The first modern financial crisis in the globalized world | DW Documentary

Hong Kong, late September 1997. The entire

world

's

financial

elite is flying to meet at the annual conference of the International Monetary Fund and the World Bank. These two institutions were established at the end of World War II to promote smooth economic growth and resolve crises quickly as they occur. When the heads of the

financial

world

arrive in Hong Kong, they will be able to look back on more than 10 years of solid and stable growth. The demise of many communist economies and increased growth in East Asia have created a boom. Meanwhile, the global economy has moved toward an increasingly intertwined division of labor.

Southeast Asian countries have contributed strongly to growth in recent years. But in recent months, the currency

crisis

in Thailand is slowly turning into a massive economic

crisis

and now threatens to spread to other countries such as Indonesia and the Philippines. So the participants at the Hong Kong conference are not just there to pat themselves on the back. Delegates from Asia in particular are concerned and are pushing for the creation of a joint crisis team made up of the finance ministers of all major countries. The heads of the financial world come mainly from the West: the kingpins of the new global economy.

When they find themselves in Hong Kong, they can't imagine that their perfect world of constant growth could be in danger. But in fact, the crisis that began in Thailand would turn into a forest fire that would engulf the entire region and bring misery to millions. The Asian financial crisis will be the

first

modern

financial crisis in the

globalized

world. However, the global financial elite is not prepared for the destructive elements that would characterize all future financial crises thereafter. Just ten years later, the world is literally on the brink of collapse when, in 2008 and 2009,

first

the banks of the United States and then the financial system of the entire Western world threaten to disintegrate.

The heads of the Western financial system and governments had not learned the lessons of the Asian financial crisis. If they had understood the causes of the Asian wildfires and fought them decisively, they could have avoided the near collapse of the financial sector ten years later. The problem was that the speed with which financial markets acted was out of sync with the speed of policy. Until the US financial crisis of 2007, the lessons of the Asian crisis hadn't really been taken seriously and people thought that it doesn't affect us, it won't affect us. And today? Where are we today?

The world is currently facing many crises. How big is the danger that the global financial economy will collapse again? Are authorities better able to keep pace with financial markets today? In retrospect, it's surprising how little was learned from the Asian financial crisis of 2008. I mean, in effect, a lot of the memory of '97, '98 was buried or somehow declared exotic. The developing and emerging countries of Southeast and East Asia had become important drivers of global economic growth since the 1980s: aptly named tiger economies. When they are hit by crisis, one after another, the middle classes almost disappear, millions lose their jobs, hunger returns to countries that had finally experienced prosperity, riots break out.

It took five years to return to the level of 1996. So it was a fairly deep and long crisis. Thailand was the model for the new global division of labor. It was one of the first countries in the region to see a large amount of foreign capital enter, starting in the 1980s. At first, investments were mainly from Japanese companies, with components or complete products manufactured in the country. Labor was cheap, as were raw materials. I remember that in the mid-1980s, Thailand's poverty rate was around 30%. Then 30% of the population was poor. Today it's down to 9%, right? So it took time, but there were people who were really able to benefit from this growth.

Almost all countries in the region were booming. More and more young professionals were leaving universities. Asian countries were allowed to enter the antechamber of sustainable prosperity. Bangkok also grew very quickly at that time because a large amount of money was flowing into Thailand through loans from abroad, mainly obtained by Thai companies taking out loans to invest. We must not forget that in 1993 the World Bank published a highly influential book that generated much controversy: The East Asian Miracle. So if the World Bank, a very influential organization, labels an entire region that way, investors will be eager to get into that region.

And that's exactly what they did. The World Bank and the International Monetary Fund are headquartered in Washington. Their analyzes and forecasts have considerable weight in the international financial world. His assessment of the region in the spring of 1997 is entirely positive. Joseph Stiglitz is the World Bank's chief economist at the time, focused on East Asia, and shared this assessment. They put a more egalitarian policy at the center. They were much more egalitarian societies than the United States. They had focused on governments investing in infrastructure, in technology, and in educational policies that I considered good policies for the United States, the kind of policies that I had promoted when I was on President Clinton's Council of Economic Advisers.

In the 1990s, the same phenomenon could be observed again and again in Southeast and East Asia. In a very short time, an urban economic culture had developed, with great opportunities for social advancement. In just one generation, farmers became engineers. Much of the money borrowed abroad was invested in the future of these countries. These in themselves are the ingredients of a success story. But what was it that triggered the Asian crisis in the summer of 1997, bringing an entire region to the brink? In the 1980s, neoliberal restructuring of the international financial system had begun: first in the United States.

The deregulation of financial institutions meant that the rules for granting loans became much more lax. A bank no longer had to maintain reserves of an equivalent amount in its vaults for the capital it lent. This rule had previously acted as a brake on loan volume. From now on, Wall Street multiplied the amount of money that individual entrepreneurs could borrow. The growth of the world economy owes much to this neoliberal financial policy. But the downside of neoliberal monetary policy is that the massive introduction of new players into the game changes the financial landscape forever. They would borrow money from wealthy investors and invest it with the intention of making the highest possible profit with the fastest possible delivery time.

Asian markets, with their above-average growth rates, were extremely attractive to them. From now on, the world of money is unstable in its very essence. It is a decisive moment, in history and in our culture, that began in New York and whose consequences can be felt to this day. From now on, financial institutions and the global financial sector will grow at a pace previously unimaginable. Investor anticipation drives bankers. The best way to make short-term profits is from short-term fluctuations in the global economy; of monetary fluctuations, as in the case of the Southeast Asian countries in crisis; From the fluctuating yields of oil, minerals and wheat.

Once deregulation began in the late 1970s and early 1980s, the financial sector exploded in size. Financiers are beginning to be paid much more than other professionals. And inevitably you start to have more financial crises. New players work at a dizzying pace. For many, the period in which they trade money does not exceed two weeks, a month or even a day. Finance has its own rules that are independent of the evolution of the real economy. So to generate as much debt, loans and financial activity as possible, getting paid is a bit like a nuclear power plant deciding to pay its employees according to the amount of electricity they can generate, not the amount of electricity they can generate. consumers really need.

And a new type of banker emerges. He defines himself as greedy, because that is what is expected of him. He competes with others, he competes for the majority of investors' capital. This gives rise to its own dynamic. One of the factors is scale. It's just the scale. It's huge. The crisis in Thailand is already a crisis of tens of billions of dollars. This is significant money. When the heads of the financial world met in Hong Kong in September 1997, very few of them had any idea of ​​what was already unfolding before their eyes. The International Monetary Fund, host of the conference, is the same institution that was supposed to oversee global financial markets and ensure their functioning.

If a debt crisis arose in a country, the Fund could provide loans, which were usually linked to harsh restructuring measures for the affected countries. Of course, as if Spielberg had planned it, the 1997 Hong Kong conference came at the perfect time. The IMF and World Bank hold their Annual Meeting outside Washington every five years, and in the midst of the crisis they met in Hong Kong. Companies and private investors in Thailand had borrowed heavily from abroad in order to further increase their exports and benefit from rising property values. As later in the American financial crisis, the rush of investments is based on the assumption of constant growth.

Therefore, companies and individuals take on short-term debt in order to be able to repay their loans as soon as possible with the expected profits. When Thailand's export boom begins to falter due to an economic crisis in Japan and the first companies run into difficulties, Japanese banks are the first to get nervous and cancel loans. In Thailand, significant investments were made in real estate and these real estate, of course, make profits, but in Thai baht. If investors accumulate US dollar debt to finance real estate projects in Thailand and the exchange rate of the Thai baht to the US dollar plummets, then they have a problem.

To prevent the devaluation of the baht, the Thai government sent emissaries to Beijing and Tokyo in early June to request bilateral hard currency loans from both countries. Thai companies needed US dollars to pay off their loans abroad. Both countries refused to provide the Thai Central Bank with enough foreign currency that it could have used to keep the exchange rate stable and counter speculation. The central bank can maintain a fixed exchange rate. At the same time, however, foreign exchange reserves are slowly beginning to decline. But little by little, we say. At some point, and it's not so easy to predict when that moment will be, suddenly people start saying that maybe it's not a good idea.

And then there is a run on the central bank reserves and suddenly they collapse and that is when there is an exchange rate crisis. The predictable downward spiral is now beginning to trigger activity among hedge funds and speculators in New York. His front man is George Soros. The speculation process is as follows: An investor deposits a billion US dollars worth in a bank somewhere in the world. He then goes to a bank in Thailand and asks for a loan for 25 billion baht. This is the official equivalent of one billion dollars. He sells the baht on the open market.

Immediately, other money traders do the same, because now they fear that the price of the baht will drop. When the exchange rate of the baht against the dollar has fallen, for example, by 30 percent, the investor buys back the 25 billion baht with just $700 million, thus repaying his loan. He made a profit of $300 million and then left the country. I have been blamed for almost everything. I'm basically there to make money. I cannot and do not look at the social consequences of what I do. You see grazing. You see very large-scale private sector activity directed against States, and in reality only very large States can survive.

Thailand is therefore not big enough to withstand a widespread leverage run on its currency by the hedge funds of this world. The United States is. But Thailand is not. So the baht skyrocketed from 25 baht per US dollar to 50 baht per US dollar. And this put businesses and companies that borrowed abroad in a lot of difficulty because they couldn't pay, especially when their loans, which are now double the size they were when they borrowed them. So that had really caused panic amongforeign creditors. Many of the creditors abroad asked for their money back. But they can't pay them.

On July 2, the Thai Central Bank abandons the fight against speculation and frees the baht exchange rate, causing an immediate devaluation. This date marks the outbreak of the Asian crisis, but it is still considered only a local problem. On July 28, Thailand requests loans from the IMF. But the IMF is reluctant to intervene and help. The problem was that the International Monetary Fund had committed itself quite early and had said that this crisis was mainly domestic in origin. The result is a massive recession for Thailand. It is a harsh psychological shock for the country that had believed so firmly in its rise to the league of prosperous countries.

As foreign investors flee Thailand, there is no authority to control the panic. There would have to have been a player who, during the speculative phase, provided dollars, ideally an unlimited amount, to the issuing banks, which cannot simply print dollars. And nobody did that. At the Hong Kong conference at the end of September, two very different realities collide. While the West celebrates the victories of neoliberalism, a robust and growing global economy, and the exponentially growing importance of the financial sector, Asia experiences rampant fear among its populations. The finance ministers of the affected countries sense the enormous social disruption they will face as a result of the withdrawal of international investors and panic in the financial markets.

But the bosses of global finance are not listening as they meet in Hong Kong. The IMF came together to push for even more capital market deregulation and liberalization. They were pushing a set of policies that would have made things even worse. The IMF forced countries to clamp down on investment of any kind, as well as consumption, at the height of the crisis, by dramatically increasing base rates. And that was a mistake. In Tokyo, ahead of the conference, people are worried that the economic power of the entire region could collapse. Trade with Southeast Asian countries has become increasingly important to the Japanese economy in recent years.

When the Thai crisis spread to Indonesia, we feared it would spread to other parts of Asia. But at that time we didn't expect it to spread to South Korea. In Tokyo's government district, Finance Ministry staff spend long hours discussing how to avoid the coming recession. The IMF's strategy for Thailand and Indonesia is considered flawed. Both countries need new, long-term loans to reform their economies without bankrupting many of the country's businesses and banks. The ability to grow and pay debt is not increased by causing a depression, which is what the IMF did. There were very clear alternatives.

And I laid out very clearly why high interest rates, tight monetary policy and austerity would predictably make things worse. And they did it. The Japanese government develops a plan to create an Asian Monetary Fund. For this, 100 billion US dollars will be allocated. This large sum would, on the one hand, calm the international financial markets and, at the same time, make large loans available to the affected countries. Japan requests the support and participation of the governments of Singapore, China and Korea in particular. Until November 1997, international institutions did not play any effective role in preventing such crises, or even in managing them.

That was a real problem. During the Hong Kong conference in late September, news on the stock market and exchange rates indicated that the crisis is spreading uncontrollably. The Japanese government proposed the establishment of the Asian Monetary Fund in Hong Kong. However, at that time, I know that the US government, particularly Larry Summers, who represented the US Treasury, was opposed to the establishment of an Asian Monetary Fund. Behind the scenes in Hong Kong, both Sakakibara and Summers seek support from other key delegations. In the run-up to the conference, the US Treasury Department had informed all East Asian governments that it was strictly against an Asian Monetary Fund.

The focus prevails. No one dares to oppose the United States. The Hong Kong conference would have been the ideal opportunity to avoid the crisis. But the loans made available to struggling countries were too small. There is small-scale maneuvering and waiting, while the crisis worsens rapidly. The global financial crisis of 2008 and 2009 is finally defeated by the US government's willingness to deploy the maximum amount of money, thus curbing panic and speculation. This political will was missing ten years earlier in Hong Kong. Until 2007, there was this feeling of arrogance that people said, well, those are Asians and we can do better.

That's a common pattern in financial markets. Hong Kong is the most important banking and stock market center in Asia. When, a month after the conference, stock prices plummet, it becomes clear to everyone that the crisis is not over: it is just beginning. Late November 1997 in Tokyo's government district: The Japanese government knows that large amounts of money are needed to quickly save Korea from default and massive economic collapse. He particularly urges the US Treasury Department to act quickly and decisively. Korea was the world's tenth largest economy at the time, as it is today. It had only $8.9 billion in its reserves.

That amount of reserves would have lasted the government only a few days. President Clinton personally made a phone call to President Kim Young-sam regarding the South Korean financial crisis. The American president intervenes, making it clear that Korea is of a different caliber than Thailand or Indonesia. Economically and, above all, geopolitically. It is the bastion of the West against North Korea and China. Korea successfully competes in the global market in important key industries such as electronics, automobile production and shipyards. Its main companies, such as Thailand, had taken on a lot of debt abroad in dollars. When the exchange rate of the Thai currency, the won, plummets, they cannot repay their loans.

Only now, at the end of November, do the heads of the US administration realize that they must act. The factor that changes their minds is the geopolitical dimension: if Korea were to declare insolvency, the reputation of the United States as a guarantor power for South Korea would be greatly affected in the eyes of the world. In Tokyo, the government is urging the US Treasury to hurry. A large rescue package is going to be put together in which many will participate. Korea has already accepted many of the IMF's conditions and everything seems to be ready for the agreement.

When the head of the IMF finally flies to Seoul as well, everyone hopes that the Korean bailout package will be ratified. But surprisingly Camdessus demands more concessions. It demands that the interest rate on loans be raised to 25 percent to attract foreign capital. The Korean Finance Minister responds that as a result, many companies would go bankrupt and the economy would collapse, so no foreign financiers would invest. But Camdessus insists on enforcing his demand. Now, in 1997, the Korean stock market fell 49%, half its value. But that is not the worst. The exchange rate between the Korean won and the US dollar fell by 65.9%.

So, if you combine the depreciation of the currency and the fall of the stock index, it is known that much of the wealth accumulated in the last 20 years disappeared. The atmosphere was somber. Of course, you know, a lot of people were losing their jobs. Companies were going bankrupt. So it was a depressing time. The loan package for Korea comprises $55 billion, the largest sum ever approved under the direction of the IMF. The IMF itself wants to contribute 21 billion, the World Bank 10, the Asian Development Bank 4. The remaining 20 billion will come from rich industrialized countries, especially the United States and Japan, which had urged Washington to raise a significant sum.

Treasury Secretary Robert Rubin, in particular, had long been reluctant to contribute funds from the US budget. I think that in the final stage, Summers managed to persuade Bob Rubin to inject money into Korea, so that together with the US government, we could inject a fairly large amount of money into Korea to resolve the crisis. Bob Rubin was a very difficult man at that time. IMF negotiators in Korea urge rapid financial aid, predicting the country's bankruptcy as the only alternative. When it becomes known that the US government did not want to pay their share in cash, but only deposit it as collateral, they are disappointed.

In the week before Christmas, a plan B that would involve Wall Street banks in the rescue of Korea is being feverishly discussed in New York. The last resort: Banks should defer loans that come due at the end of the year and accept longer maturities. But who should act as an intermediary? That's when the head of the New York Federal Reserve intervenes. He heads the most powerful branch after the US Federal Reserve. He brings together the heads of the largest American commercial banks. The bankers are ushered into a room at the FED, where Bill McDonough pleads with them to give Korea more time to pay off maturing loans.

Instead of adding fuel to the fire, he asks them to help restore confidence and stability to help the Korean economy recover. It's Christmas 1997 and Times Square is full of shoppers. On this point, Wall Street's major commercial banks agree with McDonough's argument. Between the lines, he has threatened them to cooperate or risk canceling all their loans. There is now a good chance that European and Japanese banks will follow suit. At this point, if Korea had had to declare bankruptcy, the Asian crisis would have already become a global economic crisis. McDonough saved Korea. He breathes a sigh of relief in Washington, New York, Tokyo and other metropolises.

IMF staff are also left breathless. Many of them have been working nights for the past few weeks, they are simply exhausted. Everyone hopes that the worst is over, but they are wrong. Because at the beginning of 1998 the effects of the combined impact of the currency crisis, the banking crisis and the economic crisis are becoming reality. In mid-January, Indonesian President Suharto signs a treaty with the IMF that instigates massive cuts to the economic system. Many interpret this as the subjugation of Southeast Asia. But by the time the agreements are signed, it will be too late to avoid Indonesia's economic crisis.

Riots break out, more than 1,000 people die, and poverty returns to the country in full force. The International Monetary Fund has insisted that the government cancel many of its infrastructure projects, as well as food and gasoline subsidies. Indonesia will take a decade to recover. South Korea recovers much earlier, already at the end of 1998. Until then, however, society as a whole is going through a nightmare. There are so many people who are homeless. You know, South Korea has a tradition of not having homeless people except immediately after the Korean War. But we started to have homeless people in the parks and streets.

And also a large number of small and medium-sized businesses went bankrupt and there was an increase in suicide. And the children couldn't go to schools. There was total social trauma throughout Korean society. It was one of the most tragic moments in contemporary South Korean history. It is intensely hierarchical. The costs and benefits of the programs that were imposed were enormously asymmetrical. Absolutely. Some people are rescued and others have to pay the adjustment costs. It is not in vain. Some actors in the United States took advantage of the crisis, in South Korea, for example, to buy companies at really cheap prices after the country fell into crisis.

But some of the structural reforms demanded by the IMF will actually benefit the Korean economy. The close ties between the State and the private sector are loosened, and the private sector becomes the engine of change for the better, once it is able to borrow money again and little by little regains the trust of the international financial market. There was a link of collusion between the government and large business corporations. They were simply symbiotic. And in the past, when the corporation had financial problems, the government always stepped in and bailed it out. The 1997 financial crisis was a curse for us.

But at the same time it was a blessing. A significant aspect of Korea's revival is that the Korean government refuses to meet other IMF demands that would have required export-oriented companies to significantly reduce their capacity. As global market demand turns its gaze back to Korea, they manage to pay off their loans faster than expected. From then on, the sectorBanking is efficiently supervised and the former largest bank is sold to an investment group that includes Weijian Shan. He leads the negotiations at that time. Not only do they learn lessons from how they entered the crisis, but they fundamentally restructure the banking system.

Broadly speaking, in the credit culture, they sold weak banks to foreign investors like us, recapitalized those banks, and then, most importantly, adopted a risk management system. This way they avoided being exposed to many loans, risky loans. And that's why, when 2008 came around, Asian banks were in a very good situation. At the end of 1998, Hong Kong is attacked by hedge funds, again led by George Soros. They are betting on the fall in share prices and the devaluation of the Hong Kong dollar as a result of the severe recession in Southeast Asia. But Hong Kong is able to fight back, with the city government and Central Bank together erecting a hard currency firewall worth more than $400 billion.

Speculation collapses. It is exactly the same strategy that was used to restore confidence in the global financial system in the Western world in 2008, ten years later. After the crisis, Southeast Asian countries will take measures to protect themselves against instability in financial markets. They are watching their banks more closely than in the West and are accumulating large holdings of foreign currency to defend themselves against new speculation. This is interpreted as a decoupling of East Asia from the West. But when the global financial crisis of 2008 and 2009 caused the temporary collapse of much of the Western financial system, these countries had enough reserves to be able to keep their own banks stable.

The 2008 financial crisis changes the perspective of the International Monetary Fund. Since then, the first priority has no longer been harsh austerity measures, which usually led to recession and poverty for many. Rather, the focus is on proposals for how struggling countries could become prosperous economies again in the medium term with the help of IMF loans. I think that institutions like the IMF, international institutions, have a very important role to play in this current environment of fragmentation and polarization, because the challenges that we face, whether it's climate, whether it's digitalization, whether it's inequality, the answers or the solutions It has to be global, it has to be multilateral.

An independent institution that also has relevant expertise would be a sensible consequence given the complexity of our global economy. However, the IMF can only act if the governments of each country ask it for advice and assistance. If you ask me if it would be good if we had a supranational institution capable of exerting much greater influence, then the answer is yes. The way the current international monetary and financial system is organized is far from optimal because it is too powerful and there is not enough cooperation and too few options. The consequences of the actions of one party affect all the others.

We know that the danger of global crises has not been avoided forever. Nor has the danger of major financial crises. This is because the volume of the global financial system has more than doubled since the Asian financial crisis. In 2020, it represented 463 trillion US dollars in sum moved annually by the global financial industry. The markets are shortsighted. They do not put a price on the cost of carbon, of climate change, but they also do not put a price on risk. The result of this is that we have a society, economies that are not as resilient as they should be.

I try to capture that in some of my writing with a metaphor. We make cars without spare tires. The Asian crisis was the zero hour of all crises in the era of a

globalized

world economy. Only after the financial crisis of 2008 and 2009 did people begin to think about possible precautions and regulations. This has not changed the basic paradox of global finance. The financial sector has a determining influence on the functioning of the global economy. And he still tends to think in terms of weeks or months. But I think the financial sector is really important. You cannot run a

modern

and complex society without a good financial sector.

So not only do we have to stop the financial sector from causing harm to the rest of us, but we also have to take an active role in shaping our economy and then in shaping our financial sector. Then they do what they are supposed to do. The challenges facing the world we live in today are no longer regional, but affect all countries: climate change, overpopulation, war. In addition to a growing geopolitical battle between the United States and China. The consequences of any modern crisis impact millions of people. In the Asian financial crisis, this was also a bitter lesson for Southeast Asian countries.

Poverty and misery returned for many years. The Asian financial crisis contained all the lessons we needed to avoid the crisis of 2008 and 2009. We now know that in our highly complex world, wildfires, no matter how far away, will inevitably have an impact on us too.