The Chastening

by Paul Blustein

  The United States had no right to seek fundamental changes in this system, Sakakibara argued, even though the close-knit links among keiretsu members often made it very difficult for foreign firms to crack the Japanese market. Indeed, he noted that with the fall of communism, different forms of capitalism were now competing with each other—and at the time his book was published, Japan’s seemingly boundless growth was stirring speculation that its system would triumph. The country’s GDP, ranked twentieth in the world in 1965, had rocketed to second-largest and, based on the 4-plus percent growth rates posted in the late 1980s, awed some pundits into concluding that it would overtake the output of the flagging U.S. economy within a decade or two. Japanese industrial and financial giants were muscling aside American firms in one sector after another, their competitiveness fueled in part by cheap capital raised from their keiretsu banks. Sakakibara himself declined to predict that Japanese-style capitalism would displace the U.S. version; he saw each country’s system as tailored to its national strengths and societal traits. But whereas Americans would presumably stick with their own economic practices, he said, “I personally like the Japanese system.”

  From his perch as vice minister, which gave him membership in the G-7 deputies, Sakakibara registered discontent with the way the Asian crisis was being handled by the IMF and the rest of the High Command. The Fund was too quick to blame the Asian economic model, he contended, when the real fault lay with forces beyond Asians’ control. Like Sachs and Stiglitz—with whom he conferred often—he strongly disagreed that the turmoil was attributable to cronyism and excessively cozy ties between business and government; this was, he repeatedly insisted, “not an Asian crisis but a crisis of global capitalism.” Although he never went as far as Malaysia’s Mahathir in demonizing hedge funds and currency speculators—in fact, Sakakibara counted George Soros among his regular contacts—he sympathized with Mahathir’s calls for much greater regulation over international capital markets. A U.S.-dominated IMF, he complained, was “trying to change the Asian system, without changing the international financial system.”

  Sakakibara saw an opening for an offensive in mid-August 1997, when the international rescue for Thailand was being cobbled together. Resentment was running high in the region over how the United States was insisting on including tough conditions in Thailand’s IMF program while refusing to contribute money directly to the bailout. During the Tokyo conference at which Japan led a group of neighboring nations in providing Bangkok with $10 billion in loans to bolster its IMF rescue, Sakakibara recalled, “We sensed an intensity ... that could be termed the ‘unity of Asian countries.’” Together with his deputy, Haruhiko Kuroda, he began sketching plans to launch a gigantic hard-currency fund that would use a portion of the hundreds of billions of dollars in reserves held by Japan, China, Hong Kong, Singapore, and other countries in the region. Sakakibara and Kuroda had been considering the merits of such a fund ever since the Mexican peso crisis, when they noticed that Asian nations probably wouldn’t qualify for IMF loans proportionate with the one Mexico received because their Fund quotas had failed to keep pace with their rapid economic growth. Now that contagion was spreading, they concluded, their idea required urgent implementation. An Asian fund would intimidate speculators into leaving the region’s tigers alone, by showing that a big pool of dollars was readily available for any country that came under attack.

  “In retrospect, it was all too hasty,” Sakakibara admitted in a reconstruction of the episode that he wrote about in late 1999 for Yomiuri Shimbun, a major Japanese daily. That was putting it mildly. Sakakibara sent an “unofficial” outline of the plan to South Korea, Malaysia, Hong Kong, Singapore, and Indonesia on September 10, 1997. Although the documents didn’t cite specific figures, Japanese officials let it be known they were contemplating tens of billions of dollars, and their hope was to reach agreement at the IMF-World Bank annual meeting to be held later that month in Hong Kong. The documents weren’t intended for American eyes, but “our phones were lighting up with concerns from several Asian nations about the proposal,” the Treasury’s Tim Geithner recalled. American officials were enraged. Sending the proposal to the Asians without involving Washington seemed a rude departure from the normal conduct of the U.S.-Japanese alliance, which is based on the precept that the United States should maintain a strong presence in the Asia Pacific region (a major element being the 47,000 U.S. troops stationed on Japanese soil). Summers’s phone call to Sakakibara was Just one of several conversations in which U.S. officials expressed indignation to their Japanese counterparts that the rules of U.S.-Japanese engagement had been violated.

  In that phone call, Sakakibara reminded Summers that the two men had discussed the idea for an Asian Monetary Fund at a meeting in Paris about a week earlier. But Sakakibara later admitted that he had omitted one crucial point in the Paris conversation: “I did not mention the possibility that the AMF might act independently of the IMF, since that option was still undecided.” Soon thereafter, he added, he decided that “although the AMF would basically cooperate with the IMF, in certain cases the AMF would act independently.”

  That detail, of course, was what the United States objected to most of all—the prospect that countries under financial siege could circumvent the IMF by tapping into a separate pot of money. What incentive would such countries have to correct their underlying weaknesses if they could obtain sizable amounts of money with few or no strings attached—and what would stop them from inciting even larger crises down the road by continuing to run irresponsible policies?

  The U.S. counterattack against the AMF began swiftly, with a letter dated September 17 from Rubin and Greenspan to their Asian counterparts, followed up with visits to Asian capitals by Tim Geithner and Ted Truman, the director of the Fed’s Division of International Finance, to lobby against Sakakibara’s plan. Tokyo could claim some supporters among Asian countries, including Malaysia, the Philippines, and Thailand. But Australia opposed the idea, and Chinese officials dealt it a serious blow by telling Japanese emissaries that China could take neither a positive nor negative position—in effect, a veto by the region’s geopolitical heavyweight. Other Asian policymakers may have played one side off against the other; Japanese and U.S. officials both claimed to have garnered backing for their positions from Hong Kong and Singapore.

  Tensions over the issue were sufficiently high that some of the Asians wanted to exclude U.S. officials from the meeting of deputy finance ministers called to discuss the plan on September 21 during the IMF-World Bank conclave in Hong Kong. The Americans hadn’t contributed to the Thai rescue package, so why, Washington’s critics asked, should they be allowed into the meeting? Japanese Finance Ministry officials, who were chairing the meeting, considered the argument but compromised by allowing Summers and Truman and Stan Fischer to attend as “observers.” In any event, Chinese representatives continued to withhold endorsement of the Japanese plan, and the idea was shelved at that point.

  Still, Sakakibara’s efforts forced a shift in U.S. policy. Even if the AMF was going nowhere, Asian officials liked the idea of mustering vast new sources of funding for countries in crisis. And although the Clinton administration was loath to commit direct U.S. contributions to such rescues—the risk being a fiercely critical reaction from Congress—Washington found itself obliged to go along.

  Initially, U.S. officials took the position that rescue funds should be provided almost entirely by the IMF and other multilateral institutions. The Rubin-Greenspan letter of September 17 stated that although “it is important to increase substantially the resources available to the international community to respond to crises,” the money should come via the IMF rather than via bilateral loans. The IMF’s member countries, they noted, were already scheduled to approve an increase of about $90 billion in Fund quotas, which would substantially fatten the Fund’s war chest of hard currency. In addition, the Fund—whose rules made it awkward to provide Jumbo loans quickly to member countries—c
ould establish new procedures to make such loans easier to approve in emergencies. “This in turn should help reduce the likelihood that substantial bilateral resources would be necessary in future cases,” the Rubin-Greenspan letter said.

  But the Asians were not convinced that the IMF and other multilateral lending agencies had enough financial firepower without bilateral money to back them up. In a memo to high-level administration colleagues dated September 30, Geithner reported, “The original Japanese proposal to establish an Asian Monetary Fund faces significant resistance within the region, but there is still substantial support for establishing some type of financing mechanism for mobilizing bilateral resources in support of future IMF adjustment programs.” The approach outlined in the Rubin-Greenspan letter was “likely to prove insufficiently compelling to avoid some regional financing mechanism,” Geithner said. “Our best case outcome would probably be an ad hoc arrangement for mobilizing bilateral resources alongside IMF programs.”

  Accordingly, the United States agreed to a new strategy for dealing with the crisis that combined beefed-up IMF rescues and the promise of bilateral aid as a backstop, an approach that was adopted in November at a meeting in Manila of deputy finance ministers from Asia and the United States. The so-called Manila Framework ensured that the IMF would remain as the center of the official response to crises in the region, killing off Sakakibara’s AMF. It included an agreement to establish a new type of IMF loan facility, called the Supplemental Reserve Facility, that would provide larger amounts of money more rapidly than traditional Fund loans. Moreover, the IMF and other multilateral agencies like the World Bank would provide the bulk of the up-front money in a rescue, but bilateral loans would provide a “second line of defense” that could be tapped by a crisis-stricken country if the first line proved inadequate. Acknowledging defeat of the proposed AMF, Sakakibara said, “We were taught a valuable lesson on the influence the United States wields in Asia.”

  Just as the AMF fight was winding down, Sakakibara found himself on the defensive over a new, more serious bone of contention between Japan and the United States—the state of the Japanese economy. By the time of the Manila meeting, economic conditions in Japan were reaching a frightful low, prompting outcries that, as the country accounting for two-thirds of Asia’s GDP and the single largest source of its capital, Tokyo was doing its neighbors a terrible disservice at the worst possible time.

  The 1990s had made Sakakibara’s paeans to Japanese-style capitalism look more than a trifle overstated. The country’s banks were stuck with hundreds of billions of dollars in bad loans, thanks to a collapse in real estate prices in the early part of the decade that sharply reduced the value of the collateral many borrowers had put up. The Nikkei stock index, which had peaked close to 39,000 at the end of 1989, had fallen to well under half that level; this exacerbated the banking system’s troubles because Japanese banks, unlike banks in most industrialized countries, had bought stocks directly and used them as a major part of the capital cushions they maintained to protect against loan losses. (The practice of banks buying stocks was one of the features of the keiretsu system.) The anthropocentrism of the Japanese system was still working to a large degree—companies were taking all manner of measures to avoid mass layoffs—but now Japan’s economic strengths had become its weaknesses. Keiretsu ties between banks and their corporate clients, which kept the banks from foreclosing on many struggling debtors, meant that the economy was prevented from ridding itself of unhealthy firms and renewing its vigor by creating new ones.

  The economy, after staging a recovery in 1996, slumped anew following an April 1997 tax hike, and the Nikkei, which was trading above 20,000 in June, dipped to the 15,000 level in mid-November. Now the banks were in worse shape than ever, with their capital cushions evaporating and hopes fading that cash-strapped borrowers could repay their loans. The strains became more evident as the banks, once envied the world over for their financial might, found themselves unable to borrow dollars without paying anywhere from half a percent to four percentage points more than their healthy foreign competitors. Ominous cracks in the system materialized on November 17, when for the first time since the turmoil immediately following World War II, one of Japan’s nationwide banks, Hokkaido Takushoku Bank, went under, followed a week later by Yamaichi Securities, one of the “Big Four” Japanese brokerage firms. Prime Minister Ryutaro Hashimoto won a temporary reprieve from the relentless drumbeat of bad news by announcing a surprise income tax cut on December 17, declaring, “We can’t trigger a worldwide depression beginning in Japan.”

  To U.S. officials, the sickness of the Japanese economy—and its impact on Asia—made Sakakibara’s criticisms of the IMF all the more irritating. Notwithstanding his claims that the Fund’s policies were fanning the flames of the crisis, Japanese banks were the ones running for the exits in the greatest numbers.

  Despite the bitter fight over the AMF, Sakakibara ultimately Joined forces with the U.S. Treasury often during the Asian crisis. The United States and Japan held a like-minded view on one major issue—the desirability of providing large-scale packages of official money when rescues were needed. Within the G-7, that position was coming under harsh attack.

  Hans Tietmeyer’s beef with the IMF was different from that of Sachs, Stiglitz, and Sakakibara. Tietmeyer, president of the Bundesbank, Germany’s central bank, believed that by providing huge bailout packages, the Fund was violating the basic tenets of financial sobriety. Specifically, it was creating moral hazard by encouraging bankers, portfolio managers, and other members of the Electronic Herd to take excessive risks on the assumption that IMF rescues would protect them from the consequences of default.

  German central bankers are well-known for playing the Defender of the Faith role on such matters of financial rectitude, and Tietmeyer, who once studied for the Catholic priesthood, fit the stereotype neatly. A bald, big-boned man with thick white hair on his temples and piercing blue eyes, he had grown up in a small Westphalian village near the Dutch border that he once described as having “strongly influenced me with its Catholic church culture, mixed with a dose of Prussian discipline.” He was the second of eleven children, and his father was a relatively low-paid civil servant responsible for administering the town finances, so young Hans, who was thirteen when World War II ended in 1945, had to procure his own resources for getting an education. Starting in high school, and later as an economics student at the University of Cologne, he worked on a farm, at a factory, in construction, and even in a coal mine.

  Tietmeyer entered the Economics Ministry in 1962, working for Ludwig Erhard, the father of West Germany’s postwar miracle, whose reverence for stability in prices and currency values resonated deeply with a nation still seared by memories of the hyperinflation that preceded the rise of Nazism. When the Social Democratic government of Helmut Schmidt fell in 1982 and was replaced by Helmut Kohl’s right-of-center Christian Democrats, Tietmeyer, a conservative, became state secretary at the Finance Ministry, where he was Bonn’s chief international economic diplomat and its representative in the G-7 deputies. Then in 1989, he was named to a top post at the Bundesbank, the guardian of the almighty deutsche mark and the world’s standard-bearer for central bank independence, and he became its president in 1993. His refusal to sacrifice the mark’s stability, despite pressure from fellow Europeans for easier credit and faster growth in the continent’s dominant economy, helped enshrine his reputation for uprightness and constancy. “When he comments with raised finger on the evils of debt, inflation and sloppy currencies, the words ‘Thou shalt not’ hover, constant if unspoken,” the Economist magazine said.

  A similar aversion to quick fixes underlay his opposition to large bailouts and the moral hazard they engendered. “Although rescue operations of this kind may afford relief in the short run, for the future they involve the risk of a recurrence of unwelcome behavior on the part of market players,” he wrote in the Bundesbank’s 1997 annual report. His concerns were widely
shared within the German government and by other northern European nations, and critics elsewhere also echoed the argument, notably conservative analysts in the United States and Republican members of Congress. But as a powerful G-7 insider, Tietmeyer was the world’s most influential decrier of moral hazard.

  The principle of moral hazard is easiest to grasp in the case of insurance. People who insure their autos against the cost of collisions are likely to drive a bit more carelessly than they would otherwise, and people who insure their homes against fires are likely to be a bit less cautious about removing flammable material from their attics—because they know that even if something terrible happens, they will be reimbursed for their loss. The problem becomes particularly acute when an official agency is providing the guarantee. Government deposit insurance, for example, makes people less concerned than they would otherwise be about whether their money has been deposited in banks that are lending imprudently—and as a result, some banks make riskier loans than they should.

  As the crisis in Asia unfolded, Tietmeyer and his colleagues at the Bundesbank and the German Finance Ministry were still seething over what they regarded as an egregious case of moral hazard on an international scale—the 1995 bailout of Mexico. Part of the problem was that the rescue had come as a total surprise to them. The Clinton administration, anxious to halt a panicky flight from the peso, was losing a battle in Congress to provide Mexico with billions of dollars in loan guarantees, and on the night of January 30, 1995, with Mexican reserves nearly exhausted, the Treasury persuaded Camdessus and Fischer to announce a $17.8 billion IMF loan for Mexico the following morning, to supplement a $20 billion line of credit from the Treasury’s own special pool of lendable funds. The furious Germans and British, who had not been consulted even though the loan was more than three times the amount that any IMF borrower had ever received, sought to register abstentions on the vote in the Fund’s Executive Board after the board had okayed the loan—as strong a diplomatic signal of disapproval as they felt they could send without undermining the rescue.