exchange rates float upwards. this would have eventually curtailed the short - term inflows that result when a fixed exchange rate tries to co - exist with a positive interest differential. but what we do not know is how high the exchange rate would have needed to rise in the process and the extent to which this would have added to the economic difficulties. remember the thai currency crisis was triggered by the perception that the baht had become over - valued because it was tied to a rising us dollar. in short, if capital flows are very large relative to the size of the economies, they are, one way or another, going to cause distortions. of course, the above considerations would not matter if the international capital markets were a smoothly adjusting mechanism that constantly kept the exchange rate in line with the evolving fundamentals. but this is not what people observe - they see booms and busts and do not believe the proposition that the market is always right. attempts by academic economists to persuade them that the free market always, or nearly always, gives the correct equilibrium price are unconvincing. the public ’ s scepticism is well placed because the intellectual underpinning of the free market position in relation to asset price determination - the efficient markets hypothesis is very weak. in all the exchange rate tests of which i am aware, the hypothesis has been contradicted by the facts. the third difference from an emerging market viewpoint is their relatively under - developed financial infrastructures and regulatory frameworks. they do not have as strongly a based system of regulating stock markets or banks or the underlying body of commercial ( including bankruptcy ) law or accounting practices. they also have serious deficiencies in the allocation of investment which unduly favours those who are well - connected to the government, the banks or both ( the so - called “ crony capitalism ” ). i have no intention of denying that these are serious shortcomings and that they should be rectified as quickly as possible if the countries concerned are going to achieve first world living standards. but we have to be realistic about how quickly these things can be achieved ; in our own countries, these changes took decades or generations rather than years. such problems are heightened by the phenomenon of contagion, a fourth element particularly strong among emerging markets. in cases of panic, financial markets are not very discriminating. when one country suffers a withdrawal of capital, others come under pressure. partly, this can be geography, as physical

exchange controls, in 1983. although we characterise this 15 - year period as being an era of deregulation, that is only a very approximate description. while the authorities have stopped setting prices such as the exchange rate or the interest rates banks can charge on mortgages, there is still a large everevolving body of regulation in place aimed at ensuring financial stability and efficient and fair markets. the stock exchange and the futures exchange have a comprehensive set of rules that participants must adhere to, and, of course, they are also regulated by asic. the banks and insurance companies are regulated by apra, the payments system by the reserve bank, and competition policy is enforced by the accc. underlying all this, are the body of commercial law and the accounting standards. this approach to organising financial markets - which, in deference to common usage, i will call the deregulated approach - has not been without its critics. a common criticism is that international capital has forced the australian government to run macro - economic policies that were not in the interests of the domestic economy. by this, the critics mean policies that are tighter than the ones they favour. i have never agreed with this proposition. there has been an on - going struggle in australia by governments of both sides to return fiscal and monetary policy to sustainable long - run settings after the turmoil of the 1970s. the influence of financial markets has been a helpful one in bringing this about. now that policies are in a sustainable and responsible position, i am not aware of financial markets pushing for tighter policies. the other common criticism is that financial markets in australia have been unstable. the simplest answer to this charge is to point out that they would have been more unstable over the past 15 years if we had tried to find a path through the ups and downs of the world economy with a managed exchange rate and a set of interest rate ceilings. we would not have had the daily movements as under the present system, but the pressure would have built up and when the dam broke, as it assuredly would have, the crisis would have been worse. while i am confident that the deregulated system performed better than a continuation of the old regulated one would have, i do not want to give the impression that it is without fault. we are already on record as accepting that the exchange rate went down too far in the mid - 1980s, that asset prices such as shares and, later, commercial property underwent a boom and bust at the end of the