The emergence and vigorous growth of Euromarkets and their (alleged) ability to create multiple deposit expansion without any apparent control mechanism, have given rise to a number of concerns regarding their impact on international liquidity, on the ability of national monetary authorities to conduct an effective monetary policy, and on the soundness of the
international financial system. Among the worries expressed are:
1. The market facilitates short-term speculative capital flows-the so called “hot money”—creating enormous difficulties for central banks in their intervention operations designed to “stabilise” exchange rates.
2. National monetary authorities lose effective control over monetary policy since domestic residents can frustrate their efforts by borrowing or lending abroad. It is known that with fixed or managed exchange rates, perfect capital mobility makes monetary policy less effective. Euromarkets contribute to increasing the degree of international capital mobility.
3. The market is based on a tremendously large volume of interbank lending. Further, Eurobanks are engaged in maturity transformation, borrowing short and lending long. In the absence of a “lender of last resort” a small crisis can easily turn into a major disaster in the financial markets.
4. Euromarkets create “private international liquidity” and in the absence of a central coordinating authority they could create “too much” contributing to inflationary tendencies in the world economy.
5. The markets allow central banks of deficit countries to borrow for balance of payments purposes thus enabling them to put off needed adjustment measures. Against these are to be set the obvious advantages of the markets such as
a. more efficient allocation of capital worldwide,
b. smoothing out the effects of sudden shifts in balance of payments imbalances (e.g. recycling of petrodollars mentioned above without which a large number of oil importing countries would have had to severely deflate their economies after the oil crisis), and c. the spate of financial innovations that have been created by the market which have vastly enhanced the ability of companies and governments to better manage their financial risks and so on.
On the question of whether the Euromarkets are really unbridled creators of international liquidity, the argument, as we saw above, is not settled. The connection between international liquidity and world inflation is also open to debate.
Concerns pertaining to increased fragility of the financial system are quite legitimate particularly since the advent of securitization. Authorities in GECD countries have already taken certain steps towards tightening the regulatory provisions. Uniform capital adequacy. norms and tightening of bank supervision is expected to render the financial system less vulnerable to systemic failures. The debate about the desirability of having completely open capital accounts and uncontrolled cross-border capital flow continues with a variety of proposals for redesigning the global financial system. We will briuf1y discuss some of These development toward the end of this chapter.