By Pete Engardio
Inside the Crisis that Rocked the
Global Financial System and Humbled the IMF
By Paul Blustein
PublicAffairs 431pp $30
Just three years ago, long before the panic over bio-terrorism, the world was gripped with fear of a different contagion: an epidemic of financial crises. These first infected such economies as Mexico, Thailand, Indonesia, and Russia--and then struck close to the U.S. financial nervous system with the September, 1998, near-collapse of hedge fund Long-Term Capital Management.
These days, you don't hear as much about financial contagion. True, the International Monetary Fund has had to stamp out financial fires in Argentina and Turkey. But such crises haven't spooked the global currency markets nearly as much as they did in the 1990s. Nor do we read as much about frantic calls for reforming the "international financial architecture," an issue that once obsessed Wall Street and leading U.S. think tanks.
This raises some interesting questions. Have investors and bankers perhaps learned their lesson about the hazards of pumping billions of dollars of hot money into risk-prone emerging markets? The IMF was much maligned for its failure to foresee and manage the meltdowns in Southeast Asia and Russia. Could it be that the IMF didn't do such a bad job after all, given the perilous, enormously complex challenges it faced?
After reading The Chastening, the exhaustively reported narrative of the bailouts of Brazil, Indonesia, Mexico, South Korea, Russia, and Thailand by Washington Post journalist Paul Blustein, one is still left wondering. One reason is that the book is thin on fresh analysis of what the IMF, the capital markets, and developing nations learned from these debacles--or how to combat the next ones. But then, the crises of the 1990s came so unexpectedly that much of that period was simply a blur. And as Blustein notes, Brazil pulled out of crisis and averted recession in 1999 after the IMF insisted it hike interest rates and slash spending--policies that failed disastrously in Thailand and Indonesia.
The Chastening's main accomplishment is to clear up much of the mystery about what went on behind the scenes during the big bailouts of the 1990s. Benefiting from near-complete access to most officials who were directly involved, Blustein chronicles in meticulous detail how what he calls the High Command--the IMF, the U.S. Treasury Dept., the Federal Reserve, and other finance leaders of the Group of Seven countries--crafted the rescue plans in Mexico, East Asia, Russia, and Brazil, along with the many mistakes and tribulations along the way. He shows how, despite its confident, all-knowing facade, the IMF and its army of classically trained economists were clueless about the workings of modern capital markets and the shady complexities of Asian politics and corporate finance.
Blustein also details the stormy arguments inside the High Command. We read, for example, of former World Bank Chief Economist Joseph Stiglitz squaring off with then-IMF Deputy Managing Director Stanley Fischer over interest-rate and fiscal-austerity policies. He relates the feud between the State Dept. and Treasury over how much reform to force upon President Suharto, who eventually lost power. We also read of Treasury's blatant role in pushing the business interests of Wall Street by using bailouts to force nations to open their capital markets to foreigners.
The overall portrait of the IMF that emerges pretty much tallies with what many observers have long suspected: Far from being an omnipotent wizard, the IMF is no better informed or economically astute than any number of players. Too often, its policies are the result of guesswork or backroom deals rather than an intimate understanding of developing nations. Still, while he chastises the IMF for its arrogance and blunders, Blustein also gives it some credit. After the global financial system seemed on the brink of disaster in late 1998, when Russia defaulted on foreign bonds, the contagion quickly abated once the G-7 lowered rates, the Fed engineered the rescue of Long-Term Capital, and Brazil's crisis eased.
In fact, given the nature of modern international finance--in which myriad investors whisk billions in and out of countries for obscure reasons--the IMF may simply be out of its depth. "Global capital markets have gotten so huge, so unruly, and so panic-prone that the High Command can be easily overwhelmed," Blustein observes.
What's the solution? In a cursory final chapter, Blustein lists and then dismisses as impractical many popular proposals for reforming international finance. Except for one: He notes that in two bailouts that eventually worked well--Korea and Brazil--the biggest debtors were banks, and the key borrowers were governments. The banks agreed to roll over maturing debts until a game plan for resolving the crises was worked out. Blustein endorses a similar system for private debt. The IMF would enforce a temporary halt of hard-currency repayment of corporate bonds and short-term loans, the main problem in Indonesia, Russia, and Thailand. But this, too, would be hugely problematic.
Perhaps a better remedy is for emerging markets to just avoid hot money if their financial systems can't handle it. In effect, this situation already exists: Since the Russian default, short-term private-capital flows to emerging markets have slowed sharply. Therefore, there's less money for speculators to pull out because of panic somewhere else. Of course, with growth in emerging markets still expected to outpace the West, the fast-money crowd won't stay away forever. With luck, both investors and future IMF staff will learn from the mistakes of the 1990s. Senior News Editor Engardio is co-author of Meltdown: Asia's Boom, Bust, and Beyond.