|IMF & U.S. at fault
on Asia Crisis
World Bank's recently released 200-page report alluded blame to the International Monetary Fund (IMF) and the Clinton Adminstration for worsening the world financial crisis in Asia.
The main blame was for pushing the Asian nations to send interest rates soaring, thereby triggering deep recessions and mass unemployment. The report gave a blow-by-blow account of a series of cascading misjudgments, and places much of the blame on global investors who lent money with abandon to developing nations and on Asian officials who were eager to accumulate the cash.
Joseph Stiglitz, the chief economist of the bank said, "the heart of this current crisis is the surge of capital flows -- the surge is followed by a precipitous flow out. Few countries, no matter how strong their financial institutions, could have withstood such a turnaround, but clearly, the fact that the financial institutions were weak and their firms highly leveraged made these countries particularly vulnerable."
This report comes on the wake of several economists' clammerings that the IMF formula of "one medicine cures all" approach to the Asian Financial Crisis was wrong, and IMF should not have advocated the remedies that it used in the past for Latin America.
Both the IMF and the U.S. Treasury, which saw the World Bank report before it was released, agreed that the conditions that led to the bust was the huge volume of private investment into developing countries -- and the refusal of investors to heed the risks associated with putting their money into countries with few regulatory safeguards.
But both the IMF and Treasury continue to defend their initial strategy of urging Thailand, Indonesia and South Korea to raise their interest rates, a classic economic solution intended to reassure investors and stabilize national currencies. In Thailand and South Korea, those rates have now declined to about 7 percent and the currencies have stabilized -- developments, that IMF officials say, which vindicate their approach.
The Bank's report argues that the strategy backfired: while the currencies stabilized, the countries plunged into deep recessions with substantial and high unemployment -- a very high social cost to pay for currency stabilization. The report asserts that the interest rate increases have spread the economic pain far beyond the banks, investment funds and real estate companies, and have send thousands of small businesses into bankruptcy.
The controversial IMF remedies aside, several institutions have also questioned the efficacy of borderless financial institutions, with particular reference to hedge funds, in managing the so-called "American free market" style of open global financial systems that led to the crisis in the first place.
The World Bank report is timely in that for once a world body has accepted the notion (orginally mooted by Mahathir) that global investors who lent money with abandon to the developing countries are one of the principal causes of the Asian crisis in the first place (and not the "wish words" of nepotism, crony capitalism and corruption). To qoute the law of the jungle: If water flows easily, one can expect a multitude of animals at the drinking hole -- and this can include corrupt politicians, capitalists, socialists, communists, enterpreneurs, journalists, etc etc.
There are thus two issues at hand. First there is a need to address the cause of the crisis, to prevent a recurrence of another serious financial crisis. The next is measures to contain the present financial crisis.
In addressing the first concern, the International Conference of Banking Supervisors had earlier started the clarion call to increase transparency and regulation of the global financial institutions to bring about order (and not chaos) in the system. The Group of Seven has similarly resolved on the need for greater regulation of the global financial institutions, and this was reaffirmed by the Asia-Pacific Economic Cooperation (Apec) Forum recently, which called for the strengthening of the rules of the financial marketplace, to provide stability for developing economies.
The second issue is more complex though, and will probably take a long while for resolution. As World Bank put it, financial bailouts by themselves, per IMF style, will not address the problem. World Bank warns of the risk of "rescue creep" as aid packages get larger and larger. The report stated that no reasonable amount of public money can stop a justified speculative attack on a country's currency, "By themselves, larger packages worsen moral hazard problems (the risk that investors will expect governments to bail them out) and may lead to excessively tough conditions, defeating the end objectives."
The good news is that the World Bank report predicts that most of the afflicted nations will probably climb out of the crisis in 1999 with positive growth in 2000, thereby enabling a positive world economic growth of 1.8% in 1998, 1.9% in 1999 and 2.0% in 2000. Though this is significantly below the 3.2% growth in 1997 before the crisis, a global positive growth is indeed pleasing to have than a global recession.
The World Bank predicts that the U.S. economy will slow to 2.0% for 1999 and 2000, and that recent interest rates cut by the Federal Reserve would forestall a deeper slow down.
Before we go out celebrating, a word of caution: The World Bank warns that "there is still a substantial risk that the world economy will plunge into recession in 1999," particularly if Japan is unable to end its recession. The burden of risks of the global economy, per World Bank, is now on Japan, the Land of the Rising Sun. Will Japan now rise to the occassion? We leave you with these thoughts.