by Robert Rubin
In the succeeding weeks, however, the political situation became more precarious and riots spread throughout the country. Scenes of violence on the news each evening were another reminder of the human toll involved in these crises. There were acrimonious discussions between Indonesia and the IMF about what Indonesia had to do to qualify for each disbursement of the loan. One battle concerned fuel prices, which had a costly subsidy that was politically highly sensitive. In May, Suharto raised fuel prices dramatically, which led to violent protests that left several hundred people dead. There remains a question as to whether Suharto had to act so drastically, raising prices all at once, to meet the IMF conditions. An IMF study by an internal review board released in July 2003, though critical of the IMF program in other respects, reviewed internal documents and stated that the decision to accelerate the fuel price increase was Suharto’s.
As the fuel crisis spiraled out of control, the Indonesian Parliament demanded Suharto’s resignation. Suharto asked the Indonesian people “for forgiveness” for his mistakes and shortcomings and, on May 21, 1998, handed off his presidency to Vice President Habibie.
The IMF’s efforts in Indonesia were widely viewed as a failure. However you apportion the blame, whether it was more Indonesia’s fault or that of the IMF working with the U.S. Treasury and others, one central issue is that Indonesia never took ownership of reform. The economy did not begin to recover quickly, as had happened in Thailand and Korea. The severe hardships caused by the crisis continued, with high unemployment and increased poverty. Political and financial uncertainty held back growth and investment, companies remained mired in debt, and the corrupt, slow-moving legal system slowed efforts to rebuild the banks and renegotiate foreign debts. But that is only a part of the story. At the height of the crisis, Indonesia faced a real risk of hyperinflation, economic chaos, and, possibly, a bloody civil war. Instead, the government continued to work on financial stability and on overcoming inflationary pressures. The exchange rate that had depreciated as low as 16,000 in June 1998 steadily strengthened and was around 8,500 in mid-2003. And Indonesia has now had two democratic elections, with peaceful transfers of power, while over the four years from 1998 to 2002 the economy recorded 13.4 percent growth. The international community’s efforts did not accomplish what any of us had hoped, but, by catalyzing some stabilizing policy actions and stemming possible collapse at critical moments, they did help to prevent the dire circumstances that many people had feared.
AS EVENTS UNFOLDED, I became more and more convinced that we were facing not just a serious regional problem but one with dangerous global dimensions. The immediate challenge was to deal with whatever country was in trouble and to try to prevent the contagion from spreading. But by early 1998, we were also giving more thought to the related questions of what was causing the crisis, how best to prevent similar events in the future, and how to improve our crisis response.
I think my overall approach to dealing with the unfolding crisis was well characterized by a list of principles that Tim Geithner and two of his colleagues in the international section of the Treasury, Stephanie Flanders and Brad Setser, assembled and presented to me in a framed copy when I retired as Secretary under the half-serious rubric of “The Rubin Doctrine of International Finance.” I had brought some of these principles with me to Treasury. Others developed out of dealing with Mexico and Asia and the other international policy issues faced by Treasury.
1. The only certainty in life is that nothing is ever certain.
2. Markets are good, but they are not the solution to all problems.
3. The credibility and the quality of a nation’s policies matter more for its prospects than anything the United States, the G-7, or the international financial institutions can do.
4. Money is no substitute for strong policy, but there are times when it is more costly to provide too little money than to provide too much.
5. Borrowers must bear the consequences of the debts they incur—and creditors of the lending they provide.
6. The United States must be willing to be defined by what it is against, as well as what it is for.
7. The dollar is too important to be used as an instrument of trade policy.
8. Optionality is good in itself.
9. Never let your rhetoric commit you to something you cannot deliver.
10. Gimmicks are no substitute for serious analysis and care in decision making.
Today, I would add a number 11: The self-interest of the United States requires us to engage and work closely with other nations on issues of the global economy. But while these principles provided a general framework for our response to the crisis, they don’t offer a view of what caused it or specific answers to critics of our approach.
Perhaps unsurprisingly, criticism of the IMF and the United States became much sharper as the financial contagion spread—apparently unstoppably—around the world in late 1997 and 1998, creating severe economic hardship for many people. Some of the most vocal critics rejected outright the premise that underlay our thinking—that globalization and open markets were on balance greatly beneficial, both to the United States and to the rest of the world, and that what was needed was to make them work better. Some saw what was happening in Asia as a crisis of global capitalism, which they disliked and believed was harmful to poor people. Others objected to any help for other nations as long as there were unmet needs at home and believed that open markets were detrimental to American workers. These perspectives echoed through the rhetoric of much of the antiglobalization movement that first attracted worldwide attention with the protests at the meeting, or attempted meeting, of the World Trade Organization in Seattle in 1999.
But the vast majority of those who took issue with us on some aspect of policy or another shared our broad view in favor of globalization and saw market-based economics and economic integration as the most promising approach to raising living standards around the world. Their criticism can be broken into three broad strands. Of course, brief analysis can’t do justice to all the nuances and overlapping views in what became an intense international debate. And I would not claim to be giving a complete account of the views even of those critics that I cite, but rather a description of how the debate played out.
The first set of critiques revolved around the idea that the West, especially the IMF and the U.S. Treasury, had contributed to causing the financial instability. The second strand was that we were mishandling the crisis in various ways. The third was that we were failing to take steps to prevent such problems in the future or, worse, that our actions were actually making future crises more likely.
Some who said the West was to blame for the crisis attributed the whole problem to First World “speculators.” Mahathir Mohamad, the Prime Minister of Malaysia, was the most prominent proponent of this view. Mahathir is a capitalist who wouldn’t have much in common with the protesters outside McDonald’s. But he argued that speculators had created the Asian crisis for the purpose of exploiting the developing world and buying its assets cheaply. At the IMF annual meeting in Hong Kong in September 1997, Mahathir called currency trading “immoral,” having previously singled out currency trader George Soros as part of a Wall Street conspiracy to bet against Malaysia’s currency and then drive it down to make the bets come good. Although Mahathir’s denunciation was extreme, many others felt that financial market players had deliberately disrupted currencies and economies for their own gain.
Another set of objections in this first category came from people who were largely advocates of a market-based system but who saw danger in unleashing market forces too rapidly. They argued that the United States had helped to create the problems in Asia by pushing countries to open up their economies to global flows of trade, and especially capital, before those markets were ready. Richer, more developed economies could better absorb large inflows of capital and withstand big shifts in capital flows and exchange rates as market sentiment changed. In less developed nations with weaker
financial institutions and without well-established safety nets for those hurt by economic change, these flows were more likely to be used poorly and the swings from inflows to outflows proved devastating.
Many who blamed the West for causing the crisis also agreed with the second broad strand of criticism, that the response of the international community—the IMF, the United States and other governments, the World Bank, and so on—had worsened the problems in Asia. In the view of some, Asian countries that had careened from rapid growth to negative growth hadn’t done much wrong in either their macroeconomic or structural policies, and the IMF calls for higher interest rates and budget cuts had only exacerbated their problems. One vocal critic who took this view, despite his position as the chief economist at the World Bank, was Joseph Stiglitz. In addition to attacking the IMF’s macroeconomic prescription, he said that the IMF shouldn’t be getting involved in structural economic issues, which were irrelevant to the crisis and none of its business. More broadly, he charged that the IMF’s approach in developing countries was sometimes reminiscent of colonialism.
Some other academic economists also took issue with aspects of the international community’s response to crisis. Paul Krugman, then at MIT, and Jeffrey Sachs, then at Harvard, argued that South Korea and other countries were facing liquidity difficulties rather than deep-rooted problems. Far from helping to calm the crisis, the IMF-supported policy reforms risked making it worse by scaring investors more and setting back economic growth. With markets in a self-fulfilling panic, the response should focus on providing liquidity, aided perhaps, Krugman argued, by temporary controls on capital outflows. In a widely read article, Harvard’s Martin Feldstein targeted for criticism the structural conditionality in the Asia programs.
Finally, there was a third category of critiques that called for sweeping changes to the global economic system to help avoid crises in the future. Some conservatives wanted an end to large-scale lending by the IMF, or even in some cases an end to the IMF itself. They emphasized the dangers of moral hazard and argued that insulating investors and creditors from their losses sowed the seeds of future crises. In the view of these critics, the United States had helped set the stage for the crisis in Asia by “bailing out” investors in Mexico. They argued that our actions in Asia were likely to create a cycle of overlending and retreat elsewhere. In the future, the United States should let mismanaged emerging-market economies fail, in order to teach both creditors and borrowers a lesson. Others in this camp took precisely the opposite approach, suggesting grand new institutions from a new world regulator to an international lender of last resort.
While many of these criticisms raised real and valid issues, none of them seemed to provide a realistic alternative approach to dealing with the spreading financial crisis or to reforming the international system of financial markets. The immediate imperative was to overcome the crises in the various countries. In our view that needed to be done in the context of market-based economics and globalization, which had served developing countries well, and meant reestablishing the confidence of domestic and foreign creditors and investors. To me, no simple, single solution was responsive to what was a very complex set of issues. As time went on, the international community’s approach to the immediate crises evolved in reaction to changing circumstances—both the contagion that increased the danger and the experience from earlier cases.
What caused the crisis? Development economists have grappled for decades with the question of why some developing countries have done better than others. But now, in 1997 and 1998, the question was why even some of the apparently most successful were having severe difficulties. In general, the Asian and Latin American countries that were the brightest success stories had embraced political and economic change of various kinds, seeking to export and opening up in varying degrees to foreign trade and investment, privatizing state-run industries in some cases, reducing regulation and injecting market forces—again, in varying degrees—and constructing legal frameworks for financial markets.
In certain respects, however, the Asian “miracle” economies remained less than free markets, afflicted by too-close relationships between banks and corporate borrowers and various kinds of self-dealing and protectionism. In some countries, corruption was a serious problem. And most of them lacked financial transparency at the corporate, banking, and government levels, which meant that creditors and investors could be suddenly surprised by the revelation of concealed problems.
In addition to structural weaknesses, in 1997–98 the crisis countries had made themselves considerably more vulnerable to market pressures by locking into fixed-exchange-rate systems, whether formal or informal. They were hesitant to depart from these currency regimes, most importantly because of fear of instability, but also because the promise of relative safety from exchange risk had helped to bring in foreign capital. The trouble was that a currency can stay pegged to the dollar only if economic policies are appropriate and if the markets believe that domestic concerns will be sacrificed to keep the peg intact. Over time, strains almost inevitably build up, as happened in one Asian country after another and later in both Russia and Brazil. And once the market starts to bet that a currency peg will break, it can take enormous commitment and powerful policy measures to convince it otherwise. But letting the exchange rate go is also damaging. All of a sudden, the debts of companies and governments that have borrowed in dollars or other hard currencies became much more burdensome. This “balance sheet” effect, as it came to be called, had a devastating impact on production and jobs in the afflicted countries. And, compounding the difficulties, several of the countries that got into trouble were also undergoing significant political transitions, which diffused the sense of responsibility for dealing with the crisis.
However, the global financial crisis was far from solely the fault of the countries that got into trouble. Many faulted the United States for pressing emerging markets to open up to external capital too fast. It is legitimate to ask whether some of the crisis countries deregulated their capital markets too rapidly and, if they did, how much responsibility the industrialized countries should bear. At the Treasury Department, in particular after the Mexican crisis, we emphasized the need for an adequate institutional framework and appropriate policy regimes in emerging markets. However, in hindsight, that emphasis should have been more intense. Better regulatory infrastructure and stronger financial institutions alongside more open capital markets would have reduced the potential for instability. A great difficulty in doing all of this is developing the credit culture, the trained people, and the internal practices requisite for strong financial institutions.
Absent a crisis, however, I’m not sure a greater emphasis by the United States and IMF on financial market infrastructure would have had much effect on borrowing-country behavior. In practice, most of the countries that suffered from overborrowing had gone out and sought that capital. They had also, in many cases, resisted the entry of foreign banks—which could have provided immediate aggregations of trained personnel and management, technology, and capital to their banking sectors (a view I held while I was still at Treasury, before I joined such a bank myself). And some countries restricted the longer-term investment that could have been a stabilizing force, while encouraging short-term borrowing.
Moreover, there’s a danger that arguments for opening financial markets slowly, or in stages, can become excuses for not opening them at all—since tight controls on capital flows are an easier political solution than fundamental financial system reform. I think history demonstrates that freer capital markets are conducive to a well-functioning modern economy, but they do need to be combined with appropriate regulatory systems and sufficiently strong financial institutions.
Although that is my basic orientation, I have some sympathy for those who argue that controls on the inflow, as opposed to the outflow, of short-term investments might sometimes make sense as a transitional device. Chile had some apparent success in reducing re
liance on volatile funds through restrictions on the inflow of short-term capital, but it did not use controls to avoid reform. The central reasons for Chile’s success were sound policies and a floating exchange rate.
I do believe that a significant share of blame for the crisis should go to private investors and creditors. They systematically underweighted the risks of investing in and lending to underdeveloped markets over a number of years, and consequently supplied capital greatly in excess of what would have been sound and sensible. And that excess capital, in time, fueled the extremes—overvalued exchange rates, unsound lending by domestic banks, and the rest—that led to the crisis. I remember one conversation I had with Anwar Ibrahim, the finance minister of Malaysia, who had a keen analytical mind and was highly regarded in international financial circles. Anwar ultimately had a falling-out with Prime Minister Mahathir and languishes in prison today. But just before that, Anwar said to me, “For every bad borrower, there’s a bad lender.” That comment crystallized the issue for me. In New York and Washington, the tendency was often to put all the blame on the policy mistakes of the borrowing countries. In Malaysia and elsewhere in Asia, the tendency was often to put all of it on First World lenders and investors. Anwar understood that the fault belonged on both sides—with economic management in developing countries and with creditors and investors who had poured money in while ignoring problems.
My own experience with financial markets gave Anwar’s comment a special resonance. On Wall Street, I had often seen how excesses of optimism undermined sensible approaches to valuation and risk. I remember, at the time of the South Korea crisis, being struck in discussion with a prominent New York banker by how little he and his company knew about a country to which they had extended a considerable amount of credit. That conversation reinforced for me the notion that in extended good times, even major financial institutions can become less sound in their lending practices, making the same kind of mistake that traders and individual investors do. Though the basic hazard of investing in countries with major economic and political problems should have been obvious, the prevailing mentality was to downplay or ignore those risks in the “reach for yield.”