I am here today to discuss the United States' agenda for the future global financial architecture: the actions we have taken already and are in the process of taking, and our proposals for further change.

In the past two years, the international community has mobilized enormous official resources in response to the financial crisis that has adversely affected a large number of nations and peoples around the world. This crisis has heightened the broad-based awareness -- in both developed and developing countries -- of the risks and opportunities of a global economy. While our own economy has remained strong, American workers, businessmen and farmers have been affected by the crisis. Certain sectors have been hit severely, and the crisis has created additional risks to the economy overall. That is why Americans have a critical stake in an effective response to this crisis, as well as in building a stronger, more stable international financial system for the future. And that is why the United States, and so many nations, have been intensely focused on international financial reform, and must continue to be intensely focused on reform for a long time to come.

Our approach to this work has been informed by the fundamental belief that a market- based system provides the best prospect for creating jobs, spurring economic activity, and raising living standards in the U.S. and around the world. But we have an equally strong belief that government action is needed for markets to produce the best results. There are certain purposes, for example, universal education, that markets by their nature cannot meet. And markets, by themselves, do not necessarily create the conditions needed for them to function well, for example, the provision of full and adequate information.

President Clinton's approach to international financial reform is built on these two beliefs. Our overall goal is to build an international financial system that best promotes global growth, that best contributes to broadly sharing that growth, that is less prone to crisis, and that is better able to manage crises when they occur. We want to equip all countries to be able to participate effectively in the global financial system. Achieving those objectives means both working with developing countries to identify the policies they need to realize most effectively the benefits of global finance and integration while limiting its potential risks, and creating stronger incentives for developing countries to put those policies in place. It also means acting to induce creditors and investors in industrial countries to weigh risk more appropriately, so as to help avoid the excesses in capital flows and leverage that contributed significantly to the crisis. And it means equipping the international community to more effectively deal with those crises that occur.

Let me spend just one minute on the causes of the recent crisis, because the experience of the past two years has provided important insights on how we can best go forward. The crisis that first erupted in Thailand did not have a single, simple cause. Weak policies and institutions in many developing countries, and an inadequate focus on risk on the part of banks and investors in industrial countries, combined together to produce vulnerabilities in these economies. It was this combination that led ultimately to the abrupt collapse in confidence that spread through Asia and other emerging economies from the summer of 1997 onwards. And after confidence was lost, the collapse risked become self-fulfilling, as investors who had previously extended excessive credit to developing countries over-reacted in the opposite direction, and began to pull out of developing countries indiscriminately.

Just as the causes of the crisis were complex, so too are the issues we face in reforming the architecture of the global financial markets. There are no simple answers or magic wands. There are often powerful competing considerations that need to be reconciled. And there are some problems to which there is not currently a completely satisfactory solution. The consequence is that reform is not going to involve a single dramatic announcement but a collection of actions over time. Some of these have already been taken or are in the process of happening. Others will take shape going forward.

We have helped to build a broad-based international consensus on the appropriate framework for reform. This consensus has made possible concrete progress in a number of critical areas:

• There is a dramatic improvement underway in the quality of the information available to markets about the risks in emerging market economies.
  

• A set of more powerful tools is now or soon will be in place to equip the international community to respond more effectively to crises, including the IMF's Supplemental Reserve Facility -- which has been used in all of the IMF's recent major programs -- and the proposed Contingent Credit Line. The Contingent Credit Line is designed to reduce the risk of contagion to countries with strong polices and institutions. It will be structured so as to help induce a range of policies to reduce a country's vulnerability to crisis, including the adoption of sound debt management practices, efforts to develop strong bankruptcy and supervisory regimes and the maintenance of sound macroeconomic policies and sustainable exchange rate regimes.
  

• Substantial progress has been made toward developing a much broader set of standards and best practices, based on the model of the Basle Core Principles, in areas that are essential to making financial systems work in today's global economy, be it an effective legal system, elements of sound monetary and fiscal policies, or internationally agreed principles of good corporate governance.

To continue to build a market-based system that is less susceptible to crisis, a critical challenge is to develop better inducements for developing economies to adopt sound policies and for industrial country creditors and investors to weigh risks more appropriately in decision making. These range from better transparency and disclosure for both developing countries and industrial country financial institutions to better employ the pressure for market discipline; to the conditions we place on official finance -- including the new Contingent Credit Line in the IMF; to changes in capital standards and an improved focus on risk management in industrial countries.

In all of these areas, our work must be done with full respect for and recognition of the differences among nations. Different countries may implement the same principles in different ways. Yet we all must recognize that the costs of weak policies and poor credit decisions, whether in developing or developed economies, are not just borne by the countries themselves and their creditors. In an interdependent world, as we have learned, these mistakes can well spill over and affect their neighbors and the rest of the world. This growing interdependence has given all nations a greater stake in avoiding each others' problems and being successful, and creates a responsibility for all nations to pursue sound polices.

Our framework for reform involves changes in a great many areas. What I would like to do today is focus on concrete further steps we support in five particularly difficult areas of the agenda:

• the role of the private sector in resolving crises;
  

• exchange rate regimes;
  

• how developing countries deal with capital flows;
  

• excesses in capital flows and leverage on the part of creditors and investors in industrial countries; and
  

• greater support for those most in need in crisis countries.

The role of the private sector in resolving crises

The role of the private sector in resolving crises is one of the most complex issues that we currently confront, involving powerful competing considerations. The steps we take must not undermine the obligation of countries to meet their debts in full and on time. Otherwise, the private investment and financial flows that are critical to trade and growth will diminish, and the risk of contagion will increase. Yet market discipline will work only if creditors bear the consequences of the risks that they take. The high yields on many emerging market debts indicate private creditors' expectations that some of these debts will not be paid in full or on time.

Striking the right balance between these considerations will always be difficult and must proceed on a case-by-case basis. There can be no one-size-fits-all approach. What we need to work toward is a system in which countries can address debt problems in a market-based, cooperative and orderly way, which may or may not be accompanied by official finance, and that does not threaten the health of the system as a whole.

The practical approaches the international community has taken in recent cases are establishing a growing set of examples about the right balance, and about how the relevant parties should interact with each other. The international community should continue to make these judgments in the context of this overall framework, and work towards refining these approaches over time.

When a government's capacity to pay its debts on time and in full may depend on the provision of official resources, we believe that the international community will need always to consider carefully whether there is a role for the private sector in sharing the burden of adjustment. But, as I have just discussed, the question of what this role should be in a given case is extraordinarily complicated. In some cases it may be appropriate to seek maintenance of exposure levels or to seek a restructuring or refinancing of a country's private debt obligations. In other -- truly exceptional -- cases, negotiations may break down and it may not be possible to avoid a temporary interruption in some debt payments. When a country is nonetheless implementing a strong program of policy reform, the door to official finance should be kept open even if cooperative efforts to clear outstanding arrears with private creditors have yet to be concluded. More broadly, there is no reason why one category of unsecured private creditors should be regarded as inherently privileged relative to others in a similar position. When both are material, claims of bondholders should not be viewed as necessarily senior to claims of banks.

Going forward, we believe the international community should continue to encourage the broader use of provisions in bond contracts of clauses that can facilitate creditor coordination. These clauses are desirable for both borrowers and lenders. We also support steps to strengthen national insolvency codes and to strengthen the operation of insolvency regimes, since these can help prevent private debt problems from accumulating and ultimately spilling over to the sovereign.

Exchange rate regimes

Second, choice of exchange rate regimes for emerging market economies. No exchange rate, fixed or floating, can remain stable unless it is backed by sound policies. Flexible rates generally allow more monetary policy independence and greater flexibility in response to shocks. But countries with a history of extreme volatility understandably may show a preference for greater exchange rate stability. Countries that choose fixed rates must recognize the costs and tradeoffs. They must be willing, as necessary, to subordinate other policy goals to that of fixing the rate. Recent history suggests that institutionalizing that subordination may be essential or close to essential for sustaining a credible commitment to fixed rates; and in some cases, where the conditions are right, currency boards appear to have been effective toward that end. But these institutional mechanisms will work only when backed by a real political commitment to reform and sound policy.

The right exchange rate regime is a choice for the individual country. Yet at the center of each recent crisis has been a rigid exchange rate regime that proved ultimately unsustainable. The costs of failed regimes can be significant, not only for the countries involved but also for other countries and for the system as a whole. We believe that, under the circumstances, the international community's judgments about how to respond to the recent crisis were right. Yet it is also important to shape expectations about the official response going forward, as this will have an important impact on policy choices and we want to strengthen incentives for the adoption and maintenance of sustainable exchange rate regimes. As a matter of policy, we believe that the international community should not provide exceptional large scale official finance to countries intervening heavily to defend an exchange rate peg, except where the peg is judged sustainable and certain exceptional conditions have been met, such as when the necessary disciplines have been institutionalized or when an immediate shift away from a fixed exchange rate is judged to pose systemic risks.

Some countries have recently considered making another country's currency their own: in particular, adopting the dollar. This is a highly consequential step for any country, one that has to be considered very carefully and, in our view, should not be done without consultation with United States authorities. On one hand, dollarization offers the attractive promise of enhancing stability. On the other hand, the country also must be prepared to accept the potentially significant consequences of doing without the capacity independently to adjust the exchange rate or the direction of domestic interest rates. The implications for the United States are also consequential. We do not have an a priori view as to our reaction to the concept of dollarization. We would also observe that there are a variety of possible ways for a country to dollarize. But it would not, in our judgment, be appropriate for United States authorities to extend the net of bank supervision, to provide access to the Federal Reserve discount window, or to adjust bank supervisory responsibilities or the procedures or orientation of U.S. monetary policy in light of another country's decision to dollarize its monetary system.

Dealing with capital flows

Third, dealing with capital flows, including the issues of debt management and capital controls. One of the striking elements of the recent crisis was the extent to which countries actually reached for short-term capital, and thereby greatly increased their vulnerability to crises down the road. The lesson of these experiences is that the greater protection provided by long- term borrowing is worth paying for.

Countries' own interest in avoiding the costs of crises provides a strong incentive to protect themselves better against market volatility in the future. But the costs of inappropriately reaching for short-term capital are borne not just by the countries and creditors concerned -- the international community has a large stake in these decisions. That is why we support the development of international guidelines for sound debt management to discourage countries from taking too many risks.

These guidelines would aim to encourage both a greater reliance on long-term rather than short-term borrowing and the development of domestic debt markets that allow governments and corporations to borrow at longer maturities in their own currencies. It may be cheaper to borrow at short maturities, and it is often easier than making the sometimes difficult policy changes needed to be able to borrow long-term, and to attract more investment flows. But the benefits of short-term borrowing, even if substantial, are often more than offset by the benefits of a debt profile better insulated from periods of market volatility.

Going forward, the recent crisis has shown equally clearly that it not enough for governments to do a better job of managing their own debt. They also should resist tax regimes, restraints on long-term investment, and special facilities that distort private flows toward short- term borrowing. Where financial systems and supervisory regimes are underdeveloped, steps are probably needed to limit banks' foreign currency exposures, especially their short-term foreign borrowing. The limits of governmental guarantees for the external obligations of domestic borrowers -- especially banks -- should be made clear, and the nature and scope of the domestic financial safety nets clearly defined.

Some countries may deem more comprehensive measures -- such as Chilean-style taxes on short-term capital inflows -- to be appropriate. Like all controls, they can be difficult to administer and can decline in effectiveness over time. This suggests that if they are adopted, they should be seen as transitional measures. What is most important is that they not be a substitute for fundamental reform to strengthen and liberalize financial systems.

When crisis strikes, countries may be tempted to introduce controls on capital outflows in an ad hoc response. But the bulk of experience suggests that controls on capital outflows become ineffective over time. Most important, they can do long-term damage to a country's capacity to attract foreign investment, and are often used to avoid or delay fundamental reforms.

Excesses in capital flows and excesses in leverage

Fourth, we must take steps in industrial countries to address excesses in capital flows and excesses in leverage. Excesses in capital flows and excesses in leverage are separate but related problems. Excessive leverage can at times fuel excessive capital flows. In addition, both excessive capital flows and excessive leverage can be indicative of broader failures in transparency and risk management. While creditors and debtors now may be unduly withdrawing capital from developing countries, there is still a need to address the weaknesses in risk assessment that contributed to the recent crisis.

Our market-based economy relies on market participants to provide discipline. But market discipline can break down, and market history indicates that even painful lessons recede from memory with time. That is why we support mechanisms to induce a much stronger focus on risk management during good times, because reducing the excesses of the booms will reduce the likelihood and severity of busts.

In this context we believe it critical to create the right incentives for prudent bank credit judgments and lending decisions. This is why we consider it very important that the Basle Committee work quickly to complete its updating of the Basle Capital Accord, by expanding the number of credit-risk categories and revising the current all-or-nothing system for classifying loans to sovereign borrowers. We also strongly support actions that are being taken by the international community and within the United States to focus supervisors much more strongly on banks' assessment of market risk and their systems for evaluating that risk. With respect to both of these concerns, the President's Working Group on Financial Markets, which includes the chairpersons of the principal federal regulatory bodies in the United States and the Secretary of the Treasury, will soon be releasing proposals to require more disclosure of the exposure of financial institutions to other financial institutions. This will increase market scrutiny over the interbank market -- including the market for interbank lending to developing countries -- as well as increase scrutiny of exposure to highly leveraged market participants.

As we strengthen risk management in the major financial centers, we also need to do more to make sure that these efforts are not undercut by lax practices in offshore financial centers. A variety of incentives could be used to press offshore centers to improve their standards, including a higher risk weighting on bank lending to counterparties operating out of an offshore jurisdiction that does not adhere to the regulatory standards of major market centers or provide adequate supervision.

Beyond these measures, we need to take additional steps to address excessive leverage. As events in global financial markets in the summer and fall of 1998 demonstrated, the amount of leverage in the financial system, combined with aggressive risk taking, can greatly magnify the negative effects of any shock. Additionally, the near-collapse of Long Term Capital Management highlighted the possibility that excessive leverage in one financial institution could increase the likelihood of a general breakdown in the functioning of financial markets.

In this context, hedge funds have generated a great deal of attention. But excessive leverage is not limited to hedge funds. Other financial institutions, including some banks and securities firms, are larger, and generally more highly leveraged, than hedge funds. That is why there is a strong case for improving public reporting and disclosure by financial institutions and their creditors and for tightening risk management practices more generally. The President's Working Group on Financial Markets will soon be releasing detailed, concrete proposals in these areas.

Concerns have been expressed about the impact of such highly-leveraged and other large institutional investors on market dynamics generally, and on vulnerable economies in particular. While we believe that such activity can affect markets in some circumstances and for limited periods, we do not believe that it was a basic cause of the financial market crises of the past two years.

Greater support for those most in need in crisis countries

Building a system that is less prone to crisis and better able to address crises when they occur is one of the best things that we can do to see that the benefits of growth are shared more broadly in the world. The recent crisis threatened or reversed the middle income ascendency of many and worsened the hardships of the poor. The international community should take additional steps to help prevent crises from having undue effects on the most vulnerable, and to help countries put into place, before crisis strikes, the kind of policies that can make them more resilient if it does occur.

To help protect the vulnerable during times of crisis, the MDBs should rearrange their lending priorities and make available fast-disbursing emergency lending to help support safety nets, basic health care and education. Special programs to help create jobs for the most vulnerable may also have a role. The IMF should take into consideration the impact of its prescribed fiscal stance on social spending, and make sure that budgets for core social programs like health and education are maintained, or at least not disproportionately cut, even during periods of needed fiscal consolidation.

More broadly, an open international financial system works best if all countries equip their people to prosper in a modern economy. Such policies are the responsibility of individual governments. But the international community can help, by identifying and helping to finance the implementation of the policies needed to provide this foundation for broad-based growth, from the provision of basic education and public health, to support for core labor standards that promote worker participation in the benefits of growth.

Conclusion

Market-based economic systems, and global capital flows, offer great promise for the global economy, but we can and must greatly reduce the disruptions that can occur, with all the hardship that they produce. The issues involved in this reform are complex and pose difficult questions balancing strong competing factors. As I have said, there are no magic wands. But over time, the steps we have taken and those we propose constitute a very powerful program of reform -- one that will have an increasingly powerful effect on the way the global financial system functions. The result should be a more robust global economy -- one less susceptible to crises, one better equipped to deal with crises and one with greater growth, more broadly shared. And the continued strong engagement by the United States, working with the rest of the international community, will be essential if this outcome is to be achieved. Thank you very much.