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the crash interview: david j. rothkopf
david j. rothkopf
He is the former Deputy Undersecretary of the Commerce Department under the Clinton Administration and is now president of an international advisory firm. He is also an adjunct professor of international and public affairs at Columbia University. (Interview conducted in the spring of 1999.)
You have called what we've been witnessing the biggest transformation since the industrial revolution ... What do you mean?

The ability of people to communicate with one another, to conduct business with one another, is changing society. It's changing the way they interact internally, changing their views of where opportunities lie, the sources of capital that they draw upon. It's changing the nature of the world in the same way that the industrial revolution radically reordered the world ...In this particular case, the formulas for success have changed and it's led to other things. I mean, my sense is that the creation of a sort of integrated global information society played a bigger role in leading to the downfall of the Soviet Union than perhaps conflict, because it's impossible to run a closed society in a world that depends on information as the oxygen of economies. So I think that they became increasingly less economically competitive, self-sufficient, and this led to a break down militarily and that led to that change.

Governments have got to realize that their goal is to strike a balance. Markets can be an engine for growth, but  build safety systems in their societies that allow them to react to markets overstepping, to react to the fact that markets  don't take into account social justice as an issue. ... The financial markets are truly global. I mean, people talk a lot about globalization, but the place that globalization has really taken place so far is only in the financial markets. Those are the places where traders move money to every corner of the world and move it out again, second to second, all the time. Of course, there's a great opportunity here in the sense that markets that were once invisible or only received public sector money are now able to compete to attract capital. This led to the emerging markets phenomenon to a large extent because every trader, every Wall Street guy, views the world through that window on his desk. That's his computer screen. And now, if you're visible through that window, you're competing. Those who are not, still are not.

You've written about a dual constituency that ... leaders of countries must deal with. Talk to me about that.

Well, the growth of a global economy has produced a very interesting tension. If you're leading a country anywhere in the world, you have to respond to the demands of the electorate that put you into office, and they are one group to which you are beholden. But there is also this group, these 30,000 traders and the people who are managing funds and the people who are running money around the world, who are conducting a minute-to-minute referendum on your policies, and they can pull money out of your country overnight.If you lose their confidence, they can make it impossible for you to advance your programs at home. They have different interests than the constituency that elected you. Their interests are short term. They're driven by their bonus cycles. They're driven by how the returns from your country figure versus the returns from everywhere else in the world. They are not looking at whether or not your people are doing better or whether opportunity is being created or whether you're creating a more socially just society and that's a problem.

On the other hand, they do demand that you play by the rules in the marketplace. They do demand that you're open. They do demand reform and liberalization, and that's a positive thing. So ideally the tension between people who see government as a means of creating a more just society, and markets which see governments as having the responsibility to create open markets, can be a good one because it can produce a world that functions better and ultimately creates more opportunities.

The problem is when you get into a kind of dialectic between the one and the other, and you swing from populism to liberalism and reform, and then react against that and go back again. Then you get into the one-step-forward, two-steps-back phenomenon, and there's a tension on that going on right now.

I mean, there are some countries ... Venezuela has a new president who's a populist, and it looks like he may be reacting against much of what's going on in the markets. In Russia, it's quite possible that you'll get the emergence of populist leaders who will react against what's going on in the markets. The voices of the markets, like the IMF, have become the villains of the markets. If you go to Korea right now and you talk to them about the bad year they've just gone through, they refer to it as the IMF time, so it's being used by local politicians to their advantage, and this dynamic, I think, is going to be the defining dynamic in sort of the new global politics.

But isn't it true that the IMF and the U.S. Treasury have insisted on policies that aren't politically sustainable in lots of these countries?

... I think that there were certainly many instances where the reforms advocated by the IMF, where the reforms pushed for by many in the financial community, where the policy position known by the term the "Washington consensus" was very insensitive to the needs of the people in these countries, and thus it became politically unsustainable. Because if what you're doing is saying, "Strong currency at any cost," then what you're going to find yourself in is a situation where sometimes you're forced to raise interest rates so high that you bring a recession onto a country. You know in a lot of these countries--look at Brazil--the gap between the top fifth and the bottom fifth is as extreme as anywhere in the world. If you liberalize there's an incentive for the elites in these societies to globalize, plug in, benefit themselves, buy a new BMW, read the Financial Times every morning but, on the other hand, encourage labor rates to stay low because one of the comparative advantages that they've got in these countries is having low-cost labor.

... And I think it behooves the financial community to realize that unless they come up with policies that are socially just, that deal with issues of social equity, then they will not be coming up with approaches that are sustainable and they will get into this swing back and forth, and they will ultimately hurt themselves economically. So there are very pragmatic reasons to do the right thing ...

Do you see any signs that the financial community is beginning to wake up to what you just said?

Absolutely. I mean, there's a debate going on. The Washington consensus has been put on a shelf. There is a new thought that something that is more politically sustainable is needed. People have read leading thinkers on these subjects, whether it's at the World Bank or Jeff Sachs at Harvard or Paul Krugman or others who have said, "Hey, wait a minute. Let's reconsider this. There are national interests to address in some of these countries." The result of that has been [a] calibration, and inevitably it will produce a Washington consensus, too, or better yet some consensus that is not so closely associated with the capital of the First World. It has a little bit more components of reflecting the needs of people in each one of these markets.

... There are going to be ups and downs, and this gives people a chance to adjust. And I think, also, while there are many places in the world that this economic crisis has caused enormous pain and a pain that really requires an effort to adjust, because we're talking about hundreds of millions of people, at the same time we're talking globally about a change in economic growth of a couple of points.

It's not a global depression. In Indonesia, it's a depression, but globally we're talking about an adjustment, and that's the time to react this way. That's the time to have this debate, responding properly to these things. As has been learned in many of these countries, you can avoid the worst, learn from your mistakes, and come out with a better formula. So, in many respects, this has been quite healthy ...

What you're basically saying is in this new world the markets are in charge ...

They can't be in charge. The markets have enormous power. Governments have got to realize that their goal is to strike a balance where markets can be an engine for growth, to get out of the way and let them be an engine for growth. But to build the safety systems in their societies that allow them to react to markets overstepping, to allow them to react to the fact that markets don't have conscience or vision and don't take into account social justice as an issue. But it's analogous to the situation in a society where you want to have a free society and you want people to be able to do as much as they can based on their own free will, but you have to set certain limitations.

... But, also, governments are going to set the priorities for how their countries are going to grow. They have to decide whether they want a system that brings that bottom fifth up. They have to decide how they're going to use the human capital, which is a crucial component in these equations. The new technologies that have linked together the markets of the world can also be used to link together educators and students. They can be used to build the knowledge resource so that the gross knowledge product of a country can grow in the same way that the gross domestic product of a country can grow. That is the kind of job that only a government can provide and that has to be figured into this mix.

It's in the interest of the markets in the long run, too, because they end up with value-added producers. They end up with people who are not just simply fruit pickers or miners or people dealing in the kind of single-resource commodities that have defined many of the economies of these countries. So governments are there to provide for the greater good, and they need to allow markets to do what they can to provide for that, and they need to be the watchdog.

One of the things that strikes me as an absurdity in this conversation is when you have hedge funds and other players in the global markets saying we'll be self-regulating. These guys would never think of walking out of their plush office down into the street and getting into a self-regulating taxi cab, and they certainly wouldn't use the toothpaste of a self-regulating drug manufacturer. So why is it that they think that somehow they are going to be so public-spirited that they should be allowed to do this? The answer is they can't be. Markets can't be self-regulating. Governments shouldn't over-regulate, but there's a role to play.

In retrospect ... did we push these countries too hard to open up too fast?

No, I don't think so. I think that the push was needed. What's happened in these countries in the past few years has been enormously beneficial. While many of them have gone through a rough year, they've gone through nine or more very good years, and many of them because of these policies are reacting in sounder ways. When Mexico had a crisis it didn't close its borders; it kept them open. It didn't choose public spending in a crazy way; it maintained austerity. For much of the Mexican economy there has been recovery, although there's a long way to go for a segment of the Mexican economy.

But in the wake of this crisis in places in Latin America like Chile, Argentina and Brazil in the past few weeks and months you've seen sound steps based on what they've learned during this period allowing them to recover more quickly. The same is true in Korea; the same is true in Thailand; the same is true with steps the Chinese government has taken to keep themselves from being drawn into this too much. We'll see whether they're successful or not. I'm not sure that they will be ... In some countries we haven't seen it. In Russia we certainly haven't seen it.

It's premature to point to Mexico as a success story in the sense that yes, the financial markets recovered more or less, although ... we can't say that recovery is complete until the financial system is robust again and until those people have started to see their lives improving as a consequence of all of this, and until that happens Mexico is still vulnerable ... .

You know, this crisis was not a crisis of fundamentals; this was a crisis of confidence. In many of these places things in a different mind set in the marketplace could have gone on okay. But what happens in a crisis of confidence is that when there is a misstep in one place, the markets start having to look for capital to cover margins and stuff like that from elsewhere. The places that they look or where they think maybe there's going to be a problem in the future, and a lot of that's based on the confidence that has been engendered by the government's policies there. So the Brazilians had this very unusual experience of watching Boris Yeltsin go to bed drunk and having them wake up in the morning with a hangover. So this is a phenomenon in this marketplace.

Was any of that predictable at the time that we were pushing these places to open up all of their financial marketplaces?

Many of these problems were predicted. I mean, people knew Thailand was in bad shape before Thailand tanked. People knew that there was a lot of money going back into these markets and that it could leave overnight ... I was going out giving speeches saying, "Beware, you are likely to have another emerging markets crisis a year," before this thing happened. Certainly, anybody with half a brain and a calculator could have figured out that Russia was going nowhere. ...

But a lot of people were also making 100% and 150% interest rates on Russia's short-term debt.

When you're making 150% interest rates, you get what you get. I mean, the upside is great. The reason that the upside is great is because the risk is great, and you play with fire and you're going to get burned.

You were engaged in the so-called hype. Tell me a little more about that.

Yeah, well, at the beginning of the administration, we did identify these 10 large emerging markets that we felt were enormous opportunities for U.S. export growth. And, indeed, not only were they; they are. The fact of the matter is the 10 largest emerging markets will be more important export markets for the United States than Europe and Japan combined.

So if you see exports as the key creator of U.S. jobs or a key creator of U.S. jobs, which they are, and you see them as important to the U.S. economy, then targeting these markets is the right thing to do. At the same time, if you see the markets are having strategic importance, then finding common ground and common sense of issues, helping them by bringing investors--because bringing investors brings exports to the United States. There's a direct correlation between investing and exporting. All these things are in our interests ... It's the right policy for now. Backing away at the first sign of crisis doesn't make any sense ...

So if there was a little bit of hype to change people's focus ... and to get them to sit up and pay attention, I think in the end it was worth it because we can't look away and, guess what, people aren't looking away. You could just as easily write a newspaper story today called, "The Emerging Market Boom" and people would be surprised and they would say, "Well, wait a minute, I thought they were all going through a hard time." But in many of these markets last year, foreign direct investment was up and foreign direct investment is to portfolio investment as marriage is to one-night stand.

I mean, portfolio investment comes in and goes up. Foreign direct investment stays there. That's the kind that you want to have. That's the kind of building factories and plants and infrastructure that transforms a country permanently. And that's still growing. Why? Because the power companies and the telecom companies, the automobile companies, the energy companies realize that these are the places they're going to have to be for a long time to come. So that's the bedrock of these economies, and that bedrock is strengthening, not weakening.

During these early discussions and the decisions to open the markets for exports, the trade markets, where did the push to open the financial markets come from? What role did Treasury play in all of that?

Well, first of all, the financial markets opened because of the markets. Governments were always very limited in all of this. We did a lot of stuff promoting big emerging markets ... [But] we have to view government, actually, as a lagging indicator. The United States government did not declare China a big emerging market. China's big, it's emerging, and it's a market. I mean, the fact that the government finally got around to realizing it probably should have been a sign to people that things were going to change soon.

This is true with a lot of things in these markets. Convergence happens to standards because the guys with the money want to know how much a company is making. They want generally accepted accounting practices. They want to know how the government is managing a tax regime. So this kind of thing was driven by the markets and abated by government and not the other way around.

But isn't it true that the U.S. government was making it a condition of membership in various international organizations ... that they get rid of any controls that they themselves had on the flow of capital?

... Right. So what? ... That's a good thing. We saw it in our interest, as it was, to liberalize markets, to get these countries to plug in better, to get capital to flow in. It's in the interest of these markets for capital to flow in, and to make that a condition for entry into these clubs that these countries wanted to join is a sensible, responsible thing.

The problem comes when you push too hard regarding subsets of these issues, like protecting a currency at all costs or allowing capital to flow in on a completely unregulated basis, which just doesn't make sense for a lot of these small economies, and it isn't socially just. You need to find a third way.

You ... [have] compared global economics to plate tectonics. Would you tell me a little bit about that?

... when you look at the global economy, one way to view it is using a plate tectonic model where there are fault lines all the way around. When there's a shift of one of these fault lines, particularly a big shift, it can be felt all the way around the world and we saw that last summer.

There was a fault line underneath the Russian economy. It shifted. The impact was on Brazil where there was another fault line which shifted and caused a problem throughout Latin America. You saw that with the Asian financial crisis where there were fault lines under a number of these economies that we reset into disequilibrium as a result of too much capital and too many foreign-denominated loans coming in while currencies were valued wrong ... Well, that fault line moved and what happened? Demand fell off enormously, and that's how the energy was passed through this system of economic plate tectonics, if you will, and it affected the countries of Latin America. Why? Because most of them export commodities--40% of Chile's exports is copper, and 40% of their exports goes to Asia. So at that time all of a sudden you've got a consequence in Chile.

Even to this day there are fault lines that could shift and could set off another set of these things. Wall Street with an Internet bubble in the middle of it is a fault line. Japan with a weak financial system and uncertainty about whether the government's latest round of reforms, after round after round of reforms over the course of the past decade, are going to work is another fault line. China, with the value of the yuan and whether they're going to devalue, is another fault line. A spreading war in Kosovo, a conflict in the Middle East near the source of oil, these are fault lines that exist out there. We have to recognize that in the global financial system right now these aren't isolated, these aren't remote from us. They can affect us and they can affect other markets in a fairly immediate way.

So you don't think that this rolling crisis is over?

... Personally, I'm a little worried because I think there is a bubble in the middle of the Wall Street economy. No one should have any confidence in the Japanese ability to fix their problems because they haven't been able to do it so far and they haven't taken sufficiently dramatic steps, although they may. The Chinese could be spooked by a variety of other things and need exports to produce hard currency ... We are still in an era or period in which confidence is not restored, and until it is restored, until there is a deep sense that we're back on the upward track, we stand vulnerable to upsets like the upsets we've seen in the past year.

Is there a danger that the wrong lessons are being drawn from the crisis of the last year and a half, two years?

... Not only is there a danger, there's a certainty that the wrong lessons are being drawn by some people. By most of the people at the center of the international financial system, are the wrong lessons being drawn? I don't know. I don't see the IMF being highly responsive to this. I don't see it having learned its lessons. I see that lending $5 billion more to Russia seems to me to be at best an accounting transaction, at worst another waste of money. I see still an absence to be able to address questions of social equity in an effective way, and so these things will take a while to formulate, but the general trend within the markets is to be fairly thoughtful about this at the highest levels, and there is a general movement toward understanding things better ...

Part of the problem is that in emerging markets, just as some of them are not highly liquid financial markets, they are not highly liquid information markets, and as a result a little bad information can cause quite an upset just as an inflow of too much money or an outflow of too much money can cause quite an upset of these markets.

So they're still volatile? They're still erratic?

Volatility is the toughest issue to deal with because the pipelines are getting bigger and bigger through which money goes. It allows it to go in quickly. It allows it to go out quickly. The amount of information people have allows them to make decisions very quickly. The mentality of a lot of these investors is not a long-term mentality in terms of the portfolio investors, and volatility is a big risk for a lot of these places. That's why you'll see some kind of modified capital controls in a lot of these countries growing even though that has not been for a long time the policy of international financial institutions.

It's just inevitable in a medium- and a small-sized country that they want to protect themselves against that kind of disequilibrium. You will always see greed and self-interest drive markets to places that reason wouldn't.

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