_9 Money, Politics and a Futurefor the International Financial System_ For example, recent studies suggest that at least some exposure of depositors to loss in case of bank runs is actually beneficial as it improves incentives to monitor banks (Baer and Klingebiel, 1995). In any case deposit insurance can be funded from premia charged to depositors. Lender of last resort systems need not be funded by central banks. They can in principle be provided by funded liquidity insurance schemes. Also, when private parties issue money, they have an incentive to provide liquidity in times of a credit crunch, because for them money is debt and during a credit crunch they can issue cheap debt to solvent but illiquid firms. There is no reason in principle, why they should be less informed or capable to achieve this than a central bank.

However, financial crises are not excluded in a free market system. When a crisis hits and hurts, governments will be under pressure to support citizens and powerful interest groups. No matter how seriously governments may prior to the crisis announce that they will not bail out anybody, in the midst of then crisis they will all too often be forced to reverse their policy stance. Time and again governments have bailed out private parties, who were not formally eligible. Private parties in turn anticipate this correctly and take excessive risk, which market forces were supposed to prevent. The inability of governments to commit themselves not to do anything beyond using pre-funded insurance schemes during a major crisis tends to render pure laissez faire hard to implement in today's political systems (Mas, 1995).

Even more fundamentally, a well-functioning market requires some level of trust among participants in the sanctity of contracts and property rights combined with institutions capable of sorting out disputes on these matters, reasonably well. Any market thus raises the fundamental dilemma of the economic constitution, i.e. how are sound rules established and who guards the guardians of those rules. Market forces can play an essential role as part of a system of checks and balances and lower the demands for benevolence and efficiency on the part of politicians and regulators. Interest in beneficial trade among merchants or states can provide incentives to form sensible institutions underpinning markets. However, some reasonable social institutions whether we call them government or self-regulatory bodies are required in the first place.

# **PART** B: A **STORY OF THE** FUTuRE: NATIONS STATES, E-MoNEY **AND CURRENCY** CHOICE

It is thus understandable, why the mainstream solution to financial sector reform may be the best we can hope for - with all its problems. But the future has a way of surprising us. The fundamental dilemma of the economic constitution, and the part of bank regulation in it, suggests that there are no unambiguous ways to predict the shape the next re-solution of the issue will take. In the following an unconventional view of what may happen is described, closer to the laissez faire story, but with a twist that helps deal with the government's commitment problem.

# **I. Failure of mainstream reform**

To start with it is painfully obvious that all the good recommendations for domestic financial sector reforn made by the mainstream school are seldom implemented. In the most comprehensive study of the topic the World Bank examined financial sector reforms undertaken following 64 cases of banking crises all over the world during the 1980s and 1990s. The reforms