Commentary: Financial turmoil highlights need for global economic governance reforms

The recent market rout highlights the fragile nature of the ongoing global economic recovery and shows a need for boosting policy coordination and carrying on with global economic governance reforms.

In particular, there is a need for strengthened policy coordination when countries are tempted at a time of economic challenges to adopt policies that may potentially have a spillover effect.

The recent market crash is no coincidence. Japan recently adopted the unusual move of negative interest rates, which however only pushed down the exchange rate of the yen temporarily. The markets are speculating over possible similar moves by the European Central Bank, and there are even talks that the U.S. Federal Reserve System might have to reverse its rate hikes.

While the markets may have been overly jittery, there are signs that the market is "losing confidence in the ability of central banks to perpetuate the 'levitation' of risky assets," said Rabobank, a Dutch multinational banking and financial services company.

It was revealed that even some members of the Bank of Japan had been concerned over the self-defeating effect of the negative interest rates move and the prospect that it may trigger rate cuts elsewhere.

All these highlight the need for coordinated global efforts to support growth and avoid policies that may be in fight against one another.

Widely seen as a positive move, China has pledged to avoid competitive currency depreciation. Exchange rates may reportedly be an issue up for discussion at a meeting of Group of 20 finance ministers and central bankers in Shanghai later this month.

At a deeper level, the volatilities reflect yet again the fundamental weaknesses in the current international monetary and financial system. Jaime Caruana, general manager of the Bank for International Settlements, has pointed out a blind spot in the system that consists of "domestically focused policies in a world of global firms, currencies and capital flows."

The liquidity conditions often spill over across borders through the conduct of monetary policy, the international use of currencies, the integration of financial markets and the availability of external finance and can amplify domestic imbalances to the point of instability.

"Global liquidity surges and collapses as a result," Caruana said.

It is not a new issue, but the need for addressing it has been more urgent in a highly globalized world where the markets are increasingly linked and the economies are increasingly interdependent.

In particular, the policies of advanced economies like the United States, based largely on their domestic economic conditions, often create a spillover to others, which in turn creates a spillback.

Economists agree that many of the recent challenges trace to the often misalignment of global monetary cycles dictated by the U.S. dollar and the economic conditions of the emerging economies. The roles of the U.S. dollar as both a sovereign and an international currency are not always compatible. Reforms are the only way out, given the situation that the U.S. dollar as an international currency remains irreplaceable in the foreseeable future.

International Monetary Fund Managing Director Christine Lagarde last week spoke of the need for further global economic governance reforms to better reflect the increasing weight of the developing economies. This should better help the world deal with economic challenges.

"The United States has a special responsibility as it normalizes its monetary policy -- because this can be a source of global spillovers and spillbacks," she told students at the University of Maryland.

Lagarde suggested the developing economies strengthen their fiscal conditions, manage risks and do reforms while the developed economies, which have relied heavily on extremely low interest rates, should use a more balanced policy mix.

The world can also work together to foster innovation and technology sharing, and to better manage capital flows and strengthen the global financial security net.

If the recent market rout tells us anything, it is more urgent than ever to call for globalized efforts to push forward global governance reforms. Endi