GLOBAL CRISIS

October 9, 1998

Phil Ponce is joined by Fred Bergsten, Susan Aaronson, and David Henderson to discuss the global financial crisis.

JIM LEHRER: Phil Ponce has the economy story. PHIL PONCE: Finance ministers and central bankers from 182 countries spent this week in Washington trying to stem what is now widely deemed the most serious financial crisis in half a century. The financial turmoil began in Thailand a little more than a year ago and then spread throughout Asia. The Asian flu, as it came to be known, spread to Russia and now threatens some Latin American countries. On Wednesday, Federal Reserve Chairman Alan Greenspan gave his prognosis. ALAN GREENSPAN: As the belief that the Asian contagion had moved into remission has been proved quite wrong -- the result of this, as I'm sure you're all acutely aware by now, has been a very dramatic change in the whole risk profile of the world. PHIL PONCE: By meeting's end yesterday, leaders reached what they called a broad blueprint to end the crisis. It includes allowing countries in extreme financial crises to temporarily stop debt payments to foreigners; a consensus by the G-7 major industrial nations to focus on promoting economic growth, rather than fighting inflation. The International Monetary Fund's managing director, Michel Camdessus, saw a positive outcome from the meetings. MICHEL CAMDESSUS, Director, International Monetary Fund: It is clear that we face a systemic crisis, that you will determine to maintain a sense of perspective recognizing that the global economy has brought enormous benefits and that this crisis, if properly addressed, could be seen in a longer-term perspective as just a temporary setback. PHIL PONCE: But the crisis has brought renewed criticism of the IMF, and questions about its response to the problems in individual nations that continue to flounder after receiving bailout aid. The next test may be Brazil. Yesterday, the IMF and Brazil confirmed they are negotiating such a package as the international community tries yet again to keep the Asian flu from spreading. PHIL PONCE: Joining me now Fred Bergsten is director of the Institute for International Economics and a former Treasury official in the Carter administration; Susan Aaronson is an economic historian at George Mason University; and David Henderson is an economic professor at the Naval post graduate school in Monterrey, California, and a research fellow with Stanford University's Hoover Institution. Welcome all. Mr. Bergsten, you were at the meetings this past week. What was the mood like? FRED BERGSTEN, Institute for International Economics: I've been going to these meetings for over 30 years, I'm sorry to say, and the mood was by far the gloomiest ever. Not only officials were worried, the private financiers were particularly distressed. They see a global credit crunch, a global margin call. Loans were being pulled in all over the world by private institutions. This is an extremely serious global financial crisis. PHIL PONCE: Mr. Bergsten, yesterday the World Bank president, James Wolfensohn, was on our program, and he basically acknowledged that things were very, very serious, but he - at the same time he expressed some optimism. Is that just - did that optimism in any way make itself felt at the meeting? FRED BERGSTEN: It wasn't felt at the meetings, but I think the meetings overdid the pessimism. They didn't do much at the meetings, but I think a number of things could happen literally in the next week or two that could begin to turn it around. As your lead piece said, Brazil is feared to be the next domino, but they just elected a president. He's going to put out new economic programs. He's going to get mega billions of support from the international community. Japan, which is the single most serious crisis in the world, is passing new legislation through their parliament to get their banking system in order, start stimulating their economy. I think the Congress, before it goes home in the next couple of days here, will pass substantial funding for the International Monetary Fund. That will put it back in business. And I think the central banks - the Federal Reserve here - the European central banks - will be reducing interest rates significantly over the next few weeks to try to stimulate world growth. Finally, the Japanese yen has strengthened greatly in the exchange market. That'll help the competitive position of the Asian and other developing countries. So I think there are a number of things - not actions at the meetings - but developments that are quite likely to occur over the next few weeks that will begin to pick the mood off the floor at least to some extent. PHIL PONCE: Professor Henderson, are you encouraged by any of the things that Mr. Bergsten just talked about as possibly contributing to solutions? DAVID HENDERSON: Well, I'm encouraged by some and discouraged by others. See, I think that the IMF shouldn't even be in existence. I think that it creates moral hazard. That's a fancy term meaning that when you have a safety net, there's a tendency for investors to - they know they'll be bailed out if they make bad investments, and, therefore, they make riskier investments. It's kind of "heads, I win, tails, I break even." And so I think the IMF funding is part of the problem we're looking at here, that it was the IMF bailout of Mexico that, in part, led to the problems in Korea, for example. PHIL PONCE: So you're saying the IMF people will what, use it as a crutch, investors? DAVID HENDERSON: I'm sorry? PHIL PONCE: So you're saying that investors - in your opinion - look at the IMF as a crutch. DAVID HENDERSON: They look at it as something that will bail them out when they make investments that go sour, which is what it has done. PHIL PONCE: Professor Aaronson, IMF existence a bad idea? SUSAN ARIEL AARONSON: Absolutely not. But clearly, we need to look at what is the real problem going on here and was the IFM currently doing the right approach to solving that problem, and I think we need to worry about how we best can continue to encourage democracy and capitalism around the world. And the - many of the proposals that people are talking about address fickle capital, but they really don't address who's being hurt in those countries and the political implications of their pain. PHIL PONCE: And, Professor Aaronson, who is being hurt, in your opinion? SUSAN ARIEL AARONSON: Well, in Brazil as example, in Indonesia as example, the middle class and the poor are being hurt as unemployment has gone up in all of these countries dramatically and prices have gone up. For example, the Indonesian economy has shrunk by some 15 percent. Unemployment is up dramatically I think to about 15 percent. Prices have risen 85 percent. So that means that people can't afford their basic necessities, and that's something that we should care about if we care about Indonesia's political stability. PHIL PONCE: Mr. Bergsten. FRED BERGSTEN: Let me come in because I think Professor Henderson is just wrong. There's no empirical support for his moral hazard theory. He wants to shoot the messenger. The issue is whether the IMF makes the situation better or worse. Indonesia, Brazil, and their poor people are in big trouble, but they'd be in lot bigger trouble without the IMF. They would have deeper recessions. They have bigger currency devaluation. They defraud and capital controls. The IMF at least gives them a chance to recover more swiftly with less pain. There's a lot of pain, but it would be a lot worse without the International Monetary Fund. That's why it's critical for the Congress to provide the full U.S. support for the IMF before it goes home. PHIL PONCE: Professor Henderson. DAVID HENDERSON: What you're concentrating on is the up side of the IMF. And you're right about the up side. FRED BERGSTEN: I'm glad you agree. DAVID HENDERSON: Yes. I'm saying there's a down side. I don't understand how you can deny moral hazard. When people buy insurance on a house, they're more likely to take more risks. FRED BERGSTEN: Are you against insurance on houses? DAVID HENDERSON: No. I'm against people subsidizing your housing insurance. If you buy the insurance, you have the right to take those risks, and the insurance company - the insurance company will let you - will give you lower rates when you do certain things to make it less risky. And that's fine. But that's not what we're talking about here. PHIL PONCE: Professor Henderson, there's been talk that in order to sort of moderate these - the market's volatility that there should be steps taken to sort of control the flow of capital. I assume your response to that would be - DAVID HENDERSON: Absolutely not. I mean, the reason is - think about what it means to control the flow of capital. People keep focusing on controlling the flow of capital out. Well, if you control the flow of capital out of a country, guess what, people are less willing to invest in the country in the first place. If I know that I can't take my assets and my earnings on those assets out of the country, I am less willing to invest in the first place. I mean, what these countries need is capital investment. They don't need less capital investment. PHIL PONCE: Professor Aaronson, are you in favor of controls to help - to help the middle class and the poor? I mean, is that one thing that can help this volatility, capital rushing in, then capital rushing out? SUSAN ARIEL AARONSON: Well, governments have a responsibility to their citizens and just as there are times that they must protect, there are times when they feel they must defend their currencies, and nations have historically adopted capital controls. Europe did after the Second World War. However, in general, it's not a good idea, but two countries recently have done so successfully. At the same time - PHIL PONCE: Which countries are you referring to? SUSAN ARIEL AARONSON: Chile and Argentina, I believe. DAVID HENDERSON: Interesting, though, Chile has gotten rid of most of its capital controls in the last couple of months. FRED BERGSTEN: I think - DAVID HENDERSON: If they're so good, why did they get rid of them? FRED BERGSTEN: Well, I think one has to distinguish between different types of capital controls. SUSAN ARIEL AARONSON: Yes. Absolutely. FRED BERGSTEN: What Chile and Colombia - not Argentina - SUSAN ARIEL AARONSON: Thank you. FRED BERGSTEN: -- have done is to try to prevent excessive in-flows that would lead to bubbles in their domestic economies, running the risk then that they would flow back out and destabilize. DAVID HENDERSON: And then what you're doing is you're trusting the government to decide what's an excessive in-flow. FRED BERGSTEN: Right. Exactly. DAVID HENDERSON: How do you do that? FRED BERGSTEN: Exactly. That's exactly right. DAVID HENDERSON: How do you trust people who don't have their own wealth at stake - FRED BERGSTEN: Well - DAVID HENDERSON: -- to decide what's an excessive in-flow - FRED BERGSTEN: When the people invest -- PHIL PONCE: I'll get back to you. Mr. Bergsten. FRED BERGSTEN: Well, the question is: Who leads to bigger troubles, government intervention or the excessive volatility in the market? Sometimes governments are big problems and their invention is excessive, but sometimes the markets demonstrably cause big problems too. Therefore, I think it's reasonable for a country like Chile to limit the in-flow, realizing there are some costs. I agree with Professor Henderson, but also limiting the risk and vulnerability in the longer run. What Malaysia has done recently is what he said, tried to put controls on in the midst of a crisis to stop capital flight. That stops in-flow just when they need it. That's a bad idea. But one has to be sophisticated and figure out what type of controls we're talking about. Some do make sense. But some are very poorly designed, as I said. PHIL PONCE: Professor Henderson, let me ask you this. Let's talk about the basic premise - again, the World Bank president yesterday said that one of the outcomes of this week's meetings was that there was a consensus that there is a crisis mode, that this could be the worst economic crisis in 50 years. What's your response to that? DAVID HENDERSON: Well, first of all, I think you have to be clear what you mean by the worst economic crisis, and they have never made that clear. If you say the conditions are at their worst in 50 years, that's absolutely absurd. I mean, look around the world, look at the IMF's report last week that said that the world economy is growing at 2 percent. Now how can the economy be 2 percent bigger this year than last year, and it's worse this year than last year? And look at the fact that economies have grown over the last 40 years. There's no way that this can be the worst situation in 50 years. It's kind of like Clinton's campaign statement back in '92 that this was the worst economy in 50 years, or like Bob Dole's statement in '96 that Clinton's economy was the worst in 100 years. Both were patently absurd. PHIL PONCE: Professor Aaronson, what's your sense of the crisis? SUSAN ARIEL AARONSON: I think it is a great crisis, and I think at this point in time the people that are getting hurt the most are the people who are always getting hurt. They're the politically less powerful, and I think we need to be concerned about that. DAVID HENDERSON: I agree. SUSAN ARIEL AARONSON: And it seems to me that condemning the IMF is not the solution, nor is defunding the IMF. The issue is: How can we create an architecture that fits the problem? And to me, debunking it, condemning it is in no way a solution that's constructive. DAVID HENDERSON: I think it's actually half of a constructive solution. The other half is, if the IMF is out of there, there's at least more incentive for governments in those countries to get rid of all restrictions that are keeping those economies down. PHIL PONCE: Mr. Bergsten - DAVID HENDERSON: The economies that have done well around the world are the ones that have deregulated and lowered the size of government. PHIL PONCE: Mr. Bergstein, let me get your reaction to something that India's minister of finance has quoted - he was quoted in the Washington Post this morning. He said, "The brute fact is that after five days of intense discussion and debate, we are still at a loss as to why contagion has continued to spread." Can anyone really explain this contagion? FRED BERGSTEN: I think you can explain it. I think you can explain it as a combination of huge amounts of capital, very volatile, seeking small differences in return, and faulty government policies, which have led to big trade deficits, weak financial systems, faulty systems of corporate governance, as in most of the Asian countries. You asked how serious the problem is. One third of the world - practically all of Asia - is in recession or worse. These are countries that grew 6 to 8 percent a year for the last twenty to thirty years. Now they're dropping by 6 to 8 percent a year-maybe 20 percent in Indonesia. These are depression-like swings in economic activity in these countries. Money has flowed out. It's gone to other places, safe havens, particularly U.S. Treasury securities. There's a huge amount of instability in the world markets. That's the underlying trigger for all this. But the underlying source, in turn, is faulty government policies, weak economic performance, and very fickle capital markets that move to exploit it. PHIL PONCE: Professor Henderson, quickly, your response. DAVID HENDERSON: Yes, Phil, I agree that fault government policy is a big part of it. I mean, Indonesia has all these monopolies that are given to the people in power. And that's been terrible for that economy. And the more capital investment you have in these economies, the more it will undercut those monopolies. PHIL PONCE: I'm afraid that's about all the time we have. I thank you all for joining us.

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