e right direction by conducting early warning exercises. But a much greater shift toward a signals approach and toward a more comprehensive EWS is needed.
First, a financial EWS would monitor economic indicators that history reveals to be precursors of economic collapse. Some of the most important indicators have been overvalued foreign exchange rates and high current account deficits. In early 1994, for example, the Mexican economy exhibited numerous warnings signs of financial vulnerability, including a 30 to 40 percent overvalued currency, an alarming current account deficit of 8 percent of GDP, and a rigid currency regime. This resulted in a run on the Mexican peso, soaring foreign debt as the peso collapsed, and a costly financial bailout. Thailand's economy followed a similar story line in 2006-2007, and the U.S. financial crisis of 2008 was similarly preceded by a large and unsustainable U.S. current account deficit.
Second, an EWS would take into account extenuating economic circumstances and political factors that affect financial risk. Qatar's large public borrowing requirements, for instance, would be considered a dangerous economic indicator if we didn't also factor in the Qatari government's investment in doubling the production and export of liquid natural gas. Likewise, an understanding of political factors inside the United Kingdom — most importantly, the high unemployment that made the U.K.'s attempt to raise interest rates unsustainable — could have shed early light on the impending Black Wednesday of Sept. 16, 1992.
By accounting for all these indicators and factors, an EWS would identify a coherent story line of rising financial vulnerability, where appropriate. Each economy's circumstance is different, but there are commonalities that allow us to be more effective in predicting crises. By communicating simple but comprehensive story lines to policymakers, an EWS would do more than simply ring alarm bells. Economies generally crash in the same fashion as dominos fall. By identifying key factors and decision points along the way as economic trends unfold, an EWS would provide guidance — allowing policymakers to change the alignment of dominos, as it were, and avert financial crises.
We have the historical knowledge needed to implement a financial EWS — most logically at the IMF. But we need economists who know their financial history and who are committed to a "signals approach" rather than economists who keep saying "this time is different." Nothing short of a wholesale culture change in our global financial institutions is required, one that recognizes that the urgency of the times demands early warning of financial crises — and that we are capable of providing it.
Dr. Leif Rosenberger, the economic adviser to Gen. David H. Petraeus at Central Command, has done award-winning work on the likely impact of the global financial crisis on CentCom's area of responsibility. Before that, he was economic adviser for 10 years at the Pacific Command in Hawaii.