Financial Crises

In the wake of the Mexican Crises of 1994/1995, Barry Eichengreen and Richard Portes came up with a simple and market‐friendly solution for countries in trouble financing their debts. It was to include ‘collective action clauses’ in sovereign debt contracts so as to enhance the capacity of creditors and debtors to resolve problems on their own. Although this idea, based on long established commercial practice in the London corporate debt market, was promptly endorsed by the G10, it has not been taken up by market participants. Instead, we have seen financial crises sweep round the globe with growing severity. It is of great interest to see what Barry Eichengreen now says should be done. In the introduction to his timely and eminently readable book on this topic, the author shows that, since the collapse of the Bretton Wood System in 1973, the probability of crises is around 10% a year for a panel of advanced‐industrial and emerging‐market countries. But for the same panel of 21 countries, it was only half that under the gold standard. His explanation is simple and chilling: ‘the greater incidence of currency crises, compared to the late nineteenth century, reflects the incompatibility of high capital mobility (a common characteristic of the two periods) with democratic politics ... The combined effect of these two trends – financial liberalisation and political democratisation – has thus been ... crises at rates witnessed previously only during the disastrously unstable interwar years.’ As if on cue, the devaluation‐and‐debt crisis of Brazil – which happened just after the book was written – seems to conform with Eichengreen's analysis: a country where a Left‐wing candidate was expected to win the presidential election has been punished with severe currency depreciation and interest rates of around 20% making the cost of debt service almost unbearable

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