. arguably, however, the free flow of short - term capital facilitates the servicing of direct investments as well as the financing of trade. indeed, it is often difficult to determine whether certain capital flows are direct investments or short term in nature. chile is often cited as an example of the successful use of controls on short - term capital inflows. but in response to the most recent international financial turmoil, chile has chosen to lower its barriers in order to encourage more inflows. those economies at the cutting edge of technology clearly do not need foreign direct investment to sustain living standards and economic growth. the economy of the united states in the 1950s, for example, needed little foreign investment and yet was far more dominant in the world then, than it is today. that was a major change from our experiences of the latter half of the nineteenth century, when the vast amount of investment and technology from abroad played a significant role in propelling the us economy to world - class status. even today, though we lead the world in many of the critical technologies, we still need to borrow a substantial share of the mobile pool of world savings to finance our level of domestic investment. were we unable to do so, our standard of living would surely suffer. but the inflow of foreign capital would be much reduced if there were uncertainties about whether the capital could be freely repatriated. while historically there could be considerable risk in american investments - - for example, some nineteenth century investments in american railroads entailed large losses - - the freedom of repatriation and the sanctity of private contracts were, with rare exceptions, secure. our experiences, and those of others, raise the question of the sustainability of free international capital flows when the conditions fostering and protecting them are impaired or absent. specifically, an economy whose private and / or public sectors have become heavy net debtors in foreign currency is at risk of default, especially when its exchange rate unexpectedly moves adversely. clearly, should default become widespread among a number of economies, the flow of international capital to other economies perceived as potentially in similar circumstances will slow and in certain instances reverse. the withdrawal of the ongoing benefits of free flowing capital, as recent history has so amply demonstrated, often can be abrupt and disruptive. the key question is obviously how do private sector entities and governments and, by extension, economies as a whole allow themselves through currency mismatches to reach the edge of insolvency? indeed, where was the

certainly not all, economies that have recently begun to participate in the international financial system. doubtless at the head of the list is reinforcing the capabilities of banking supervision in emerging market economies. conditions that should be met before engaging in international borrowing need to be promulgated and better monitored by domestic regulatory authorities. market pricing and counterparty surveillance can be expected to do most of the job of sustaining safety and soundness. the experience of recent years in east asia, however, has clearly been less than reassuring. to be sure, lack of transparency and timely data inhibited the more sophisticated risk evaluation systems from signaling danger. but that lack itself ought to have set off alarms. as one might readily expect, today ’ s risk evaluation systems are being improved as a consequence of recent failures. just as importantly, if not more so, unless weak banking systems are deterred from engaging in the type of near reckless major international borrowing that some systems in east asia engaged in during the first part of the 1990s, the overall system will continue at risk. a better regime of bank supervision among those economies with access to the international financial system needs to be fashioned. 1 in addition, the resolution of defaults and workout procedures require significant improvements in the legal infrastructures in many nations seeking to participate in the international financial system. 2 none of these critical improvements can be implemented quickly. transition support by the international financial community to those in difficulty will, doubtless, be required. such assistance has become especially important since it is evident from the recent unprecedented swings in currency exchange rates for some of the emerging market economies that the international financial system has become increasingly more sensitive than in the past to shortcomings in domestic banks and other financial institutions. the major advances in technologically sophisticated financial products in recent years have imparted a discipline on market participants not seen in nearly a century. whatever international financial assistance is provided must be carefully shaped not to undermine that discipline. as a consequence, any temporary financial assistance must be carefully tailored to be conditional and not encourage undue moral hazard. it can be hoped that despite the severe trauma that most of the newer participants in the international financial system are currently experiencing, or perhaps because of it, improvements will emerge to the benefit, not only of the emerging market economies but, of the long - term participants of the system as well. parenthetically, a century ago, banks were rarely subsidized and, hence, were required by the market to hold far more capital than they