A Break in the Clouds

ANTHONY SPAETH SingaporeThe greater the international crisis, the stronger the need for action. But since that's complicated, it's far easier for the experts to get together and discuss ... and discuss and discuss. As the world pivots on the verge of global recession, talk is frenetic and the cliches are flying, with the exception of perhaps one: If it ain't broke, don't fix it. Asia is submerged in debt, Russia is melting down and even the United States is starting to look shaky. The system has faltered--many components are just plain broke--and somebody's got to come up with a fix. The global economy simply cannot live with the kinds of vast and systematic disruptions that have occurred over the past year, says U.S. President Bill Clinton. There is not a moment to waste. And of the scores of memorable similes set loose to describe the fragile world economy, one leaps out for its frequent invocation: Titanic.But what if the Titanic's crew had managed to seal the bulkheads and fix the pumps? That notion became metaphorically interesting last week when Japan finally roused itself from a long slumber. Squabbling lawmakers passed a bill to recapitalize Japanese banks with taxpayer money. If all goes well, which is far from certain, the banks will start lending again instead of continuing to rewrite account books with erasers to hide bad loans and insolvency. The government had already promised a big dose of fiscal stimulus. Together, those moves could help Japan stem its decline and, after seven years of stagnation, maybe even grow again--a prospect that could mean salvation for other Asian economies. Under prodding from opposition parties, Washington and Finance Minister Kiichi Miyazawa, the world's second largest economy has earmarked $500 billion for its banks and $83 billion for stimulus, on top of a Miyazawa Plan that would provide $30 billion in aid for the rest of Asia. That adds up to well over a cool half-trillion.Time for a quick reality check. Despite the impressive sums, there are doubts about Japan's plans, some justified, others made plausible by Tokyo's recent track record. How many times have we seen a report that there's agreement in Japan on a banking plan and a few days later it falls apart? asks Dan Tarullo, senior fellow at the U.S. Council on Foreign Relations and former assistant to President Clinton for international economics. It's impossible to know if we're really on the brink of significant progress. Agrees Jim McGinnis, banking analyst at Dresdner Kleinwort Benson in Tokyo: I don't think they have any intention of spending the money. They still believe that pigs will fly and that the economy will recover.PAGE 1||||If nothing else, Japan seems to be climbing out of its funk. And there are other signs that the clouds on the global economic horizon may be starting to break up. Elsewhere in Asia, two of the most badly affected economies, Thailand and South Korea, appear to have hit bottom and are preparing for a rebound. And in Washington last week, Federal Reserve Chairman Alan Greenspan signaled his intent to keep the U.S. economy growing by trimming the interest rate a quarter percentage point, the second such cut this month. The health of the developed-world's economies, and particularly America's, are critical for an Asia that hopes to rev up its export-driven growth strategy once more.What about the long term? Despite all the hand-wringing, doomsaying and seemingly inexhaustible prescriptions for getting out of this mess and avoiding future ones, the global economic system isn't likely to undergo a major overhaul. Clinton's summit of finance ministers in Washington earlier this month and the subsequent annual meeting of the International Monetary Fund and World Bank both failed to come up with even a sketchy outline for a new, improved approach. British Prime Minister Tony Blair, who has called for a new system for the next millennium, will probably hold a similar gathering in London next month with similar non-results. In Singapore last week, 700 leading economists, government officials and businessmen--assembled for the World Economic Forum's annual East Asia summit--felt they needed to trumpet their prescriptions to the world. They released a 12-point action plan, but what participants wanted most were down-to-earth, short-term measures like lower interest rates, recapitalization of Japanese banks and open markets everywhere. There may be heady talk of a new architecture for the global economy--but the planet's movers and shakers seem to have decided that fixing the roof is the most prudent, and perhaps the only, path for the near future. You can't, insists U.S. Deputy Treasury Secretary Larry Summers, reform the international monetary system on the back of an envelope.That the world has outgrown the institutions designed after World War II to govern global finance is a given fact, and much of that growth has come in just the past few years. The amount of money that crosses a trader's desk is enormously greater today than when I left Wall Street six years ago, says U.S. Treasury Secretary Robert Rubin, to say nothing of 10 or 20 years ago, or 50 years ago when the Bretton Woods institutions were created. (A 1944 conclave at Bretton Woods, New Hampshire created the IMF and the World Bank.) In this decade alone, many countries have opened their borders to international capital flows they had never imagined, including mutual-fund investments in their local stock and currency markets and foreign-currency loans for local companies. They also invited in speculators who deal in financial instruments so complicated that even many experts don't fully understand them. Those countries were encouraged to do so by Washington, the IMF and the World Bank in the cause of free markets and globalization. Many benefited enormously. The so-called emerging markets--once known as underdeveloped and then developing countries--became the darlings of investment-fund managers, and money flooded the world in a gold rush for which prospectors never needed to leave their desks in New York or London. All they required was a fax machine and a lawyer to invest in a Thai office block, or a computer terminal to buy the Indonesian rupiah.|2|||Or to sell it, which is what finally happened in mid-1997. When the crash began in Thailand, investors throughout the region rushed for the exits. Investors were spooked by various common flaws in countries that had once seemed attractive: corruption, short-sighted borrowers, imprudent banks. When it was an Asian crisis, says David Hale, chief global economist of the Zurich Group, people could say it was caused by borderline criminals and incompetents. But as Russia imploded and Brazil teetered, it became clear that Asia's woes would eventually be felt by the whole world. The Asian crisis became a global crisis, as trigger-shy investors stopped lending and investing anywhere, including in the West. What we have is a crisis of global capital markets, says Jeffrey Sachs, director of Harvard University's Institute for International Development. It is a full-fledged financial panic as we have not seen in decades. Agrees Kenneth Courtis, chief economist and strategist of Deutsche Bank Group Asia Pacific in Tokyo: I think we are inches away from slipping into a crisis like the 1920s.Gulp! In less trenchant terms, the IMF has said the world economy will see no snapback in 1999 and possibly a deeper, wider and more prolonged downturn afterward. That has swung the debate from rebuilding the financial hardware to a more pressing need to stave off a worldwide depression. Fed Chairman Greenspan has responded with two cuts in U.S. interest rates. At the time of the first, he also set forth his view on the dangers that deflation--marked by a worldwide decline in prices in the face of depressed demand and oversupply of many products--now poses. We are clearly facing a set of forces that should be dampening demand going forward to an unknown extent, he said. This is a time for monetary policy to be especially alert.With Japan in its worst recession since the war, the U.S. and Europe are the only regions gobbling up the exports that the rest of the world hopes will pull them out of their misery. But Wall Street has stumbled, wiping out billions of dollars in paper wealth since mid-summer, and many companies have seen their earnings drop. A serious slowdown in the American economy could tip the entire world into a deflationary spiral. That, in turn, could fuel protectionism, which would surely make things worse. The No. 1 question we face, says Deutsche Bank's Courtis, is how to increase growth in the world economy.The good news is that some of Asia seems ready for a renewal of fortunes. It's now widely agreed that the IMF programs in Asia--though they ultimately provided some stability--were often brutal to the point of incompetence. Indonesia, Thailand and South Korea were all told to raise interest rates and cut government spending at a time when their economies were in free-fall. Before the IMF could alter its strategy, enormous damage had been done. Even the World Bank, its sister institution, has publicly criticized that course, and some IMF honchos have grown contrite. The Asia crisis has been a painful learning process for everyone concerned, pronounced Hubert Neiss, director of the fund's Asia-Pacific Department, at the Singapore summit last week, and that includes the IMF.||3||When Indonesia started to collapse, for example, the IMF was obsessed with how the markets were reacting and got carried away with its demands on the government of then-President Suharto. The IMF reading of the markets was that they wanted blood on the walls, says a senior World Bank official. They wanted people to be punished. The IMF demanded the dismantling of Suharto-era monopolies, which few mourn, but also budget cuts that required the ending of fuel and food subsidies for average Indonesians. Partly as a result, some 79 million people have been pushed below the poverty line since the crisis began, and the country is far from recovery. Everything that could be drained from countries was drained, says Harvard's Sachs, a vehement critic of the IMF. It's the most massive overkill of the financial markets and international institutions imaginable.But after the drainings, two of the IMF's star pupils--Thailand and South Korea--now seem poised for a rebound. As Sachs describes it: You can only panic once. The bankers and mutual-fund managers fled, but in the ensuing months, those countries' debts have been partly worked out by individual creditors and debtors--either swallowed by the banks or stretched out over many years. With new sources of credit and international confidence, those economies can begin humming again, along with battered countries that didn't run to the IMF, such as Malaysia. It will be a slow road back to financial health, but the pump priming will probably begin with the $30 billion promised Asia by Japan's Miyazawa, an amount to be distributed for trade and debt restructuring. (A similar offer by Japan last year at the start of the crisis was shot down by Washington, which worried it might dilute the authority of the IMF. After more than a year of economic deterioration in Asia, Washington now seems happy for Japan to spread around some cash.) And the U.S. Congress finally agreed last week to give the IMF an additional $18 billion, badly needed in case Brazil collapses, although it attached tough, possibly unenforceable conditions on how the new funds are lent.Real recovery will depend ultimately on whether Japan can get a grip on its banking problems, and last week offered the first real hope of that prospect. For years, Japan hid its banks' woes for a variety of reasons. First, it hoped that its economy would somehow improve and the banks might grow out of their bad loan portfolios. Second, a full revelation of the situation would have exposed the ruling Liberal Democratic Party and the Finance Ministry to withering criticism--and cost many top bank executives their jobs. Third, Japan had allowed its deposit-insurance fund to dry up: full disclosure might easily have led to mass bank runs. (The fund was replenished with $142 billion last February.) In Washington, Treasury Deputy Secretary Summers was also adamant that Tokyo not bail out the banking system with public money.Last April, Summers changed his mind, but the government of Prime Minister Ryutaro Hashimoto was floundering. His successor, Keizo Obuchi, was able to get legislation going, though only after earlier compromises with the opposition fell apart. Last week's move had all the urgency and heft the world had been waiting for. But it would be premature to break out the champagne. Many of the necessary details couldn't be decided upon by the quarreling parliamentarians and were left to be worked out later--possibly not until early next year. Banks desiring re-capitalization funds will have to adhere to new restrictions; in an earlier such plan, many banks took only a token amount as a result. Nonetheless, Japan has acted with a resolve that has been absent for most of the decade--and has put an appropriately high price tag on the job needed to be done.|||4|If the U.S. and Europe evade recession and Japan removes the blindfold and earplugs, the international economic system as we know it might be pulled back from the brink. (Although there are other dangers, including Brazil and the unpredictable effects of a possible devaluation of China's renminbi.) But what about the need for some new architecture for the global economy? Indonesia, Thailand, South Korea and many other countries now concede that they borrowed too much, built some unwise skyscrapers and steel plants, and tolerated excessive corruption. But that hardly explains how the fastest growing region of the world, fueled by foreign funds, open markets and all the other trappings of the globalized era, could become a quasi-basket case almost overnight. I have never seen the kind of economic meltdown and destruction of wealth that we've seen in Asia in just nine months, says Marc Faber, a prominent fund manager in Hong Kong. In many ways, the crisis erupted because countries that suddenly opened up to foreign capital weren't prepared to handle these new flows. We have simply outgrown our infrastructures, both hard and soft, says Victor Fung, chairman of Hong Kong's Trade Development Council. Our regulatory structures were built for economies one-fifth the size of today.But no one is sure how to go about fixing the system. In the debate over new architecture, there are parts of the house nobody wants remodeled. Freer trade has undeniable benefits, as does foreign direct investment. In addition, much of the woe of the past 18 months has come not from faulty design but wholesale avoidance of the most basic building codes. South Korean and Indonesian banks lent money without proper credit analysis; Malaysian and Thai authorities didn't adequately regulate their banks. Japan, too, didn't watch over its banks and even helped them cover up their problems.And foreign lenders are every bit as much to blame. The biggest damage was done by short-term capital flows, or hot money--foreigners purchasing local shares or currencies and offering local businesses short-term loans. As Japanese banks looked for new lenders, as foreign mutual funds sought out booming new markets to invest in and as predatory hedge funds found clever ways to bet against currencies, the money simply poured in. If there's any consensus for new architecture in the near future, it will probably be for setting up narrower doorways for such hot money: a country should allow in only as much as it can afford to lose overnight.Most of the other measures needed to prevent meltdowns in this globalized era have nothing to do with architecture: making sure banks and corporations have honest books, for example. If you look at the history of the American capital market, says Summers, the principle of generally accepted accounting principles has been more important than any innovation in the last century. Those are jobs more important than sexy. In the current parlance of the global international economy, what may be needed is fewer architects and more janitors--cold-eyed regulators and accountants--willing to start cleaning out neglected basements.||||5