Statement of
Robert B. Zoellick
on the
Asian Financial Crisis
before the
Committee on Banking and Financial Services
U.S. House of Representatives

January 30, 1998

Mr. Chairman and Members of the Committee:

It is a pleasure to be with you today. My statement addresses four questions:

• What happened to the economies of East Asia?

• What are key developments to watch in the future?

• Why do these events matter to Americans?

• What should the U.S. be doing?

I. What happened to the economies of East Asia?

Each country’s circumstances are different. Nevertheless, there has been one core problem throughout most of East Asia: Imprudent credit decisions have led to bad loans.

Some of the bad decisions stemmed from poor banking practices. Some stemmed from flaws in the economic policies and structures of countries. And some stemmed from political influence over lending. However, all the lending problems caused by these mistakes were exacerbated by weak supervision of banks and the lack of transparency (open information) in financial markets.

In Southeast Asia, many of the countries had pegged their currency exchange rates to the U.S. dollar. As a result, these economies were linked to U.S. monetary policies, which during the 1990s expanded credit considerably. In addition, Japanese banks were eager to lend. Therefore, the nations of Southeast Asia faced the risks of "easy money" -- the temptation of too much borrowing and overleverage. These risks were compounded by another risk: borrowing U.S. dollars while earning revenues in local currencies. Once local currencies began to fall in value relative to the U.S. dollar, otherwise healthy Asian companies began having a harder (or even impossible) time paying back their dollar debts.

The low cost of capital, and underestimation of risks, led to a real estate bubble in some Asian markets and the building of excess industrial capacity in others. These lending mistakes were compounded by errors of crony capitalism and corruption.

Moreover, as the value of the U.S. dollar rose, the currencies pegged to the dollar rose as well, increasing the prices of exports from those countries and lowering the costs of imports. Thus the exports from these Asian economies faced stringent competition from China, Latin America, and elsewhere. As a result, they had a harder time generating export earnings to pay back their debts.

Once the speculative bubbles started to burst, and bad debts accumulated (starting in Thailand), investors -- and in particular, local investors -- feared holding the Asian currencies – so they sold. As the selling momentum increased, turning into panic, investors dumped the currencies of other countries that may have had excess capacity, overbuilding, or even current account deficits that signaled the country was relying on inflows of foreign capital. Some investors sold because they feared the herd actions of other investors in smaller markets around the world that do not have the depth to resist speculation and bounce back. Moreover, once the trouble started, most Asian countries could not raise interest rates (making their securities and currencies more attractive), without causing more strain for borrowers struggling to pay back borderline debts.

Japan and Korea also faced the core problem of bad credit decisions compounded by poor financial supervision. Banking-industrial-government linkages exacerbated the lending problems in these countries; these national economic structures represent deeper problems that will not be subject to a quick or easy adjustment.

Today, Japan has a two-tier economy, composed of a small number of world-class multinational manufacturing companies and an inefficient, overly regulated, costly base of smaller businesses that have not had to compete on the basis of price – especially with the rest of the world. Ten years ago, this protected local market and its inefficient businesses may have offered the large Japanese multinationals a cushion; today, these inefficiencies are holding back the large Japanese firms.

Furthermore, the Japanese government’s failure for over seven years to face up to the consequences of huge bad loans on the books of its banks has led to higher costs, suspicions about the banks’ strength, limits on lending, and lack of confidence in Japan’s recovery. Japan’s tax increases then choked off possible growth from spending by consumers and businesses.

Korea’s structural situation is even worse. The state-capitalism of the chaebol system produced: capital allocation based on political pressure; high leverage (borrowing) in cyclical industries; union expectations and practices that increased costs and priced Korean firms out of markets; the discouragement of small business; and a poor environment for foreign direct investment that brings technology, know-how, and more reliable equity investment. Korea’s national economic system – which promoted large scale efforts to direct capital and labor toward basic industries for export – has been unable to adjust quickly to changing market signals.

Viewing the region as a whole, last year’s financial meltdown is becoming this year’s economic downturn. Over coming months, you will read more about bank closings, bankruptcies, unemployment, and recessions.

II. What are key developments to watch in the future?

Events in East Asia have been driven by a combination of market psychology and economic fundamentals. Over time, economic fundamentals should guide market psychology, but markets can overshoot and group behavior can, for a time, send markets crashing or soaring. Sometimes the sharp shifts in prices and values can become so extreme, or last long enough, that they seriously disrupt the activities of workers, businesses, and banks. Under those conditions, the psychology that drives markets can indirectly reshape the fundamental economic conditions.

Asia’s longer term economic potential remains good, especially if countries make institutional reforms and establish the requisite legal and financial infrastructure. The length of this slump depends in part on how quickly countries adjust prices of assets and companies reflect the changes in their balance sheets. Delays will freeze the movement of funds that healthy businesses need. The depth of the downturn also depends on whether subsequent events subject Asia to new blows or give it an encouraging boost.

Therefore, going forward, it is important to keep an eye on developments that are likely to shape market psychology, economic fundamentals, or both. I suggest attention to five topics.

First, will Asian currencies devalue further? In particular, will countries seek to "compete" by devaluing their currencies to make their exports "more competitive?" So far, all the currency devaluations except Taiwan’s appear to have been driven by capital flight. Yet if countries believe they must devalue "to catch up," their actions are likely to trigger another round of attacks on weak currencies. Indeed, this self-defeating pattern occurred in the 1930s, shattering overall confidence in money and prompting more direct forms of protection from foreign competition.

Today, the devaluation question focuses on China. China devalued its currency by about 40 percent in 1994, but that adjustment has been eroded by China’s inflation and the sharp declines in currency values elsewhere in Asia. So some in China might argue that its exports – which fuel China’s growth and ability to create jobs – require another devaluation. Fortunately, at least for now, the Chinese have stated they will not devalue. The U.S. and others should stress to China that this approach is an important contribution to stabilizing other Asian markets and enabling the rest of Asia to rebound through stronger sales. A devaluation by China would also probably shatter Hong Kong’s ability to maintain the peg of its currency to the U.S. dollar, which is important to Hong Kong’s business confidence. Another devaluation by Taiwan would also likely trigger a dangerous chain reaction.

Second, will Japan take the steps, especially through tax cuts, to spark Japan’s domestic demand and growth? Japan should stimulate growth at home. In the past, Japan has usually relied on exports for growth. But that course will not create the demand in Japan to buy goods from other Asian countries that need the boost. Moreover, a Japanese export-growth strategy is likely to place trade pressure on the U.S. and Europe at a time when their open markets will be key to the rebound of others in Asia. As one colleague summarized, Japan is playing the same role in Asia today that the U.S. played in the world economy in the 1930s. That is not a compliment.

In 1997, fearing a large budget deficit, Japan’s Ministry of Finance actually pushed through a tax increase. The Japanese government has now proposed a small one-time tax cut; after criticism of this proposal, some Japanese political leaders have hinted that Japan needs bigger and longer lasting tax cuts. Some Japanese business people and journalists support such economic stimulation. The U.S., others in the G-7, and countries in the region should mobilize pressure that will give these internal Japanese constituencies support for further tax cuts.

Third, will Japan clean up its financial sector and do so in a transparent fashion? The Japanese government has belatedly proposed a 17 trillion yen fund to protect depositors and a 13 trillion yen fund to recapitalize banks. (It has also eased capital adequacy tests.) This package is roughly patterned on measures the U.S. took in the 1930s.

It will be important to watch whether Japan promptly enacts this plan and how the implementation proceeds. Japanese banks are afraid to lend and investors are wary of giving the banks money. As a result, many Japanese businesses are facing a credit crunch. Other Asians are facing called loans. Japan needs to reestablish confidence in its banking system. To do so, it must face up to losses openly so that financial markets can see that the surviving (and probably consolidated) institutions can get back to business. As it confronts these challenges, Japan must also prepare the way for its banks to face outside competition. Opening its markets to foreign financial firms can help draw capital and lessen the deadweight of an inefficient domestic financial sector.

Fourth, will Korea and Indonesia follow through on their IMF plans, avoid debt moratoria, and begin to reestablish confidence? These two countries are particularly important, although Thailand and the Philippines are also working through IMF programs and other countries (e.g., Malaysia) are struggling with the financial fallout. Korea is a big economy, the 11^th largest, sitting on one of the most dangerous military fault lines in the world. A further collapse in Korea would fuel negative psychology in Asia and beyond, as well as posing a major political crisis for Korea’s newly elected President, Kim Dae Jung, who takes office in March. Expectations have arisen, perhaps unreasonably, that the President-elect’s influence with Korea’s unions will enable him to maintain labor peace while businesses lay off large numbers of workers.

Indonesia is influential because it is the fourth most populous country in the world, giving it political weight in the region. It is also the largest Islamic nation. Indonesia’s President Suharto has been in power for 32 years. As viewers of the movie "The Year of Living Dangerously" will recall, Indonesia does not have a history of peaceful political transition.

In the cases of both Korea and Indonesia, failure of IMF plans would weaken its (and the U.S.’s) credibility and ability to stabilize jittery markets. The inability to stabilize markets would increase costs, lead to the closure of otherwise healthy businesses, and delay countries’ recoveries.

Fifth, will the U.S. be willing to support, and where appropriate, lead efforts to stabilize markets, press for reforms, and revive growth? Given America’s size and influence, its behavior will also affect market psychology. If the U.S. appears committed to overcoming a problem, it may not be able to counter all threats, but the likelihood of success improves considerably. Moreover, the U.S. has an unparalleled ability to mobilize others to act. On the other hand, signals of indifference, or even retreat, could feed nervous markets that might slide into panic behavior. Recent visitors to East Asia report an overwhelming (and unrealistic) belief in America’s ability to save the region from disaster.

Whether we like it or not, America’s resources and reputation vest it with great responsibility. Asian officials pressing reforms will seek U.S. attention, encouragement, and support. Reform politicians in Thailand and Korea, just coming into power and taking unpopular actions, will think America will want to stand by them as they confront old and often corrupt power structures. And investors around the globe will scrutinize signals of U.S. commitment and staying power.

This responsibility does not mean the U.S. should try to solve all the problems by itself. The U.S. does not have the capability to do so. Moreover, even if the U.S. could handle that load, it would create a dependency that would be counterproductive for others as well as for America. So the challenge for the U.S. is determining what combination of actions is most important, feasible, and in the interests of the U.S. and the other countries. If the U.S. strikes this balance effectively, it could come out of this crisis with increased power and a better opportunity to shape East Asia’s politics, economics, and security in the 21^st Century.

III. Why do these events matter to Americans?

I suspect that the members of this Committee have been asked, and will themselves ask, how these events in Asia will affect their constituents: why does it matter to us? My reply would have three parts: (a) the big risk; (b) the economic effects; and (c ) the political-security effects.

A. The Big Risk

When markets slip into free fall, no one knows where they will stop and what havoc might be wreaked along the way. Sometimes markets bounce back. Other times they recover, but only slowly. Yet at times big declines become panics, setting off massive destructive chain reactions that extend far beyond the initial explosion.

Such waves of financial and then economic destruction were not uncommon in the 19^th Century, even though the world was less interdependent than today. Some of these financial events became seminal episodes in U.S. political history – like the panics of 1819, 1837, 1857, or 1873 – that crippled American governments. In 1857, for example, the crisis swamped Britain, Sweden, Germany, New York, and Ohio, and then spread to the rest of the United States.

After the international debacle of the 1930s, the U.S. led the way in creating international institutions and regimes to cushion the blows, to contain their effects, and to increase the probabilities of recovery. The U.S. has used this system over the past 50 years for just those purposes. Circumstances differed in each case; remedies varied, too. But the fundamental decision was to activate the insurance policy so that a crisis did not become a calamity.

East Asia is large and important to the U.S. – economically, politically, and in terms of security. Over the past 60 years, East Asia was important enough to warrant three American wars and billions of dollars of defense expenditures. U.S. interests in the region have not lessened over time.

I hope the financial situation in East Asia will stabilize. But no one can assure you of that result with certainty. And that doubt sets up the big risk: a loss of confidence that leads to a greater collapse of currencies and markets, with ripple effects turning into waves that lead to more bankruptcies and bank failures, and to deeper recessions. Such events would not only hurt U.S. exports and slow growth, but could undermine a host of business activities around the world. Such economic events, although unlikely, would certainly have political and possibly security implications. It is definitely in the U.S. public’s interest to protect against this scenario.

B. Economic Effects

Even the events to date, however, will affect the United States and world economies. The consequences include the following:

• The Asian economies will buy less from the United States and others, hurting U.S. exports and increasing the U.S. trade deficit. U.S. exports to Asia totaled about $200 billion in 1996, roughly 3.5 percent of America’s GDP. Those sales amount to about 30 percent of all U.S. exports, more than we sell to Europe. U.S. sales to Asia range from capital goods and aircraft to agricultural products, with much in between, and support millions of U.S. jobs. Because Asia will grow more slowly – and many countries will be in recessions -- overall global growth will slow, reducing increases in income and purchases around the world.

• East Asia’s financial problems will spill over to other developing country markets. Asian capital invested in these markets will be needed at home. (Both Russia and China are concerned about this loss of funds.) In addition, mutual funds and other investors are now more reluctant to put money in any emerging economy.

• The devaluations and excess production capacity in East Asia will lower prices for many tradeable goods (e.g., steel, petrochemicals, electric goods, semi-conductors, footwear, textiles). This competition will hurt exports from other developing countries, particularly in Latin America and Eastern Europe. Some U.S. firms will benefit from lower prices for imports; others will face price-cutting for their goods.

• I suspect the drop in U.S. exports and the low import prices will squeeze the earnings of some U.S. companies, especially when combined with slowly increasing U.S. labor costs. I believe this slippage in earnings will show up more clearly in this quarter’s results. The steady increase in corporate earnings has been a key contributor to the increases in the stock market over the past few years.

• U.S. investors in Asian equity markets, including small holders of mutual funds, have already experienced huge declines. Given these drops, some American investors will now perceive opportunities to purchase Asian assets at low prices. However, given the overcapacity, considerable systemic uncertainty, and the lack of good accounting information for most Asian businesses, the capital invested is likely to be tentative and of modest scale compared to the continued drains.

• Investors fleeing foreign securities have been turning to the "safe haven" of U.S. dollar securities, especially the debt of the U.S. government. This inflow has helped hold down U.S. interest rates and increase the value of the U.S. dollar. A higher value for the dollar makes U.S. goods more expensive abroad (cutting exports further) and lowers the cost of imports. Over time, however, if the U.S. trade deficit grows to a size considered unsustainable, investors are likely to move out of U.S. dollars, reversing the drop in interest rates.

These effects will be significant (sometimes disruptive, sometimes beneficial) for individual businesses and sectors. Given the strengths of the U.S. economy at present, however, the changes should be manageable from the viewpoint of the whole country. If the Asian crisis deepens, the risks of greater damage to the United States increases considerably.

C. Political-Security Effects

The political and security effects of the economic crisis in East Asia are likely to be wide-ranging, and they are only starting to be perceived. Indeed, events could follow very different courses, with contrasting outcomes. To the degree possible, the United States should be steering developments to circumvent dangers and even create opportunities out of tumult.

This crisis has severely squeezed, and in some cases wiped out, middle classes that have been developing in Asian countries over 25 years. Historically, such trauma to the middle class unleashes perilous forces. Asia’s trial will be heightened because many Asian political leaders have based their domestic legitimacy on records of improving their citizens’ prosperity.

One possible recourse is for people to challenge the political leaders, either promptly or during the next transition of power. Countries might move toward more open political systems and against corruption and crony capitalism. But powerful established groups usually do not cede their authority gracefully. They may substitute new faces without changing the underlying system. The old regime may hand authority to reformers who then pay the public price by taking painful steps to clean up the inherited mess. The rulers may blame outsiders – whether in the form of ethnic groups, other countries, the United States, the IMF, foreign investors, or a host of others. And they may respond to opposition with force.

Since the Vietnam War, the countries of Southeast Asia have come to recognize that each would be better off if all prospered. Through ASEAN, the Association of Southeast Asian Nations, these countries have worked together to dampen possible conflicts, build trust, and promote economic growth. But short-term crises, and the risk of losing control at home, can blind countries to their common regional interest. The combination of excess capacity and rounds of competitive devaluations could lead Asian nations down the blind alley of 1930s-era policies.

As I noted earlier, the countries of Asia are now openly depending on the U.S. for help, in striking contrast with some of the rhetoric of recent years about the decline of the U.S. economy and its decaying society. Although it might be tempting to some to "teach Asia a lesson," a policy of spite would leave a terrible legacy for the U.S. in the post-Cold War world. Indeed, the U.S. would be ignoring its own successful lesson from the far-sighted approach America chose after 1945.

Further economic and political unraveling could lead to breakdowns that would threaten American security. If the U.S. leaves a leadership vacuum in an area of strong interest, regional powers may strive to fill it on their terms. Perhaps others will resist this, or maybe no one would fill the gap, leading to regional conflicts or fragmentation. In any event, Asians would conclude that the U.S. is unreliable, undermining America’s abilities to lead coalitions for causes as diverse as conflicts in the Gulf, opening markets to trade, non-proliferation of weapons of mass destruction, bases for the projection of American power, the environment, human and religious rights, or countless others. Great powers cannot ignore upheavals in regions of vital interest without giving up the influence that compensates for their labors.

Nevertheless, U.S. intervention involves risks. Some Asians might resent the U.S. as the agent of painful adjustments. Others may fail to recognize that self-help actions are critical. Ultimately, the benefits and costs for America are likely to depend on the skill of the U.S. performance and the results.

There are also specific political and security issues that could be triggered by the economic events, including the following:

• Indonesia’s continuing difficulties are based in part on the uncertainty about President Suharto’s future and who might follow him. Suharto recently announced his intention to stand for a seventh term (of five years) as President in the March 11 elections. Speculation about his choice for Vice President has added to the questions about Indonesia’s willingness to undertake serious reforms. The future of Suharto’s family, which has gained extraordinary wealth and public influence, is inevitably connected to this political conjecture. Moreover, the ethnic Chinese in Indonesia, comprising an estimated three percent of the population, control much of the country’s wealth (with some reports guessing the proportion at about two-thirds). During the upheaval of 1965-66 that propelled Suharto to power, hundreds of thousands (and perhaps more) of Indonesians were killed, many of them of Chinese origin. The slaughter has been traced to fear of communism and China, but also to resentment of local Chinese wealth. Ominously, China recently issued a warning against threats to ethnic Chinese in Indonesia. Traditionally, the non-Chinese peoples of Indonesia and other countries in the region have been highly sensitive to China’s possible intervention on behalf of overseas Chinese.

• Korea’s President-elect, Kim Dae Jung, has been an outsider in Korean politics. Most of his statements since his election have signaled plans to implement serious economic reforms. He will certainly face resistance from the traditionalists in bureaucracies and the corporate conglomerates. At the same time, the powerful Korean labor movement, with which Kim has ties, is likely to object to the upheavals that will follow from corporate restructuring and recession. It is not yet clear whether Kim’s new team will have the depth and experience to navigate these powerful, contending currents.

  Moreover, Korea’s northern neighbor remains a heavily armed economic basket case. No one should be complacent about North Korea’s political stability. North Korea has the capability, even just with conventional artillery emplaced in the north, to reduce the southern capital of Seoul to rubble. The U.S. has about 37,000 troops in Korea to help deter trouble from North Korea.

  Shortly after his election, President-elect Kim signaled his interest in reviving North-South talks. But the South now has many fewer resources to devote to assisting the North. Indeed, I expect Korea (and perhaps Japan) will even ask the U.S. and others to help them cover the billions of dollars they pledged to build the nuclear facilities in the North under the Framework Agreement that the U.S. negotiated with North Korea.

• The rampant corruption that permeated Thai politics contributed to the country’s financial collapse. But the new Thai government appears committed to cleaning up both the current symptoms and underlying causes. The Thais have been troubled, however, by the perception of the lack of U.S. support, beginning with the U.S. failure to make even a token contribution to their financial package last year.

• Because China’s currency is not freely traded in world capital markets, it has been spared financial assault. But China faces enormous economic challenges. Indeed, China’s bad debt and banking problems dwarf those of countries that have been badly hit. It will now face tougher export competition and the prospect of less investment from Asia and perhaps elsewhere. Both changes will make it harder for China to close inefficient state-owned enterprises and open new businesses that will create jobs. China’s leaders have so far avoided actions that might exacerbate the crisis. And they appear to recognize that China will need to combine a carefully sequenced solution to unprofitable state enterprises, existing bad debts, the absence of an effective financial system, and opening to global competition and capital. Nevertheless, China’s leaders will need great skill to manage that awesome combination of challenges.

• Hong Kong, in the aftermath of its return to China, is struggling to maintain the confidence that is fundamental to its special status. Disease, a sharp fall off in visitors, and problems in the property and stock markets each have added to the burdens of transition. If the HK dollar loses its peg to the U.S. dollar, market confidence -- and Hong Kong’s confidence in itself -- will deteriorate sharply.

• Across the region, political tensions about open trade and foreign investment will be rife. Some Asians believe that openness, competition, and deregulation will counter crony capitalism, corruption, and mistaken decisions by economic bureaucracies. Others will argue that Western capitalism is a conspiracy aimed at achieving U.S. domination, or that open markets leave their economies too exposed to market whims.

  Similarly, some Asians recognize that foreign investment will help restabilize markets and, over time, link their economies to more know-how, technology, and competition. But purchases of Asian assets at fire sale prices will spur resentment and tales of conspiracy, even as it has at times in U.S. history.

  These vitally important decisions for Asia’s future – affecting political as well as economic outlooks – will not depend only on intellectual arguments. The debate will take place with a background chorus of fears, frustrations, and even bewilderment.

In sum, the economic events in East Asia are triggering a host of political and perhaps even security consequences. These developments pose risks and opportunities for U.S. policy. In considering whether to offer financial support, one should consider how many risks one is willing to multiply, given the potential consequences.

IV. What should the United States be doing?

So what should the United States do? Broadly conceived, the U.S. response needs two stages: first, stopping financial contagion that makes all the other problems harder to solve and that could shake businesses, lenders, workers, and governments in all quarters of the globe; and second, laying the foundation for economic and political reforms that can only be achieved over the longer term. More specifically, I have ten suggestions:

First, the U.S. should organize a coalition – with the European Union and countries in Asia – to press Japan to stimulate its economy, preferably with tax cuts, and to clean up the bad debts of its financial sector in a transparent fashion.

These two actions would provide a big boost for market psychology and an engine of growth for Asia. They would help Japan, the region, and the world. Japan’s political system appears unwilling to take these steps on its own, but there are constituencies in Japan that are supportive. If internal advocates combine with broad-based foreign pressure (not just the U.S.), there is some chance Japan might assume self-interested responsibility.

Second, the U.S. should support international efforts to help countries stabilize currencies and markets if the countries are willing to take actions to reestablish confidence and to start to address the underlying problems. Markets can and do overshoot; financial panics can crack the real economic foundations of manufacturing, services, agriculture, and other sectors. But the U.S., IMF, World Bank, and others can only assist if countries face up to the actions they must take. The U.S. should be particularly attentive to the prospects of nations whose turmoil might create security dangers and of countries led by reformers who have been propelled into office by the crisis.

Third, the U.S. should continue to signal its close attention to the security of the region. This posture may help deter problems from arising or rash moves by parties seeking to position themselves in the absence of U.S. power. It will reassure governments worried about large-scale breakdowns. And this U.S. security leadership could enhance America’s leverage on political and economic topics.

Fourth, the U.S. should continue an ongoing, high-level dialogue with China about economic events in Asia, focusing on Chinese actions (especially devaluation) that would fuel the fire and those steps China can take to help stabilize the situation. This interaction may provide the basis for deeper U.S.-Chinese cooperation on resolving China’s bad debt and financial problems, while gradually opening China to the international economy. This contact could lead to a mutually agreed formula for China’s membership in the WTO. China is a rising power in the world, and Sino-American association during this crisis could offer a practical demonstration of our common interest in integrating China safely into the international system.

Fifth, the U.S. should demonstrate its ongoing commitment to an open trading system. Without dynamism in world trade, the countries of East Asia, and developing economies around the world, will have a hard or impossible recovery task. In terms of growth, price stability, employment, innovation, and national wealth and power, the United States has benefited enormously from the liberalized global trading system. If the U.S. now hesitates, or worse, retreats, how can we expect others to stand up to those who oppose competition? I believe that the President should renew his request to Congress for trade negotiating authority ("fast track"), Congress should grant it, and the U.S. should propose a liberalizing agenda in the G-7, WTO, APEC, and elsewhere to maintain the momentum for reducing barriers to trade. This agenda could provide a multilateral context (and justification) for Asian countries to open their markets in concert with the IMF-World Bank reform programs.

Sixth, the U.S. should be willing to provide financial support for stabilization and reform through the IMF, World Bank, and complementary borrowing agreements. In effect, these arrangements provide an international lender of last resort, like the Federal Reserve does within the United States, for countries facing a liquidity crisis. In exchange for the temporary loans, the countries must agree to take various actions. Although large financial institutions coping with crises inevitably will be subject to criticism, these tools are vital for coping with international financial panics. That is one reason why the U.S. urged the creation of the IMF and World Bank over 50 years ago.

In particular, I urge the Congress to grant the IMF the additional resources negotiated through the quota increase. I also believe Congress should authorize the New Arrangements to Borrow. Given the risks in the world economy today, this is not the time to add to them by leaving the lender of last resort short of funds.

It is also important to recall that the U.S. funding for the IMF is like a payment into a credit union. The U.S. receives an asset, against which it can borrow if necessary (as the U.S. did as recently as 1978). Therefore, the U.S. commitment does not increase the deficit. It is not like foreign aid. It is a form of investment or loan that serves America’s self-interest. Indeed, in the 50-plus years the IMF has existed, it has not cost the U.S. taxpayer a nickel.

The IMF and the U.S. should condition their loans on the cooperation of private lenders. Private lenders can ease the payments crisis by rolling over their debts in Asia, as banks have done for Korea. These lenders are seeking to avoid a moratorium on debt payments. As part of the bargaining, lenders have sought various guarantees and higher interest rates in return for extending the riskier debt. Given a general belief that lenders should pay for their errors with losses, these financial institutions would make a mistake by overreaching in these negotiations. On the other hand, a call for the lenders to take large losses now would compound the systemic financial problem by prompting the flight of lenders from Asia and even developing countries in other regions.

Seventh, a primary focus of the IMF and World Bank should be to help the Asian countries restructure their financial systems and institute safety and soundness supervision. This is not easily accomplished during a crisis, because bank closings may provoke depositor panic. Nevertheless, a combination of consolidations, takeovers, closings and clarity on depositor protection in remaining institutions can manage this problem. The reestablishment of confidence in financial intermediaries, and the resumption of lending, is critical to prevent the crisis from spreading into a depression.

In recent years the World Bank has strengthened its capabilities to provide assistance for the establishment and supervision of financial intermediaries. Therefore, the IMF and World Bank should be working closely together. If their personnel resources are not sufficient, the U.S. should consider offering the assistance of teams from its financial supervisory offices.

Eighth, the IMF’s emergency packages also have focused on macroeconomic targets – such as budget deficits and interest rates. Some critics have attacked these requirements as a threat to growth. There is no doubt that the IMF has to strike a fine balance: on the one hand, high interest rates can be necessary to keep up the value of the local currency, and big deficits (funded by printing money) might trigger hyperinflation. On the other hand, high interest rates and fiscal restraint can impede a rebound in growth. The U.S. should support steps to prevent hyperinflation, but otherwise push for sufficient IMF flexibility to enable countries to focus on the underlying financial sector problem.

Ninth, while coping with the immediate crisis, the U.S. should be leading an effort to determine what changes in the international financial system might make future crises less likely. We should also consider how to enhance the ability to deal with these situations. One possibility is to develop an international bankruptcy system to cope with such problems, as Chairman Leach has suggested. A global bankruptcy mechanism would, however, subject American investors and businesses to controls that might be burdensome. Therefore, some observers have suggested more modest limitations that could be instituted in crises. Others have recommended a reexamination of the debtor negotiation arrangements used in the 1920s. And some are looking at models developed by countries with smaller capital markets – Chile, for example – to limit rapid movements of portfolio capital.

After the 1987 stock market crash, President Reagan established the Brady Commission to review and make recommendations to deal with concerns voiced at that time about the interconnection of markets and institutions. Given the importance of this topic, and the need to develop broad-based support for a workable agreement, I believe the Executive and the Congress should establish a serious commission of outsiders to review possibilities and propose alternatives. This U.S. effort might then contribute to a similar work prepared by the G-7 and perhaps other countries. This analysis might also examine the performance of the IMF and World Bank.

Finally, given the potential scope of the East Asian problems, it is critical for the President and senior members of his Administration to discuss with the American people what is happening and why it matters. Secretary Rubin’s recent speech at Georgetown was a good effort, although it would have been advisable to begin a serious educational effort months ago. Secretary Rubin also needs to be joined in an ongoing and concerted way, by the Vice President; Secretaries Albright, Cohen, and Daley; and Ambassador Barshefsky. Federal Reserve Chairman Greenspan, who has earned bipartisan respect, could also inform the public. Perhaps Members of Congress will join them in explaining the importance of events in East Asia to their constituents. If the U.S. expects to have an effective foreign policy after the Cold War, its government will have to engage citizens on the changing dangers and opportunities. This crisis involves many elements I expect we will see again, in various forms, in East Asia as well as around the world.

I would be pleased to try to answer your questions.