Henry A. Kissinger

The Washington Post, October 6, 1998

Free-Market capitalism remains the most effective instrument for economic growth and for raising the standard of living of most people. But just as the reckless laissez faire capitalism of the 19th century spawned Marxism, so the indiscriminate globalism of the 1990s may generate a worldwide assault on the very concept of free financial markets. Globalism views the entire world as one market in which the most efficient and competitive prosper. It accepts - and even welcomes - that the free market will relentlessly sift the efficient from the inefficient, even at the cost of periodic economic and social dislocation.

Even well-established free-market democracies do not accept limitless suffering in the name of the market, and have taken measures to provide a social safety net and to curb market excesses by regulation. The international financial system does not as yet have these firebreaks. Nor is there much of a recognition that it needs them.

Ours is the first period experiencing a genuinely global economic system. Markets in different parts of the world interact continuously. Modern communications enable them to respond instantaneously. Sophisticated credit instruments provide unprecedented liquidity. Hedge funds, the trading departments of international banks and institutional investors possess the reach, power and resources to profit from market swings in either direction, and even to bring them about. It is market stability that they find uncongenial.

Broadly speaking, direct foreign investment benefits from the well-being of the societies in which it operates; it runs the risks and is entitled to the benefits of the host country. By contrast, modern speculative capital benefits from exploiting emerging trends before the general public does. It drives upswings into bubbles and down cycles into crises, and in a time-frame that cannot be significantly affected by the kind of macroeconomic remedies being urged on the political leaders.

For example, when Asian credit-worthiness began to fall, financial institutions and fund managers holding the debt were tempted to sell Asian currencies short, thereby accelerating devaluation and compounding the difficulty of repaying debt. Speculators were acting rationally, but the result was a deeper, more vicious and more intractable crisis.

To maintain their overall performance, speculators, as losses mounted in Asia, were driven to cash in their holdings in Latin America and thereby spread the crisis. Regulators in the United States, Europe and Japan have not succeeded in dampening the increased volatility of the market. And small and medium-sized countries are defenseless in the face of it.

The International Monetary Fund, the principal international institution for dealing with the crisis, too often compounds the political instability. Forced by the current crisis into assuming functions for which it was never designed, the IMF has utterly failed to grasp the political impact of its actions.

In the name of free-market orthodoxy, it usually attempts - in an almost academic manner - to remove all at once every weakness in the economic system of the afflicted country, regardless of whether these caused the crisis or not.

In the process, it too often weakens the political structure and with it the precondition of meaningful reform. Like a doctor who has only one pill for every conceivable illness, its nearly invariable remedies mandate austerity, high interest rates to prevent capital outflows and major devaluations to discourage imports and encourage exports.

The inevitable result is a dramatic drop in the standard of living, exploding unemployment and growing hardship weakening the political institutions necessary to carry out the IMF program.

The situation in Southeast Asia is a case in point. Crony capitalism, corruption and inadequate supervision of banks were serious shortcomings. But they did not cause the immediate crisis; they were a cost of doing business, not a barrier to it. Until little more than a year ago, Asia was the fastest growing region in the world, its progress underpinned by high savings rates, disciplined work ethic and responsible fiscal behavior.

What triggered the crisis were factors largely out of national or regional control. The various countries had exchange rates linked to the U.S. dollar. When the dollar appreciated significantly starting in 1995, and the yen fell sharply, Southeast Asian exports became less competitive and export earnings fell. At the same time, the dollar pegs created unprecedented opportunities for speculation. It was possible to borrow dollars in New York and lend them locally for at least twice the cost of borrowing - at no apparent currency risk. The borrowers invested in real estate and excess plant capacity, creating a dangerous bubble. Local currency became overvalued and local currency holders converted into dollars, inviting speculative raids - all without significant warnings from international financial institutions.

When the crisis spread to Indonesia, the largest country of Southeast Asia, the threat to the global financial system could no longer be ignored. At U.S. urging, the IMF intervened in both situations with its standard remedies, leading to massive austerity. Thailand's democratic institutions have so far proved relatively resilient. But for how long can it sustain interest rates of more than 40 percent, a negative growth of 8 percent and a 42 percent devaluation of its currency?

In Indonesia - a rich country with vast resources and an economy which was praised by the World Bank in July 1997 for its efficient management - the IMF, advised by an administration afraid of being accused of having political ties to leading Indonesian financial institutions, decided to make its assistance conditional on remedying virtually every ill of which the society suffered. It demanded the closing of 15 banks, the ending of monopolies on food and heating oil, and the end of subsidies.

But when 15 banks are closed in the middle of a crisis, a run on other banks follows inevitably. The ending of subsidies raised food and fuel prices, causing riots aimed at the Chinese minority that controls much of the economy. As a result, as much as $60 billion of Chinese money fled Indonesia, or more than the IMF could possibly provide. A currency crisis had been turned into an economic disaster.

For a few months, a special Treasury representative worked with the government and the IMF to ease the pressures. But by April the IMF was back at the old stand. This time the explosion swept away the Suharto regime. A currency crisis, having been transmuted into an economic crisis, has become a crisis of political institutions. Any real economic reform stands suspended. The shortcomings of Suharto were real enough, but to try to deal with them concurrently with the currency crisis has produced a political vacuum in the most populous Islamic nation in the world.

All this might make sense if the IMF programs brought demonstrable relief. But in every country where the IMF has operated, successive programs have lowered the forecast of the growth rate which, in Indonesia, is now a negative 10 percent, in Thailand a negative 5 percent and in South Korea an optimistic positive 1 percent.

The inability of the IMF to operate where politics and economics intersect is shown by its experience in Russia. In Indonesia the IMF contributed to the destruction of the political framework by excessive emphasis on economics; in Russia it accelerated the collapse of the economy by overemphasizing politics. The IMF is, quite simply, not equipped for the task it has assumed.

The IMF must be transformed. It should be returned to its original purpose as a provider of expert advice and judgment, supplemented by short-term liquidity support. When the IMF focuses on multibillion-dollar loans, it plays a poker game it cannot possibly win; the house, in this case the market, simply has too much money. Congress should use the need for IMF replenishment to impose such changes.