The hoopla surrounding the proposal aroused European suspicion that one of its main motivating factors was to show the president taking command, and that suspicion was correct. The proposal was originally something the Treasury had been working on, based on an idea that had been bruited about for a while at the IMF, and White House aides had seized on it as an opportunity for Clinton to exercise U.S. leadership even though some Treasury officials harbored misgivings.
The proposal aimed to create a new type of IMF loan package, called a “Contingent Credit Line” (CCL). Its purpose, Clinton explained, was to “help countries ward off financial contagion” rather than wait until they were undergoing full-blown attacks on their currencies. Under the CCL, a country could “prequalify” for a loan from the IMF by running sound economic policies, so if a crisis erupted elsewhere, speculators would be deterred from attacking the country’s currency because of their knowledge that its government had access to a sizable line of credit.
Similar ideas had been rejected by the IMF in the past as likely to create more problems than they would solve. One main disadvantage is that if a country that has prequalified starts running bad economic policies, the IMF would be compelled to announce that the country no longer has access to the credit line—thus risking the very crisis the whole arrangement was supposed to prevent. Another drawback is that simply by signing up for a CCL, a country would risk sending a signal to the markets that it fears a speculative attack.
Despite such problems, Gene Sperling, the top White House aide on economic issues, decided the proposal was tailor-made for Clinton when he first heard about it from Treasury officials. He knew the president wanted to duplicate the success of his Council on Foreign Relations speech on September 14, which garnered much glowing feedback from fellow world leaders. Under pressure from the White House, the Treasury acquiesced to plans for Clinton to present the CCL as an American proposal. Although some in the department were unenthusiastic, “We felt it was a further useful tool for the IMF—not a cosmic redesign of the institution, but on balance, the right thing to do,” Summers said.
A bitter debate arose over the plan during the meeting of G-7 finance ministers and central bank governors on Saturday, October 3, 1998, at Blair House, across Lafayette Park from the White House. As might be expected, the Germans were the principal antagonists of the United States, because they saw the CCL as yet another Fund facility that risked creating moral hazard. Klaus Regling, Germany’s G-7 deputy, attacked the idea at some length, voicing skepticism whether any well-run country would want to make use of such a financing arrangement. Rubin acknowledged that he had heard a similar objection from Camdessus. But the U.S. Treasury chief would not be denied, suggesting that the meeting would continue all evening until the issue was resolved. (“He said something about bringing in dinner if we have to, or maybe it was sleeping bags,” one participant recalled.) In the end, the G-7 agreed to state that it would “explore” the CCL.
The divisions healed to some extent when Greenspan delivered an extraordinarily downbeat appraisal of the economic outlook. The Fed chief told the G-7 that in almost fifty years of watching the U.S. economy, he had never witnessed anything like the drying up of markets in the previous few days and weeks. He would use similar words in public several days later, but at the time, they sobered his elite audience. The Europeans, though convinced that the overall U.S. approach was influenced by politics, respected and trusted Greenspan without reservation. “He usually doesn’t talk a lot in the G-7, but he was worried, and we were impressed,” said Jean Lemierre, who was the French G-7 deputy. Regling, too, said: “I had never heard Greenspan so alarmist like that.”
U.S.-European tensions surfaced again, however, in a meeting on Monday, October 5 of a new group called the G-22, which brought together finance ministers and central bankers from a number of industrialized countries and emerging markets to consider ways of averting and containing future crises. The first problem was that Clinton decided to chair the group’s meeting personally—and then failed to show up on time. After enduring security checks to enter the hotel, the senior economic policymakers of about two dozen countries—including Britain, Germany, Japan, France, South Korea, Mexico, Argentina, and Singapore—cooled their heels for an hour and a half waiting for the president’s arrival. An announcement of Clinton’s appearance finally came—in the form of a request asking the attendees to stand, as a military band blared “Hail to the Chief.” With eyes rolling, the ministers and central bankers shuffled to their feet, wondering why they were being subjected to such ceremonial fanfare at what was supposed to be a working meeting.
Much of the meeting went smoothly, from the U.S. perspective, with ministers from several emerging-market nations asserting that the crisis had proved the importance of exercising prudent policies such as avoiding excessive short-term borrowing. Clinton, despite his tardiness, wowed the group with his focus and mastery of the subject; even the Europeans had to admit he showed no signs of being under political siege.
But then Hans Tietmeyer took the floor. The Bundesbank president objected to Clinton’s characterization of how serious the crisis was. Sure, Tietmeyer said, the turmoil in the markets had created difficulties in some parts of the world, such as Russia, Asia, and Latin America, but the world as a whole was not in the same situation. Europe, a very large part of the global economy, was relatively quiet, the central banker observed, and it was enjoying solid economic growth as it moved into the euro era. Talk of global recession should not be exaggerated, because it would send the wrong signal to the markets and only exacerbate financial strains, he said. Responding to Tietmeyer, Clinton said he hoped the group could at least agree that the crisis was serious.
This and other conflicts at the IMF-World Bank meeting were symptomatic of a mounting frustration within the High Command, especially among the Europeans, over the heaping quantities of official money that had been deployed in international rescues and the extent to which that money had flowed out of the very countries it was supposed to help. Already, battle lines were forming over plans for one more megabailout.
12
STUMBLING OUT
On this much, there was consensus: Contagion had to be stopped at Brazil.
For months, the High Command had watched Latin America uneasily for signs of the same symptoms that first surfaced in Asia, and now the country that accounted for nearly 45 percent of the region’s output was undoubtedly contracting a case of what economist Paul Krugman had dubbed “bahtulism.” Despite Brazil’s many differences with Russia—Brazilian banks were reasonably healthy, the country’s industries were vibrant, its government was capable of collecting taxes—the similarities were too striking for the Electronic Herd to ignore. Brazil’s $65 billion budget deficit was equal to about 8 percent of its GDP, and the government had issued a large amount of short-term bonds to cover the shortfall between revenue and expenses. Furthermore, like the ruble had been, the Brazilian real was subject to a “crawling peg,” in which the central bank of Brazil allowed the currency’s value to slide only modestly each year against the U.S. dollar. The system obliged the central bank to dole out dollars when people demanded them in exchange for reais—and in the weeks following the Russian default, demand for dollars was shooting through the roof.
During August and September 1998, the country’s reserves of hard currency had dropped from $75 billion to about $45 billion as financial institutions and other investors cashed in their reais for dollars; prominent among these nervous Nellies were a number of foreign banks that were paring their interbank lines in a manner that resonated of the Korean episode. The São Paulo stock exchange, a favorite of emerging-market investors in 1997, was taking stomach-churning dips of up to 16 percent a day during September 1998.
Having seen what the Russian collapse had wrought, the High Command was petrified of a similar outcome in Brazil, the world’s eighth-largest economy with a GDP of $800 billion. Much of the press commentary at the time sugges
ted that the main worry was the potentially adverse effect on U.S. bank loans and corporate foreign investment in Brazil. But what really kept policymakers like Bob Rubin and Stan Fischer awake nights was a scenario in which a Brazilian bust engendered a multiple-ricochet effect around the globe, ultimately bringing down the biggest industrial economies.
Under this scenario, the most direct impact would fall on Argentina, which depended on the Brazilian market for about one-third of its exports, and a slump in Argentina would force the government in Buenos Aires to expand the money supply and abandon its currency board. That in turn would prompt speculators to test the world’s other prominent currency board, Hong Kong’s, and once the Hong Kong dollar fell victim, Asia would undergo a whole new cycle of devaluations Just as it was starting to climb out of its hole. With the world’s most promising export markets flattened, and Western financial institutions debilitated by losses, recession would set in virtually everywhere. “The discussions about Brazil were based on the idea that it was probably the last case before the collapse of the system,” said Jean Lemierre, France’s G-7 deputy at the time. “Strong military words were used—‘last line of defense,’ that kind of thing. The feeling was that if we and the IMF are unable to save Brazil, it’s the end of the story.”
But how to save Brazil? On that question, the High Command was all over the map. The outcome would show more starkly than ever the extent of U.S. dominance over the G-7.
Around 11 P.M. on October 5, 1998—the same night as the meeting at which Tietmeyer tangled with Clinton—another contentious gathering of high-level officials got under way at a hotel a few blocks away. The Europeans were on the warpath, the target of their ire being the IMF and the U.S. Treasury, which they perceived as working hand-in-glove on an ill-conceived bailout for Brazil. Much of the heat was aimed at Teresa Ter-Minassian, deputy director of the Western Hemisphere Department of the IMF, who did most of the talking at the meeting in her capacity as the Fund economist with principal responsibility for Brazil and Argentina. An Italian, born and raised in Rome (the Armenian surname is her husband’s), with a Ph.D. in economics from Harvard, Ter-Minassian was one of the highestranking women on the IMF staff. Her career at the Fund, which spanned more than twenty-five years, included the distinction of having led the team that negotiated the last program for a Western industrial country, Portugal, in 1983 and 1984.
Ter-Minassian made the case that an international loan package in the tens of billions of dollars could give Brazil a “breathing space” and a “safety net” that would enable the government to achieve one of its most critical goals—maintaining the fixed exchange rate for the real, which helped keep inflation in check. The government, led by President Fernando Henrique Cardoso, was determined at all costs to avoid a devaluation, and Ter-Minassian outlined a plan for the IMF to support the government’s strategy, a key component of which was a strong and sustained effort to shrink the budget deficit. Cardoso, who had Just won reelection, was showing every sign of getting tough on the deficit, Ter-Minassian noted. The president had made a nationally televised speech during his campaign warning the electorate in unusually blunt terms of his intention to take painful fiscal measures if he was reelected. Now that the election was over, Cardoso would have to persuade the nation’s notoriously balky Congress to raise taxes and cut government benefits. But for Brazil to survive its battering in the markets, investors also needed to see that the international community had faith in the government’s policies and that the country had plenty of hard currency to meet its obligations, Ter-Minassian contended.
European officials, including Germany’s Klaus Regling and Jürgen Stark and the Bank of England’s deputy governor, Mervyn King, voiced deep skepticism that Brazil could avoid devaluing the real, even with a sizable loan package. At the exchange rate of 1.2 reais to the dollar, the real was seriously overvalued, they believed; it was making Brazilian goods uncompetitive on world markets, the result being that the country’s exports were falling well short of its imports, with the current account deficit ballooning to over $30 billion, or 4 percent of GDP. The Europeans cited articles by Rudiger Dornbusch, an MIT economist credited with predicting the Mexican peso crisis in 1994, who had been arguing for months that the real was overvalued by roughly 25-35 percent. Canadian and Japanese policymakers supported the European view.
Ter-Minassian’s European tormentors weren’t swayed by her arguments that by certain measures, Brazilian competitiveness was improving. And they were indignant over the attitude of the IMF and the U.S. Treasury that the Brazilians should get a Fund-led rescue even without accepting the need for a devaluation. As far as the Europeans were concerned, it looked as if the IMF’s money—and the European taxpayers’ money that would be included in a rescue—would simply provide the means for members of the Herd to pull their money out of the country before the real crashed. “We left that meeting deeply dissatisfied,” one European official recalled.
Behind this dispute lay a series of events involving some bad advice the Fund had offered Brazil a few years earlier—which the Brazilians had rejected.
The old saw about Brazil, a country of 165 million people richly endowed with natural resources, is that it’s “the country of the future ... and always will be.” One reason the country’s vast potential has proved so evanescent is its propensity for hyperinflation, a problem so ingrained that for years the government had indexed wages in an effort to adjust them to prices—the result, of course, being worse inflation.
In early 1994, the Brazilian economy was undergoing the latest in a series of hyperinflationary outbreaks, with prices rising at close to 30 percent a month, or 2,700 percent a year. So rapid were the changes that, under the indexation system, many products were priced in terms of “UVRs” (real units of value); if you went into a hardware store, for example, you might see a hammer being sold for 30 UVRs, and the amount of money you paid for it was some multiple of the 30 UVRs times a conversion figure that reflected the increase in inflation over the past couple of days.
The government had tried a variety of highly touted anti-inflation initiatives over the years to attack the problem, but nothing had worked in restoring a semblance of economic stability for more than a few months at a time. Cardoso, who was then finance minister, and the central bank governor, Pedro Malan, were determined to put an end to the scourge. They conceived the Plano Real, which would replace the old currency with the real and make it equal to the UVR. Inflation ultimately results from too much money chasing too few goods, so shortly after the plan’s introduction, Cardoso and Malan also imposed a special form of discipline over money creation. The discipline involved using the exchange rate as an “anchor”; that is, the central bank would be required to keep the real’s market value closely linked to the dollar, thereby limiting its ability to increase the amount of reais circulating in the economy.
In private discussions with the Brazilians, the IMF pooh-poohed the Plano Real as too impractical and gimmicky. The Fund’s advice was analogous to that of a diet doctor telling an obese patient, “Forget about wiring your Jaws shut. Just stick to eating carrot sticks and cabbage soup.” IMF staffers would later recall the episode with chagrin, for the plan, which Cardoso and Malan launched anyway in March 1994, worked better than its architects had dared to dream. Monthly inflation dropped to the single digits by the end of the year; by 1996, the annual rate was 9.6 percent. Cardoso, a sociologist who had moved from the left wing to the political center, won the presidency in 1994 based in part on his anti-inflation credentials, and he named Malan his finance minister. As Brazil at long last seemed to be conquering its demons of instability, the country’s fortunes glowed with promise. Foreign money poured in, not Just short-term but long-term as well, including European and American multinationals eager to set up factories and stake their claims. In a sign of the country’s burgeoning middle-class market, McDonald’s announced in autumn 1996 that it would invest $500 million to increase its Brazilian outlets from 200
to 530. Most gratifying, living standards of the poorest Brazilians improved as workers’ paychecks finally started keeping up with prices in a meaningful way. The number of households with color televisions and freezers soared.
No one championed the Plano Real more ardently than Malan, a pipe-smoking former professor with sternly handsome features and swept-back hair. Born in 1943 near Rio de Janeiro, the son of a general, Malan earned a Ph.D. in economics from the University of California at Berkeley, writing a thesis attacking the protectionism that favored well-connected Brazilian industrialists. He taught at the Catholic University of Rio de Janeiro and returned to the United States in the mid-1980s as his country’s representative on the World Bank’s board and also as its chief debt negotiator with commercial banks. But he gave up the cushy life of a World Bank executive director to return to Brasília at Cardoso’s behest, and as finance minister he gained a reputation as a serious, dogged practitioner of the orthodox economic principles in which he was schooled. When Brazilian markets came under speculative pressure during the Mexican peso crisis of 1994-1995, he fought off government colleagues who favored lowering interest rates and allowing the real to fall, arguing that to do so would ensure the return of inflation. He got Cardoso’s backing, and Brazil stayed the course—the result being even further declines in inflation, to a mere 3 percent in 1998.
But the longer the Plano Real remained operative, the stronger and more overvalued the Brazilian currency became. By mid-1998, the only question in most analysts’ minds was whether the real was 30 percent overvalued, as Dornbusch, Sachs, and others estimated, or maybe only half that much, as senior IMF economists including Stan Fischer believed.
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