JPRI Critique, Volume X, No. 6: September 2003
Thailand Wipes the IMF Slate Clean
by Marshall Auerback
The Asian financial crisis has finally come full circle with the news that Thailand has repaid two years early its outstanding debts from a $17.2bn International Monetary Fund package.  There is a wonderful symmetry to this: When the Thai baht collapsed on July 2, 1997, no one could foresee that this would be the start of the greatest economic crisis since the Great Depression, one that would spread contagion all across the emerging world before impinging on the very center of world financial markets with the collapse of Long Term Capital Management.  In years hence, perhaps this final repayment by the Thai government to the IMF will be similarly regarded as an epochal event:  a symbolic shifting of the guard in Asia,  America’s former East Asian satellites moving away from the embrace of neo-liberal globalization under American tutelage toward a rapid new acceptance of China as the future dominant economic locus of the region and a concomitant reversion to Asian style capitalism.
For over 10 years, the baht had been successfully pegged around 25 to the U.S. dollar; in July, 1997 it rapidly fell by 25 per cent in the space of days.  Currency speculation spread across the region, hitting Korea, Malaysia, Indonesia, the Philippines, and even economic stalwarts like Singapore, which at the time had foreign exchange reserves equivalent to almost $30,000 per capita. 
As Thailand’s final repayment to the IMF makes clear, the economic damage may be over, but the legacy of mistrust and bitterness lives on.  Standing in front of a giant Thai flag on national television, Prime Minister Thaksin Shinawatra vowed that Thailand would never again fall prey to world capitalism or require IMF help after proudly announcing the final repayment. 
One can readily understand Thaksin’s skepticism in regard to the Fund.  The policies imposed by the IMF during this tumultuous time badly exacerbated the situation.  As former chief economist of the World Bank, Joseph Stiglitz, has noted:  Since the IMF was founded precisely to avert and deal with crises of this kind, the fact that it failed in so many ways led to a major rethinking of its role, with many people in the United States and abroad calling for an overhaul of many of the Fund’s policies and the institution itself.  Indeed, in retrospect, it became clear that the IMF policies not only exacerbated the downturns but were partially responsible for the onset: excessively rapid financial and capital market liberalization was probably the single most important cause of the crisis, though mistaken policies on the part of the countries themselves played a role as well. (Globalization and its Discontents,  W.W. Norton & Co., 2003).
Although the IMF has since acknowledged mistakes made during the crisis, the U.S. Treasury continues to treat traditional IMF orthodoxy as gospel.  The US also continues to display unremitting hostility to capital controls of any kind, even though they were shown to operate very effectively as a short term palliative during the 1997/98 crisis in China, India, and Malaysia. 
The U.S. Congress has begun to hold hearings on the free trade agreements negotiated by the U.S. with Chile and Singapore. There is little overall political opposition to these bilateral agreements, but the hearings will focus on a matter of great importance: the inclusion of restrictions on the use of capital controls. Chile and Singapore, both models of sound economic policy management, resisted an obligation not to use capital controls under any circumstances. In the end, they were forced to compromise by an administration opposed to any imposition of capital controls, making one wonder whether the lessons of the 1997 crisis, in particular the role of destabilizing, speculative Western portfolio flows, were truly learned in the U.S.
The intention of the Bush administration to use these two agreements as ‘templates’ for other trade agreements, possibly including the Doha round, means that acceptance of the capital control provisions could engender a trade policy that causes far-reaching damage. Because developing countries have relatively small financial markets and do much of their borrowing in dollars or euros, they are vulnerable to rapid financial outflows if creditors suspect difficulties in repayment. As money is withdrawn, the country’s currency depreciates rapidly, which can lead to more investors pulling out in an effort to avoid losses. Meanwhile, import prices soar, spurring inflation. This vicious circle spells calamity for the country’s economy: capital flows can be, and have often been, perilous, as the events in 1997 clearly demonstrated to the Thais.
Additionally, the prohibition on capital controls in the context of all new trade agreements has the makings of a U.S. foreign policy debacle and risks reintroducing a renewed element of financial instability at a time when the world economy can ill-afford it. Imagine that a government imposes short-term capital controls in order to manage financial problems, as Malaysia did in 1998. Compensation will ensue, but only for American investors under the terms of the proposed new deals with Singapore and Chile. The citizens of the developing country will then see a rich U.S. corporation or individual being indemnified while everyone else in the country suffers from the crisis. One would be hard-pressed to think of a better prescription for continuing anti-American outrage.
It is worthwhile recapitulating why capital controls are particularly suited in the Asian context.   The Asian developmental state, of which Thailand has been a prominent example, is based on very high savings, mostly by households.  Households hold their savings in bank deposits, and banks have to lend.  With neither households nor government being significant net borrowers, the borrowers must be firms, so firms must sustain high debt-to-equity ratios.  But a high level of bank deposit/loan intermediation is vulnerable to shocks that perturb cash flows or funding sources.  The deeper the debt intermediation, the more likely that any shock will cause illiquidity, default and bankruptcy, which is clearly what occurred in 1997.  Therefore, contrary to IMF orthodoxy, banks and firms must cooperate to buffer systemic shocks, and the government must support them.
Asian industrial strategy identifies major world industries as priority targets.  Successful assault on these industries requires resource mobilization on a huge scale.  That is only possible through borrowing neither equity markets nor retained corporate earnings are feasible alternatives.  Large-scale lending by banks to deeply indebted firms both of which require state support allows the state to implement its industrial strategy.
Given Asia’s high debt-equity ratios, the IMF’s call-for high real interest rates to sustain the external value of the currency simply forced bankruptcies of highly indebted but profitable firms.  By contrast, the IMF thought that if the market believed there was enough money in the coffers, there would be no point in speculating against the currency, and thus ‘confidence’ would be quickly restored.  But, as Stiglitz notes, the bailout in reality served another function:  It enabled the countries to provide dollars to the firms that had borrowed from Western bankers to repay the loans.  It was thus, in part, a bailout to the international banks as much as it was a bailout to the country; the lenders did not have to face the full consequences of having made bad loans.  And in country after country in which the IMF money was used to sustain the exchange rate temporarily at an unsustainable level, there was another consequence: rich people inside the country took advantage of the opportunity to convert their money into dollars at the favorable exchange rate and whisk it abroad.
Opening the economy to mobile foreign capital also compounded the vulnerability of the financial structure for those less quick to capitalize on the IMF bailout in the manner described above by Stiglitz.  Although restructuring, combined with bankruptcy, can be used to extinguish existing debt, this is a very deflationary path to real debt reduction that has been a socially costly feature of all great depressions. If corporate debt is equal to 30 percent to 50 percent of GDP, as was the case in Thailand during the height of the crisis, debt reduction by way of bankruptcy has huge direct social costs.
There are also great contagion effects. The principal lenders are banks, which are always highly leveraged; extinguishing debt through bankruptcy destroys the domestic banking system. Fire sale liquidations depress prices of domestic assets far below their actual values, causing temporary insolvency for many firms that are sound on a long-run basis. These forced liquidations, urged upon the country’s major business elites by the IMF, antagonized many of them. Although there was certainly a strong element of self-interest in their opposition, many of these tycoons who did not or could not take advantage of the opportunity to convert their money into dollars at a favorable exchange rate legitimately pointed out that even profitable firms could suffer fatal liquidity crises as a result of the collapse of trade credits when bankruptcies are widespread.
Asians remain confident that their growth strategies work.  The Asian countries will keep intact the mechanisms that are critical to their effectiveness.  The Thai experience clearly illustrates this phenomenon.  Thailand was forced to accept an IMF bailout in August 1997, after exhausting its foreign exchange reserves in defense of its fixed exchange rate regime (a regime that had been praised by the IMF just six months earlier).  As a quid pro quo for receiving IMF funds, the latter imposed structural reforms and huge cuts in government spending (precisely the opposite set of policies now being implemented by the U.S. in order to forestall its own economic crisis).  GDP contracted by 10 per cent in 1998.
By 1999, the worst of the crisis was over, and the IMF’s influence diminished accordingly.   Then came the political blowback:  The pro-IMF administration of technocratic Prime Minister Chuan Leekpai was thrown out of office by 2001 and a newly formed protest party, the Thai Rak Thai led by billionaire businessman, Thaksin Shinawatra, swept to power.  His anti-IMF bent and proposed reflationary policies were heavily criticized as unrealistic and excessively populist at the time of his election.  But his call for a three-year moratorium on agricultural debts and his proposal to create a national asset management company to purchase large debts held by the country’s banks did arrest the prevailing deflation, which had been exacerbated by IMF policies that called for precisely the opposite policy mix.
Thailand today is booming again: growth a paltry 1.7 per cent in 2001, accelerated to 5.3 per cent last year, and then roared to 6.7 per cent annualized in the first quarter of this year, notwithstanding geopolitical concerns relating to Iraq and the anticipated shock stemming from higher energy prices.  The Thai stock market has been one of the best performers in the world, up over 40 per cent this year in U.S. dollar terms.
The reality is that even before Prime Minister Thaksin’s triumphant pronouncements last week, the IMF was already a spent force in the country.  Bangkok stopped drawing from the package in June 1999, after receiving $14.2bn, and since then the IMF has since had virtually no influence on domestic economic policy.  This has pretty well been the experience throughout emerging Asia, as the economies recovered, and current accounts swung massively into surplus again.
Geopolitically, the consequences have been even more momentous.  Thailand was a long-standing U.S. ally for virtually the entire cold war period.  Along with much of the rest of the region, there is now a decided shift inward, which longer term will have momentous implications for the U.S. dollar reserve currency system.   Thailand has become a leading advocate of an Asian Monetary Fund and a regional bond market, as an alternative repository for the region’s surplus savings.  Antipathy for and suspicion of Western speculative capital and Western (IMF/Treasury) policy is on the rise, as Thaksin’s recent pronouncements make clear. China has become the new model. 
Behind its exchange controls, China weathered the regional crisis well, growing in excess of 8 per cent in 1998.  This is all the more remarkable given the exogenous shocks to growth in the region and the concomitant slowdown in world trade during that period.  China moved aggressively to reflate and thereby help lead the region out of its deep recession.  It has held the line on its renminbi exchange rate to avoid another round of currency depreciation in the region, notwithstanding pressure to the contrary by the U.S. Treasury.  Ever more it appears to other Asian nations as the successful model and the future economic locus in Asia and perhaps globally.
MARSHALL AUERBACK, a British-based international portfolio strategist for David W. Tice & Associates, writes regularly for the Japan Policy Research Institute.

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