Is capitalism heading for breakdown?

News Analysis: George Soros's new book says that speculators threaten to destabilise the world economy

"AS A fund manager, I depended a great deal on my emotions. The predominant feelings I operated with were doubt, uncertainty and fear," writes George Soros in his new book, The Crisis of Global Capitalism. Wrecking ball, bubonic plague, depression, total breakdown - these are just a few of the emotional phrases Mr Soros uses in his analysis of global financial markets.

When someone who has benefited to the tune of billions of dollars from the financial markets says that destabilising speculation threatens a complete breakdown of the capitalist system - which has delivered such amazing advances in prosperity over the past five decades - it is worth paying attention. Certainly, opponents of free market economics have hailed Mr Soros's recantation with glee. But is there analytical substance behind the emotional gloss of the Soros critique?

Financial markets have always been prone to crises. Human nature seems to contain a herd instinct, and besides, it can be rational for investors to create a bubble so long as they are confident about getting out before it bursts.

There is nothing inherently damaging about such self-fulfiling speculation. Indeed, in his Tract on Monetary Reform, John Maynard Keynes - usually quoted for his condemnation of "casino capitalism" - emphasises the importance of speculators to healthy capital markets. Speculators provide liquidity and reinforce existing trends rather than bucking them, he argued. The speculation has to have something to feed on in the first place.

Even so, the financial markets have clearly been a destabilising force in the world economy since the Asian crisis first erupted in July 1997. It raises the question of whether, as capital flows have grown larger and more footloose, the speculative froth has reached unacceptable proportions. In particular, would it be sensible to reintroduce capital controls, which have been steadily dismantled over the past three decades?

Although some economists - notably Paul Krugman of the Massachusetts Institute of Technology - think there is a good case for capital controls, Mr Soros is clearly against them "Capital controls are an invitation for evasion, corruption and the abuse of power," he writes.

Certainly, the first regime to reach for controls, post-crisis, was the authoritarian Malaysian government. Meanwhile Chile, which did have restrictions on capital inflows, has recently lifted them. Exchange controls were effective after the war, when so much economic activity was subject to planning and restriction, but by the early 1970s they were all but useless. So, while one lesson of the Asian crisis is that developing countries should liberalise slowly and cautiously, it must not be forgotten that there were good reasons for the abolition of capital controls in the first place.

But if this type of restriction is not the answer, what can be done? Mr Soros concludes that there should be international financial regulation, but not by the International Monetary Fund. The IMF is part of the problem, he says. Rather, he puts the onus on the Group of Seven countries but concludes that the prospects of the G7 taking effective action are dim as it has not yet intervened in Russia.

However, it is difficult to see the G7 as the right vehicle for international financial management, important as it might be in the case of a large and politically important country such as Russia. Apart from anything else the G7 itself is in flux, with the introduction of the euro in January likely to see the rapid emergence of a G3. In addition, the biggest countries cannot practically be involved in overseeing all of the rest of the world, which is why the IMF and other such bodies exist.

In the end, it is not the institutional arrangements that matter. If the IMF did not exist, there would be calls for its creation after this year's crisis. The two key problems are whether the response to financial market turbulence should include genuine international co-ordination through the creation of a worldwide lender-of-last-resort, and what sort of exchange rate regime should exist.

As Mr Soros knows, fixed exchange rates can easily become sitting ducks for speculators. They are sustainable only if the countries locking their currencies to another are prepared to adjust their domestic economic policies for the sake of the exchange rate. The gold standard survived only as long as they were. But the UK in 1992 was not prepared to match its macroeconomic policy to Germany's, and the pound's exchange rate mechanism link was doomed.

The only viable alternatives in a world of huge capital flows are freely floating exchange rates and currency union. Europe has opted for the latter. If the rest of the world is stuck with floating rates, how can governments hope to counter the instability of the financial markets?

One solution is to have perfect domestic policies at all times, giving speculators nothing to run against. But this is a touch utopian - even if they all had first-rate policy makers, economies are buffeted by all sorts of shocks.

Another would be to create a genuine international authority with the task of stabilising the world economy and markets. At present the work of adjusting to crisis is forced on to a combination of the IMF and national central banks.

The IMF, which has meagre resources, effectively bails out banks that face the risk of default by a borrower by providing liquidity to the borrower, while national central banks bail them out by providing liquidity to the lender within their own boundaries if there looks to be a serious threat to the domestic banking system.

Perhaps the creation of an international lender of last resort would be preferable to this messy ad hoc response. Mr Soros seems to think some such source of finance is needed to resolve the crisis in the markets he helped destabilise. So, too, do some G7 officials. But the proposal is controversial.

Others believe that lending to borrowers in emerging markets is a risky business whose risk should fall directly on the speculators themselves - not least Soros Fund Management.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Executive / Foreign Exchange Dealer - OTE £40,000+

£16000 - £40000 per annum: Recruitment Genius: A Foreign Exchange Dealer is re...

SThree: Experienced Recruitment Consultant

£20000 - £40000 per annum + OTE + Incentives + Benefits: SThree: Established f...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40/45k + INCENTIVES + BENEFITS: SThree: The su...

Recruitment Genius: Collections Agent

£14000 - £16000 per annum: Recruitment Genius: This company was established in...

Day In a Page

The long walk west: they fled war in Syria, only to get held up in Hungary – now hundreds of refugees have set off on foot for Austria

They fled war in Syria...

...only to get stuck and sidetracked in Hungary
From The Prisoner to Mad Men, elaborate title sequences are one of the keys to a great TV series

Title sequences: From The Prisoner to Mad Men

Elaborate title sequences are one of the keys to a great TV series. But why does the art form have such a chequered history?
Giorgio Armani Beauty's fabric-inspired foundations: Get back to basics this autumn

Giorgio Armani Beauty's foundations

Sumptuous fabrics meet luscious cosmetics for this elegant look
From stowaways to Operation Stack: Life in a transcontinental lorry cab

Life from the inside of a trucker's cab

From stowaways to Operation Stack, it's a challenging time to be a trucker heading to and from the Continent
Kelis interview: The songwriter and sauce-maker on cooking for Pharrell and crying over potatoes

Kelis interview

The singer and sauce-maker on cooking for Pharrell
Refugee crisis: David Cameron lowered the flag for the dead king of Saudi Arabia - will he do the same honour for little Aylan Kurdi?

Cameron lowered the flag for the dead king of Saudi Arabia...

But will he do the same honour for little Aylan Kurdi, asks Robert Fisk
Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Humanity must be at the heart of politics, says Jeremy Corbyn
Joe Biden's 'tease tour': Could the US Vice-President be testing the water for a presidential run?

Joe Biden's 'tease tour'

Could the US Vice-President be testing the water for a presidential run?
Britain's 24-hour culture: With the 'leisured society' a distant dream we're working longer and less regular hours than ever

Britain's 24-hour culture

With the 'leisured society' a distant dream we're working longer and less regular hours than ever
Diplomacy board game: Treachery is the way to win - which makes it just like the real thing

The addictive nature of Diplomacy

Bullying, betrayal, aggression – it may be just a board game, but the family that plays Diplomacy may never look at each other in the same way again
Lady Chatterley's Lover: Racy underwear for fans of DH Lawrence's equally racy tome

Fashion: Ooh, Lady Chatterley!

Take inspiration from DH Lawrence's racy tome with equally racy underwear
8 best children's clocks

Tick-tock: 8 best children's clocks

Whether you’re teaching them to tell the time or putting the finishing touches to a nursery, there’s a ticker for that
Charlie Austin: Queens Park Rangers striker says ‘If the move is not right, I’m not going’

Charlie Austin: ‘If the move is not right, I’m not going’

After hitting 18 goals in the Premier League last season, the QPR striker was the great non-deal of transfer deadline day. But he says he'd preferred another shot at promotion
Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

How Isis profits from destruction of antiquities

Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

'If we lose touch we’ll end up with two decades of the Tories'

In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea