Global Policy Forum

By David E. Sanger

Washington - Few alarm bells rang here a year ago this weekend, when Thailand's currency melted down.
"There were no crisis meetings," recalled Daniel Tarullo, President Clinton's top international economic adviser until a few months ago, "and certainly no sense that this was the start of an economic crisis that might roll around the world." It turned out to be just that. A year later, there is no end in sight -- after three huge international bailouts, the forced resignation of Asia's longest-serving ruler, a banking crisis in Japan and trouble looming from Russia to South Africa to Malaysia. The economic crisis that was supposed to be abating now, much as Mexico's did after a year, is growing more intense.

Unlike a nuclear test in India or a provocation from Iraq, this crisis started so slowly that in November, Clinton dismissed it as "a few small glitches in the road." Today it stands as the largest single threat to the six-year economic boom in the United States. While the effects on most Americans have been remote, factories are beginning to slow, exports are beginning to pile up on the docks and members of Congress from agricultural states are beginning to speak publicly about the need for swift action, even if they are unsure what that action should be.

From the White House to the International Monetary Fund, officials are concerned that the effects of the crisis will be worse and longer-lasting than they thought even three months ago. What particularly scares Clinton administration officials, though they are loath to say so on the record, is that the unpredictable economic contagion is no longer limited to the Pacific Rim.

"Just look at how our view of this has changed in the past year," said one of Clinton's top advisers. "First it was all about Thailand. Then it was about containing this all to Southeast Asia. And look at where all this is headed in the next year: Russia, Japan, maybe China -- the superpowers." Clinton alluded to this fear in Hong Kong on Friday, wrapping up his tour of China. "Restoring economic stability and growth will not be easy," he said. "The steps required will be politically unpopular and will take courage. But the United States will do all we can to help any Asian government willing to work itself back to financial health."

Just what kind of help he has in mind was left vague. He can send Treasury Secretary Robert Rubin and his deputy, Lawrence Summers, on more trips around the globe urging countries to follow the monetary fund's conditions for loans -- a mixture of budget austerity and high interest rates that is now being adjusted to dampen street protests by laid-off workers and by families who cannot buy gasoline or food.

Despite Clinton's statement of commitment in Hong Kong, his options are limited. Congress is deeply reluctant to contribute an additional $18 billion to the monetary fund. The battle has turned into a bitter struggle over the fund's traditional secrecy, its track record and animosity among some members of Congress toward international organizations of any kind. Summers likens denying the fund this money to "canceling your life insurance just after you've been diagnosed with a life-threatening disease."

But the IMF's record is mixed at best, and Republicans cite harsh criticism of its actions by everyone from Milton Friedman, the well-known economist, to former Secretary of State George Shultz. Stanley Fischer, the No. 2 official at the fund, dismisses their arguments that the fund has made the crisis worse as "nonsense." But right or wrong, it is a view that is gaining political currency in Washington.

Clinton has made clear that he has no intention of repeating his own successful bailout of Mexico. In that case, he circumvented Congress, using a fund controlled by the Treasury and the Federal Reserve to lend $12 billion to Mexico, one of America's largest trading partners. It is unclear what the United States will do if Russia desperately needs aid in the next few months and the IMF says it does not have the resources.

It is not only Congress and the administration that are at odds. The World Bank, which focuses on issues of poverty and development, is critical of its sister institution, the monetary fund. The State Department carps that the Treasury has focused on reforming banking systems and opening markets but paid too little attention to America's broader strategic interests.
The CIA, one senior intelligence official acknowledged, "hasn't a clue how to deal with this kind of crisis, where the enemy is the markets or a finance ministry that lies about a country's currency reserves." The only point of agreement, in fact, is that Washington officials are publicly understating the depth of the problems so that they do not scare the markets.

"This is off the radar screens in terms of severity," said Allen Sinai, the chief global economist at Primark Decision Systems, an investment advisory group. "It is the single most negative economic event since the Great Depression in the United States. "But what makes this problem so distinct is that it is not just an economic bust. It is laced with every type of financial crisis and instability that has ever shown up in the real world or any textbook. And while there are some brilliant minds working on it, no one can deal with it -- not Rubin, not Summers, not any single country, not the IMF."

Without question, an astounding array of economic and political predictions emerging from Washington and Wall Street in the last year have proved wrong. For example, the Treasury and private economists said last summer that they expected that the problems confronting Thailand would follow the Mexico pattern. The surprise devaluation of the peso triggered sell-offs in other emerging markets, giving rise to the phrase "economic contagion," but after three or four months, markets settled down. After a year of pain, Mexico was on the mend.

But the Asian crisis today looks nothing like Mexico's. The economic contagion has yet to stop. It just smolders underground for a while, erupting in various places around the globe as investors take a new look at a country and suddenly see a host of risks that should have been obvious before. They head for the exits, pulling money out of the currency and the stock markets. That turns long-festering but manageable problems into an immediate crisis.

There were other misguided predictions. When the monetary fund devised a $43 billion bailout plan for Indonesia in October, American officials and the fund described it as deliberate overkill. Indonesia's economy was in fundamentally better shape than other nations', they said, and President Suharto's iron control over the country made it easier to get the country back on track. But the economy turned out to be in worse condition than it appeared. And Suharto resisted the monetary fund's urgings for months, privately telling former Vice President Walter Mondale, who was sent there on a special mission, "If I do these things, they will throw me out of office." When Suharto was forced to resign after riots took 1,200 lives, the Natonal Security Council estimated that his successor, B.J. Habibie, would be gone within weeks. That was two months ago, and Habibie seems to be settling in.

Contrary to many early predictions, the U.S. economy has so far been helped as much as it has been hurt by the events in Asia. While exports are down, both the reduction of activity and price competition from abroad kept inflation contained. That has given the Federal Reserve a reason to keep interest rates down.

Then this spring, there was premature optimism. The IMF declared that the crisis was stabilizing. Rubin told Congress that a reignition of systemic, global economic trouble was "a low-probability event." But within a month, the eruption of Japan's banking crisis sent the yen plunging again, and that undercut other currencies througout East Asia.
Fearful of broader contagion, Rubin reluctantly ordered the United States to buy $2 billion in yen to help calm the markets. In return he received assurances from Japanese politicans that they would act. On Thursday they announced a plan to reform the country's banks. But the initial verdict from the markets was that the plan was too vague, and the yen plunged again, taking markets throughout Asia with it.

Today Asia faces two big questions. The first is whether Japan will lead a recovery or worsen the pain. The second is whether the monetary fund -- and by extension the Treasury, which has enormous leverage over the fund's policies -- has the right formula.
The fund's solution has been to urge countries to raise interest rates, in hopes of attracting back investors who were fleeing from their currencies, and to balance their budgets. As investors trickle back in, the theory is, interest rates can fall and the currency will gradually strengthen. That has happened, modestly, in South Korea. But the most common criticism is that high interest rates are killing otherwise healthy businesses and the budget austerity is contributing to shrinking the national economies. "The year has been a fiasco, and so has the policy," said Jeffrey Sachs, a Harvard economist who has been among the administration's fiercest critics. "Asia would have been better if the IMF had never set foot in these countries. All these strategies were designed to restore the confidence of the markets, and they didn't."

While many applauded the monetary fund's attack on crony capitalism and particularly on the Suharto-controlled cartels in Indonesia, that effort may not have struck at the heart of the country's economic troubles. But it did build credibility for the fund among the Indonesian people and on Capitol Hill. Rubin and Fischer argue strenuously that if the monetary fund had failed to step in, a bad situation would have turned disastrous. "It's a balancing act," said Fischer, "and we constantly readjust the mix to get it right. But I can't believe that serious people believe that without temporarily increasing interest rates, we could have contained the problems" caused by plunging currencies.

The biggest risk to these countries in Asia, Fischer argues, is not the IMF's prescriptions, but its rapidly-depleting treasury. "If this situation were to worsen," he said, "and we needed to provide additional aid, we would simply not have the resources." The fund has only $10 billion to $15 billion left to lend out before it has to take extraordinary measures, he said.
Opponents in Congress say the fund has plenty of untapped resources and is crying wolf.

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