Trouble in the High Command

The Chastening: Inside the Crisis That Rocked the Global
Financial System and Humbled the IMF
By Paul Blustein. Public Affairs, 431

There's nothing like a nice vacation to take your
mind off looming global
financial meltdown. Just ask former U.S. Treasury Secretary Robert Rubin, who
sneaked away for a fishing trip to the British Virgin Islands as the South Korean
economy teetered on the verge of default in December 1997. Or Central Bank of
Russia boss Sergei Dubinin, who took some personal time in Italy just as the
Russian ruble was crumbling in August 1998. Or Stanley Fischer, the former deputy
managing director of the International Monetary Fund (IMF), who was enjoying a
family holiday on the Greek island of Mykonos that same month when the Russians
hit ruble trouble (although he cut his trip short to help them through the
currency woes).

The series of crises that battered the world economy during the late
1990s--in Asia, Russia, Brazil, and the United States--interrupted many a holiday
for the world's top financial-policy makers and bureaucrats, and tested some key
officials who might otherwise have labored in placid obscurity. The crises and
the individuals coping with them are the subject of Paul Blustein's The
Chastening, a postmortem of how the international economy came close to
collapsing between 1997 and 1999. Blustein, a Washington Post economics reporter,
offers a sobering conclusion: The financial world is vulnerable to recurring
instability, and the IMF bureaucrats, U.S. Treasury policy-makers, and Group of
Seven officials charged with overseeing world economic conditions-- Blustein
sarcastically calls them the "High Command"--are ill-equipped to deal with it.

The instability of the late 1990s began in Thailand in early 1997, when the
Thai baht (then pegged to the U.S. dollar) came under strong selling pressure in
international currency markets. After draining its hard-currency reserves, the
Thai central bank was eventually forced to devalue the baht. Even IMF support
through a $17.2-billion bailout package was unable to prevent the crisis from
spreading to Indonesia, Malaysia, and two particularly worrisome nations--for
geopolitical as well as economic reasons--South Korea and Russia. When the
contagion hit Russia in August 1998, forcing the authorities there to devalue the
ruble and default on loan obligations, the U.S. market finally felt the pain.
Financial markets in the United States seized up and Long-Term Capital
Management, a major Connecticut-based hedge fund, fell apart--saved in the end
only by the Federal Reserve, which brokered a rescue involving major U.S. banks.
In early 1999, pressure from currency markets hit Brazil as well, forcing the
country to devalue its real despite an IMF-led $41.5-billion international
bailout package just two months earlier.

Although by now the specifics of each crisis have been analyzed in countless
academic papers, seminars, and conferences, Blustein offers a useful journalistic
summary, neatly devoting a chapter to each country and generally avoiding the
garbled wonk-speak typical of his subject matter. Although he occasionally
overdoes the local color ("The moon was full, imparting luminosity to the snow
coating the Alps as Stan Fischer left Davos, Switzerland"), Blustein conveys a
good sense of the frantic and often comical life of the High Command. Readers
learn how IMF and World Bank economists couldn't exchange electronic documents
during the Indonesian crisis for the simple reason that Fund staffers used
WordPerfect software while bank economists relied on Microsoft Word. Blustein's
readers also see then-IMF Managing Director Michel Camdessus and fellow IMF
official Hubert Neiss (a flat-topped, barrel-chested Austrian national) sneaking
cloak-and-dagger-style into Seoul in November 1997 and registering at their hotel
under fake local names--quite convincingly, I'm sure. And certainly we all can
empathize with the plight of Korean economic official Kim Ki Hwan. Waiting
patiently in his Washington hotel room for a crucial phone call from his home
government, Kim missed the connection because, as he put it, "you cannot deny
yourself a call from nature."

By revealing the accidents, compromises, and guesswork involved
in dealing with international financial turmoil, Blustein goes a long way toward
dispelling the IMF's well-cultivated image as a font of macroeconomic wisdom--a
"high priesthood" of finance, as Blustein puts it. In particular, the author
identifies three reasons why the High Command failed in anticipating and
containing the crises.

First, the IMF did not have the in-house expertise to focus on the banking
and corporate-finance problems prevalent in many of the affected countries.
Blustein offers a damning description of how the IMF Institute (a boot camp for
entry-level economists) teaches a simplistic, formulaic approach to crisis
management. If an economy faces a high external deficit--that is, if it spends
more hard currency than it earns--the Fund's knee-jerk reaction is to grant a
loan package on the condition that the domestic authorities impose fiscal
austerity and higher interest rates. By dampening domestic demand, the IMF
reasons, it can compel the country to stop "living beyond its means." Yet in an
era of massive capital flows moving lightning-fast throughout the global economy,
the author argues, crises can erupt for reasons that have little to do with a
country's fiscal or monetary policies. Or as Moshin Kahn, the Pakistani director
of the IMF Institute, admitted to Blustein: "It's not clear our economic theory
works." In Thailand, for instance, the IMF pressured the government to "restore
confidence" through tight fiscal policy, when the true problem was not Thailand's
budget but rather its corrupt banking system and overvalued real-estate market.

Second, even if the IMF correctly diagnoses an economic imbalance, the
countries in question are rarely willing to undergo politically painful economic
reforms until a crisis is upon them. In times of apparent prosperity, no one
wants to take long-term economic imbalances seriously. Blustein quotes a former
IMF economist who explained how, when Fund surveillance teams warned Asian
economies of impending troubles, "they'd be politely told 'go away' and the
country would grow seven percent." And even when a crisis appears imminent,
countries often conceal crucial economic data from the High Command. Blustein
details how Thailand's central bank lied about its available dollar reserves in
1997, not only to the IMF but also to Thai cabinet members. "Only a handful of
[Thai] officials knew the dreadful secret ... ," writes Blustein. "The Bank of
Thailand was nearly out of hard currency." In a particularly surreal exchange, a
senior Thai financial official finally told Stanley Fischer the truth--but only
on the condition that Fischer not tell anyone else at the IMF.

Third, and perhaps most important, the High Command is made up of groups with
often competing interests. Blustein devotes much attention to the divides between
the IMF and its most influential member, the U.S. Treasury. Under pressure from
U.S. financial firms, for instance, the Treasury took advantage of the South
Korean crisis to push hard for the Korean authorities to open up the country's
financial sector to foreign competition. Though the Americans claimed that such
policies would help Korea in the long run, IMF officials privately decried the
Treasury's ulterior motives. "The U.S. saw this as an opportunity ... to crack
open things that for years have bothered them," complained a Fund staffer. The
U.S. position ultimately prevailed, with the Koreans allowing foreigners to
establish bank subsidiaries and brokerage houses by mid-1998.

As the book's title suggests, Blustein seems to believe that the failings of
the late 1990s may chasten the IMF and prod it to change some approaches. Recent
developments suggest that the Fund is indeed willing to experiment. In late 2001,
for instance, Argentina seemed next in line for a massive IMF bailout as it
struggled with a multiyear recession and a staggering $132-billion public debt.
But rather than put together yet another financial-assistance package, the Fund
canceled a $1.3-billion loan installment to Argentina in early December 2001, on
the grounds that the government had exceeded its agreed-upon fiscal-deficit
target. The results were dramatic: Just a few weeks later, Argentina's elected
government collapsed, with President Fernando de la RĂșa leaving the Casa
Rosada by helicopter amid widespread protests and looting. Argentina officially
defaulted on its debt in early January. A few low-key statements of support
notwithstanding, the IMF has remained largely silent. For better or worse, the
era of knee-jerk, billion-dollar bailouts may be ending.

But what new crisis-management system might emerge? In November, senior IMF
official Anne Krueger announced the Fund's intention to create a global
bankruptcy system whereby an economy experiencing massive capital outflows could
request a "temporary standstill" on its debt obligations, thus gaining breathing
room to negotiate with its creditors. Predictably, however, Krueger's initiative
faces numerous problems. It would require changes in national or state laws to
prevent individual creditors from suing for full repayment during the standstill
period. (New York State law, in particular, would need some tinkering.) A global
bankruptcy system could also discourage private investment in emerging markets
since creditors would fear a future repayment moratorium. And finally, many poor
countries may be unwilling to avail themselves of the system, for fear of
destroying their creditworthiness in the eyes of the international financial
community. Indeed, as the High Command discovered during the 1990s, almost any
new effort or mechanism to reform the global financial architecture seems only to
create additional problems with unintended consequences that invite--rather than
prevent--further financial turmoil.

It's enough to make you want to take a long vacation.