In an Uncertain World

by Robert Rubin

  In combination with President Kim’s public commitment to economic and financial sector reform and the international community’s financial support, our coordinated effort showed signs of having the desired effect. South Korea’s currency and stock markets soon stabilized, although they did not rise appreciably for some time. Contagion seemed to abate and our fears about the global financial system eased for the moment. In the end, the banks did not suffer from their participation. They were paid back in full and ended up receiving a higher rate of interest in the interim. And in the end we did not disburse any U.S. funds. Treasury’s discussions on the loan agreement with South Korea—initially quite heated—petered out after a few months. The money turned out not to be needed.

  That wasn’t the end of the South Korean stage of the crisis. At several points in 1998, there were dicey moments when we feared that the plan wasn’t working, or when political developments elsewhere threatened to plunge the country back into economic gloom. But basically, the South Korean economy was on the mend. And what had mattered most wasn’t anything the IMF or U.S. Treasury had done but South Korea’s own response. President Kim Dae-jung and his colleagues, the heroes of the South Korean recovery in my view, showed how sound, courageous political leaders can make a great difference—in fact, the key difference—in overcoming economic duress.

  CHAPTER NINE

  A Crisis Considered

  WHEN THE ASIAN FINANCIAL crisis swept through a country, it often changed not just the economy but the political landscape as well. By early 1998, new governments were in place in Thailand and South Korea, and their commitment to economic reform was essential to calming financial markets. But in Indonesia, the prospect of political change only threatened to make financial difficulties worse. For me, Indonesia’s escalating crisis highlighted how difficult overcoming financial turmoil can be when political, economic, and foreign policy concerns are interwoven.

  Indonesia, the fourth most populous nation in the world, was a key strategic U.S. ally in Southeast Asia. It had been under military rule for more than thirty years, dominated by one man, seventy-six-year-old President Suharto (who, like many Indonesians, has no other name). Suharto’s autocratic regime had delivered both stability and a dramatic rise in living standards to what had been a largely rural and very poor country when he took control in 1965. A mix of economic openness and tight political control had allowed the economy to develop rapidly. Domestic and foreign-owned businesses flourished, while ethnic tensions were kept at bay. Ethnic Chinese entrepreneurs, who had suffered persecution in the past, prospered in relative safety, while Indonesians mainly of Javanese descent controlled the military and the powerful state sector. Foreign investment was encouraged, foreign banks poured money into Indonesian companies, and jobs were plentiful.

  But as financial turmoil moved across the region, the pervasive corruption and crony capitalism that helped to shore up Suharto’s support came under closer scrutiny. Political and family connections were all-important in business. Indonesia’s legal system was corrupt and slow-moving. Public money was siphoned from the budget for projects that enriched family and friends. Officially sanctioned monopolies in plywood, cars, and cloves—used in cigarettes and a mainstay of Indonesia’s economy—channeled money into corrupt hands. Foreign investors and creditors who were now fleeing the country called for fundamental reform to put the economy on a sounder footing. But the reforms they wanted risked undermining a regime already under pressure from the spreading economic chaos.

  Unlike Thailand and South Korea, Indonesia had no early prospect of a democratic shift of power. As Suharto’s government wrestled with the worsening economy, the danger that the society could explode into violence made the task of recovery vastly more difficult. The confidence of domestic businessmen and savers, many of whom were ethnic Chinese, was closely bound up with Suharto’s survival. They—and we—were afraid of a replay of the civil unrest that had marked the previous change in power in 1965, when half a million people, including many Chinese, had been murdered. Domestic capital was now also flooding out of the country, from local entrepreneurs who feared a change in the regime that had served their economic and political interests.

  This made reestablishing market confidence particularly difficult, because reforms that would reassure foreign investors might alarm domestic investors. Certain Indonesian officials themselves had identified a wide array of reforms to combat corruption, from restructuring banks to curbing key monopolies and opening up the government’s books to scrutiny. Foreign confidence now hinged to a significant degree on these reforms being implemented. But such reforms could further weaken Suharto and thereby worsen domestic capital flight.

  There was no easy way to deal with the inherent political and economic conflicts, and the handling of the Indonesian situation sparked widespread criticism of Treasury and of the IMF, including from Capitol Hill. We at Treasury and officials at the Fund may well have underestimated how damaging certain reforms would be to Suharto and how destabilizing the growing threat of his departure was in itself. But these issues were on investors’ and creditors’ minds and couldn’t be ignored. Whether triggered by foreign or local money leaving the country, the escalating crisis threatened an economic unraveling that could quickly spiral as investors became frightened.

  An initial IMF program for Indonesia in the fall of 1997 underscored this problem. In that episode, Suharto’s government had failed to follow through on commitments that hit at entrenched interests close to the President. Though the government closed some debt-ridden banks, doing so only helped to create a run on the others left open—including banks that were also insolvent but politically connected, and that were, in some cases, owned by Suharto’s friends and family. Many people believed that the IMF should have foreseen this. To show how complicated crisis response is, many criticized the IMF for pressing for bank closures at all (at least without putting into place full deposit insurance to reassure depositors at those banks left open), while others thought that the IMF should have insisted on closing more banks. One case in particular was highly publicized and became a symbol of the concerns about whether Suharto would ever truly reform. A bank owned by Suharto’s son Bambang was closed but reopened three weeks later under a different name. News reports described workers pulling up to Bambang’s skyscraper in downtown Jakarta, pulling down a blue Bank Andromeda sign in the lobby, and putting up a blue Bank Alfa sign in its place.

  At the same time, rather than keeping monetary policy tight, Indonesia’s central bank supplied whatever loans were needed to prop up those banks facing massive withdrawals. The rupiah plunged and inflation soared. We had significant evidence by now that adhering to a tight monetary policy, even if this meant sharply higher interest rates, was an essential element in stopping a financial market panic. But that would mean cutting off government credit to failing banks and companies, many of which had close ties to Suharto.

  As it became clear in early 1998 that the first IMF program had failed and the crisis was deepening, we at Treasury felt keenly the need to understand Indonesia’s political situation better. In addition to internal discussions with the foreign policy experts in the administration, we reached out to others. Larry and I both knew Henry Kissinger, and he paid a quiet visit to us at Treasury. In addition, Paul Wolfowitz, former U.S. ambassador to Indonesia and later number two at the Pentagon in the second Bush administration, also came to Treasury for a lengthy discussion. And Larry and I both spoke to Lee Kuan Yew, the strongman who had built Singapore. Lee is deeply knowledgeable about geopolitical and cultural matters and had done much thinking about Southeast Asia from a realpolitik point of view. Although he had earlier been supportive of Suharto, he had become doubtful that Suharto would take needed steps on the economy. As a consequence, Lee was highly pessimistic about Indonesia’s future. He worried that ethnic conflict and political unrest generated by Indonesia’s sinking economy could have a spillover effect, leading to clashes between ethnic Chine
se and non-Chinese elsewhere in the region.

  We made a series of attempts to get through to Suharto about the need to take ownership of reform, including a phone call from President Clinton on January 8. The response from Suharto, who felt that he had run his economy successfully for a quarter century, was not promising. When Clinton encouraged him to continue dealing with the IMF, Suharto blamed foreign “speculators” for driving down his country’s currency. When Clinton pressed Suharto on corruption and mentioned specifically the reopening of his son’s bank, the Indonesian leader buried him in legal technicalities. This mighty autocrat said he had no power in the matter—it was all up to the courts.

  Our next move was to send Larry to Jakarta to meet with Suharto in person. The two of them sat down in the presidential palace for an hourlong session, but Larry, who was seldom reticent, hardly got a word in. As he described it to me, he got only one turn at bat, while Suharto played nine innings. Next to arrive in Jakarta was Michel Camdessus, who succeeded in securing Suharto’s signature on a second, strengthened IMF program on January 15, 1998. There’s a notorious photograph of Camdessus standing with his arms folded, looking over Suharto’s shoulder as Suharto signs the document, an image that seemed to many critics to typify the heavy hand of IMF conditionality.

  Ironically, we saw in the coming days how much countries themselves determine their own fate and how little the IMF or anyone else can do in the absence of a genuine commitment to reform. Suharto had agreed to stringent conditions on a broad array of issues—from the government clove monopoly to aircraft manufacturing. He also promised to keep tight control of monetary policy. I was skeptical about whether this program would work any better than the first. Suharto hadn’t done anything to suggest that his basic attitude toward reform had changed. But the situation was sufficiently worrisome that even an uncertain IMF program—designed, as was usual, so that the government wouldn’t be able to draw down much of the money if Suharto didn’t follow through on reforms—seemed better than none.

  This program was hugely controversial. Some outside critics thought the West was simply taking the opportunity to force our own free-market policy preferences on Indonesia via IMF conditionality, and ignoring the government’s views about what would be best. Others argued that in focusing on confidence in this way, the IMF and we at Treasury were following the whims of the financial markets—which might be irrelevant or even counterproductive—rather than focusing on fundamental problems. If the markets wanted Indonesians to wear blue shirts, would blue shirts become essential to the restoration of confidence?

  My view was that by and large the markets tend to shine a spotlight on real economic problems, although they may exaggerate the importance of those problems at times (as well as ignoring them at other times). In a situation like Indonesia’s, foreign investors and creditors might become preoccupied with a symbol, such as the ending of a specific monopoly or the removal of a single corrupt official. But those symbols weren’t just blue shirts; in most cases they related to significant underlying issues: monopolies, corruption, mismanagement, and weak financial systems.

  In Indonesia, many of the changes that the IMF pushed were outside its usual realm of expertise on exchange rates, interest rates, and government finances. And in hindsight, many people involved agree that there were too many conditions spread across too many different areas. Expecting the government to fix so many problems at once just wasn’t realistic and probably blurred focus on the most urgent ones. The most controversial structural measures, however, were not dreamed up by the IMF, the U.S. Treasury, or other outsiders. The IMF had often been criticized for following a “cookie cutter” approach that ignored the distinctive features of different countries. In this case, the Fund’s policy conditions were informed by the views of a number of Indonesian officials, such as the respected economist Widjoyo Nitisastro, whom Suharto had put in charge of negotiations, as well as by the World Bank.

  But as happened with the first program, financial markets seemed to have no faith that Suharto would do what he said. At the same time, spreading violence and fears of a political breakdown worsened capital flight. Many merchants closed their businesses and factories and fled. The rupiah dropped from 7,300/dollar the day before the announcement to 15,450 on January 23. Indonesia stood on the brink of hyperinflation.

  Rather than implement reforms, Suharto continued to look for another way out. One idea he turned to was a “currency board,” a mechanism to stop the fall of the Indonesian rupiah by tying it to the U.S. dollar and putting Indonesia’s monetary policy on autopilot. But this kind of regime is difficult to maintain even for countries with the economic requisites: ample foreign currency reserves, a real commitment to sound monetary and fiscal policies, and a strong banking system, which is needed because the central bank would no longer be able to provide finance to prop up ailing banks. We feared that trying to fix the exchange rate in this way might merely be an opportunity for Suharto’s cronies to get their money out of the country before the arrangement collapsed and the rupiah fell still further.

  Eventually, the IMF persuaded Suharto to drop the idea. But that got us no closer to solving the problem, which was how to structure something Suharto would credibly agree to that would also reassure international markets and persuade Indonesians to keep their money at home. In wrestling with these issues, Treasury worked closely with other countries that had a huge stake in the region, such as Australia, Japan, and Germany, which had particularly close ties to Indonesia.

  The immense difficulty of dealing with Suharto—who reportedly promised his cabinet that he would fight a “guerrilla war” against his own economic program—was brought home to us in February, when he formally nominated B. J. Habibie as Vice President. A loyal crony with little independent standing, Habibie now looked like the obvious successor should the President leave. Some saw the move as a way to show critics that Suharto’s ouster would only make things worse. Jim Steinberg of the NSC said in one of our meetings that perhaps we should be reaching out to the reform forces in Indonesia, so that if Suharto did fall, they wouldn’t feel we’d been their opponents. The argument on the other side was that doing so could hurt our relations and effectiveness with Suharto and might destabilize the situation even further if it became known.

  I remember sitting in Erskine Bowles’s office one day in early February and saying, “We’ve got to find some way to get our message across to this guy.” We needed someone Suharto would take seriously. Out of that discussion, we decided to ask Walter Mondale to go to Indonesia. The question of what Mondale would say to Suharto showed yet again the difficulty of balancing financial market and other concerns. Our view at Treasury was that Mondale should be as direct as possible with Suharto and tell him his government didn’t have much of a future if it didn’t become serious about economic reform. The State Department worried about the danger of appearing to withdraw our support from a crucial ally. Suharto was seen as the only glue holding a fragile country together; Indonesia falling again into chaos or civil war was a real danger. The foreign policy team also felt that we risked turning Suharto hostile to the United States by insisting he meet strong conditions. This is the kind of complexity that arises in dealing with the wide range of issues relating to crisis response. Persuading countries to adopt good policies and improve governance is a vast challenge in itself. But when doing so touches foreign policy and national security goals, that difficulty greatly increases.

  We negotiated vigorously over Mondale’s script. On the one hand, we had to respect Suharto’s sensitivities, but on the other, the IMF program wasn’t going to work unless his policies changed. David Lipton, our liaison with the foreign policy team on the Mondale trip, worked on the plane on the economic message before Mondale himself took it over, impressing David with his adroit way of getting the sensitive points across. Essentially, Mondale told Suharto that Clinton was not attempting to displace him, but was just trying to help his country do well. If he adopted sen
sible reforms, he would find us to be extremely supportive. Beyond the touchy structural issues, Mondale stressed that the solution to the crisis required Suharto’s commitment to fighting inflation and restoring financial stability, as he had done when he had become President thirty years earlier. But Mondale felt that he was no more successful than the President and Larry had been at getting Suharto to change his attitude on the fundamental issues of corruption and transparency.

  Shortly afterward, Suharto appointed a “crony cabinet,” which included his daughter and various other friends who had accumulated great fortunes with his assistance. To many, this was just one more reason to doubt Suharto’s commitment to reform. Others felt that he chose this group of trusted allies to make one last stab at stabilizing the economy. And in fact the government did begin to get serious about monetary control, markets began to recover, and the IMF and World Bank structured new programs around this effort. Multilateral pressure had been critical in getting Indonesia to pay attention to the message about monetary control to stop the dangerous spiral of a weakening exchange rate and accelerating inflation. In this case, Japan and Germany—the second- and third-largest economies in the world—also weighed in with us directly. A high-level team was sent from our three countries to work with the Indonesians, including Ginandjar Kartasasmita, now the coordinating minister for economics and finance, whom I called ahead of time to ask him to receive the team.