In an Uncertain World (32 page)

Nevertheless, the dangers were great enough that we supported a larger-than-usual IMF package to address the financing needs opened up by a sudden rush of capital out of the country. In contemplating such a package, we did worry about the “moral hazard” problem that had gotten so much attention during the Mexican peso crisis. There were actually two separate moral-hazard issues. The first pertains to countries. Do large rescue packages encourage countries to borrow unwisely or adopt unsound policies? I didn't worry so much about that because, as this crisis itself would show, countries and their political leaders pay a high price for financial missteps. The possibility that a nation might be saved from devastation at the eleventh hour by international loans hardly constituted an incentive to mismanage the economy.

The other kind of moral hazard, the kind that affects creditors and investors, was a more serious concern: insulation from loss can sow the seeds of future crises. Part of the issue in Thailand had clearly been excessive and undisciplined investment from the developed world. “Rescuing” these investors, especially in a relatively small economy like Thailand's, could encourage lenders and investors to give insufficient weight to risk in pursuit of higher yield in other developing countries and undermine the discipline of the market-based system. In supporting an IMF rescue program, we would be interfering with the free play of market forces. As a result, investors would escape some of the burden of problems they had helped create.

This concern was outweighed by the importance of reestablishing stability and avoiding a dangerous worsening of the crisis. As negotiations between the IMF and Thailand came to a head, the question was not whether to help Thailand but how best to do so. The answer was official resources combined with a bold enough reform program to turn the economy and investor confidence around. Thailand, like the other so-called Asian tigers, had great cultural and economic strengths, including a strong work ethic and a high savings rate. But to restore the confidence of both domestic citizens and foreign creditors, the government needed to address both macroeconomic problems and structural flaws in the economy—not just its overvalued currency but its weak financial sector, which had contributed to a real estate and investment boom financed in foreign currency. Investors and lenders were now as single-mindedly focused on Thailand's economic flaws as they had been on its strengths. Only when sound policies were pursued would confidence—and investment capital—return and economic recovery take place.

While Treasury focused on a large IMF package allied with strong reform measures, officials from the State and Defense Departments as well as the National Security Council thought we should also contribute additional American resources, using the Exchange Stabilization Fund as we had done in Mexico. They argued that Thailand had been an important military ally of the United States since the Vietnam War and that failing to provide a specific American component to the support package, as many other countries were doing, sent a signal of abandoning the Thais in a time of need. And there was some feeling to that effect in the region. Even if the ESF didn't make much difference economically, they argued, the failure to offer direct bilateral support could have adverse political and strategic consequences.

On balance, the possible negative effects of trying to put up U.S. money seemed to me to outweigh the positives. We—and the IMF—thought that the money raised without a U.S. contribution was sufficient to address Thailand's problems. Another problem was that we did not have full use of the ESF as a result of the so-called D'Amato restrictions. These had been imposed by Congress after the Mexico crisis to curb future ESF lending to troubled economies and were due to expire in the fall. Attempting to use the ESF could easily result in a new, perhaps more stringent, version of the restrictions. I put great weight on preserving the ESF option going forward, both because unforeseen problems could arise and because loss of access to these funds could itself have damaging effects on confidence. In retrospect, I think protecting that option was the better decision on balance, but I probably did give too little weight to the symbolic benefits—economic and geopolitical—of a bilateral contribution to the Thai package.

This disagreement with the President's military and foreign policy advisers also raised a complicated question of who should perform what role. Thailand and the rest of the Asian crisis raised foreign policy and military issues that State and Defense were best equipped to handle, as well as international economic issues for which Treasury was best suited. The two chief levers for our financial intervention—control of the ESF and the U.S. government's relationship with the IMF and the World Bank—were at Treasury. I felt strongly about not trying to use the ESF and got a bit carried away in one meeting in the White House Situation Room. After I finished delivering a lecture on the subject, Sandy Berger asked me whether I was prepared to allow the President to have some input into the decision.

Sandy's point was right. In practice, Thailand was one of those cases where one agency, in this case Treasury, needed to have a clear lead role but within an interagency process. Handling a foreign financial crisis involves complex technical and economic questions, including effects on markets and confidence. Moreover, our military and foreign policy purposes would only be served over the long term if Thailand recovered economically. For this reason, the President tended to look to Treasury to take the lead throughout the Asian crisis, while the NEC, led by Gene Sperling, and the NSC, under Sandy Berger, made sure we did not act without a full airing in the interagency process. As we at Treasury became more and more caught up with the crisis, with discussions stretching into the night, others in the government were also drawn in more deeply. Later on, in the heat of the crisis, interagency process included a daily conference call among Treasury, NEC, NSC, State, Defense, and others. We also worked closely with our finance ministry counterparts in other countries and relied tremendously on the administration's foreign policy team, notably Dan Tarullo at the White House and Stu Eizenstat and Al Larson at the State Department, to lead the effort to reach out to leaders and governments around the world.

In the end, the IMF put together a $17 billion support package for Thailand—$4 billion from the IMF itself as well as bilateral contributions—that was huge relative to the size of Thailand's economy and to rescues prior to Mexico's. The August 1997 program specified economic reforms, including substantial restructuring of the financial sector and a more credible monetary policy regime to provide some stability to the still-falling exchange rate, as well as public disclosure of basic financial data. One controversial but technical issue Treasury had to deal with right at the start of the Thai program was whether or not to disclose how bad the government's financial position truly was. The IMF learned during the negotiations that the government had been hiding the extent of its currency intervention by selling dollars on the forward market. This meant that although the Thai central bank showed reserves on its books, almost none of those reserves were usable: the central bank had already promised to deliver them to someone else in the future, at a price that was by now highly disadvantageous to Thailand. When the program was announced, we insisted upon full disclosure about the unavailability of the Thai central bank's reserves. Our view was that this information was bound to leak out eventually and that Thailand's and the IMF's credibility would be harmed by keeping it secret. Moreover, without true transparency, no one would ever believe in the integrity of Thailand's finances. But this revelation spooked the nervous markets further.

Despite the size of the finance package, the IMF program failed to take hold in September and October, a reflection not just of the newly disclosed bad news about the reserves but, even more important, concern about the Thai government's commitment to reform. The Prime Minister closed insolvent finance companies that were undermining the health of the country's financial system but never fully followed through with the program. Policy drifted as the governing coalition fell apart. Only when the Prime Minister resigned several months later did the new Thai government begin to take real ownership of the reform conditions built into the IMF program. And only then did investor confidence slowly begin to return.

   

AFTER THAILAND BROKE the baht's link to the dollar in July 1997, financial crisis swept across the region. In the days and weeks that followed, it affected one country after another that had been widely viewed as on a strong footing. In the course of a few weeks, currencies came under attack in Malaysia, Singapore, the Philippines, and Hong Kong as investors scrambled to pull out their money. When the crisis began to affect Indonesia—a huge country with some 225 million people and a pro-Western anchor in Southeast Asia—it generated deep concern.

The markets were relatively calm into early October, but turmoil returned shortly thereafter. Investors' alarm showed in Hong Kong, where the Hang Seng index, the most important stock market gauge in the region, lost 23 percent of its value over four days, starting on October 20. South Korea, the third-largest economy in the region after Japan and China, was also coming under pressure. The region now clearly had serious problems that threatened to spread even more widely. On October 23, the stock markets in Brazil, Argentina, and Mexico dropped in concert with those of the Asian countries. Then our attention was forced back to the United States. On October 27, the Dow dropped 554 points, to 7,161, before the New York Stock Exchange suspended trading in advance of the closing bell. A meeting we'd convened to discuss Indonesia turned into the session where we drafted the public statement on the U.S. stock market that I read on the steps of the Treasury.

My focus wasn't on the level of markets per se, but I was concerned about the volatility in the markets and the ways the Asian crisis could affect us, in terms of both financial contagion and damage to our exports. The Asian countries were the biggest customers of the United States—at that time, 30 percent of our nation's exports went to Asia. For California, Oregon, and Washington, that figure was higher than 50 percent. If the Asian economies were seriously weakened, key sectors of our economy could suffer because consumers in Asia would be poorer and thus less able to buy our goods.

Within a few days, on October 31, the United States joined with others to add our bilateral money—money lent directly from one country to another—to an IMF package for Indonesia. This time there was less debate with the foreign policy team. The D'Amato restrictions had expired, and we were developing—with our G-7 and other partners—a framework whereby bilateral funds would be pledged as a “second line of defense,” to be used only after the IMF money had been drawn and only in the context of a successful IMF program. Both made the risks of a congressional assault on our use of the ESF less likely. And in the context of a widening crisis, the balance of judgment shifted to using the ESF to build confidence and to demonstrate support for a crucial U.S. ally.

Despite these efforts, Indonesia's economy remained in turmoil and the broader crisis showed no signs of ebbing. By now there was immense focus around the world on what was happening in the financial markets and intense debate about what should be done. As additional countries in the region got into trouble, it drew more and more attention to the position of the region's two largest powers, Japan and China. The former had been America's chief Asian ally for fifty years and had become one of the world's richest countries. The latter had historically been part of the Communist world and was often a strategic antagonist. The irony was that Japan's policies and practices—by failing to reverse Japan's economic morass—were contributing to the crisis while, in important respects, China's policies promoted stability.

Our focus on Japan's economic weakness had begun long before the Asian crisis erupted. But as we became increasingly worried about the risk of contagion in the region during the fall of 1997, we became more troubled by the adverse impact Japan's failure to deal with its own economic problems was having on the region. Japan appeared to be experiencing not just a cyclical downturn but a serious, long-term economic quagmire that it lacked the political will to address. The country's monetary and fiscal policies were too tight, and more fundamentally, its economy had formal and informal rigidities that were a great impediment to growth. One critical problem was the deeply troubled Japanese banking sector. The government wouldn't move to close insolvent banks or require them to foreclose the nonperforming loans on their books. Dubious loans supported insolvent companies through the so-called
keiretsu
system of close cooperation between companies and banks. And with banks' assets tied up in these companies, the flow of credit to productive uses was severely hampered.

In our view, by far the most important action Japan could take on behalf of Asia was to get its own economic house in order. Japanese growth had slowed dramatically, and the Nikkei index, which had been as high as 39,000 yen at the end of the 1980s, was down to around 15,000 in November 1997. For the country responsible for what was, by some measures, two thirds of the region's GDP to be slumping so badly made the recovery elsewhere in Asia much harder and the risk of further contagion much greater. Japan was a major market for the other countries in the region, and the weakness of the yen, which mirrored the strength of the dollar, further undercut these export-dependent emerging-market countries. Japanese banks were also an important source of capital. But the Japanese banks were pulling their money out of Thailand, Indonesia, and South Korea.

The IMF can influence economic policy in emerging-market countries, at least when those countries need to borrow, by attaching conditions to its loans. But wealthy nations can influence each other in the direction of sound economic policy only through diplomacy and the kind of debate that takes place in the various international institutions and in such fora as the G-7 meetings. There is a great deal of formal and informal process around the G-7 that is useful in this regard. The finance ministers and central bank heads of the seven largest developed economies meet several times a year, aside from the better-known summit meetings of the heads of state. These meetings—and the need to agree on what to say to the press afterward—provide a vehicle for sharing advice and exerting some pressure. But the effect on any industrial country's policies is still very limited, at best.