Charting a different course

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: “The United States has been a model for China,” says Yu Yongding, a prominent economist in Beijing. “Now that it has created such a big mess, of course we have to think twice.”

The future of global finance depends on what kind of rethinking takes place in Beijing and the rest of the emerging world. So far the signals have been mixed, even within the same country. In India, for instance, the central bank—long a reluctant liberaliser—recently changed its mind about allowing credit-default swaps, arguing that the subprime crisis showed the time was not “opportune” for such innovations. But at the end of August India launched exchange-traded currency derivatives, giving people a means to hedge against fluctuations in the rupee.

Chinese officials have been unusually outspoken about Wall Street’s failures. But just as several rich countries, from Britain to Australia, have banned or reined in short-selling (selling borrowed shares) in a misguided effort to stop share prices falling, China’s cabinet agreed to allow investors to buy shares on credit and sell shares short.

By and large, emerging economies’ attitude to Anglo-Saxon finance is deeply pragmatic, defined more by the lessons of their own financial crises in the 1990s than by today’s calamities on Wall Street. Those crises inflicted far greater economic pain than anything the rich world has seen so far. Mexico’s GDP, for instance, fell by 6% in 1995 and Indonesia’s by 13% in 1998.

Those collapses held powerful lessons: foreign-currency debt was dangerous, the IMF was to be avoided and prudence demanded the build-up of vast war chests of foreign-exchange reserves. Rich countries typically have foreign-currency reserves worth about 4% of their GDP. The level in emerging economies used to be much the same, but over the past decade that ratio has risen to an average of over 20% of GDP. China has a whopping $1.8 trillion, and eight other emerging economies have more than $100 billion apiece.

At first sight, fat cushions of reserves have stood emerging economies in good stead. They are one reason why these countries have proved so resilient in today’s global turmoil. But these war chests introduced many distortions and rigidities that helped to inflate the global financial bubble and stoke domestic inflation. The challenge for emerging economies is to create a system of global finance that is more flexible yet still safe.