mr greenspan offers some suggestions to improve the international financial architecture testimony by the chairman of the board of governors of the us federal reserve system, alan greenspan, before the committee on banking and financial services of the us house of representatives on 20 may 1999. mr chairman, mr. lafalce, and members of the committee, we at the federal reserve are in broad agreement with the approach outlined by secretary rubin, and expect to continue to work closely with the treasury in this area. as i have indicated previously before this committee, dramatic advances in computer and telecommunications technologies in recent years have enabled a broad unbundling of risks through innovative financial engineering. the financial instruments of a bygone era, common stocks and debt obligations, have been augmented by a vast array of complex hybrid financial products that has led to a far more efficient financial system. these same new technologies and financial products, however, have challenged the ability of inward - looking and protectionist economies to maintain effective barriers, which, along with the superior performance of their more open trading partners, has led, over the past decade, to a major dismantling of impediments to the free flow of trade and capital. the new international financial system that has evolved as a consequence has been, despite recent setbacks, a major factor in the marked increase in living standards for those economies that have chosen to participate in it. notwithstanding the demonstrable advantages of the new international financial system, the mexican financial breakdown in late 1994 and, of course, the most recent episodes in east asia and elsewhere have raised questions about the inherent stability of this new system. these newly open markets were exposed to a huge expansion in capital inflows that their economic and financial systems were not ready to absorb. these flows in turn were engendered by the increasing diversification out of industrial country investment portfolios, augmented by huge capital gains through 1997. net private capital inflows into emerging markets roughly quadrupled between 1990 and the onset of the asian crisis. such diversification was particularly directed at those economies in asia that had been growing so vigorously through the 1970s, 1980s, and into the 1990s – the so - called “ asian tigers. ” in the event, these economies were ill prepared to absorb such volumes of funds. there were simply not enough productive investment opportunities to yield the returns that investors in the west were seeking. it was perhaps inevitable then that the excess cash found its way in too many instances into ill conceived and unwisely financed

euro, the region ’ s ) equilibrium real exchange rate and real interest rate. but looking at exactly the same phenomenon in another way, those who seek international currency status should not forget that an appreciating currency — and one that is very often a safe haven in times of economic and political crisis — implies a reduction in competitiveness and a drag on economic growth through a declining current account balance. as the international role of the euro increases, the demand for euros will increase — both directly as currency and indirectly via euro - denominated assets — potentially leading to an appreciation of the euro. i say potentially because we all know that the price of anything, including the euro, is affected by supply as well as demand. and the euro will encourage an increase in both the issuance of eurodenominated liabilities as well as in the demand for euro - denominated assets. as a result, there is some uncertainty about the effect of portfolio decisions on the price of the euro. even if the euro appreciates, this consideration suggests, the magnitude of the appreciation may not be very large. but let us nevertheless explore the implications of a net increase in the demand for euros and hence an appreciation of the euro over time, given that this is the result many have emphasized and one with particularly important implications for the international financial system. the effect of a large reallocation of portfolios away from the dollar and dollar - denominated assets and into the euro and euro - denominated assets would, by definition, imply a swing from current account surplus to deficit for the euro area as investors acquire net claims on the region. indeed, the appreciation of the euro would be the cause of the euro - area ’ s move from surplus to deficit. but such an appreciation of the euro would bring a reduction in competitiveness that could provide additional pressure for structural reform in continental european product and labor markets. and the counterpart to this from our side would be a reduction in net claims on the united states, and might be just the medicine the doctor ordered to help us move to a more sustainable external position. i ’ d like to say a few words about how monetary policymakers think about the exchange rate when judging the appropriate level for domestic short - term interest rates. as you know, the american economy is relatively closed when compared with individual european countries — u. s. exports of goods and services, for example, are only 14 percent of our gdp, compared with germany where exports are 31 percent