FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, members of this Committee, I am glad to have this opportunity to discuss the recent financial crises in emerging markets, the implications for the United States, and American leadership of international efforts to contain these crises and build a stronger, more stable global financial system for the years ahead
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I. The Global Economic Situation

A crisis that began in Asia more than a year ago is today having a substantial impact -- not merely in the Asian economies but globally. The problems that were first seen in Thailand spread rapidly to neighboring East Asian economies, and in recent months to Russia and to some extent Latin America. The troubles of Thailand, Korea and others have in turn worsened, and been worsened by, a further deterioration in conditions in Japan, the world's second largest economy, which just recorded a third consecutive quarter of negative growth and is facing banking system problems that are many times larger as a share of the economy than our own Savings and Loan crisis in the early 1980s.

Economists and historians will be debating the causes of these crises for many years to come. But there is growing agreement on what the important factors were:

• financial systems that did not channel capital efficiently, were inadequately regulated and created an illusion of security that could not ultimately be supported;
  

• exchange regimes that attracted capital but were not accompanied by appropriate complimentary macroeconomic policies and created room for speculative pressures;
  

• a deterioration in the global economic environment, especially in Asia, due to the evident economic difficulties in Japan;
  

• difficulties in some countries -- notably Indonesia and Russia -- in effectively carrying out basic government functions, such as tax collection and bank regulation, with integrity;
  

• and substantial reductions in confidence, as investors began to worry about other investors withdrawing their capital, and themselves raced for the exits.

All of these factors have been contributing to financial crises and disturbances for many centuries. But I think it is fair to say that they came together more virulently in these crises than they have in the past -- something we can partly attribute to recent improvements in information technology, which have raised the scale and speed of international flows, and to the development of derivatives and other sophisticated financial instruments that increase the apparent degree of liquidity in markets. The very dramatic withdrawal of capital -- a swing of more than 10 percent of GDP in the case of several of the Asian economies -- and substantial movements in many disparate markets suggest a contagion and generalization that may be leading to overreactions in some cases. Yet as Secretary Rubin said last week: "credit and investment decisions need to be made with careful analysis and judgment of the long term strengths and fundamentals of an economy, and unaffected by the prevailing mentality of the moment."

I do not need to remind this committee that containing these crises, and the losses in market confidence that have accompanied them, is critically important to America's future. It is about safeguarding American jobs, American savings and American national security:

• trade has accounted for one third of our growth in this expansion and is the prime engine of high-wage jobs. More than 30 percent of those exports -- and 40 percent of our agricultural exports -- go to Asia. Already, exports to the economies in crisis are down by nearly one third, year-on-year. Private forecasts are suggesting that the crisis could add one half, even one percentage point of GDP to the United States current account deficit this year.
  

• American markets have been remarkably strong in recent years and American savings are ever more dependent on our markets. But the performance of our markets is increasingly linked to the performance of global markets, because our companies' profitability depends increasingly on these markets and because ever more capital flows across international borders. Indeed, it is noteworthy that in the last six weeks, in the wake of the spread of problems in emerging markets, we have seen substantial reductions in all but the most creditworthy firms' ability to access both the equity and debt markets and seen some evidence of contractions in bank lending.
  

• given the proven scope for financial problems to trigger broader civil and international conflicts, history suggests that a strong response to the crisis that prevents it from festering is forward defense of America's core interests. I need hardly point out that a prolonged crisis in Russia raises important national security concerns, given Russia's pivotal and continuing role with respect to nuclear security, the battle against terrorism and other critical problems.

While the fundamentals of the American economy remain strong, as Chairman Greenspan recently reminded us, the United States cannot remain unaffected in a world that is experiencing greatly increased stress. In a global economy, our future prosperity and security is inextricably bound up with the prosperity and security of our allies and trading partners -- and that, in turn, will depend critically on American leadership in the face of global problems and uncertainties.

That is why, since the earliest days of this crisis, we have worked, domestically and internationally, to support the return of stability and growth in the countries in crisis and to prevent further contagion in other markets.

II. The United States Approach

Our response to this situation has been rooted in a concern for America's economic and security interests. It has rested on three pillars:

First, strengthened policy in the major economies of the region in support of growth and confidence, because no country will emerge safely from crises in an environment of regional deflation and weak demand:

• the United States must continue to do its part in maintaining sound policies: that means continuing to support and maintain open markets, it means continuing to invest in people, and it means preserving the budget surplus and thereby reducing pressure on global capital markets and on our own trade deficit.
  

• as the Chinese have recognized, their continued commitment to addressing their financial sector problems and to maintaining a stable currency will also be very important to the stability of Asia.
  

• and Japan, which even today accounts for more than two-thirds of the Asian economy, has an especially critical role to play. Immediate and effective measures to strengthen the financial system and strong fiscal action in Japan that provides a substantial and sustained stimulus to the economy are urgently needed for Japan to resume the strong domestically-driven recovery that is now so crucial to global growth and financial stability.

The second pillar has been the recognition that while the global economic 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 prerequisite for 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. That means sound monetary and fiscal policies; that means policies to strengthen the financial system; and that means structural reforms to open the economy, raise transparency and improve the functioning of markets. Particularly at a time when money is flowing out of a country, it is critically important to take steps to attract money in.

The third pillar has been 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, which leads to a rush to be the first one out and thus causes 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.

The crisis is still very much an unfolding story, and very large challenges lie ahead. There is no question that there is enormous economic and social distress being felt in the countries worst affected. This 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. Although there is clearly a great deal of work yet to do, 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.

It is vital to remember that the distress and difficult outcomes being seen in Asia are not a consequence of IMF policies or IMF finance. These are, rather, the attempts to palliate the true cause of the distress: the withdrawal of private capital and declines in domestic confidence that led to that withdrawal. Put simply, we must not confuse the doctor with the disease. In those cases, such as Indonesia and Russia, where governments did not carry through on their policy programs, inflation, interest rates and losses in output 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 will inevitably arise. Notably:

• on the one hand, there is the legitimate view that structural defects of national economies relating to crony capitalism need to be addressed. On the other, there are concerns about generating a backlash by pushing too hard for large-scale restructuring of native institutions.
  

• on the one hand, there is a concern for exchange rate stability, given what we have seen can happen when downward spiraling currencies go out of control. On the other, there is the concern about raising interest rates significantly at a time when the banking and broader financial system is under serious strain.
  

• one the one hand, there is the need to provide confidence at a time when contagion causing significant withdrawals of capital and increases in interest rates in emerging markets. On the other, there is the concern about moral hazard and encouraging irresponsible behavior by investors and governments.

These issues of balance will no doubt be debated and there is no guarantee that the IMF will get it precisely right on every occasion. But let me say that 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.

I might just add, Mr Chairman, that when the IMF supported Russia last July -- in the face of what were clearly serious obstacles to carrying out effective policies -- it was taking a calculated risk in defending the fixed exchange rate regime. It was a risk that in the end was not rewarded but was justified, in our judgment, by the large stake that the world has in continuing Russian reform. Russia today needs to build a political consensus behind policies of reform. When Russia is prepared to move down that path, the United States and the international community are prepared to support it.

III The Way Forward

Mr. Chairman, we noted some time ago that the 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 are as serious globally as any we have encountered in a long time. In this context, the President in his remarks in New York last week, and the G7 finance ministers and central bank governors' statement released at the same time, have discussed how this approach can best 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. In this regard the President and Japanese Prime Minister Obuchi devoted a substantial portion of their meeting this week to financial problems, with the President stressing our belief that it is essential for the global economy that Japan swiftly infuse public money, on a substantial scale with appropriate conditions, into its banking system. In our judgment this is the only way both to maintain stability and provide for growth going forward.

Second, we are focused on reinforcing the capacity of the international community to provide financing to countries that are pursuing sound policies and are nonetheless affected by contagion. Of course, adequate funding for the IMF is critical to this effort, and let me reiterate the importance of Congress taking action. It remains a central plank of our approach to these crises that the IMF cannot help countries that are not committed to helping themselves. But where policy makers are committed, the IMF's involvement is central to an effective international response. And today the IMF's resources are at historic lows.

The Senate has twice now approved full IMF funding by large bi-partisan majorities. Let me pay tribute to members of this committee for the leadership they have shown in supporting the IMF requests and working with us on crafting tough but realistic reforms. At a time when the markets are looking to see if the international community has the capacity to deal with these crises, passage of IMF funding would send a critical signal.

Third, in conjunction with 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. This was also an important area of discussion between the President and Prime Minister Obuchi.

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, the unacceptably large number of major financial disturbances we have seen in recent years suggests a need to give very serious thought to how the global financial system and its institutions function with respect to preventing and responding to crises. This has been an important preoccupation since the Naples Summit 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 launched an intensification of this effort by convening a meeting in April of a broader grouping of 22 countries, including key developing and emerging economies. Last week, he asked that Chairman Greenspan and Secretary Rubin chair a second meeting of finance ministers and central bankers early next month to continue the work undertaken by this grouping and to expand the reach of its efforts. At the April meeting, ministers and governors created working groups that will shortly be coming forward with concrete proposals for change in three areas.

First, increased transparency and disclosure. Mr Chairman, if one were writing a history of the American capital market I would suggest to you that the single most important innovation shaping that capital market was the idea of generally accepted accounting principles. We need that internationally, and we need it at the level of individual companies and financial institutions. Crucial issues here include: ensuring that markets and policy makers have an accurate understanding of the true reserve position of governments and the scale and maturity of a country's external obligations; measures to increase openness about the underlying policy process in individual countries; and steps to make the private sector more open in a world in which a single financial and corporate institutions may have substantial cross-linkages with markets and institutions overseas.

Second, concrete proposals for how best to strengthen domestic financial systems and put in place the legal and regulatory infrastructure to realize the opportunities of open capital markets while handling the risks. This means "best-practice" models for supervising financial institutions for developing a strong credit culture, including effective risk management procedures, and it means finding the best ways to bring together the World Bank and IMF to help countries in their efforts and for the international system to provide incentives for those efforts to be substantial.

Third, concrete proposals for more effective burden-sharing arrangements in the response to financial difficulties, particularly at the domestic level, so as to reduce the scope for individual failures to become domestic, systemic failures -- and for national crises to become international ones. Among the crucial issues here are devising effective corporate insolvency regimes and developing more effective mechanisms and institutions for assuring that creditors and debtors are able to resolve problems fairly and cooperatively.

Mr Chairman, I would expect that the review would also consider how the international financial institutions' structure and programs can best be adapted to the kinds of crisis we have seen in recent years. Here there is a growing consensus on a number of points:

• the IMF needs to be more transparent. Thanks in large part to our persistent efforts within the institution, there have been some real gains in transparency, though we agree that the work is far from over. For example, nearly 100 countries have now published Board summaries of their annual economic reviews with the Fund, and Letters of Intent detailing the IMF's programs with countries have been published for all of the recent crisis programs in Asia, Russia and Ukraine.
  

• the IMF needs be more accountable for its policies and programs. Again, an important step has been taken with the introduction of external evaluations of key IMF policies, the first of which was published earlier this year. But further progress will be needed.
  

• the IMF needs to be in a position to deal with a new kind of crisis -- one that is a capital account emergency rather than a trade account emergency. Here we have made a good start with the creation of a new Supplementary Reserve Financing facility to let the IMF lend at premium rates in short-term liquidity crises and improve borrower incentives, a mechanism that grew out of recent developments in Asia and has played a major role in the IMF's assistance to the region.
  

• growth needs to be a priority in IMF programs. While sacrificing stability is never right, we have seen that the political sustainability of reform depends on it being designed in a way that can show results. Questions of tax policy, structural reform, social safety nets, curbing corruption and the appropriate treatment of workers will all bear on the issue of growth in some cases. All of these debates must feed into broader questions of program design in such circumstances, including the difficult questions of balance that I mentioned earlier.
  

• and in its surveillance the IMF needs to be focused on issues bearing on the safety and sustainability of capital flows. This goes to factors such as the quality of the legal and regulatory infrastructure underpinning the domestic financial system, standards of credit management and financial disclosure, and the nature and scale of a country's foreign exchange exposures.

More broadly, there are a range of ideas for reform of exchange rate regimes, the ways in which capital flows or financial firms are regulated, or the creation of new institutions, which may be important to explore. The task is not to deny the benefits of open, truly global capital markets -- but to work out the best set of policies (international and domestic) for ensuring these are safe and sustainable.

IV Concluding Remarks

Mr. Chairman, these are immensely challenging times in the global economy. But one thing is clear: United States leadership has been indispensable during this crisis and our economic well being and national security are critically at stake. We have pursued a sound and coherent strategy, in concert with the IMF and our economic partners, while adjusting judgments and programs when circumstances warranted.

Looking forward, as Secretary Rubin has said, the key is for all countries to work together and meet our respective challenges. For the countries in crisis, that means sustained adherence to sound reform programs. For the major industrialized nations that means cooperating to spur global growth. In particular, in Japan, the world's second largest economy, it means implementing the policies needed to repair the financial system and achieve sustained domestic demand-led growth.

Finally, for the United States it means continuing to pursue sound policies at home to maintain our strong economy. Most immediately, it means the imperative of approving full funding for the IMF, which is needed for our own prosperity as well as for the rest of the world's. In so many ways, the world's response to these crises looks set to determine the shape of the global economic system of the next century. Yet our capacity to be influential on these issues will be very much related to whether we meet our obligations to the IMF today. Thank you. I would now welcome any questions.