FROM THE OFFICE OF PUBLIC AFFAIRS October 1, 1998RR-2731 Last October the international community was in Hong Kong for the Annual World Bank and IMF meetings and the discussion was about the collapse of the Thai baht and the potential spread of financial problems around East Asia. One year on, the setting for the meetings is Washington and the concerns are global. The problems of Thailand spread rapidly to neighboring East Asian economies, and in recent months to Russia and to some extent Latin America. The situation has in turn worsened, and been worsened by, a further deterioration in conditions in Japan, which just recorded a third consecutive quarter of negative growth and is facing the largest problems in its banking system of any major industrial economy in recent memory. I would like to spend most of my time today reviewing the approach we have taken to these crises and our efforts going forward, along the lines of Congressional testimony that Secretary Rubin, Chairman Greenspan and I have given in recent weeks. I. Causes of the Crises Economists will be debating the causes of these crises for many years to come. But there is growing agreement on what the important factors were:
Markets' tendency to excess is age old. The transmission mechanisms are not. If the Mexican peso crisis was the first 21st century financial crisis, the second has provided an even clearer illustration of the scope for the new information technologies and financial instruments to act with unprecedented speed and force. When we have now seen withdrawals of capital of more than 10 percent of GDP in the case of several of the Asian economies, and a doubling or more of bond spreads in many disparate markets, it is difficult to believe that the contagion and generalized flight from risk has not been exaggerated. Containing these crises is critically important to America's core interests: it is about safeguarding American jobs, American savings and American national security. Already:
The goal is clear: to contain this crisis and help to restore growth and stability to the economies already affected. Let me now say a little about the means. II. The United States Approach Our response to this situation has rested on three pillars. First, that no country will recover against a backdrop of regional deflation and weak demand. Strengthened policy is needed in the major economies of the region to support growth and confidence:
Second, that while the external environment is important and international support can make a difference, countries shape their own economic destiny. A strong domestic response by the countries affected is the absolute first step toward restoring stability -- because any amount of financial support that goes into an economy will flow right back out if policies are unsound and governments are not credible. Third, that conditioned international financial assistance can play an important part where policy makers are committed to reform but need financial breathing space to put reforms in place. Financial crises have elements of a self-fulfilling prophecy -- like bank runs, everyone expects failure or everyone expects everyone else to expect failure, leading to a rush to be the first one out and, thus, failure. Temporary, conditioned support gives countries a bridge to overcome this self-fulfilling prophecy and help restore stability. And here the IMF has a critical role. This crisis is still a moving story. And there is enormous economic and social distress being felt in the countries worst affected. That is inevitable given the massive withdrawals of private capital that have occurred. But it is encouraging that in those countries that were first hit and where policy has been most determined there has been evidence of containment. Countries that have consistently followed policies that the IMF were able to endorse and support -- specifically the Philippines, Korea and Thailand -- have begun to see signs of a return to stability. In Korea and Thailand the currencies have broadly stabilized, nominal interest rates are down in the low teens, and real interest rates have fallen to well below pre-crisis levels. At the same time these countries are now working to expand their fiscal policy to use the room provided by their sound policies for the fastest possible return to growth. In debating these crises it is vital not to confuse the doctor with the disease. The distress being seen in Asia are not a consequence of IMF policies or IMF finance. These are, rather, attempts to palliate the true cause of the distress: the withdrawal of capital and decline in confidence that led to that withdrawal. In countries such as Indonesia and Russia, where governments did not carry through on their programs, inflation, interest rates and output losses will certainly be much higher -- and the return of confidence is now that much more remote. To be sure, as countries choose their policies and the IMF makes judgments about what types of programs it is willing to support financially, difficult questions of balance have inevitably arisen and provoked vigorous debate:
These issues of balance will no doubt continue to be debated and there is no guarantee that the IMF will get it precisely right on every occasion. But the very breadth of disagreement among critics about what, precisely, was done wrong provides some confidence that in the bulk of cases the balance was struck right. I have no doubt the situation over the past year would have been much worse -- with greater devaluations, more defaults, more contagion, and greater trade dislocations -- without the programs agreed with the IMF and the finance it has provided. III. The Way Ahead Even in Hong Kong we noted that financial strains being felt in Asia could spread and have far reaching consequences for the rest of the world financial system. And certainly, financial strains have increased in recent weeks -- to the point where they may present what President Clinton has called the one of the most serious financial challenges facing the global community in 50 years. In this context, the President's remarks last month in New York and the G7 finance ministers and central bank governors' statement released at the same time showed clearly how our joint efforts should be carried forward: First, recognizing that with inflation low or falling in most parts of the world, and the consequent shift in the balance of risk in the global economy, we are working with our G-7 partners in an enhanced emphasis on implementing policies to promote sustainable global growth. Going forward: ul> Second, we are working to reinforce the capacity of the international community to provide financing to countries that are pursuing sound policies and are nonetheless affected by contagion. Where contagion is a serious concern the emphasis must be on finding new ways to make liquidity available and restore confidence that do not raise undue moral hazard effects. Adequate funding for the IMF is critical to this effort. Yet today the IMF's resources are at historic lows. And measures that would secure additional funding are still awaiting Congressional approval. Let me reiterate that at a time when the markets are looking to see if the international community has the capacity to deal with these crises, continued delay is a risk the United States can ill afford to run. Third, alongside the international financial institutions and the countries in the region, we are looking at ways to accelerate the pace of comprehensive corporate and financial restructuring in countries where there is a systemic problem -- notably in Asia where the severe indebtedness of both the financial and corporate system is a serious barrier to recovery and where addressing the overhang of domestic debt is essential. Fourth, we are also working with the Multilateral Development Banks to provide increased social safety nets in the countries in crisis to help the least advantaged citizens in those countries who are experiencing hardship. As the President said last week, "if we want these countries to do tough things, we have to protect the most defenseless people in the society and we have to protect people who get hurt when they didn't do anything wrong." Finally, we need to give very serious thought to how the global financial system and its institutions function with respect to preventing and responding to crises such as these. This has been an important preoccupation since the Naples Summit in 1994 and has as a crucial element the bringing together of both traditional and newer players on the international financial scene. Last year, under President Clinton's leadership, we intensified this effort by convening a meeting in April of a broader grouping of 22 countries, including key developing and emerging economies. At that meeting, finance ministers and central bank governors created working groups that will be coming up with concrete proposals early next week. In a speech in New York earlier today Secretary Rubin outlined some of the most important priorities:
Working with the rest of the international community we have made progress on all of these
fronts in recent years. The release of the three Working Group reports we will take us even
further toward our long-term goal: a stronger, more stable international financial system. And as
we go forward this effort will continue to be extended and broadened. The number and variety of
proposals for responding to the short and long- term challenges we face is not in question. What
must now be considered carefully is their effectiveness and long-term durability.
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