Crashed

by Adam Tooze

  I

  In the summer of 1997 the Asian financial crisis had started in Thailand and had spread from there across Southeast Asia to Indonesia, Malaysia and Singapore, before ricocheting two thousand miles to the northeast to unleash havoc in South Korea. After a year of severe recession, by 2000 Thailand, Indonesia, Malaysia and Korea were all growing again. From a combined GDP in 1997 of $2.3 trillion in purchasing power parity (PPP) terms, by 2008 the output of these four economies had nearly doubled to $4.4 trillion.3 This gave them a weight in the world economy comparable in PPP terms to France and Italy combined, or California plus Texas. In terms of economic policy, the East Asian economies were model students. Learning the lessons commonly prescribed after the crises of the 1990s, they adopted tight fiscal policies and built up huge currency reserves. Indonesia, where the 1998 crisis had triggered the fall of Suharto’s dictatorship, went so far as to adopt a fiscal straitjacket modeled on the EU’s Maastricht criteria.4 Though this discipline was restrictive and particularly so for a developing economy in need of public investment, when the crisis struck in 2008, the regions of Southeast and East Asia had room to maneuver.5 And they needed it. Though the crisis did not originate in Asia, they were acutely vulnerable to global shocks.

  Most at risk in 2008 was South Korea, whose famous corporate export champions, the chaebol—Daewoo, Hyundai, Samsung—and their giant steel plants, shipyards and car factories suffered a shuddering blow. “We are collateral damage in a crisis that is not our doing,” observed one professor at Korea University in Seoul. “We live in an unfair world.”6 But however real this sense of victimization, it does not capture the complex reality of South Korea’s situation. What set South Korea apart in Asia, and gave it a vulnerability akin to that of Eastern Europe or Russia, was the global integration of its financial system.7 After the shock of the 1990s the South Korean central bank had made sure to accumulate ample foreign reserves—$240 billion by the summer of 2008. But this did not cancel out the vulnerabilities in the Korean financial system. Unlike in Europe, subprime wasn’t the issue. South Korean holding of toxic US mortgage securities amounted to only $850 million.8 The problem was not on the asset, but on the funding, side of the balance sheet. Since the early 2000s, Seoul had promoted itself as a regional financial hub for Northeast Asia. It had liberalized currency and capital flows. A large part of South Korean banking was owned by foreign investors, and Korea’s banks had shifted to the unstable new model of wholesale funding, borrowing short term on global dollar markets to invest long term at higher interest rates in Korea. This was made all the more attractive by South Korea’s export success and the steady appreciation of the Korean won against the dollar. The problem for the chaebol was to hedge their dollar export earnings against devaluation. One way to do this was to borrow in dollars and invest in Korean assets, repaying the dollar loan at more favorable exchange rates in the future.9 The trade was profitable if short-term dollar funding remained cheap and exchange rates continued to move as expected. By June 2008, as a result of this hedging tactic, South Korean businesses had $176 billion in short-term dollar loans outstanding, an increase of 150 percent since 2005. The banking sector owed $80 billion, which had to be rolled over by the summer of 2009.

  When short-term dollar lending markets shut down across the world and the dollar surged, the logic of the won-dollar carry trade went abruptly into reverse. As Korean businesses scrambled to cover their dollar exposure, a disastrous cycle ensued. Preemptive buying of dollars led to an immediate collapse in the value of the won. When national currency holdings slid perilously close to the psychological threshold of $200 billion, that added to the panic.10 Between the summer of 2008 and May 2009 the won plunged from 1,000 to 1,600 to the dollar, increasing the local cost of US dollar loans by 60 percent. Only tiny bankrupt Iceland suffered a more drastic depreciation. The cost for Korean borrowers of insuring dollar bonds against default (CDS premiums) surged from 20 basis points (0.2 percent of the value of the loan) in the summer of 2007 to 700 by October 2008.11 Adding 7 percent to the interest burden of a bank bond ruled out further borrowing for the foreseeable future. Even banks with government backing, such as Woori, found themselves shut out of repo markets.

  Nowhere else in Asia experienced the full combination of plunging exports, devaluation and a massive liquidity squeeze that hit South Korea in 2008. But the impact on the entire region was dramatic. In Thailand the financial meltdown coincided with an escalating political crisis that culminated in huge demonstrations, the occupation of the Bangkok airport by middle-class protesters and, in December 2008, the removal by judicial means of the government headed by the People’s Power Party, affiliated with the exiled oligarch and ex–prime minister Thaksin Shinawatra. With exports of goods and services, notably tourism, accounting for almost 70 percent of GDP, the civil disorder left Thailand’s economy vulnerable.12 Year on year to the third quarter of 2009, Thai exports fell by 25 percent. In Malaysia’s case the export dependence was even greater: 103 percent of GDP.13 That the value of exports exceeded GDP was possible because Malaysia, even more than China, was an assembly hub for global manufacturers fed by imported raw materials and subcomponents. By the winter of 2008–2009 Malaysia’s globalized manufacturing sector was contracting by 17.6 percent. Malaysia’s electronics assembly plants were experiencing a 44 percent year-on-year contraction. By contrast with Thailand and Malaysia, in Indonesia, the largest and poorest of the ASEAN group, exports accounted for only 20 percent of GDP. But its exports consisted of commodities, whose prices plunged from the summer of 2008.

  For those Asian economies hit mainly by the export shock, the policy response was simple: fiscal and monetary stimulus. None of the reactions was on the scale of China, but they were impressive nevertheless. In Thailand, following the “judicial coup” of December 2008, a new government took office, closely associated with the Bangkok establishment, the royal family and the military. It was headed by Abhisit Vejjajiva, who was educated at Eton and Oxford. Given the impact of the crisis on Thailand’s highly open economy and his need to build legitimacy, Abhisit immediately embarked on a stimulus program. The first phase, announced in January 2009, amounted to 116.7 billion baht, or 1.3 percent of GDP, with priority given to popular consumption, including “saving the nation checks” distributed by way of the Social Security Administration, bonuses for senior citizens and subsidies for public education. At the same time, the Bank of Thailand slashed interest rates to 1.25 percent—compared with the 12.5 percent they had reached during the 1998 crisis—and directed six government-owned banks to rush loans, especially to small businesses. But the January plan was only the beginning. As the severity of the crisis deepened, Abhisit upped the scale of the stimulus to a remarkable 17 percent of 2009 GDP—$40 billion—to be spent over the next four years. In 2009 the budget deficit surged from 1 percent to 5.6 percent of GDP.14

  Compared with its massively export-dependent neighbors, Indonesia enjoyed a degree of insulation from the global shock. But it was also by far the largest state in the region and it was extremely difficult for its central government to deploy resources effectively across its sprawling island territories. With former minister of finance and governor of the Bank of Indonesia Boediono leading the way as vice president, Jakarta opted for a stimulus based largely on tax cuts rather than on government spending.15 This meant that out of Indonesia’s working population of 97 million and its teeming mass of 48 million small businesses, only the 10 million workers and 200,000 firms that were registered for tax would benefit. But within that sector the impact was considerable. The tax cuts amounted to 1.4 percent of GDP at PPP. This may not sound like much, but given the modest scope of the Indonesian central government budget, it amounted to 10 percent of public expenditure.

  As in Thailand, the crisis struck Malaysia at a moment of political flux. The ruling nationalist party was going through a succession crisis. As the government of Prime Minister Abdullah Ahmad Badawi disintegrated, it w
as no coincidence that the man who moved to replace him was the forceful minister of finance Najib Razak. He did not take long to claim credit for a $16.4 billion stimulus that was launched in the spring of 2009. This was “the biggest economic stimulus initiative Malaysia has ever taken,” which, when tax cuts and guarantees were included, amounted to 9 percent of GDP.16 It was marketed as a major step toward rejuvenating the New Economic Model, which had supposedly guided Malaysia’s development since independence. Fueled by foreign investment and the petrochemical boom, Malaysia hoped to catapult to the status of a fully developed economy on a par with Singapore, its enviable neighbor. There were tax cuts and reductions in interest rates by the central bank, but the main drivers of the program were the finance ministry and the Khazanah Nasional, Malaysia’s sovereign wealth fund. One of the main vehicles for their lending was 1Malaysia Development Berhad (1MDB), a fund designed to channel gulf petrodollars into Malaysian national development and to act as a counterpart for infrastructure development projects by China’s electricity grid, called State Grid. At the time of its launch, Najib’s program met with wide international acclaim. Malaysia was promoted from eighteenth to tenth place in the global ranking of competitiveness issued by the International Institute for Management Development and attracted major investments from Goldman Sachs and Citigroup. Goldman’s Singapore office was particularly eager to help, with a gigantic $6.5 billion bond issue by 1MDB. Only later, thanks to investigations by the Wall Street Journal and the New York Times, would it emerge that 1MDB was not just a vehicle for Malaysian economic development and mouthwatering fees for Goldman. It also served as a conduit for billion-dollar corruption on the part of Malaysia’s prime minister.17

  All of Asia had to deal with the export shock. What set South Korea apart was the emergency in its financial sector. To help offset the closing of dollar funding markets, the Korean state was forced in October 2008 to provide $100 billion in foreign loan guarantees and at least $30 billion in other liquidity and support measures. Korea’s crisis-fighting mobilization in the autumn of 2008 was not limited to the government. Major Korean exporters, such as steelmaker Posco, Hyundai Motor and Samsung Electronics, flushed hundreds of millions of dollars into the Seoul exchanges so as to ease pressure on the won.18 The Korean state pension system volunteered to buy bank bonds to ease funding difficulties. Meanwhile, Korea’s president, Lee Myung-bak, a former CEO at Hyundai’s construction division, called on his citizens to save on imported fossil fuels and to commit their personal dollar savings to rescuing the won. The queues at the exchange booths were both a gratifying display of patriotism and an alarming sign of the extremity of the situation. Meanwhile, the Bank of Korea intervened actively in foreign exchange markets, desperately trying to stem the collapse of the won. But what was most effective in stopping the run against was help from the outside.19 On October 30 the Bank of Korea announced the opening of a $30 billion swap line with the Fed, allowing it to auction dollars in generous amounts. With the foreign exchanges no longer in panic mode, Seoul could set about restoring the banking sector. In early 2009 the South Korean government issued a further $55 billion in liquidity backstops for interbank lending and set aside $23 billion for restructuring banks and nonperforming loans. It then added a $7.8 billion bond market stabilization fund and a $31.3 billion fund for corporate restructuring. Meanwhile, President Lee was true to his nickname—“the Bulldozer”—kicking off 2009 with a gigantic construction program, budgeted at $94 billion over a four-year period.20 Headline projects included large investments in nuclear power, upgrades to the railway system and the president’s favorite, the $15 billion Four Major Rivers Restoration Project, to restore riverbeds and construct a new dam system.21 South Korea, Lee promised, would not just achieve 7 percent growth, a per capita income of $40,000 and claim the seventh spot in the global ranking of national economies—“7-4-7” was his slogan—it would also establish itself as a pioneer of “green growth.”

  Across East and Southeast Asia, the response to the 2008 crisis set down a historical marker. Against the backdrop of their humiliating reliance on the IMF and the Clinton administration in the 1997 crisis, countries like Thailand, Malaysia and South Korea had reached a new level of autonomy. No more than in China or in the West was this merely a matter of technocratic competence, though they had plenty of that. Major stimulus efforts were political through and through. But whatever the local interests that mobilized in each case, the policy responses of the Asian emerging markets were effective. And this new resilience was acknowledged in Washington. One of the reasons why Fed officials advocated a swap line for South Korea was that they did not believe Seoul was willing to have recourse to the IMF any longer. Better to welcome South Korea discreetly to the top table rather than to risk a politicized clash that might upset fragile global markets.22 The Asian economies rebounded quickly and they would soon attract new foreign capital flows. In addition, two of them, South Korea and Indonesia, emerged from the crisis as full members of a new organization designed specifically to reflect the complex reality of a multipolar global economy.

  II

  The G20 owed its existence to an initiative launched in December 1999 by then US Treasury secretary Larry Summers and Canadian prime minister Paul Martin. Their vision was to create a forum for global governance that was more representative than the Bretton Woods institutions, such as the IMF and the World Bank, but not so unmanageable as the United Nations. Twenty members seemed like a round number. As the story is told, the list was drawn up by Summers’s assistant, Timothy Geithner (then in charge of international affairs at the Treasury), and Caio Koch-Weser, former managing director at the World Bank and then at the German finance ministry. With data for GDP, population and world trade to hand, they went down the list “ticking some countries and crossing others: Canada in, Spain out, South Africa in, Nigeria and Egypt out, Argentina in, Colombia out, and so on.”23 Once the list had been approved by the G8, the invitations were then dispatched to the relevant finance ministries and central banks. There was no prior discussion or consultation. The rich countries decided to form a bigger club and asked twelve new members to join. It was global governance made simple.

  Throughout the 2000s the G20 functioned as a top-level forum of technical experts.24 The meetings were often perfunctory and some busy Treasury ministers chose not to attend. But Paul Martin was indefatigable in his efforts to have the G20 upgraded to a full leadership summit. To no one’s surprise he was blocked by the Bush administration, which preferred to deal bilaterally with China and otherwise to assemble self-selecting coalitions of the willing. It was far from a foregone conclusion, therefore, that this ad hoc intergovernmental forum should become the global platform through which the world’s leading economies responded to the financial crisis. When President Sarkozy addressed the UN General Assembly in September 2008, he called for the G8 to be expanded to a G13 or G14, adding China, India, South Africa, Mexico and Brazil. Both France and Japan preferred a smaller group, because this maximized their leverage. It was Britain’s prime minister, Gordon Brown, who took up the proposal and, following the General Assembly meeting in September 2008, convened an impromptu gathering in New York to formulate a joint approach to the White House. The questions were how to get the United States on board and whom to include. Britain favored the larger G20 format, as did Australia, Canada and the Latin Americans. After the uncoordinated shambles of the bank bailouts in September and early October, the Bush administration had a new appreciation of the need for cooperation. What the White House wanted to avoid was a global assembly in New York under UN auspices, which was sure to be packed with critics of the Bush administration. The Americans preferred a meeting in Washington, where the IMF could put a dignified gloss on proceedings. Though it was by tradition headed by a European, IMF voting rights were weighted by financial contribution, giving the United States a veto. That was a global design with which the Bush administration could live. The invitation to the first G20 h
eads of government meeting finally went out on October 22, calling a gathering for November 14. On his way out of office, Bush’s administration, which had given unilateralism a bad name, would reluctantly inaugurate a new chapter in global multilateralism.

  For new members of the elite circle, such as Australia, Brazil, Korea and Indonesia, the G20 was an exciting departure. For the United States it promised at least minimal coordination across the major economies. For China it was a convenient mechanism for gaining global influence without having to accept an excessive burden of responsibility. But the G20 was far from meeting with universal approval. As Der Spiegel reported, for Norway’s foreign minister Jonas Gahr Støre, the formation of an oligarchy of globally significant states was one of the greatest setbacks to international organization since World War II.25 In his words, “The spirit of the Congress of Vienna [1814–1815], where great powers assembled to effectively govern the world, has no place in the contemporary international community. The G20 is sorely lacking in legitimacy and must change.” They were strong words, but to a degree beside the point. The Congress of Vienna was a reactionary convention reinstating the ancien régime in the wake of the French Revolution and Napoleon. The G20 was an exclusive club, for sure, but it was a new club, with new members, whose promotion to global prominence a small European state like Norway might well resent. The G20’s organizing principle was not the ancien régime logic of the balance of power or traditionalist legitimacy, or, for that matter, the logic of globalism as it appealed to Rooseveltian New Dealers in 1945. The G20 was a reflection of the new world created since the 1970s by globalized economic growth. The nations represented at the G20 might represent only 10 percent of UN member states and 60 percent of the world’s population, but they were responsible for 80 percent of trade and 85 percent of global GDP and their share was increasing. There was no pretense of equality within the G20, let alone with states beyond. But the members of the G20 did at least recognize one another as elements of the global economic system that were too significant to ignore. At the UN the exclusivity of the G20 provoked something of a countermovement. But when in 2009 the UN General Assembly convened its own committee on the global economic crisis, the G20 ignored it.26