One emerging market was viewed by Blinder, Stiglitz, and their allies as a near-paragon of prudence in the financial realm: Chile, which maintained a set of rules designed to limit incoming short-term capital. Foreign investors and lenders were required to leave 30 percent of their money in non-interest-bearing accounts at the central bank for one year—in effect, a tax on the short-termers. But most IMF and Treasury officials looked askance at Chile’s system of capital controls. Summers resisted the idea of encouraging other countries to follow Chile’s lead, because such controls could easily be used to protect powerful domestic financial interests against the cleansing influence of competition. Asked at a World Bank seminar in late 1997 why Washington didn’t favor more Chilean-type systems in emerging markets, Summers replied: “It’s kind of like telling an alcoholic that a little bit of wine is good for your health. It may be true, but you don’t want to tell him.”
The high-water mark for the cause of globalizing money flows came at the September 1997 annual meeting of the IMF and World Bank in Hong Kong. The IMF had already been using its influence to urge countries to open their financial systems, and now—with U.S. backing—the Fund was moving to formally override the preferences of its founders, White and Keynes, for restricting capital movements. The IMF’s policy-setting Interim Committee, consisting of member nations’ finance ministers and central bank governors, declared:It is time to add a new chapter to the Bretton Woods agreement. Private capital flows have become much more important to the international monetary system, and an increasingly open and liberal system has proved to be highly beneficial to the world economy. By facilitating the flow of savings to their most productive uses, capital movements increase investment, growth and prosperity. Provided it is introduced in an orderly manner, and backed both by adequate national policies and a solid multilateral system for surveillance and financial support, the liberalization of capital flows is an essential element of an efficient international monetary system in this age of globalization.
Citing the turmoil in Southeast Asia, which had erupted only three months before, the IMF committee noted “the importance of underpinning liberalization with a broad range of structural measures ... and to building sound financial systems solid enough to cope with fluctuations in capital flows.” But the statement concluded with an “invitation” for the IMF Executive Board “to complete its work on a proposed amendment to the Fund’s articles that would make the liberalization of capital movements one of the purposes of the Fund.”
Camdessus delivered a rousing endorsement of the move in a speech at the meeting, in which he was careful to explain that the Fund would not encourage countries to remove capital controls prematurely, nor “prevent them from using capital controls on a temporary basis, when Justified.” He continued:Certainly, there are risks in tapping global markets: Sometimes they react too late, and sometimes they overreact. No country—I repeat, no country—is immune to these risks. But let us not forget that markets also provide tremendous opportunities to accelerate growth and development, as Southeast Asia itself so vividly shows....
Freedom has its risks. But are they greater than those of complex administrative rules and capricious changes in their design?
Freedom has its risks. But is there any more fertile field for development and prosperity?
Freedom has its risks! Let us go then for an orderly liberalization of capital movements.
Some developing countries had already embraced the call with alacrity—or perhaps a better word is abandon. One, in particular, had already begun paying a steep price.
3
WINNIE THE POOH AND THE BIG SECRET
The IMF staffers who gathered in the office of First Deputy Managing Director Stanley Fischer on July 25, 1997, faced a vexing problem: Thailand didn’t want their help.
Three weeks earlier, amid severe financial turmoil, the Thai government had abandoned its long-standing policy of maintaining a fixed value for the baht against the U.S. dollar, and the baht was sinking fast, having already lost 19 percent of its value in foreign exchange markets. Despite this frightening disintegration in the country’s economic fortunes, however, Thai officials were refusing the IMF’s overtures to start negotiating the terms of a rescue loan. The Thais were deeply reluctant to subject their economic policymaking to IMF approval, and there was no way for the Fund to impose itself on Bangkok. As an international organization whose members are sovereign nations, the IMF is forbidden from even sending a mission to a country unless it has been invited by the country’s authorities.
Among the people seated around Fischer’s conference table was an economist named Ranjit Teja, whose presence was a small but noteworthy illustration of how blissfully unanticipatory the Fund was about the carnage that would ensue from Thailand’s financial crack-up. Teja, a thirty-nine-year-old Indian with a Ph.D. from Columbia University, had been promoted the previous month to a new Job, chief of the division responsible for South Korea, and he had spent a few weeks boning up on the country’s economy to prepare for a routine annual visit to Seoul in the autumn. But at the end of June he had been reassigned again, to Thailand, mainly because of his strong background in programs—that is, drafting and negotiating economic plans for countries seeking IMF loans. The notion that Korea would need a Fund program a mere four months hence seemed about as far-fetched as the chance of a snowstorm on that late July day.
Still, Thailand’s woes were plenty worrisome, and as far as the IMF staffers were concerned, a program for Bangkok was an urgent necessity. The lower the baht fell, the closer Thailand’s leading banking and industrial firms edged toward bankruptcy. Many of them had sizable foreign debts—which they were required to repay in U.S. dollars—and the burden of repaying those debts was escalating as the baht was descending. At the old rate of 25 baht per dollar, repaying a $1 million loan would have required 25 million baht; at that day’s rate of 32 baht per dollar, the cost had risen to 32 million baht—a 28 percent increase. Deepening the alarm among the meeting participants was the prospect that the turbulence would spill over Thailand’s borders and affect its Southeast Asian neighbors. Already, signs of financial contagion were sprouting. Earlier in the week, Indonesia’s currency had sunk by 7 percent against the dollar in a single day. The Malaysian ringgit and Singapore dollar were also badly hit.
Frustrated by the Fund’s inability to intervene in the rapidly deteriorating situation, Fischer decided the time had come to dispense with diplomatic niceties. The deputy managing director, who had been talking privately with Thai officials and believed they were coming around, ordered a mission to depart for Bangkok immediately.
“Just go,” he said to the economists from the Asia and Pacific Department seated nearby.
“But they haven’t asked for us,” his subordinates protested, astonished at this proposed breach of protocol.
“Just go,” Fischer replied, “and in the time it takes for you to get there, I’ll persuade them.”
Thus began the IMF’s foray into what would soon be known as the Asian financial crisis. The Fund was not only surprised by the ensuing events but ill-prepared in certain respects. The Asia and Pacific Department was something of a backwater at the IMF, reflecting the prevailing view at the Fund that, in general, Asia was doing splendidly and needed little attention. The brightest and most aggressive of the institution’s economists tended to gravitate to other departments, such as the ones overseeing Latin America or Europe, where the challenges were pressing and the assignments more glamorous. More important, the Asia and Pacific Department’s staff had spent little time in the countries that would be hardest hit—Thailand, Korea, and Indonesia—because when countries are not subject to IMF programs, they are generally visited by missions only once a year, for a couple of weeks, as part of a surveillance process in which the Fund assesses the economy and gives advice, mostly on budget, tax, and monetary policy.
Thailand was the one Asian country where the IMF saw a crisis coming and was geared up
to handle it. What went wrong, according to the Fund’s version of events, was that the Thai government stubbornly refused to face reality. Thai officials repeatedly ignored private warnings from Washington to take preemptive measures aimed at easing the tremendous pressures threatening the stability of their currency and their economy.
True, but hardly the whole truth. Closely scrutinized, the Thai saga does not reflect gloriously on the IMF’s role in either preventing or containing the country’s tribulation. The Asian crisis would get off to a roaring start in Thailand, but the IMF would get off to a stumbling one.
The Bank of Thailand, like the central banks of many other nations, is an institution staffed with well-educated bureaucrats who deem themselves above the usual tugs of petty politics. Among the bank’s employees in 1997 was Paiboon Kittisrikangwan, a University of Chicago M.B.A. whose Job had been notable for its humdrum routine.
Thailand maintained a relatively fixed exchange rate of roughly 25 baht per U.S. dollar, and Paiboon’s chief task was to manage the technical aspects of this policy. The dollar-baht rate, though fairly constant, wasn’t rigid; it depended on a special formula that included a small weighting for the value of a few other currencies, such as the Japanese yen and German mark. So every morning, Paiboon or one of his colleagues would meet with senior Bank of Thailand officials to make a mathematical calculation of the appropriate baht-dollar rate for the day. If, for example, the formula dictated that the rate for the day should be 25.80 baht per dollar, Paiboon’s department would stand ready that day to buy or sell unlimited amounts of U.S. dollars at that rate, plus or minus 0.02 baht. This was a fairly conventional system for an economy with many internationally oriented businesses that had a variety of currency needs at different times. From its reserves, the Bank of Thailand would sell dollars for use by banks and importers, who needed the U.S. currency for foreign transactions; at the same time, it would buy dollars earned by Thailand’s exporters, who needed baht to pay their local workers and suppliers.
The system had held for more than a decade, and it was an integral part of the strategy that had helped make Thailand, a country of 66 million, a hotbed of growth. In the decade starting in 1986, the country’s gross domestic product expanded at a compound rate of more than 9 percent a year, one of the highest in the world, reaching $182 billion in 1996. Exports grew at an even more phenomenal clip, rising 19 percent a year during the first half of the 1990s. Living standards for millions of Thais improved markedly as they streamed from impoverished villages to booming cities where Jobs beckoned at factories and construction sites offering far higher pay than could be had in the countryside. Bangkok still had plenty of poor people crowded into slums and shacks, but a striking feature was its burgeoning middle class, whose members indulged their newfound spending power on automobiles with such gusto that the city gained notoriety for the worst traffic Jams in Asia. The media were abuzz with the capital’s rapidly proliferating department stores, restaurants, and high-rises, which were often—and deservedly—described as “swank” or “glitzy.”
Much of the force driving the growth, at least in its early stages, came from heavy investment in factories by foreign multinationals, especially Japanese auto and electronics companies. For these investors and others, one of Thailand’s attractions was the stable value of the baht. The fixed-rate policy reduced their worries about the value of their holdings and the costs of production fluctuating. The fixed exchange rate also made doing business simpler and more predictable for homegrown Thai exporters.
The system was particularly favorable for Thailand in the first half of the 1990s because during much of that time, the dollar was weakening relative to other major currencies, and with the baht linked closely to the dollar, Thai exports became less expensive on world markets. Thai-made clothes, shoes, auto parts, and electronics became better deals vis-à-vis similar products made elsewhere—and orders flooded in.
But the dollar began a powerful rebound in mid-1995, and the fixed-rate system started working inexorably against Thai exports, making prices for those same clothes, shoes, auto parts, and electronics less attractive. Compounding the problem was a downturn in the worldwide market for electronic components, of which the country had become an important manufacturer. In 1996, export growth went flat while imports continued to grow, and Thailand found itself saddled with an uncomfortably high trade deficit, with the current account gap rising to 8 percent of the country’s GDP.
Large trade deficits are not necessarily damaging to a country’s economy. A country can spend more hard currency than it earns as long as it can “run up a tab” without “maxing out on its credit cards,” especially if it is making wise use of the incoming foreign money. In some ways, Thailand’s trade deficit was a sign of strength; it meant that foreigners were willing to lend so much money to the country because of their faith in its future.
Indeed, by some traditional indicators, Thailand was not living beyond its means at all. Its government budget was in surplus, and inflation was comfortably below 6 percent. So by itself, the trade gap might not have been cause for undue concern. But Thailand had another problem as well—a financial system infected with a go-go mentality.
Among the system’s most visible symbols was Finance One, which was run by Pin Chakkaphak, a graduate of the Wharton School of Business at the University of Pennsylvania, who affected a casual style that included occasional rollerblading Jaunts through Bangkok’s Lumpini Park. In the mid-1980s, he began building a financial services empire that quickly grew to $4 billion in assets, and he shrugged off worries about the independence with which his subordinates aggressively pursued business. “I don’t believe in coordination,” he was once quoted as saying.
Pin’s firm was the largest of Thailand’s finance companies. These companies weren’t banks, exactly, but they were similar. They provided about 20 percent of all the credit in the country, and they specialized in lending to Thai consumers and businesses—on easy terms, with low interest rates and little money down—in some of the economy’s hottest areas, including autos, property, and purchases of stock on margin. They raised large sums by selling interest-bearing “promissory notes” to the public, and they also borrowed substantial amounts from local banks and foreign investors, much of it in the form of very short-term loans. Thailand’s commercial banks, which accounted for more than three times as much credit as the finance companies, were less aggressive, channeling a much higher proportion of their loans into manufacturing, but they also lent substantial sums to property developers. Overall, loans to private borrowers surged from $89 billion in 1992 to $204 billion in 1996.
Lucrative as this lending binge was when the stock and real estate markets were soaring, it began to turn sour in 1996 when interest rates rose, stock prices sank by 35 percent, and the economy slowed due to sagging exports. Finance companies were saddled with $4.8 billion in margin loans to stock investors, many of which couldn’t be repaid. Most ominous of all was evidence that the property market, where far more loans had been advanced, was grossly overbuilt. That year, 600,000 square meters of office space came on the market in Bangkok, more than half of it unleased, with another 900,000 square meters planned for 1997 and 1.3 million more planned for 1998—and most of the future expansion was already under construction. The most spectacular real estate boondoggle was a $1 billion-plus development on the city’s outskirts called Muang Thong Thani Estate, which was designed to house hundreds of thousands of people and included high-rise condominium buildings, townhouses, retail shops, and a sports complex. Sales were abysmal, and with weeds growing high amid the unoccupied buildings, the desperate developer—allegedly a major contributor to the ruling party—furiously lobbied for government deals to move Parliament and part of the Defense Ministry onto the property.
By early 1997, Thai banks and finance companies were reporting increases in their nonperforming loans—loans on which payments were at least six months overdue—which in May reached about 12 percent of a
ll loans outstanding. Disturbing as the figures were, financial analysts in the region reckoned the true amount of dud loans to be much higher, especially for the finance companies. The skepticism was Justified, for the government’s oversight and regulation of the financial sector could generously be described as benevolent, if not lax.
A shocking case had come to light in mid-1996 involving the Bangkok Bank of Commerce (BBC), the country’s ninth-largest bank, which was run by a former central bank official named Krikkiat Jalichandra. The revelations showed that the central bank knew in 1993 that nearly 40 percent of BBC’s total assets consisted of nonperforming loans, many of which consisted of loans to Krikkiat’s associates, other bank insiders, and influential politicians to finance speculation in real estate and corporate takeovers. Yet the central bank had refrained from taking any serious enforcement actions; although regulators had ordered BBC to shore up its financial position, they had not required it to disclose how deeply its capital had eroded. The head of the central bank, Vijit Supinit, would explain later that he wanted to avoid alarming the public and undermining confidence in the banking system.
Distressing as the BBC scandal was, it was modest compared with the bombshell that dropped on March 3, 1997, when an uncharacteristically grim Pin Chakkaphak stood before reporters and TV cameras to sign an agreement that effectively dissolved his empire by merging Finance One into one of the country’s commercial banks, Thai Danu. (In a humiliating turnabout for Pin, the bank was one he had tried to acquire the year before.)
The Chastening Page 7