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.

Arts & Entertainment
Madonna in her music video for 'Like A Virgin'
music... and other misheard song lyrics
News
Waitrose will be bringing in more manned tills
newsOverheard in Waitrose: documenting the chatter in 'Britain's poshest supermarket'
News
The energy drink MosKa was banned for containing a heavy dose of the popular erectile dysfunction Levitra
news
News
Much of the colleges’ land is off-limits to locals in Cambridge, with tight security
educationAnd has the Cambridge I knew turned its back on me?
VIDEO
Sport
Australia's Dylan Tombides competes for the ball with Adal Matar of Kuwait during the AFC U-22 Championship Group C match in January
sportDylan Tombides was diagnosed with testicular cancer in 2011
News
Ida Beate Loken has been living at the foot of a mountain since May
newsNorwegian gives up home comforts for a cave
Extras
indybest10 best gardening gloves
News
Russia's President Vladimir Putin gives his annual televised question-and-answer session
peopleBizarre TV claim
Arts & Entertainment
tvIt might all be getting a bit much, but this is still the some of the finest TV ever made, says Grace Dent
Arts & Entertainment
Comedian Lenny Henry is calling for more regulation to support ethnic actors on TV
tvActor and comedian leads campaign against 'lack of diversity' in British television
News
Posted at the end of March, this tweeted photo was a week off the end of their Broadway shows
people
News
peopleStar to remain in hospital for up to 27 days to get over allergic reaction
Arts & Entertainment
The Honesty Policy is a group of anonymous Muslims who believe that the community needs a space to express itself without shame or judgement
music
News
Who makes you happy?
happy listSend your nominations now for the Independent on Sunday Happy List
Life & Style
life
Have you tried new the Independent Digital Edition iPad app?
Independent Dating
and  

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

iJobs Job Widget
iJobs Money & Business

1st Line Helpdesk Engineer Apprentice

£150.00 per week: QA Apprenticeships: This company has been providing on site ...

Telesales & Sales Support Apprentice

£221.25 per week: QA Apprenticeships: This company is a well established Inter...

Client Relationship Manager - SQL, Python

£40000 - £50000 per annum: Harrington Starr: Client Relationship Manager - SQL...

**Financial Services Tax**

£35000 - £50000 per annum: Pro-Recruitment Group: Take your chance to join the...

Day In a Page

How I brokered a peace deal with Robert Mugabe: Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC

How I brokered a peace deal with Robert Mugabe

Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC
Video of British Muslims dancing to Pharrell Williams's hit Happy attacked as 'sinful'

British Muslims's Happy video attacked as 'sinful'

The four-minute clip by Honesty Policy has had more than 300,000 hits on YouTube
Church of England-raised Michael Williams describes the unexpected joys in learning about his family's Jewish faith

Michael Williams: Do as I do, not as I pray

Church of England-raised Williams describes the unexpected joys in learning about his family's Jewish faith
A History of the First World War in 100 moments: A visit to the Front Line by the Prime Minister's wife

A History of the First World War in 100 moments

A visit to the Front Line by the Prime Minister's wife
Comedian Jenny Collier: 'Sexism I experienced on stand-up circuit should be extinct'

Jenny Collier: 'Sexism on stand-up circuit should be extinct'

The comedian's appearance at a show on the eve of International Women's Day was cancelled because they had "too many women" on the bill
Cannes Film Festival: Ken Loach and Mike Leigh to fight it out for the Palme d'Or

Cannes Film Festival

Ken Loach and Mike Leigh to fight it out for the Palme d'Or
The concept album makes surprise top ten return with neolithic opus from Jethro Tull's Ian Anderson

The concept album makes surprise top ten return

Neolithic opus from Jethro Tull's Ian Anderson is unexpected success
Lichen is the surprise new ingredient on fine-dining menus, thanks to our love of Scandinavian and Indian cuisines

Lichen is surprise new ingredient on fine-dining menus

Emily Jupp discovers how it can give a unique, smoky flavour to our cooking
10 best baking books

10 best baking books

Planning a spot of baking this bank holiday weekend? From old favourites to new releases, here’s ten cookbooks for you
Jury still out on Manchester City boss Manuel Pellegrini

Jury still out on Pellegrini

Draw with Sunderland raises questions over Manchester City manager's ability to motivate and unify his players
Ben Stokes: 'Punching lockers isn't way forward'

Ben Stokes: 'Punching lockers isn't way forward'

The all-rounder has been hailed as future star after Ashes debut but incident in Caribbean added to doubts about discipline. Jon Culley meets a man looking to control his emotions
Mark Johnston: First £1 million jackpot spurs him on

Mark Johnston: First £1 million jackpot spurs him on

The most prize money ever at an All-Weather race day is up for grabs at Lingfield on Friday, and the record-breaking trainer tells Jon Freeman how times have changed
Ricky Gervais: 'People are waiting for me to fail. If you think it's awful, then just don't watch it'

Ricky Gervais: 'People are waiting for me to fail'

As the second series of his divisive sitcom 'Derek' hits screens, the comedian tells James Rampton why he'll never bow to the critics who habitually circle his work
Mad Men series 7, TV review: The suits are still sharp, but Don Draper has lost his edge

Mad Men returns for a final fling

The suits are still sharp, but Don Draper has lost his edge
Google finds a lift into space will never get off the ground as there is no material strong enough for a cable from Earth into orbit

Google finds a lift into space will never get off the ground

Technology giant’s scientists say there is no material strong enough for a cable from Earth into orbit