Did the IMF botch up the Asia's economic crisis?

Did the IMF botch up the Asia's economic crisis?

By David DeRosa

NEW YORK (Bloomberg): Former U.S. secretary of state Henry Kissinger on Tuesday at the National Governors' Association had strong criticism of the International Monetary Fund's handling of the Asian financial crisis. By implication, Kissinger's displeasure with the IMF extends to the Fund's supporters at the U.S. Treasury.

There is a lot of criticism of the Fund today. Another former U.S. secretary of state, George Shultz, told a Senate panel on Thursday that "We should end the IMF now." He went on to say "If there had been no IMF, probably the situation (in Asia) would be better than it is today... It seems to me a lot of (the crisis) may have been induced by the IMF."

What Shultz was saying is that the IMF, with its readiness to come to the aid of distressed emerging-market nations, represents a pure case of moral hazard. First Mexico received assistance in 1995 during the "peso crisis." Next thing you knew, Thailand, Indonesia, Korea, and then Russia all had their hands out to the IMF.

There is wisdom in what Shultz told the senators, however extreme his statement may have sounded at the time. The existence of the IMF rescue squad, standing ready to be the lender of last resort, may have contributed to the manufacture, or least exaggeration, of some of the recent crises.

On a deeper level, it is important to realize that a far larger moral hazard was prevalent in Southeast Asia long before the IMF was a factor.

The essence of political cronyism goes beyond the mere sharing of profits among politically well-connected friends. There is the far more insidious side to the system: every project sanctioned by participation of the right people carries an implied governmental guarantee that the crony capital will be returned safely. No matter how badly a project may have been miscalculated, insiders can count that high-level forces will be brought to bear to make it into some kind of success.

That's how a country starts to dote on excessive leverage, free flowing bank credit, and investments in preposterous and grandiose real estate projects. It is only human nature for a trapeze artist to take more risks when performing over a safety net.

This, in fact, is a central theme in the IMF's programs for the afflicted Asian nations. The IMF is insisting on a wholesale dismantling of tariffs, protectionist legislation, production quotas, and in a word, cronyism. The Fund is dead right to do this.

Kissinger's criticism of the Fund is less credible. Here is a quote from his speech: "When the IMF tried to address (Indonesia's) problems, they dealt with real issues, there was corruption, crony capitalism, there were monopolies. All those things need to be changed, except they did not produce the crisis. They were independent of the crisis.

"Over a longer period the crisis was mostly a speculative crisis. The attempt to fix all of them simultaneously led to a flight of capital that was greater than anything the IMF could possibly provide, in fact greater than the IMF had provided up until now."

Kissinger, I respectfully submit, is wrong on several counts. The problem with his analysis is that it misunderstands the root causes of the crisis. For example, Kissinger told the governors that the status of the Asian countries before the crisis was pretty good. "More or less they had their deficits under control, they had inflation under control, they were privatizing, they were welcoming investment, and investment was flowing in," he said.

The truth is, what killed Asia was not so much foreign speculation in local currencies -- although that may have been a contributing factor -- but the combination of fixed- or managed- exchange rate regimes and a headlong plunge into local investments that were wholly ruinous.

The myth of the Asian "tiger" economy that could sustain breathtaking growth, combined with the illusion of exchange rate stability, managed to pull in gargantuan sums of foreign capital (unfortunately mostly denominated in foreign currencies) which, with the help of thoroughly lax banking sectors, fueled a massive speculative bubble.

If by deficit, Kissinger meant balance of trade, then consider that Thailand, Malaysia, and Indonesia were all running huge current account deficits right before the crash. There is a fundamental identity in national accounting: If a country imports more than it exports, which defines the existence of a current account deficit, then it must import investment capital to close the gap. As Kissinger noted, this was indeed the case. Investment funds were flowing into Southeast Asia right up to the end.

Where did all that money go? Down a rat hole. Asia was a very sick place in the economic sense. The wonder is that the bubble was sustained for as long as it was.

Most importantly, the IMF did not cause the Asian crisis. These countries were ready to roll over all by themselves.

The writer is president of DeRosa Research and Trading and Adjunct Professor of Finance at Yale School of Management. The opinions expressed here are his own and don't necessarily represent the judgment of Bloomberg LP or Bloomberg News.