Once upon a time there was a country, confident, with steady economic growth and political stability. That country was ready to play a larger role in the region and the world. But, while the fundamentals of the country were indeed strong, problems in other countries spread to the region and caused investors to flee.

The stock market index rapidly went south and the exchange rate dropped. Fears of recession and a creeping sense of fallibility emerged. The country's leadership watched helplessly as their hard work crumbled before their eyes. Then they decided to do something radical which just might turn things around.

This description, is it about Indonesia's current trouble? Nope. The country was Malaysia in 1997 and the radical path, then rejected by the International Monetary Fund and most economists, was capital control.

Why was it considered radical?

Policy makers wanted to do three things: stabilize exchange rates, use their monetary policy to achieve domestic goals and maintain a regime of free international capital mobility, as described by Maurice Obstfeld, Jay C. Shambaugh, and Alan M. Taylor in 2004. But academics regard attaining all three at the same time, coined a trilemma, as impossible and self-contradictory. At most policy makers thought they could manage to pursue two out of the three objectives. After the collapse of the Bretton Woods agreement, most countries agreed to pursue only the first and third objectives.

Some European countries went even further and established the euro as a common currency, creating a supranational monetary authority which left no wiggle room. Those countries could no longer independently adjust their monetary policy to suit their domestic economic goals. If European countries, with all their economic might and long history of monetary policies, are still prone to crisis, then it should not be surprising if other regions also score lower on the stability meter.

The Asian economic crisis in the late 1990s put into question the virtue of free international capital mobility (Paul Krugman 1999, Joseph E. Stiglitz 2002), and cast doubts on the link between financial openness and buffering potential crises (Sebastian Edwards 2005). The impact of a sudden cessation of capital inflows coupled with massive capital outflows on a country's output and exchange rate could be devastating, especially after a period of regular capital inflows.

The chronicles of economic crises usually follow a similar path. An economy which has been receiving a large amount of investment and capital inflows for a considerable period and expects to do so going forward abruptly faces loan repayments under newly adverse conditions, which leads to defaults, or near defaults, on its loans. Factor in a large drop in the exchange rate (as in many of Latin American crises) and you get a downward spiral that can rapidly spread, a timeworn recipe for crisis. (Barry Eichengreen and Charles Wyplosz in 1996 demonstrated how a currency crisis in an industrialized country can spread to others.)

But the IMF and its collection of recipes in the Washington Consensus enshrined free international capital mobility on a pedestal. Thou must not experiment with capital control!

But, as with all economic policy, capital mobility is a means as an end. With the exchange rate breaking a psychological threshold, very close to touching Rp 12,000 per US$1.00 as I write, standard economic policy calls for raising the interest rate. But the Indonesian economy is slowing down and expected to head into a recession. Should we exchange short-term stability for long-term growth?

Crisis is the worst of times and the best of times.

The downturn brings many unexpected troubles but also opens door for unconventional solutions. France's President Nicholas Sarkozy has been talking about a new financial order the West sidestepped during last decade's Asian crisis. Other quasiradical ideas now floating around are global lender of last resort, global currency and foreign exchange trade suspension.

Asian nations have committed to pooling US$80 billion in emergency funds for crisis management at a recently concluded Asia-Europe meeting. The gathering provide convenient cover since most of the capital will actually come from Japan, China and South Korea with their red-hot export engines and stacks of foreign currency.

It's time to build a global war chest to fend off speculative attacks without overburdening conditions and lengthy procedures the IMF used to invoke. A global lender of last resort would function like a central bank on a larger scale; in the event of a liquidity crunch it could lend freely, temporarily and with penalty rates. Near-instantaneous decisions are needed to calm markets and the current IMF arrangement does not allow for that.

Building upon the regionalization trend, especially in Europe, and taking it to the next level would inevitably lead to the need for a global currency. While the road is long and arduous to get there, the benefit is too great to ignore. Policy makers will no longer have to deal with currency speculators and uncertainty. Nevertheless, considering the diverse structural differences between countries, an intermediate step of regional currencies among similar economies would be a wise path to take.

The last measure is the application of trading suspensions to global currency markets to put the brakes on speculation which provokes excessive downward (or upward) currency valuations. Trading suspension is a widely accepted instrument in developed stock markets.

In the United States, for example, trading suspension was codified more than 70 years ago as Section 12(k) of the Securities Exchange Act of 1934. In the event of emergency, defined as sudden and excessive fluctuations of securities prices generally, or substantial threat against fair and orderly markets, the Securities and Exchange Commission is authorized to suspend trading in any security for a period not to exceed 10 business days.

If proven effective in preventing widespread panic, why don't we apply this wise practice to global foreign exchange markets?

Considering the depth of the problem and numerous pronouncements by prominent economists that we are facing the worst economic downturn since the Great Depression. Maybe now is indeed the time to get radical.

The writer is a Ph.D. candidate in economics at the University of Sienna, Italy, and a lecturer in the graduate public policy program at the Faculty of Economics, University of Indonesia. He can be reached at b.martawardaya@ui.edu

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