The Storm Clouds Spread

It was deja vu all over again for officials from more than 180 countries gathering last weekend in Washington, D.C., for the annual meetings of the IMF and World Bank: frantic emergency policy discussions held in the context of highly volatile stock markets, wild fluctuations in exchange rates, a generalized loss of confidence and trust and a cascading paralysis of markets. All this comes despite the fact that a series of dramatic, and previously unimaginable, policy steps have already been taken by the U.S. and other industrial countries—massive injections of liquidity, coordinated interest-rate cuts and partial nationalization of some financial institutions.

This is an eerily familiar combination for developing-country officials in particular. Yet it should be noted that this crisis is different from past situations in three key respects.

First is the transfer of problems from Wall Street to Main Street. Most now understand that, regardless of who is to blame (and the list is long), the global prosperity of societies around the world is being fundamentally threatened. That's because the epicenter of the crisis is not an emerging market, but the U.S., which, in addition to being the largest economy on the planet, also provides the world's reserve currency and the deepest and most liquid financial market for government and corporate paper. As a result, the crisis has destroyed trust between buyers and sellers in a cascading number of markets.

Second, the policy response to date has been bold—indeed, unprecedented—and yet insufficient. A large part of this reflects the time it has taken the U.S. to make the three transitions that proved key to successful stabilization efforts in Asia and Latin America: on the design front, moving from individual actions to a comprehensive package of self-reinforcing measures; and on the implementation side, shifting from a sequential approach to a simultaneous one, and from an inward focus to a globally coordinated one.

Third, the crisis has altered the financial landscape in a profound way, and shifted power away from unfettered markets to greater government interference. The result will be a significantly more regulated global financial system that will gain greater short-term stability at the cost of long-term productivity and flexibility.

That stability will not come immediately. After all, too many things are still in flux: institutions, policies and, most fundamentally, market rules. With the enormous shifts still taking place in the U.S., which possesses by far the biggest and most influential markets, the global system lacks any meaningful anchors. We should therefore expect additional market accidents, institutional failures and policy mistakes in the weeks ahead.