This morning, I would like to reflect for a moment on what many -- including me -- have called the most serious financial crisis of the last 50 years. I would also like to make some observations first, about that crisis and second, about sustaining and strengthening the market-based economic system which, in my view, holds the best prospect for increasing the economic well-being of the peoples of our globe.

As you all well know, the global economy is now well into the second year of a financial crisis that first erupted in Thailand in July 1997, and that has since had profound effects around the world. Emerging markets from Asia to Europe to Latin America have been severely affected, and even many of the strongest industrial economies, including the United States, have experienced substantial damage in some sectors. It is probably no exaggeration to say that in total billions of people have been impacted.

This crisis was caused by complex and in many ways unprecedented problems in developing and industrial countries that built up over many years, and the world will need to work through these problems over time. I believe that, on balance, the international community, including the IMF, has made sensible judgments in confronting these complexities, adjusting its judgments as appropriate. Having said that, by examining and re-examining our experiences in this crisis with an open mind, we can better prepare ourselves for decisions going forward, and I think it likely that much will change in maintaining or restoring financial stability in the years ahead. However, one thing is clear: there are no easy answers and no magic wands, and each of us must do our part.

To come back to the moment, there have been some important positive developments in the last six months or so, including actions to promote growth in many industrialized countries and progress in Korea and Thailand, but there are also many serious challenges and risks ahead.

As we look back over the experience of this crisis, we can see that the absolute key to financial stability and economic growth is consistent adherence to strong macroeconomic and structural policy. It is essential that when a country develops problems, that country develop a solid program of policy reform geared to its particular circumstances, and that where appropriate, external financing be provided. But the critical factor -- whether in countries responding to crisis or countries working to avoid crisis -- is political will. Only nations that take ownership of good policies and consistently follow them will be able to maintain their credibility and the confidence of markets. And I would add here that one of the most difficult policy challenges is to conquer the widespread corruption that is a major impediment to economic development -- as well as a terrible social problem -- in too many countries. The industrial countries, too, have an important role to play in achieving this objective, as recognized by recent actions of the OECD.

Thus, while economic policy and finance -- the province of economists and the international financial community -- must be gotten right, and this is surely no easy matter, I have come to believe that the ultimate key is not economics or finance, but politics -- the art of developing support for strong policy, especially for the hard decisions that involve present sacrifice for future benefit.

President Clinton has often spoken of both the difficulty and the importance of persuasively communicating about, and developing support for, difficult economic policies. In all countries, but particularly countries going through a painful adjustment process, that is not just a question of persuading people that difficult policy choices will produce future overall economic benefits, but a question of making sure that the recovery program provides -- and is seen as providing -- for broad-based sharing of those economic benefits.

As I look back over the last several decades in which I have been involved, in one way or another, in the global financial system, I do not think there is any question that the ever growing movement toward a market-based economic strategy and toward global economic integration has brought enormous benefits to billions of people around the globe, even with the adverse impact of the recent financial crisis. However, because of the economic crisis and its effects in all of our countries, the voices in opposition to market-based economics and to global integration have grown. The answer is not to abandon the market-based system, but rather to pursue policies to help adapt to the ongoing, dynamic change that is so central to economic success, and at the same time, take steps to reduce the risks of the system.

Meeting these goals requires us to address any number of challenges, but today I would like to focus on two. First, we must effectively address the economic dislocation that comes with an openness to change. And second, we must reform the architecture of the international financial system to reduce its susceptibility to crises and to improve our response to crises.

First, openness to change -- from technology, open markets, and flexible labor and capital markets -- is absolutely central to overall progress in job creation and increased standards of living. But, openness to change also increases dislocations. And that is a hard reality of change and progress that cannot be avoided. The constructive reaction to that reality is to provide robust programs to equip and enable people to succeed in the global economy -- with special emphasis on those who experience dislocations -- and to provide social safety net support where needed. This is not an easy path politically -- quite the contrary. But it is the essential path for enduring growth and a strong economy.

Study after study has shown that more open economies enjoy stronger growth. It is worth noting that the U.S. is probably the most open major economy in the world to trade and to change more generally, has had a strong record of job creation and has achieved record low unemployment in recent years -- though, as an aside, let me say that certainly we have enormous issues of our own to face going forward.

The destructive reaction to this hard reality is either to ignore the problem of dislocation -- which is both economically wasteful and politically not sensible -- or to opt against change, by limiting technological development, closing markets, or reducing flexibilities in labor or capital markets. That is the path to economic stagnation at best and to falling further and further behind in the global economy.

One proposal that has gained support of late is to impose controls on capital outflows. Such capital controls may provide temporary benefit, but the preponderance of evidence suggests that over time they retard growth, deter investment from abroad, become harder and harder to administer, and are often used as a substitute for reform. Having said that, it is critically important that countries put in place appropriate macroeconomic policies, financial systems, and legal systems and the other fundamentals of a market-based economy as they open their economies to global capital flows. The two must go hand in hand.

The pressure to reduce market openness to trade is even greater, and more dangerous to the economic well-being of the global economy. All one needs to remember is the impact of Smoot-Hawley and competitive devaluations in the 1930s.

Today there is the almost universal tendency to extol the benefit of exports, and to ignore the benefit of imports or even disparage them. And that leads to distorted trade policy. Imports reduce prices and increase choice for consumers; reduce prices and increase choice for producers, which should lead to greater job creation and higher wages; increase competition and productivity; and, for all these reasons, reduce inflation and presumably reduce market interest rates. Moreover, trade is not a zero-sum game; but one of mutual advantage. The increased efficiencies deriving from each country specializing where it has the greatest comparative advantage raise standards of living for all.

To maximize the economic benefits of trade globally and to maintain political support for open markets, countries must engage in fair trade practices. In the United States, we are committed to open markets, but we are also committed to enforcing our trade laws, not only for our benefit but also to promote the most efficient global trading system.

While imports contribute to economic well-being just as exports do, there is the separate but related question of trade imbalances. The United States has a large and growing trade deficit, while Europe and Japan have large and stable or growing trade surpluses. Relative growth rates undoubtedly have something to do with that, but it is almost impossible, I believe, to avoid the conclusion that the United States has simply been more open to absorbing the exports of countries seeking to recover from crisis. The international system cannot sustain indefinitely the large imbalances created by the disparities in growth and openness between the U.S. and its major industrial trading partners. We can contribute to this rebalancing by continuing to strengthen our fundamentals and by working to increase our far too low savings rate. One thing we will not do is use our currency as an instrument of trade policy.

The other industrialized countries can contribute by acting to achieve higher rates of domestic demand led growth and by greatly reducing formal and informal barriers to trade. By each industrialized country doing its part, the imbalances in the industrialized countries current account would be reduced, the absorption of exports from the developing countries pursuing recovery would be more appropriately shared, and global economic well-being would be enhanced.

Let me now turn to the second major challenge we face in sustaining and strengthening the market-based economic system reforming the international financial architecture. There has been enormous focus over the last 18 months by the international community on how to reduce the susceptibility of the market-based economic system to financial instability, and how to respond better if crises occur. This challenge poses enormously complex issues and, as in the case of dealing with the current crisis, there are no magic wands or easy answers. We must approach this matter with great analytic rigor and seriousness of purpose, exploring the full range of effects of any proposal under examination. Widely discussed reforms that sound attractive on their surface, on full examination often raise serious questions to which there are currently no good answers.

For example, some have proposed that countries meeting certain policy criteria be pre-qualified to receive international assistance in the event of a crisis. This idea has much appeal on the surface as a way to induce strong policy ex ante, and it is well worth pursuing to see if there is some variant of it that could work, but there are a number of difficult questions that first must be answered. These include: identifying qualifying criteria that have sufficient predictive reliability; addressing the issue of moral hazard or what to do if a qualifying country ceases to qualify; and dealing with the issue of countries that do not pre-qualify but develop financial problems posing systemic risks.

Similarly, it might be appealing, as some have proposed, to develop an early warning system that could credibly and reliably reduce or prevent crises occurrence through advance warning. Nothing in my 26 years on Wall Street or my six years in government suggests that there is any predictive capability even remotely reliable enough for such a system. In addition, the early warning itself could create precisely the instability and even panic that such a system is designed to prevent.

Having said that, I would guess that we would all agree that the status quo is unacceptable and that major changes must occur. I believe these changes should focus on the following five areas.

First, perhaps the most important factor in preventing crises from occurring is for developing countries to develop and follow sound policy regimes. It may be that this can be aided by the elaboration of international best practice codes on fiscal policy, financial sector policy, transparency and other important areas of economic management. But perhaps the even greater challenge is to create incentives for countries to adopt these best practices. Disclosure and the discipline of the markets are probably the most effective forces -- if the markets themselves act with discipline, but there may be other means to encourage countries to pursue sound policies. These could include international surveillance of national regulators, higher capital standards for bank lending to countries with less robust policy regimes, and higher capital requirements for countries with less sound banking systems.

Let me add that while I believe that the international community can identify and in some instances even codify broad parameters for a successful economy, this must be done with sensitivity to the differences that exist amongst nations and with recognition that different countries may implement the same principles in different ways. We must respect our heterogeneity.

Second, we must develop measures with respect to providers of capital in industrial countries to reduce the volatility of capital flows. When the situation in Korea reached crisis proportions in late 1997, I was appalled though not surprised to learn how little some creditors seemed to know about the country and its banks to which so much had been lent. And that is exactly what happened amongst the creditors in the Long Term Capital Management hedge fund debacle.

Based on my own experience -- and many of you have had very similar experiences -- I believe that it is in the nature of markets, and probably ultimately in human nature since markets are driven at least in the short and intermediate run by human psychology -- to become ever more careless about adequately analyzing and weighing risk as good times continue. This is sometimes called reaching for yield. This creates excesses, and that is exactly what happened amongst interbank creditors and investors with respect to developing countries. And it was this interaction between these excesses and the macroeconomic and structural problems in the developing countries which led to a crisis of such severity.

I might add that the opposite has probably been happening since the crises erupted, with creditors and debtors now overweighting risk and unduly withdrawing capital from developing countries. What we need are mechanisms to induce appropriate focus on risk during good times; reducing the excesses of booms will reduce the likelihood and severity of busts. Presently identified possibilities include improved regulatory focus on risk management, changes in bank capital standards to more accurately reflect risks being taken, and improved disclosure of risks by industrial country creditors and investors to allow for greater market discipline by their own sources of capital. And we must continue to search for additional measures in this area.

In that regard, let me say a word about leverage. Leverage throughout the international financial system has been substantially reduced over recent months, and that probably makes the financial system safer today than it was last summer. Without prejudging anything, it does seem to me that this whole question of leverage merits further examination. As a related matter, while I do not believe that hedge funds have been a significant factor in the financial crisis, their activities may well have amplified market movements in some cases for some period of time. I think questions about hedge funds should be addressed, but as part of a broader review of financial institutions generally with respect to leverage, the appropriate scope of prudential regulation, risk management and disclosure.

Third, we need more effective means of dealing with crises when they arise. The international financial community has taken a series of limited but useful steps to better equip the IMF to deal with crises, including the precautionary facility proposed by the G-7 and the Supplemental Reserve Facility already in place. Many propose going beyond these limited steps to create a lender of last resort through the IMF, various public and private insurance mechanisms, or a pre-qualification procedure of some sort, as I discussed earlier. Ultimately, mechanisms may be developed in some of these areas, but for the reasons I discussed previously with respect to pre-qualification, so far no proposal seems to me to come close to answering the questions it raises.

The private sector must play an appropriate role in sharing the crisis burden, both because of moral hazard concerns -- the view that creditors should bear the consequences of the risks they take if capital markets are to work effectively -- and because there will never be sufficient official finance to deal with the crises of today's vast markets. However, the question of how to accomplish this is extraordinarily difficult, including how to minimize the risk of triggering anticipatory capital withdrawal from the country in crisis and more broadly from emerging markets. Moreover, any such proposal must balance the principle that private sector lenders bear the consequences of their actions against the principle that borrowers must be held responsible for paying their debts if creditors are going to be willing to lend further in the future. Global financial markets will only provide capital at less than penalty rates in a system where there is a commitment to meeting obligations and strong penalties for not meeting obligations.

Fourth, there is the question of sensible exchange rate regimes. For major currencies, I believe that means floating rates supported by sound policies. Target zones and similar measures are no substitute for sound underlying policies and suffer from the defect that they could be pro- rather than counter-cyclical, thereby exacerbating, rather than countering adverse economic developments. To paraphrase Winston Churchill's famous statement about democracy, the floating exchange rate system is the worst possible system, except for all the others. For developing countries, the issue is far more complicated; fixed rate and flexible rate regimes have been successful and unsuccessful in different countries, and I would guess that there will be much debate and perhaps even innovative thought on these matters in the years ahead. But again, whatever the regime, in the final analysis, the key is sound underlying policy.

Fifth, we must do far better in enabling all of our citizens to participate in the growth and economic well being produced by the global economy. That means not only strengthening social safety nets for those in greatest need and promoting core labor standards around the world, but also greatly increasing investment in education and health care to provide all of our citizens with the requisites for economic success. The World Bank, and the other multilateral development banks, are deeply engaged in pursuing these objectives, and deserve our full support. Along these same lines, I do not believe that a market-based economic system, and a healthy global economy, are sustainable unless we take strong steps to address the tremendous income inequality that is all too evident around the world -- within nations and between nations.

To accomplish all of these architectural objectives -- both in the devising and in the implementation of policy -- we must provide effective means for bringing together industrial economies and developing economies.

Let me conclude by saying that I spent 26 years in the world of trading, and lived, as many of you have, the development of today's global financial markets and global economy. I have now spent the last six years in government, first at the White House and then at the U.S. Treasury Department, working with others in the U.S. Government and with colleagues around the world, on the difficult policy questions raised by the global economy.

I do not think there is any question but that a market based economic system and global economic integration offer the greatest promise for the world's people and are far preferable to the alternatives. However, I think there is equally no question but that unfettered markets do not and cannot by their nature best deal with all needs, and that there are enormous challenges ahead for us if we are to have a market-based system that fulfills its potential. We must approach this task with the great seriousness of purpose and with the comprehensive analysis that are commensurate with the complexity of the challenges. We must put in place what can be done now as quickly as possible, and continue to work together on the large issues that still lie ahead. This will, I have no doubt, occupy all of us -- in the private sector and in government, in developing countries and in the industrial countries for some time to come. By undertaking all of these difficult challenges, we can move toward a robust global economy with far less instability whose benefits are broadly shared.

Thank you.