The Chastening Read online

  The global crisis was widely pronounced to be over in spring 1999, and that assessment by and large held up. Not only did world growth proceed apace in 1999 and 2000, but most of the hardest-hit countries bounced back. Korea was growing feverishly; the Brazilian economy was bounding along at a healthy clip; Thailand was on the mend; and Russia was posting positive growth, an achievement that eluded it for most of the 1990s. Even Indonesia, whose economy had been the most severely damaged, was growing, though its recovery was extremely fragile. Arguably, the crisis strengthened the long-term economic prospects of some of these countries; Korea, in particular, benefited from loosening the ties among its banks, conglomerates, and public officials.

  Thus, despite all the hardships wreaked on people in places like Jakarta and St. Petersburg and Rio de Janeiro, the crisis might be viewed as a setback of little consequence for a world enjoying a spell of robust growth. Who cares that a handful of countries suffered a comeuppance for the crony capitalism, corruption, overborrowing, and other sins of which they were guilty—and since they didn’t drag the rest of the world economy down with them, doesn’t that reflect the resilience of the global financial system, the effectiveness of its safety nets, and the cleverness of its High Command?

  On the contrary, such a blithe interpretation of the crisis ignores its implications, both for the stability of individual countries’ economies and for that of the global economy as a whole. The affected nations, for all their flawed economic fundamentals, had been the darlings of financial markets not long before their crises struck, and once the Electronic Herd turned negative, the punishment it inflicted was grossly out of proportion to the countries’ “crimes.” Disregarding their fate is tantamount to shrugging off the crash of a new type of advanced aircraft on the grounds that the only passengers killed were a careless few who left their seatbelts unfastened—and concluding that since everyone else miraculously survived, worry about future flights is unwarranted.

  The news accounts at the time of the crisis, as disturbing as they were, do not adequately convey how frightening, disorderly, and confounding it all was, most notably for the people in charge of quelling it. An extensive look inside the crisis-fighting effort illuminates the degree to which the policymaking wizards of Washington and other capitals found themselves overwhelmed and chastened by the forces unleashed in today’s world of globalized finance.

  The pace at which economies were felled by “contagion”—the spread of market turmoil from one country to another—caught top policymakers flat-footed. So rapid was the onset of Korea’s crisis in November 1997 that it came less than a month after the IMF staff had drafted a confidential report assessing the Korean economy as essentially safe from the turbulence besetting Southeast Asia. Equally unsettling was the swiftness with which the markets often delivered their negative verdicts on the IMF’s handiwork. Fund officials had Just sat down to lunch in Jakarta on January 15, 1998, to celebrate the signing that morning of Indonesia’s “strengthened” program when they heard the shocking news, from cellphone calls, that the rupiah was falling instead of surging as they had anticipated.

  Most chilling of all was how perilously close the U.S. economy came to Joining the global meltdown in September and October 1998, when U.S. financial markets, especially the bond market, ceased functioning normally as a provider of capital to business, and the near-collapse of a giant hedge fund threatened to paralyze the nation’s financial system. Thanks to the benign outlook for inflation, the Federal Reserve felt free to cut interest rates sharply at that time—but had it not done so, the convulsions on Wall Street might well have engendered a worldwide slump.

  Rubin, Summers, and Greenspan are brainy, all right—indeed, they rank among the smartest and most capable economic policymakers in recent memory—but the aura they attained as economic saviors conveys the false impression that the international economy was in the hands of masterminds coolly dispensing remedies carefully calibrated to tame the savage beast of global financial markets. The reality, as I describe in chapters to come, is that as markets were sinking and defaults looming, the guardians of global financial stability were often scrambling, floundering, improvising, and striking messy compromises.

  The mad dash to rescue Korea in November 1997 was Just one illustration of how the IMF and the rest of the High Command were knocked for loop after loop during the crisis. The second rescue of Korea, though successful, came harrowingly close to falling apart as the U.S. Treasury and the Fed, deeply uncertain about the viability of the plan, waited until the last minute to sign on. In Brazil, top Treasury and IMF officials backed a bailout, over the strenuous obJections of European policymakers, aimed at propping up the Brazilian real—only to find when the real crashed that the Europeans’ skepticism about the bailout’s prospects was Justified.

  As the crisis progressed, fierce disputes erupted within the G-7 and between the World Bank and other players. The United States, which dominated G-7 decisions, was at loggerheads with Japan over the issue of the IMF’s right to force crisis-stricken Asian countries to revamp their economic systems. U.S. officials also clashed repeatedly with their German counterparts, who criticized large IMF loan packages as bailouts for the rich that would foster reckless investor behavior in the future. By the time the Brazilian crisis rolled around in late 1998, British and Canadian officials were also taking sharp issue with the U.S. approach, urging that instead of resorting to large IMF loans, the international community should use its leverage to impose temporary halts on the withdrawal of money from countries in crisis by private lenders and investors.

  These and other episodes afford a dramatic backdrop for understanding and scrutinizing the IMF, an institution that, even to wellinformed laypeople, is a source of great perplexity—sinister to some, awe-inspiring to others. Demystifying the IMF has never been more important, not least because of its sudden notoriety as the target of antiglobalization protesters.

  Fund officials may complain about how poorly the public understands their institution, but the IMF cultivates its mystique, seeking to appear all-knowing, scientific, and detached. To outsiders, it often comes across as a high priesthood with pretensions of divine powers and insight. Its public pronouncements and documents are loaded with economic Jargon that seems almost deliberately designed to obfuscate or intimidate. Sometimes this practice descends into farce. Several years ago, for example, an IMF report described Vietnam’s invasion of Cambodia as “a misallocation of resources due to involvement in a regional conflict.”

  The IMF has a tremendous stake in maintaining an image of omniscience as it dispenses loans and prescribes remedies for ailing economies, because it wants to convince everyone—especially financial markets and officials of the governments seeking its assistance—that it knows what it’s doing. When a nation with an IMF program fails to regain stability, the Fund almost invariably blames the country’s government for failing to meet the conditions and targets that were agreed to, or for failing to show convincing commitment to achieving them. IMF officials typically shake their heads in resignation over the difficulty the country’s politicians are having in, say, slashing popular subsidies or maintaining painfully high interest rates. From their lofty positions, they enlist support from professional analysts and the press for their view that the fault surely does not belong with their prescriptions. “It’s the only program that serious people can imagine putting together,” a senior IMF official told me, with a touch of asperity, in mid-December 1997 as Korean markets were melting down after Seoul had Just received the biggest IMF loan in history.

  Peering behind the IMF’s facade provides a less confidenceinspiring picture, even for those who broadly share the Fund’s views about how to handle countries in economic difficulty. I have met current and former IMF staffers who, speaking candidly under a promise of anonymity, recall with anguish having been thrown into the midst of crises with bewildering origins and no obvious solutions. “Everyone was working on the assumption that all you n
eed is an IMF program, but this was proved wrong over and over,” lamented one such Fund economist. “We reached agreement with these countries Just to see the currency go over and over again.”

  Often, IMF officials felt outgunned—and small wonder. While the Fund can marshal huge resources for the countries it aids and can demand far-reaching reforms from their governments, it has been dwarfed by the growth of global markets.

  The Federal Reserve, one of the most potent crisis-fighting institutions around, provides an illuminating comparison. As the U.S. central bank, the Fed plays the role of America’s “lender of last resort,” standing ready during financial crises to use its power to create unlimited amounts of money. The classic scenario of Fed intervention involves a run on a bank caused by rumors that prompt depositors to withdraw their funds, which in turn causes runs on other banks that do a lot of business with the first bank. The Fed’s duty is to lend as much cash as the banks need to cover their depositors’ demands—and keep lending until the panic eases, because otherwise the whole system might crash.

  The IMF plays a similar role on the international stage. As with Korea in 1997, countries sometimes run dangerously low on hard currency, so the IMF stands ready as a lender of last resort. But the IMF can’t simply create more hard currency—be it dollars, Japanese yen, British pounds, euros, or any other such monetary units—the way a central bank like the Fed can. The IMF has a war chest of these currencies contributed by member countries, and the size of its loans is limited as a result. In absolute size, the war chest is gigantic, and it has grown—from $27 billion in 1980, to $60 billion in 1990, to $88 billion at the beginning of 1997, Just before the advent of the crisis in Asia. (The figure in 2002 was $135 billion.) But during that same period, purchases and sales of bonds, stocks, and other securities across international borders by firms and individuals resident in the United States soared from $249 billion in 1980 to $5 trillion in 1990 and $17.5 trillion in 1997. (When similar figures are added for residents of other advanced countries such as Germany, Japan, and France, the sums are more than twice as big.) For emerging markets alone, the amount of private capital flowing into them from abroad rose from $188 billion in 1984-1990 to $1.043 trillion in 1991-1997.

  Beyond the problem of the IMF’s limited resources, though, is its sometimes inept deployment of them. It is no secret that the Fund made serious mistakes in its efforts to rescue countries from crises. Some of these involved the Fund’s well-known penchant for overprescribing austerity, an example being the excessive fiscal stringency it demanded of Thailand. Others reflected the Fund’s lack of expertise in banking issues, an example being its decision to close sixteen banks in Indonesia without providing a proper safety net for the remainder of the country’s banking system.

  This weakness does not mean, as some suggest, that the IMF is a hopelessly misguided or malign institution that systematically imposes harmful economic blueprints on countries in distress. Universities and think tanks are full of people who believe that if only the Fund would follow their approach, crises like the ones in the late 1990s would never occur or would be much less severe. Whether these advocates are right is impossible to say with certainty, and the arguments continue to be the subject of much dispute. Some critics wage their attacks from diametrically opposite perspectives. Supplyside economists, for example, excoriate the IMF for being too quick in encouraging countries to devalue their currencies. By contrast, Jeffrey Sachs of Harvard University and his followers assert that the Fund errs grievously by forcing countries to stick too long with currencies that are overvalued. This book is not an economic treatise, however, and thus does not champion any particular ideology or school of thought about how the IMF should change its economic paradigm.

  For anyone evaluating the IMF’s performance, the question “compared with what?” must be constantly borne in mind. The fact that the Fund blundered does not mean that it failed to do a lot of good, or that it failed to keep outcomes from being even worse than they turned out to be. For example, the Korean economy, and quite possibly the global economy as a whole, might be far weaker today had Seoul not been prevented from defaulting in late 1997.

  Even so, the crisis of the late 1990s exposed how woefully illequipped the IMF is to combat the new strain of investor panics plaguing recently liberalized markets. The Fund proved unable to prevent the countries victimized by crises, especially in Asia, from suffering much worse than they deserved. Its ineffectiveness at minimizing the punishment meted out by the Electronic Herd does not bode well for the future. Nor does its ineffectiveness at foreseeing and squelching contagion.

  Subsequent events have reinforced these conclusions. A sizable IMF bailout for Turkey in late 2000 failed at keeping the Turkish lira from collapsing in value two months later. More tragic was the case of Argentina, whose economic performance had won acclaim from Washington and Wall Street during the late 1990s. Despite a $40 billion IMF-led package in December 2000 and another $8 billion program in August 2001, Buenos Aires was forced in early 2002 to default on its debts and abandon its pegged currency system; the result was an economic contraction that threw millions into poverty and obliterated the wealth of the country’s middle class. Not long thereafter, financial paroxysms beset Brazil anew; in early 2003 it was unclear whether a $30 billion IMF program approved the previous summer would keep Brazil from following Argentina’s course.

  The global financial system showed its susceptibility to upheavals of intense destructive power in the late 1990s. We could leave the system more or less as it is and hope that when future crises strike, the Ph.D.s at the IMF, together with “the Committee to Save the World,” rise to the occasion. But the account of how they struggled the last time around should chasten us all out of any sense of complacency.

  2

  OPENING THE SPIGOT

  Every year the IMF extends positions to about 100 economists, many of them recent recipients of doctorates from the world’s most prestigious graduate schools—Harvard, Stanford, MIT, Chicago, Oxford, Cambridge, the London School of Economics. The organization they are Joining employs 2,600 people, including lawyers, computer technicians, and other support personnel, but the heart of its staff is the economists, who number more than 1,000.

  Their new workplace stands on 19th Street in downtown Washington, three blocks west of the White House. It is a beige limestone building thirteen stories high with a curved driveway that is often the parking spot for one or two limousines bearing visiting dignitaries. In the lobby, which has a sunlit atrium and polished marble floor, a cosmopolitan atmosphere pervades, thanks to the patter of Spanish, French, Arabic, and other languages spoken by staffers (all of whom are required to be fluent in English) casually flicking their ID badges to pass through the electronic security apparatus. Although smartly tailored business clothing predominates, the occasional turban, head scarf, or dashiki adds a touch of color. Staffers hail from more than 120 nations; about a quarter are American.

  The new recruits have been lured partly by the pay. In 2002, entry-level Ph.D.s at the IMF earned salaries between $69,000 and $103,500 a year—tax free. Another draw is their status as elite international civil servants, who fly business class (often, first class) and stay in deluxe hotels when on mission. But a maJor attraction for these newly minted Ph.D.s is the knowledge that, within months, they are likely to find themselves overseas sitting across the table from a finance minister or central bank governor, helping to design a country’s economic policies.

  Upon reporting for duty, the recruits head for the IMF Institute, located in an office building a couple of blocks north of the headquarters, where they undergo a two-week training program. In addition to lectures on technical economic issues, the students take a course called “Financial Programming,” which teaches them how the IMF helps countries in trouble. The institute’s director, Mohsin Khan, spent a couple of hours one wintry afternoon walking me through the course in a manner comprehensible to non-Ph.D.s. The result was an illuminating
introduction to the IMF’s modus operandi, and Khan, a cheerfully outspoken Pakistani, also treated me to some candid observations about deficiencies in the Fund’s traditional approach.

  We start the course [Khan told me] with a very simple analogy. Consider the case of an individual. He’s faced with a negative net worth—that is, his liabilities, his debts, are greater than his assets—and his income is less than his expenditures. He’s spending more than he’s making.

  How can he do this? Because he’s got credit—he can borrow. But now he’s maxed out on his credit cards. No one will give him credit anymore.

  The bank says to him, “OK, we will bail you out. We will advance you some money. But now, everything you do has to be controlled by a financial planner. We can’t allow you to keep spending the way you have, because you’ll Just run out of credit again. The financial planner is going to do two things: He’s going to help you increase your income and help you control your spending. So that, in fact, you can only spend, beyond your income, to the extent we supply you with credit. We’ll give you a loan of $10,000. The most you can overspend is that $10,000. And the financial planner is going to set targets for spending and help you earn more income, so you can pay the money back.

  “Furthermore, you are going to be watched very carefully. You’re not going to get the $10,000 all at once. It’s going to be spread out over a year. If you’re living up to your commitments, you’ll get the money. If not, we’ll have to talk again.”