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Time to Reweave the World's Financial Safety Net

September 13, 1998|Roger C. Altman | Roger C. Altman, an investment banker, served in the U.S. Treasury under President Jimmy Carter and as deputy secretary of the U.S. Treasury in the first Clinton administration

NEW YORK — Imagine a map of the world. In mid-1997, when Thailand's economy became the first in Asia to collapse, we could have colored that country red. Now, only 14 months later, the entire developing world would be crimson. The worst international economic crisis in 50 years, which no one foresaw, has ravaged two-thirds of the globe. Standards of living, so painfully raised, are falling. The U.S. economy and financial markets, initially expected to escape unscathed, are also damaged.

Stunned observers are asking whether the international economic and financial system is broken. Several larger developing nations that were pursuing open-market policies for years, including Hong Kong, Malaysia and Russia, are reversing course. They are, in effect, dropping out of the global economy. There are increasing calls for curtailing the worldwide system of floating exchange rates and free flows of capital. Previously, these were icons of global economic progress.

But our international economic system, based on open and competitive markets for goods and capital, is the right one. It is the safety net underneath that is torn and needs repair. Resources for the International Monetary Fund, emergency lender to governments, must be vastly expanded. An early-warning system on financial and economic weaknesses and individual nations is long overdue. The United States and Europe should engineer a lowering of worldwide interest rates now to cushion against global recession and deflation.

It is important to understand how a collapse of this magnitude could have happened and whether its spread can be stopped, as well as the flaws in the international system that have been exposed. These are the crucial questions that must be answered--and fast.

Let's begin by understanding the illness. First, a part of the problem is the classic tendency of financial markets to overshoot, both on the upside and the downside. As Federal Reserve Chairman Alan Greenspan observed last week, they are usually too euphoric or too pessimistic. The current, wholesale investor boycott of all developing countries is a prime example.

Second, a group of Asian economies is sicker than anyone realized. A combination of complacent global investors and poor data issued by these countries enabled them to appear healthier than they were.

It turned out that much of the recent growth in countries such as Thailand, Indonesia, South Korea and Malaysia was artificial. For reasons of cronyism and politics, their governments had induced local banks to shovel loans into unproductive enterprises. Foreign lenders also were eagerly providing financing. The result was overcapacity, unprofitability, bad loans and a dependence on foreign capital, usually denominated in dollars.

When the real condition of numerous industries and banks became clear, investors fled. They sold local assets so aggressively that currencies fell sharply. To defend them, nations depleted their treasuries and verged on national insolvency. This prompted a series of huge, IMF-led Asian bailouts. They succeeded in preventing defaults, but not in averting severe declines in their financial markets and economies.

Third, the world's second-largest economy, Japan, has been the victim of unprecedented policy errors. The result has been a severe credit crunch and the worst postwar recession. The Japanese banking system has lost almost all its true capital and cannot lend. Because Japan is the largest market for goods and services of other Asian economies, its weakness has depressed the region. Indeed, it is millstone around the neck of the entire world economy.

Unlike the savings-and-loan crisis here, in which our authorities acted decisively, Tokyo has not addressed this problem. There is political paralysis and deepening recession. Without a functioning banking system, no economy can grow. Japan is suffering that fate.

Fourth, the IMF is the world's designated emergency lender and crisis manager, but it is almost out of money and suffers from a leadership crisis. The U.S. Congress has refused to support additional funding for the agency and has undermined its credibility. Investors know larger developing nations don't have the usual safety net afforded by the IMF. They aren't willing, therefore, to stick with those countries or return to them. This has worsened the crisis.

Nonetheless, the spread of this international economic crisis can be contained. It will not plunge the entire world into depression. The self-correcting character of financial markets will provide part of the solution. Today's investor boycott of essentially healthy countries will run its course. The Hong Kong and Mexican markets, for example, will recover because their long-term economic outlooks are sound.

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