Section 7 from THE ASIAN FINANCIAL CRISIS
 

7. STABILIZING THE SITUATION

Stabilizing the financial crisis is critical, as Section 4 show how effects could be transmitted to major economies. This section suggests that the IMF (the only currently available international institution) risks failing in its attempts to do so, and that what the IMF is seeking in the most affected communities would require a 'cultural revolution'. For such reasons, the IMF's role is being reconsidered, and this could lead to changes in the international financial system as a whole.

If the crisis is not stabilized then security issues could become important for Australia.

7.1 Is the IMF Able to Solve the Problem?

The IMF is a key component of the international financial system which Western nations (especially the US) have supported since World War II. There are advantages in having an organization like the IMF:

• a lender of last resort can shorten the depression which follows a financial system crisis <154>. It is better to sort out problems of bad debts in a financial system quickly (as the US did in the 1980s) rather than cover them up (as Japan did) because the latter allows them to become worse <470>. If money is not made available, then investors will raise risk premiums and growth in Asia will be weak for 20 years <409>
• whilst containing a crisis, it is possible to help catalyse needed reforms much faster than otherwise would be possible <164, 380>.

However, the IMF risks failing to stabilise the situation, and faces policy uncertainties and resource constraints.

For example:

• The IMF was part of the Bretton Woods system which was based on fixed exchange rates - which ended in 1973 so (theoretically) making the IMF unnecessary. But it has been very busy. The IMF has $200bn funds, but only half of this is useful. Half the countries which the IMF has helped are no better off today. IMF role can create moral hazard <310>
• There is doubt about the future of the IMF. It may not receive required funding; its strategy may not be adequate; its decisions lack transparency and may be based on ignorance of affected economies; and opponents object to provision of bail-out funds - its whole purpose in existence <634>

Firstly, despite IMF intervention, currency and share markets in Asia have not stabilized.

• Asia has an effective debt moratorium already. <527>
• There is open discussion of default in Indonesia and Thailand. There are no experts on how to solve the problem - though some (probable) principles. The IMF has not stabilised anything. The worst is not over. Indonesia (with an unrealistic budget) and Malaysia (which is printing money) alarm investors. Korea and Thailand want IMF conditions moderated - a view which is supported by economists who fear long term stagnation <610>

In Indonesia a profound financial and economic collapse leads to fears about violent overthrow of the government. Furthermore the IMF have expressed concern that the problems in Asia could deepen and spread. Others need (they suggest) to adopt reforms similar to those proposed in Asia <440>

Korean banks are exporting the problem. Being exposed to losses from their chaebol they are selling assets in Russia and Latin America <245>. Japan is also (apparently) being forced to sell assets <>

A number of emerging market economies seem to be at risk, including: Malaysia - which appears likely to be forced to seek IMF support; Russia; Brazil (and others in Latin America); countries in central Europe <602>; and China (see Attachment C). But of most global significance is the potential for a financial crisis in Japan (see Attachment B).

Second: there is uncertainty about the policies which the IMF has adopted, and the organization is being subjected to criticism as outlined in Attachment J, because:

• its activities may create 'moral hazard' (and future problems), by allowing irresponsible financial institutions to avoid the consequences of unwise investment;
• its requirements for severe spending cuts on top of market panics, may be inappropriate, and make the situation worse

Third, the IMF is facing funding constraints. Its available funds are $50-60bn, yet $75 bn (or $100bn <154>) was needed by Korea <216>.

The IMF was not actually able to solve Korea's problem <427> because it was impossible to roll over its short term loans <349>. South Korea's problem threatened a collapse of the global payment's system <353, 354>. Ultimately agreement with financial institutions to reschedule Korea's debts was required. Financial institutions accepted this as an alternative to admitting losses. However, experience in Latin America and elsewhere is that rescheduling implies that large losses will eventually be incurred.

The IMF was not set up to help large economies, it being assumed that large economies (like Korea) would be able to support the IMF. It could not cope if the crisis spreads to Russia or Brazil. <381>. More-over what would happen if Japan (the source of 25% of the world's savings) were to need a lender of last resort?

The IMF is seeking a doubling of its capital base <381> though it may not receive a sympathetic response.

Most US politicians oppose a funding bail-out of Asian nations. <367>. US Congress is concerned about IMF rescues, which allowed undisciplined investors to be saved <584> and that the IMF imposes harsh conditions on countries <597>; and that it supports authoritarian regimes <669>

Despite such concerns, the problem of dysfunctional and insolvent financial systems in Asia must be solved. Even if the IMF has exacerbated the problem, there is no choice, as the region will not overcome its loss of confidence without IMF endorsement - and the region depends on foreign capital for rapid growth <554> Thus it seems important that the IMF's authority not be undermined until the crisis has been stabilised <667>

7.2 The IMF is asking for a 'cultural revolution'

However the problem which affected countries face is multi-dimensional (ie political, financial, and economic). This is not widely discussed because it can not be easily solved, being linked to the overall system of governance <33>.

The greatest policy difficulty facing the IMF, is the virtually unknown fact that adopting Western style financial management in the most affected countries, would require a 'cultural revolution'. Attachment K considers the issues involved in countries which have been influenced (as most in Asia have been) by Chinese traditions. Particular issues considered include:

• The fundamentally different approach taken to information (which also affects the nature of power, and governance);
• The implications of this for business and economic arrangements (eg the communitarian market style; management of the 'real' economy not of abstracts like money or economic principles; competitiveness based on learning by networks; and business financing by debt - to avoid external ownership);
• The absence of any tradition of providing information to others;
• The primary commercial and economic goal of power (eg market share; value of assets), rather than financial returns;
• The risks in separating economic control and political power in Asia's communitarian and mercantilist economic environment;
• The lack of the legal / institutional frameworks to implement the expectations of the IMF and Western financiers;
• The probable weaker competitive performance (and greater scope for losses) if the financial management expectations of the IMF and Western investors were to be met.

Unless such a 'cultural revolution' occurs, then either IMF requirements will not be met, or (more likely) they will be met superficially without material change to the way things are really done (as occurred in Korea in 1980 <>).

A parallel can be drawn with the US / Japan Strategic Impediments Initiative (which evaluated obstacles to imports into Japan in the light of Japan's major trade imbalance with USA). The US sought (and gained) large numbers of concessions in terms of liberalising government controls - but no matter what was done the outcome was the same - because the practice of doing business only with friends is embedded in the behaviour of all. Though US analysts recognised (eventually) that they were dealing with a completely different style of market economy, they failed to gain any real understanding of how it worked.

However leaving financial management practices unchanged would not be a viable alternative. Large financial losses were generated in countries which adopted variations on the Japanese economic development model, and these need to be avoided in future. This can not be achieved without a new economic model as suggested in Section 8.1.

• SE Asia must establish credibility for good governance, because without outside capital it would only grow at 3% pa. The IMF will try to achieve this, but a lot of problems will remain. <274>
• The crisis will not disappear quickly, as it is associated with the whole way of doing business - rather than being confided to a small groups of companies. Investors have learned that companies do not work in shareholders interests, and that they lie. They will not rush back in <527>

A preliminary speculation about alternative economic models is attempted in Section 8.2.

7.3 Alternatives to the IMF?

Alternatives to the IMF are being developed, due to concerns about its effectiveness.

Firstly, a new regional support fund (with similar resources to the IMF) has been envisaged <133>.

An Asian Fund

• The initial task of the new organisation, would involve surveillance urging prudence <148> It would need to involve Japan and Taiwan. <279>.
• New Asian facility would work closely with IMF - though it unclear if it can be used for measures not part of IMF program. Japan would develop the facility <286>
• Fund would mobilise funds from donors with more economic and political interests than the IMF <287>
• Despite its severe problems Malaysia has been attempting avoid the need to seek IMF help. It brought down its own austerity package, because of belief IMF help would cause additional problems <376>. It has promoted an Asian facility, because of fear of what IMF would do to its pro-Malay (ie anti Chinese) policies. <287>
• However it is proving difficult to develop an alternative. ASEAN leaders will endorse IMF reforms, but ask for a standby facility allowing support to be provided quickly <370, 376> Also Japan said it would not provide support on terms less harsh than IMF <376, 426>. And though Malaysia's problems are domestic (with lower net debt) it is apparently preparing for international funding support <287>

The proposal for an Asian 'IMF' can be seen as an initial step in the creation of an alternative international financial system - which could presumably) be based on 'Asian values' and try to overcome some perceived weaknesses of the IMF (eg its apparent inability to use anything but fiscal measures to rectify problems in troubled countries).

The USA has objected to the creation of an alternative to the IMF in the past <279>.

Secondly, the IMF is working on more sophisticated fall-back plan <367> And the US now proposes to make a large commitment to leadership in engaging the Group of Seven industrialised nations (G7) in dealing with the crisis, after having been slow initially to understand its significance <660>. The US arranged a G7 meeting with Asian leaders for 21 February 1998 <558> (a move which gained APEC approval <227>).

Thirdly numerous other suggestions are being offered,

For example:

• internally buying amongst ASEAN countries (a Malaysian suggestion), though each traditionally exports mainly to developed countries <366>
• creation of International Credit Insurance Corporation <480>
• recycling of the large quantities of funds withdrawn by Europe into investment <544>. In response, it was said that Europe wanted more deregulation and financial transparency to ease the crisis <560>
• a new international agreement like the Plaza Accord which allowed Japan to start its decade long funding of Asian growth <544>
• a broader solution through the G7, rather than through the IMF <584> perhaps related to exchange rates, or more IMF funds <610>
• establishing currency boards like that in Hong Kong <610>
• debts restructuring by banks <610>
• nationalizing debts by the issue of government bonds <610>

 The difficulties being experienced in resolving this financial crisis, make the establishment of a new international financial framework increasingly likely. This question will be hotly contested, and will critically affect the structure of economic power in the early 21st century.

An international agreement recently developed through the World Trade Organisation involved significant liberalisation of financial markets <308> .

Under this Australia would get more access to Asian markets. It could also help in restoring confidence, renewing capital flow and creating more competitive markets <>.

Similarly, proposals for a Multilateral Agreement on Investment (MAI) are being developed by the OECD. Under this, a uniform and hospitable environment would be created for investment.

However financial market liberalisation is not always accepted as sufficient for reform

For example:

• A backlash is developing about the destructiveness of financial markets, which has important implications as Japan and China seek to replace the USA economically. The IMF, initially welcomed in Thailand, is now resented <22>
• Mahathir demanded regulation of financial markets <288> - to avoid enslavement of peoples <198>
• George Soros, part of that system, warns of its exploitation of the weak <288>
• Regulation is required to protect the weak, which has been prevented by globalization <288>
• Global capital has fuelled not only rapid growth but also 36 financial crises since 1980 - this being unprecedented in history. The problem is not speculators, but high inflation, or attempts to hold exchange rates. Even regulated systems (eg Japan) can have problems. But Japan had serious economic consequences by not writing off its bad debts. The Bank of International Settlements' capital adequacy ratios are not enough in regulating banks. <283>
• there are important questions about whether developing countries should liberalize their economies quickly (and rely on firms to do the right thing) or retain control as China did. <675>, and as Taiwan also did

• Asia's crisis has generated a struggle between Western and East Asian market concepts. The claims for a new system is based on perceived injustices due to the mythology that East Asian success was unstoppable. Thailand rejected IMF warnings. Korea denied the need for help. Property markets in the region won't admit reality by cutting prices. Mahathir hopes to escape without an IMF solution. Western finance is blamed for the crisis, with the IMF as the target <169>
• The IMF should require that developing countries not get access to finance, unless adequate data is provided <435>.

The USA announced that an international meeting of finance ministers would seek significant changes in the world financial system <643>. It was believed that the reforms after the Mexican crisis (ie a stronger IMF monitoring role) were insufficient <648>.

The stakes are high, because the alignment of the international financial system with the practices of the USA is a major advantage (eg it allows the USA to continue large current account deficits despite having the largest net foreign debt in the world). Any shift in that system could quickly erode the US's position.

Complications: The re-development of the international financial system is complicated because:

• There are obstacles to developing an international financial system likely to be effective across all economically important cultures (see Attachment K). Finance has not been the most important factor in economic management or in measuring economic success in East Asia.
• Globalisation has been claimed to make it impossible for governments to ensure an equitable distribution of incomes (Kapstein, 'The New crisis of capitalism', Weekend Australian, 8-9/6/96). Senior Japanese bureaucrats have claimed that this will fundamentally inhibit the pursuit of the core goals of Western societies (Sakakibara 'The End of progressivism')
• Japan has been claimed to be a non-capitalist market economy (because business and financing and effective ownership has been through the bureaucracy). This however may also have been the reason that it has incurred large financial losses which it is apparently unable to resolve.
• Share-markets may no longer be effective in their major tasks of directing savings towards investment (Rogers 'Conspiracy theory takes aim at the share-market', Australian Financial Review, 31/10/97)
• The pursuit of financial criteria was widely seen as having led to weaknesses in US corporations during the 1980s, which has resulted in emphasis now on non financial performance indicators. The difficulty was seen to be that financial data indicate the results of past efforts, and tell nothing about the key factors in strategy required to achieve future results (eg Eccles 'The Performance Measurement Manifesto', Harvard Management Review, Jan-feb 1991). Similarly, knowledge is now often regarded as having replaced capital as the main factor in the productivity of firms.

It is possible than a satisfactory new international system will not be found. If this resulted in the establishment of two competing systems, Australia could have a problem because of its Western culture and mainly Eastern markets.

7.5 Security

In the event that financial, economic and political aspects of crisis can not be managed, then security issues could again become important, In this respect it can be noted that:

• Indonesia (Australia's largest near neighbour) is suffering massive economic and political problems, as a result of this crisis. If Indonesian incomes sink below the poverty line there could be large scale economic migration to other countries, eg Australia <121, 547>
• Regional instability is feasible within Indonesia, an event whose significance for Australia has been increased by agreement to a joint defence treaty.

`Indonesia: The Javanese empire': Like the old Soviet Union, Indonesia is a nation in which one culture is more equal than others. Much as Russia overshadowed the other republics, so Java dominates Indonesia. Although Indonesia is unlikely to fall apart, the policies of central government will continue to be shaped by recent memories of provincial rebellions. A long history of rebellion against central authority has had an important effect on government in Indonesia. It makes any decentralization of power extremely fraught. That in turn places constraints on political and economic development . The Jakarta government knows that economic development is being held back by over-centralization, but it fears the political implications of letting go. The hand of central government is visible everywhere. All the Jakarta ministries have a regional office, as they do in every provincial capital. ( Rachman, G. Economist Apr 17, 1993)

• Half of Indonesia's firms are technically bankrupt. Indonesia is unstable on an ethnic basis if anything goes wrong. Australia's security planners should consider the implications <410>. Furthermore there is friction between offshore Chinese and indigenous communities in Indonesia. The Chinese hold 70% of the wealth in Indonesia, and have been strongly supportive of the Soeharto regime. Attacks on Chinese have increased, and the army has publicly criticized Chinese. In Indonesia's civil war in 1965, about 500,000 ethnic Chinese were murdered.
• As a result of Indonesia's instability there is some chance of violent overthrow of the existing regime <>. This could be replaced by a regime with (not quite fundamentalist) Islamic orientation.
• A major arms race has occurred in SE Asia <125> (on the basis of economic growth) for several years (eg 'If the eagle takes flight', Economist, 4/8/90), and Australia's traditional technological edge over regional forces has been eroded. The Defence Department sees strong Asian growth as a threat - as expressed by the Macintosh report in April 1997.<356> However the current crisis has slowed the arms build up <656>
• Rapid economic growth has been seen as vital to peaceful development in Asia <66>
• China is seen to have great power ambitions, and as a potential disturbance to regional security <356> China had always been the region's super-power - except over the past 200 years <22>. China (the Han empire) could also (like Indonesia) be susceptible to regional conflicts
• Some in the US perceive the desire of Asian countries to increase exports as an act of political hostility <429> And, as argued in Attachment K, the basic economic approach of many countries in Asia has involved a mercantilist goal of economic power, rather that consumer welfare.
• At present the IMF is destabilising Asia trying to make it more like Australia <356> Anti-Western sentiment is increasing in the region <148>

In considering security issues, it is useful to consider Samuel Huntington's warning that future international divisions and conflict could be along cultural divides (ref). Perhaps the Asian financial crisis reveals the fault line between East and West, through their fundamentally different financial systems <148>

It is in Australia's interest, more than any other country, to ensure that this risk is avoided, and this could be the source of a major opportunity.