CAMBRIDGE: Foreign policy in today’s world increasingly falls under the jurisdiction of investment bankers. Read about the future of Russian reforms, or the prospects of Chinese democracy, and as likely as not the commentators will be investment bankers. Obviously, these international money managers must constantly follow the news to make their portfolio decisions. But it’s equally true that these portfolio decisions are now determining the news, not merely following it. When money managers panic about economic prospects in one economy or another, they can create economic havoc and political chaos.

The dialectic of money and international politics was revealed again this week in Russia. The international money managers had decided that Russia was at the brink of the economic cliff. These investors were therefore stampeding out of Russia just one year after they had poured large sums into Russia. The huge and sudden outflow of money from Russia in turn threatened to force the Russians to devalue the Russian Rouble.

The investment bankers told us that such a devaluation would be a disaster for Russia, by provoking inflation, a loss of confidence in the government, and perhaps political crisis. Western governments believed this argument, and responded by offering Russia another $17 billion in loans from the International Monetary Fund, the World Bank, and some other sources. This money will now be used in part to repay foreign investors that are taking their money from Russia. Thus, the investors will get their money out, and Russia will avoid a devaluation . . . at least in the short run.

This bailout procedure, now familiar from similar bailouts in Mexico and Asia, raises several serious questions. Who is really helped by such actions? Will the bailout solve Russia’s problems? Will such bailouts encourage future irresponsibility in lending?

Consider the Russian situation in more detail. All of the foreign investors knew that they were taking a gamble lending money to Russia. Indeed, many of them received interest rates as high as 60 percent on the Russian treasury bills that they purchased in the past year. The high interest rate reflected the market’s view that the rouble might lose value during the period of the investment.

When the gamble indeed started to look bad, partly because of low world oil prices (affecting Russia’s exports), partly because of the Asian crisis, and partly because of the continuing irresponsibility of the Russian government, the investment bankers started to scream. Suddenly, a devaluation would be a disaster. The world had to help.

The one thing the bailout surely did was to help the foreign investors. Thanks to the IMF, there was no gamble at all. Market forces be damned - Washington will guarantee a solid rate of return (even 60 percent in dollar terms!). Whether Russia is helped by the bailout is an open question. A devaluation might not have been a disaster; or it might still be needed in the future. It’s all too early to say. The IMF’s advice, which accompanies the new loan, might also do real damage to Russia. After all, IMF programs rarely lead to quick economic recoveries, and sometimes the IMF’s advice is so bad that the economic conditions actually worsen.

The Russian people certainly won’t notice a decrease in the crisis in the short term. The IMF money will be invisible to the average Russian household. Some of the IMF money will simply flow back to U.S. and European investors, and some will stay as reserves at the Russian Central Bank. The Russian Government will be forced to spend less, and tax more, as a condition of the loans. In short, for the average Russian citizen, there is simply more austerity ahead.

The Russian bailout, whether ultimately justified or not, exemplified a very unhealthy situation in the world economy. There is a tremendous amount of irresponsible hot money circling the globe. Investors act with herd instincts: rushing in to suddenly popular "emerging markets" and then rushing out. These boom-bust cycles do great damage, which is one reason why the IMF has responded with so many emergency loans in recent months. But the IMF’s own policies can exacerbate the crisis, by bailing out the creditors, by encouraging them to act irresponsibly again in the future, and by linking the loans to ineffective policy recommendations.

Equally disturbing, it is the voice of the investors that is heard more and more loudly in each crisis. They are the ones interpreting each crisis for the general public. They are the ones telling Washington what to do next. And naturally they are speaking in their immediate self interest, not necessarily in the broader public interest. The IMF has fallen under their spell, making the world safer for speculation and perhaps more dangerous for the rest of us. It is time for a new and more responsible approach to managing global capital flows.

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