currency board system that had served as an anchor of monetary stability for argentina since 1991. in the case of europe, the sovereign debt crisis that we are seeing now has been the consequence of a breakdown of the fiscal prudence and discipline over many years. very few people would now doubt that macroeconomic and financial stability could be achieved in the longer run in the absence of fiscal discipline. market discipline this is probably the most complex if not intriguing dimension of the three disciplines needed to maintain financial and macroeconomic stability. traditionally, we all believe that market forces would be the last guard when national authorities failed to exercise monetary or fiscal discipline or both. in theory, the market should respond to a breakdown in monetary or fiscal discipline by demanding higher risk premium for the sovereign debt issued by those countries that are not behaving in a prudent manner. however, market discipline also seems to have broken down in many instances. for example, right after greece joined the euro zone, the market was somehow attracted by the so called convergence play and for 8 years from 2001 – 2008 it ignored the fundamentals of greece and its single a rating and traded greek sovereign debts as a triple a credit, with a spread of as low as 8 basis points above german bunds in february 2005. looking back, the rationale for this kind of convergence play defies common sense and any analysis of fundamentals. however, the breakdown of the market discipline had played a key role in encouraging and facilitating continued erosion of fiscal discipline of the national authorities by conveying the wrong signals about the market tolerance, and appetite for their sovereign debts. as an illustration, the sharp fall of interest cost ( 10 - year government bond yield ) from over 10 % in the mid 1990s to a low of 3 % in the mid - 2000s had also helped lower the cost of greek government borrowings and created the illusion of the affordability and sustainability of the rising pile of government debts. there are many reasons why market forces are failing to impose discipline when national authorities or firms fail to behave prudently. however, it is fair to say that financial innovation in the last decade or so contributed in no small part to the breakdown of market discipline. bis central bankers ’ speeches coming back to the us, the proliferation of mbs and complex financial derivatives of cdos had, as we now know, greatly increased the leverage and thus risk of the entire financial system. what was worse was that the structure of these financial products was so complex and so far removed from

and redressed before consumers and investors can regain confidence on a brighter future. to some of you my speech today may have sounded rather gloomy. you might have felt that it is easy for someone from asia, a region that is growing strongly and to some extent suffering from overheating pressures, to lecture colleagues in europe, which is in the midst of a sovereign debt crisis and suffering from low growth and high unemployment, about what are the right things to do. but it is far too easy to overlook the fact that emerging asia ’ s dynamism today is the result of very painful adjustments that took place after the widespread devastation caused by the asian financial crisis of 1997 – 98. you may or may not know that hong kong had had a very serious housing market bubble, which collapsed in late 1997. in the six years after that, housing prices declined by close to 70 %, with unemployment rising three times. at the same time, the economy contracted by 8. 7 % over 5 quarters with deflation amounting to 15 % during this period of adjustment. there was a lot of pain and sense of gloom during this very difficult period, but hong kong people did not give up and kept on trying their best to deal with the problems. after this very painful adjustment, hong kong has re - emerged stronger and more resilient than ever before. bis central bankers ’ speeches in conclusion, i wish to leave with you the following message : the breakdown of monetary, fiscal and market disciplines has contributed to the deepness and severity of the latest crisis in the advanced economies. in my view, there is unfortunately no easy way out or clever solution that could avoid the need and thus the pain of structural adjustments that would redress the imbalances built up in the last decade or two. going forward, we must realise that we have to restore the 3ds or three disciplines, without which the conditions for sustainable economic recovery would not exist. are we now in an era of awakening? i am not totally sure but i think, or at least i hope, we are. if not, then market forces would eventually push all of us into that position, except that the later the awakening occurs the heavier the price we will have to pay. bis central bankers ’ speeches