The Chastening: Inside the Crisis That Rocked the GlobalFinancial System and Humbled the IMF By Paul Blustein. Public Affairs, 431 pages, $30.00
There's nothing like a nice vacation to take yourmind off looming globalfinancial meltdown. Just ask former U.S. Treasury Secretary Robert Rubin, whosneaked away for a fishing trip to the British Virgin Islands as the South Koreaneconomy teetered on the verge of default in December 1997. Or Central Bank ofRussia boss Sergei Dubinin, who took some personal time in Italy just as theRussian ruble was crumbling in August 1998. Or Stanley Fischer, the former deputymanaging director of the International Monetary Fund (IMF), who was enjoying afamily holiday on the Greek island of Mykonos that same month when the Russianshit ruble trouble (although he cut his trip short to help them through thecurrency woes).
The series of crises that battered the world economy during the late1990s--in Asia, Russia, Brazil, and the United States--interrupted many a holidayfor the world's top financial-policy makers and bureaucrats, and tested some keyofficials who might otherwise have labored in placid obscurity. The crises andthe individuals coping with them are the subject of Paul Blustein's TheChastening, a postmortem of how the international economy came close tocollapsing between 1997 and 1999. Blustein, a Washington Post economics reporter,offers a sobering conclusion: The financial world is vulnerable to recurringinstability, and the IMF bureaucrats, U.S. Treasury policy-makers, and Group ofSeven officials charged with overseeing world economic conditions-- Blusteinsarcastically 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 theThai baht (then pegged to the U.S. dollar) came under strong selling pressure ininternational currency markets. After draining its hard-currency reserves, theThai central bank was eventually forced to devalue the baht. Even IMF supportthrough a $17.2-billion bailout package was unable to prevent the crisis fromspreading to Indonesia, Malaysia, and two particularly worrisome nations--forgeopolitical as well as economic reasons--South Korea and Russia. When thecontagion hit Russia in August 1998, forcing the authorities there to devalue theruble and default on loan obligations, the U.S. market finally felt the pain.Financial markets in the United States seized up and Long-Term CapitalManagement, a major Connecticut-based hedge fund, fell apart--saved in the endonly 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 thecountry 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 countlessacademic papers, seminars, and conferences, Blustein offers a useful journalisticsummary, neatly devoting a chapter to each country and generally avoiding thegarbled wonk-speak typical of his subject matter. Although he occasionallyoverdoes the local color ("The moon was full, imparting luminosity to the snowcoating the Alps as Stan Fischer left Davos, Switzerland"), Blustein conveys agood sense of the frantic and often comical life of the High Command. Readerslearn how IMF and World Bank economists couldn't exchange electronic documentsduring the Indonesian crisis for the simple reason that Fund staffers usedWordPerfect software while bank economists relied on Microsoft Word. Blustein'sreaders also see then-IMF Managing Director Michel Camdessus and fellow IMFofficial Hubert Neiss (a flat-topped, barrel-chested Austrian national) sneakingcloak-and-dagger-style into Seoul in November 1997 and registering at their hotelunder fake local names--quite convincingly, I'm sure. And certainly we all canempathize with the plight of Korean economic official Kim Ki Hwan. Waitingpatiently in his Washington hotel room for a crucial phone call from his homegovernment, Kim missed the connection because, as he put it, "you cannot denyyourself a call from nature."
By revealing the accidents, compromises, and guesswork involvedin dealing with international financial turmoil, Blustein goes a long way towarddispelling the IMF's well-cultivated image as a font of macroeconomic wisdom--a"high priesthood" of finance, as Blustein puts it. In particular, the authoridentifies three reasons why the High Command failed in anticipating andcontaining the crises.
First, the IMF did not have the in-house expertise to focus on the bankingand corporate-finance problems prevalent in many of the affected countries.Blustein offers a damning description of how the IMF Institute (a boot camp forentry-level economists) teaches a simplistic, formulaic approach to crisismanagement. If an economy faces a high external deficit--that is, if it spendsmore hard currency than it earns--the Fund's knee-jerk reaction is to grant aloan package on the condition that the domestic authorities impose fiscalausterity and higher interest rates. By dampening domestic demand, the IMFreasons, it can compel the country to stop "living beyond its means." Yet in anera 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 acountry's fiscal or monetary policies. Or as Moshin Kahn, the Pakistani directorof the IMF Institute, admitted to Blustein: "It's not clear our economic theoryworks." In Thailand, for instance, the IMF pressured the government to "restoreconfidence" through tight fiscal policy, when the true problem was not Thailand'sbudget but rather its corrupt banking system and overvalued real-estate market.
Second, even if the IMF correctly diagnoses an economic imbalance, thecountries in question are rarely willing to undergo politically painful economicreforms until a crisis is upon them. In times of apparent prosperity, no onewants to take long-term economic imbalances seriously. Blustein quotes a formerIMF economist who explained how, when Fund surveillance teams warned Asianeconomies of impending troubles, "they'd be politely told 'go away' and thecountry would grow seven percent." And even when a crisis appears imminent,countries often conceal crucial economic data from the High Command. Blusteindetails how Thailand's central bank lied about its available dollar reserves in1997, 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 ofThailand was nearly out of hard currency." In a particularly surreal exchange, asenior Thai financial official finally told Stanley Fischer the truth--but onlyon the condition that Fischer not tell anyone else at the IMF.
Third, and perhaps most important, the High Command is made up of groups withoften competing interests. Blustein devotes much attention to the divides betweenthe IMF and its most influential member, the U.S. Treasury. Under pressure fromU.S. financial firms, for instance, the Treasury took advantage of the SouthKorean crisis to push hard for the Korean authorities to open up the country'sfinancial sector to foreign competition. Though the Americans claimed that suchpolicies would help Korea in the long run, IMF officials privately decried theTreasury's ulterior motives. "The U.S. saw this as an opportunity ... to crackopen things that for years have bothered them," complained a Fund staffer. TheU.S. position ultimately prevailed, with the Koreans allowing foreigners toestablish bank subsidiaries and brokerage houses by mid-1998.
As the book's title suggests, Blustein seems to believe that the failings ofthe late 1990s may chasten the IMF and prod it to change some approaches. Recentdevelopments 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 itstruggled with a multiyear recession and a staggering $132-billion public debt.But rather than put together yet another financial-assistance package, the Fundcanceled a $1.3-billion loan installment to Argentina in early December 2001, onthe grounds that the government had exceeded its agreed-upon fiscal-deficittarget. The results were dramatic: Just a few weeks later, Argentina's electedgovernment collapsed, with President Fernando de la Rúa leaving the CasaRosada by helicopter amid widespread protests and looting. Argentina officiallydefaulted on its debt in early January. A few low-key statements of supportnotwithstanding, the IMF has remained largely silent. For better or worse, theera of knee-jerk, billion-dollar bailouts may be ending.
But what new crisis-management system might emerge? In November, senior IMFofficial Anne Krueger announced the Fund's intention to create a globalbankruptcy system whereby an economy experiencing massive capital outflows couldrequest a "temporary standstill" on its debt obligations, thus gaining breathingroom to negotiate with its creditors. Predictably, however, Krueger's initiativefaces numerous problems. It would require changes in national or state laws toprevent individual creditors from suing for full repayment during the standstillperiod. (New York State law, in particular, would need some tinkering.) A globalbankruptcy system could also discourage private investment in emerging marketssince creditors would fear a future repayment moratorium. And finally, many poorcountries may be unwilling to avail themselves of the system, for fear ofdestroying their creditworthiness in the eyes of the international financialcommunity. Indeed, as the High Command discovered during the 1990s, almost anynew effort or mechanism to reform the global financial architecture seems only tocreate additional problems with unintended consequences that invite--rather thanprevent--further financial turmoil.
It's enough to make you want to take a long vacation.
