so to speak-than Soros allows. The IMF's new contingency credit lines have begun to establish a more robust link between sound domestic policies and eligibility for financial assistance. It is too early to say how strong the resulting incentives for good behaviour will prove to be, and the relatively small sums available may constrain the system's effectiveness. It will also be difficult for the IMF to announce withdrawal of eligibility in the event of backsliding, without then precipitating a crisis. But the principle of the change is correct, as Soros acknowledges.
By contrast, he does not even mention another change since the Asian crisis-the establishment of the Financial Stability Forum. The Forum, partly created by Gordon Brown, is designed to fill an important gap identified by analysts of the Asian crisis. All the affected countries claimed that they have been signed up to every possible code of good financial practice. Korea, Thailand, Indonesia and the rest were all fully compliant with the recommendations of the Basel Committee of Banking Supervisors, the International Organisation of Securities Commissions, and the International Association of Insurance Supervisors-organisations which determine, for example, how much capital internationally active banks should hold on their balance sheets to meet unexpected losses.
It was a great disappointment then to discover that in practice, in many countries, the recommendations had been honoured in the breach. When the crisis hit, it was clear that Asian banks in particular were undercapitalised and unsound with opaque accounts, inadequate provisioning and unhealthy concentrations of connected exposures. Part of the reason for this weakness has been the lack of linkage between the international institutions responsible for economic policy and the regulatory groupings. As a result, there has been no pressure on countries to comply with regulatory standards. This disconnect between financial sector supervision and macroeconomic policy partly reflects a failure to appreciate that unstable financial systems can be as important a source of instability as unsound macro policies. In pre-crisis Asian countries, public finances were largely under control: their financial systems, by contrast, were out of balance.
The Forum was designed to help plug these gaps, by bringing finance ministers, central bankers and regulators together in one place, with the IMF and the Bank. It is not a big new institution: its secretariat is modest. Some argued that a stronger central body was needed, but that view did not command much support. So we are left with an improvement in the plumbing, rather than a new piece of architecture.
Will it work? There are promising signs. The Forum's meetings are already picking out early warning signs of potential troubles ahead. And the IMF has been stimulated to introduce a programme of Financial Sector Assessments, in which countries' compliance with accepted principles of financial supervision is systematically assessed and reported. Indeed, at the Financial Services Authority (the regulatory body in London of which I am head) we expect to be assessed later this year. This is a splendid idea, we continue to remind ourselves. We can hardly wait. Having recommended similar doses for developing countries around the globe, we have little choice but to take our medicine like a lamb.
This is inglorious, detailed work. But many countries have been unwilling in the past to accept the need to write-off bad debts in the banking system and adopt transparent accounting procedures. We do not have to search among developing economies to find examples: Japan is a case in point. It will be interesting to see, therefore, whether the countries which receive unfavourable financial sector assessments are prepared to act promptly on the recommendations in them. The jury is out on that point.
Running in parallel with these developments are other initiatives designed to enhance transparency and market discipline. New codes and guidelines on statistical reporting and public sector accounting have been sponsored by fertile brains in Washington and elsewhere.
None of this impresses Soros. It reminds him of the Maginot Line-designed to fix the last crisis but one, not the next. The economist John Eatwell is also underwhelmed. For him, nothing less than a World Financial Authority (WFA) will do, an authority with the power to regulate cross-border transactions and impose capital and other standards on financial institutions wherever they may be located. He sees the current nation-state basis of financial regulation as ill-suited to the stresses of a global system.
Eatwell recognises that a WFA is unlikely to command widespread support just now. Even a single financial authority in one country, like the FSA in London, has provoked claims that it will be too powerful. Few states are ready to see de facto control over their financial sectors pass to others. So I see little chance of a new multinational regulator. Even in the EU, there is little enthusiasm for such a move.
And the centre of gravity in the debate on the role of the international financial institutions is, in Washington at least, moving in the opposite direction. The Meltzer Commission report, if taken whole, would amount to a significant diminution of the roles of both the IMF and the Bank. It is highly unlikely to be implemented tout court; but, as Soros says, it is likely to exert a constraining, negative effect on their operations. And there are many on the right of US politics who believe that the moral hazard argument-that the IMF creates instability by implicitly underpinning profligate countries and incontinent lenders-is the clinching problem.
There will be pressure on Bush to rein in the IMF and the Bank even further. Larry Lindsey, the new chairman of the Council of Economic Advisers, described the IMF in 1998 as "not central to a sound global economic strategy." The attitude of Paul O'Neill at the US Treasury will be crucial. His background at Alcoa, and elsewhere in the real economy, gives us few clues to the line he is likely to take.
One thing is certain. The next year will reignite debate on the international financial architecture. As the US economy slows, we shall see strains emerge in the system. The IMF is already wrestling with awkward problems in Argentina and Turkey. Others will follow. How the new IMF team handles them will be carefully watched by Republican sceptics.
In the meantime the plumbers-and I proudly count myself as one-will struggle to make incremental changes designed to strengthen financial regulation wherever there is a political appetite to do so; worthy activity, if dull at times.
Is this enough? Who knows? But I am mindful of the cautionary words of Jacob Frenkel, former head of Israel's central bank, who warns against tighter regulations which may "prevent 15 of the next three crises" and obstruct many other useful, wealth-creating developments too.
