Observations of a Banker on Asia
A speech by Jon S. Corzine, governor of New Jersey and former Goldman Sachs chairman and CEO
April 7, 1998
I'm delighted to join you this afternoon and honored to speak before such a distinguished audience here at the Asia Society. My topic today is the economic crisis in East Asia. And I will focus my observations on what I consider to be some of the lessons we might learn from the recent turmoil.
Since the crisis struck last fall, it has made headlines not just among financial types, but broadly in the American public. The crises in Thailand, South Korea and Indonesia in particular, have been followed closely by millions of Americans who, whether they have investments in the region or not, are acutely aware that ours is a global economy. What happens in Asia matters to the U.S. economy, and it certainly matters to our exceptional and robustly valued stock market.
My own perspective, or bias, if you will, is clear. I speak as the Senior Partner of Goldman Sachs, a global financial services firm for which East Asia represents an important and growing part of our business – about 20% today. We are unabashed promoters and beneficiaries of a soundly functioning global economy. Fortunately, our exposure in the worst hit countries of Asia has been far more lost opportunity than financial loss. Still, my firm numbers among those regularly accused of benefiting from IMF rescue packages in the region and elsewhere. On this subject of moral hazard, I will return later in my remarks. In short, what happens in Asia matters – to all of us.
Now, let me begin with a short discussion of the causes and consequences of a crisis that, in a matter of months, led many observers to stop enthusing about an East Asian "miracle" and start warning of an East Asian "meltdown."
Tolstoy, in Anna Karenina, wrote that "all happy families resemble one another, but each unhappy family is unhappy in its own way." Well, financial crises are much like unhappy families. The crises that hit markets in East Asia starting last summer was quite different from the one that struck Mexico in 1994-1995 and that in turn was different from the one that hit a number of European economies and currency regimes in 1992-1993.
In East Asia, for instance, there was little or no sign of the fiscal or monetary excess that often signals an impending crisis. In fact, the governmental sector in many of these economies was actually in slight surplus over the four years 1994-1997. Moreover, the crisis was not preceded by any significant acceleration in money supply or domestic credit. Finally, current account deficits were more than offset by private capital inflows. Official reserves and real exchange rates were rising.
What did occur in East Asia during the years preceding the crisis was an extreme build-up of hot capital inflows, largely denominated in short-term banking instruments. This liquidity, in turn, contributed to a bubble in asset prices and investment in dubious projects. Real estate prices in the region were recognized by many to be at unsustainable levels as 1995-1997 unfolded.
Now bubbles are not a new phenomena. They reach back at least to the famous tulip mania of the 18th century. And the bubbles of East Asia were fed by the all-too-human mix of over-optimism, herd instinct and hot money. The bubbles were also sustained and facilitated by a lack of transparent economic accounting and financial data in most of the countries involved, an important subject to which I will turn at greater length later.
For some observers, this lack of transparency provided the foundation for so-called systemic problem labeled "crony capitalism". The trigger for the crisis was a combination of chance events – a confluence of approaching national elections, a rising dollar, a weak yen, a collapse in global demand for computer parts, and the expectation of tighter monetary policy in the G-7 countries. All these factors led to a decline in export growth in 1996-1997 and threatened the large capital inflows needed to finance widening current account deficits. This, in turn, led to rising international concerns about exchange rate stability in the region. The first country to be hit was Thailand, but others quickly followed as investors realized just how over-valued many of the region's assets had become. Investors withdrew and hot money attacked. Currencies collapsed. Stock markets crashed. The East Asian bubbles burst.
The banking systems of the affected countries were hit especially hard. Devaluation led to a sharp rise in the carry costs of foreign currency liabilities. Declining land and equity prices undermined collateral backing the banking sector's assets. Credit extension dried up. What began as a currency run rapidly became a general banking crisis.
What are the consequences of the current economic crisis? For the countries involved, those consequences are at least, in the short-term, problematic. Corporate bankruptcies and worker layoffs will continue. There will be no immediate and easy return to pre-crisis growth rates. The human costs of these events is real and high. The crisis countries can expect sharply lower growth rates over the next several years in the range of one percent in 1998 and between three and four in 1999. These rates are well below pre-crisis estimates of 6.0 percent. Moreover, there is still the possibility – not strong, perhaps, but no means trivial – that the crisis might deepen or spread. Two potential developments, I believe, are of particular concern.
The first would be the potential for a competitive devaluation by China in an attempt to keep its exports competitive with those of the crisis countries. This could lead to a futile and destructive round of further devaluations throughout the region. Beijing, to its credit, has thus far stood firmly against any such course of action. And its recently announced massive infrastructure investment program – whatever its other merits – at least signal China's determination to bolster flagging growth through domestic demand.
The second possible development of concern is a retreat on programs countries have negotiated with the IMF. To date, with the exception of Indonesia, the track records of the various crisis countries have been, on balance, good. The governments of Thailand and Korea, in particular, deserve credit for their political courage. But the IMF programs in East Asia – like IMF programs everywhere and always – remain unpopular. Any effort by affected countries to curtail or delay these programs could prompt yet another crisis of confidence among international investors.
All this said, there remains strong optimism about the medium-to-long-term prospects in the region. The East Asia of today is most distinctly not like Latin America in the early 1980s. Currencies and equities again, with the exception of Indonesia – are on the rebound, reflecting what we at Goldman Sachs believe to be an initial overshoot and current under-valuation. Investor interest is already on the rise and likely to climb even higher as reform efforts make the investment climate in East Asia even more attractive. Particularly for direct, private equity investment.
Above all, the current crisis should not blind us to the fundamental strengths of the affected economies. Supply side growth is still strong throughout the region. Domestic savings rates remain high. The people of the region are generally educated and motivated to improve their and their children's lives. All of the affected countries are blessed with dynamic entrepreneurial classes. And the governments of the region remain fundamentally committed to growth and a free-market approach.
Let me now turn to the consequences for the American and world economies. Here in the United States, my economists tell me we can expect the crisis to slow growth in 1998 modestly, by perhaps 0.5 percent because of weaker export performance. They are, however, slightly more concerned today than three months ago as Asia's imports shrink. Obviously, the stock market has a different view. On the positive side, cheaper exports from the region will tend to depress inflation by perhaps 0.25 percent. Both effects will be largely lost in our robust ongoing economic expansion.
For the world economy, the crisis in East Asia will have a slightly higher impact, slowing growth by perhaps 1 percent and dampening inflation by perhaps half that. But there is, as of now, no sign of a growing substantial global weakness resulting from the Asia crisis.
So what are the lessons? Let me now move on to the lessons we can learn from the recent events. They range from the very specific to the quite general. My comments do not pretend to be exhaustive. But they do provide, I hope, a useful perspective for thought on a phenomenon both complex in its causes and far-reaching in its consequences.
The first lesson is the vital importance of strong domestic banking systems. In East Asia, as in much of the developing world, these systems have proven to be the Achilles heel of otherwise healthy economies. Liberalization means much more than freeing exchange rates and opening equity markets. It also means building what could be called "financial infrastructure". This includes an independent central bank, an effective securities regulatory regime, and an arms-length relationship both between regulators and financial institutions and between financial institutions and their customers. This lack of distance, I must note, is critical, and was, at least prior to last year's turmoil, severely lacking in a number of the crisis countries of East Asia. Rebuilding those banking systems of East Asia will be a daunting proposition. As we know from our own S&L experience, major financial restructuring can be a painful, protracted, and expensive process. The bad news is that recapitalization in a number of these countries could require as much as 20 to 30 percent of present GDP, admittedly spread out over a number of years. The good news is that these countries, by virtue of their strong public sector balance sheets, are in a good position to undertake this massive but critical task effectively.
The second and related lesson is the high value of transparency. This term, much bandied about since the crisis, means nothing more or less than the timely, comprehensive, and accurate release of pertinent financial, accounting and macro-economic data. The importance of transparency to sound decision-making by investors, and therefore the efficient allocation of capital, should be obvious. There is no such thing as perfect knowledge, of course, except perhaps in rarefied economic theory. It remains an unachievable ideal. But the closer one approaches that ideal, the more optimal the economic outcome. Lack of transparency contributed significantly to the crisis in East Asia. During the bubble, it permitted over-optimistic investors to assume to the best. Once the crisis began, it encouraged skittish investors to assume the worst. It helped the crisis spread. Investors, faced with nonexistent, incomplete, or simply suspect information in a number of neighboring economies, decided to abandon the region, country by country. Now, the crisis clearly was not simply caused by a lack of transparency. Indeed, the first country struck – Thailand – provided some of the most reliable macro-economic and financial data in the region. But the lack of transparency did clearly have an effect and it was a pernicious one in setting the stage for the regional crisis before it occurred and worsening it when it struck. At the micro level with respect to companies and individuals, the data issues were and continue to be severe. Financial institutions' due diligence and discipline on credit extension did not meet global standards. The problem continues today and slows turnaround. Lack of adequate bankruptcy laws with transparent processes and procedures keeps outside equity capital on the sidelines except at a very high cost capital.
The third lesson is the critical importance of the IMF as international lender of last resort. I have neither the time – nor, frankly, the expertise – to provide you with a thorough analysis of the Fund's activities before and during the East Asian crisis. The Fund is not perfect. Like all human institutions it makes mistakes. And it may well have made mistakes in East Asia. But to suggest, as some do, that the United States and other major countries withdraw or reduce their support for the Fund is, to be blunt, simply foolish. Some on the Left are highly critical of IMF programs, that, they say, fall disproportionately upon the poor in effected countries. Some on the Right argue that the Fund undermines market discipline by protecting governments and investors from the consequences of their decisions. Both critiques contain an element of truth – but both miss the broader point. While IMF programs frequently do involve austerity, the hardship they impose is nothing compared to that which would ensue in their absence. And, while IMF bailouts do involve an element of what economists call "moral hazard" by encouraging over-risky behavior, they also play a vital role in ensuring that a financial crisis in one country or region does not spread into the broader global financial system. Contagion, particularly in this world of vast and near-instantaneous international capital movements, constitutes a threat to the world economy that simply cannot be ignored.
On the issue of "moral hazard," let me make two additional points. First, the idea – common on both Left and Right – that major foreign investors have escaped scot-free from the crisis in East Asia is simply false. Losses – sometimes major – have indeed been incurred here in the United States, in Europe, and in Japan. Second, a policy of insuring that foreign investors take "a haircut" as part of a rescue package would and has, I believe, found support among major financial services firms. Needless to say, any such policy would need to be equitable in effect, consistently applied, and congruent with broader goals such as stemming capital outflows and bolstering investor confidence. But it is wrong to dwell too much on this point. The key objective is to help these countries to resume access to capital needed to sustain growth and invest in sound projects. At the heart of this analysis lies a fundamental and important truth: major financial firms like my own have a stake – a truly vital stake – in a system of international crisis management, one that is both economically effective and politically sustainable. The IMF is at the heart of the effort to make this happen.
This brings me to a last, very general but critical lesson to be learned from the crisis in East Asia. It is this: globalization – far from being some implacable, impersonal force beyond our control, is in fact a human creation. The "East Asian Miracle" is a case in point. Insofar as the word "miracle" suggests supernatural intervention, there never was an "East Asian Miracle". The countries of the region did, in fact, enjoy extraordinarily high growth rates. But the reasons for this success were anything but divine: the hard work of their citizens, the creativity of their business people, the commitment, however imperfect, of economic-policy makers to free market solutions. Despite the crisis, East Asia retains its great human strengths. And it will return to the world's economic vanguard.
In East Asia and elsewhere, economic globalization brings many rewards: a more efficient allocation of world resources, levels of growth not otherwise available, and, not least, a hope for rising standards of living among hundreds of millions of individuals once isolated from the world economy. But we can only achieve those rewards if we are prepared to create and sustain the sort of institutions, policies and norms necessary for the international free markets to work. And when I say "we," I mean all of us: multilateral institutions, sovereign governments, international businesses, and individual citizens like you in this audience. On one level, the economic crisis in East Asia reminds us how far we have to go if we are to seize all the opportunities of globalization. But the response to the crisis – especially the near-universal recognition within the region and outside it that there is no longer an alternative to interdependence – should also remind us of how far we have already come.