FOCUS ON TRADE Number 51, June 2000
Asian Monetary Fund revival? by Kristen Nordhaug
In the last issue of Focus on Trade (#50) Walden Bello reported on the Asian Development Bank's proposal to establish a system of currency swap arrangements to protect regional currencies against financial crises. This system would include the ASEAN countries, Japan, South Korea and China. Put in context, the Chiang Mai proposal may be seen as watered-down versions of the 1997 Japanese proposal for an Asian Monetary Fund (AMF), with a US$ 100 billion funding. In contrast, the currency swap arrangement would require US$ 20-40 billion dollar.
The previous effort to establish an AMF in the middle of the Asian financial crisis was effectively thwarted by the US Treasury, which favoured the exclusive control by the IMF over emergency funds to the region. Again the US Treasury appears to be less than happy about the present discussion, yet the IMF's new managing director Horst Koehler gave a cautiously sympathetic response to the proposal, sprinkled with reservations about moving too fast.
Something is brewing, but what? It is useful to re-cap the previous struggle over the AMF in 1997, and its backdrop in terms of long- term economic interdependencies to see if that can shed some light on current events. A good starting point would then be the situation of US-Japanese economic interdependence, which emerged in the 1980s.
The US-Japanese alliance
During the Reagan period (1981-9) growing military spending and tax cuts pushed up the US budget deficit to record heights. This went along with enormous trade and current account deficits, while Japan became a major capital surplus country, with huge trade surpluses, especially with the United States. Large proportions of the Japanese capital surplus were invested in US assets, especially in long-term US Treasury bonds (hereafter referred to as Treasuries). The main investors were Japanese insurance companies. These investments helped to finance the US budget deficit, kept down the US interest rates and brought a sizeable part of the US current account dollar deficit back home. They also benefited Japanese trading interests, as the US administration became more willing to accept Japan's trade surpluses and protectionism, albeit grudgingly. Furthermore, the Japanese dollar demand which resulted from the purchases of Treasuries helped to hold down the yen/dollar exchange rate somewhat.
Nevertheless, huge current account deficits in the United States, and huge current account surpluses in Japan pushed up the yen exchange rate relative to the dollar during most of the period 1985-95. The industrialisation of Japan's East Asian neighbours benefited from the strong yen as Japanese producers responded to declining export competitiveness by relocating core manufacturing to East Asia. But by mid-1995 the economic weaknesses of Japan led to a sharp realignment of yen-dollar exchange rates.
In the early 1990s the Japanese financial system was caught in a bad debt trap. There was no full-blown crisis as liberal accounting standards allowed the banks to refinance de facto insolvent borrowers. Instead Japan experienced a protracted economic stagnation. The crisis in Japan also influenced the US economy as Japanese purchases of long-term Treasury Bonds declined. As a result, long-term US interest rates were pushed up.
In 1993 the new Clinton administration began to attack these problems by attempting to reduce the US budget and trade deficits. The latter included a "result-oriented trade strategy" towards Japan, and allowing the dollar to weaken relative to the yen. By 1995 Japanese exporters were suffering from the strength of the yen and Japan's bad debt problem was resurfacing with a series of bankruptcies among medium-sized financial institutions.
US policy makers now feared a Japanese financial collapse with ensuing large-scale panic selling of Japanese holdings of US Treasuries with severe consequences to the US economy. During spring 1995 the US and Japanese central banks and ministries of finance co-operated to prevent a financial meltdown. The Bank of Japan lowered its interest rate to boost the Japanese stock market, weaken the yen and allow the banks to use cheap money to purchase safe government bonds. The discount rate was cut from 1.75 in March 1995 to 0.50 per cent in August. The Bank of Japan began to purchase large amounts of Treasury Bonds. As financial institutions became convinced that the yen would fall, they also began to purchase Treasury bonds. The international dollar demand resulting from these purchases pushed up the dollar exchange rate relative to the yen. From April 1995 to May 1997 the yen declined nearly 40 per cent. It was also agreed on a broad truce on trade conflicts between the two countries to sustain Japanese exports.
By 1996 the Japanese economy appeared to revive from its troubles. In the United States low interest rates helped by large-scale Japanese purchases of Treasuries boosted the economy at the right time for Clinton's 1996 re-election. The US-Japanese alliance had become reinforced, but it had serious side effects in East Asia.
Exporting Japan's bubble
Most East Asian currencies were pegged to the dollar, the dollar appreciation therefore reduced East Asian export competitiveness in Japan and vis-à-vis Japanese competition in third markets. Japan's loose post-bubble monetary policies also created surplus liquidity which "leaked out" to East Asia. Japanese banks lent large amounts of money to the region at a low interest rate, both to Japanese subsidiaries and to locally owned firms. While foreign direct investment and lending to East Asia were dominated by Japanese, most foreign portfolio investments came from the United States and Europe. Yet a large proportion of the funding of these portfolio investment came from Japan. Investors borrowed at low interest rates in Japan, changed yen into dollar and re-invested those dollars throughout the world. A large amount of the funds went to the East Asian high-growth area. Most East Asian countries (with exceptions such as China and Taiwan) undertook significant capital account liberalisation to attract these funds from the early 1990s.
East Asian foreign debt soared as a result of the inflow of loans. A large proportion of these loans were short-term (one year maturity or less) which were used to finance long-term investment and renewed on a regular base. Most of the loans were not hedged against exchange rate changes. The defence lines of foreign reserves were becoming increasingly thin. In Indonesia, Thailand and South Korea, which eventually would receive "rescue packages" from the IMF, the amount of short-term debt exceeded foreign reserves. Their economic stability came to rely on the willingness of foreign lenders to renew short-term loans. Furthermore, domestic bank lending was expanding at a fast pace and much of this lending was financed by offshore borrowing. A foreign debt crisis would therefore have strong domestic repercussions.
The declining yen from mid-1995 and the devaluation of the Mexican peso after the 1994/5 Mexican crisis reduced the export competitiveness of the region. This may have reduced the investors' confidence, especially in the case of Thailand, which had negative export growth in 1996.
It is significant that the crisis was triggered in May 1997 when Japanese officials hinted at an increase of the Japanese discount rate. The threat never materialised, but it induced global investors who had been capitalising on the interest rate margins between the yen and regional currencies to sell Southeast Asian currencies. During May and June a number of major Thai financial institutions failed. By 2 July the Bank of Thailand floated the baht.
As the Thai crisis evolved, foreign investors "discovered" that many countries in the region had huge amounts of outstanding debt and modest currency reserves. Hedge funds speculated against regional currencies and stocks, while smaller "security seekers" fled the region. Lenders refused to renew loans falling due. Large-scale dumping of assets and currencies pushed down asset values and forced the central banks to let their currencies float. A 1996 net inflow of private capital to South Korea, Thailand, Malaysia, Indonesia of US$ 93.0 billion changed to a US$ 12.1 billion net outflow in 1997. The countries were caught in vicious circles of currency depreciation, increased foreign debt and ensuing collapse of the domestic financial system. They then had to go to the IMF to ask for emergency credits. Stand-by agreements were signed by Thailand (5 August), Indonesia (31 October) and South Korea (4 December).
Wrong medicine
The IMF stabilisation programmes were based on the premise that institutional structures were flawed and that wide-ranging institutional reform was needed. Accordingly, the IMF insisted on closing financial institutions and enforcing strict regulatory standards. These policies enhanced the investor panic as seen in Indonesia where the abrupt closing of sixteen commercial banks caused panic run on the whole banking system.
The IMF was also demanding policies of fiscal contraction and discount rate increases in a failed attempt to stabilise East Asian currencies. Zealous demands for budget surpluses, which the countries failed to meet, did not enhance investor confidence. High interest rates made investors fear growing domestic debt problems.
Rather than organising the re-negotiation of debt, the IMF attempted to be an international lender of last resort, but it failed to deliver on its promise. The 'bail-out' loan was sliced into tranches to be disbursed over the programme period, pending adjustment performance. However, these tranches were too small compared to the debt falling due to stem the panic, and disbursement was delayed by drawn-out and complicated negotiations.
The IMF was backed by the Clinton administration, which had developed a more pro-active, systematic and coherent foreign economic policy than its predecessors. The newly established National Economic Council (consciously modeled around the Cold War agency, the National Security Council) co-ordinated US foreign economic policy-making. A number of "emerging markets", mainly in East Asia, were targeted for an offensive with increased emphasis on US foreign investment interests. The administration actively supported multilateral agencies such as the IMF, OECD, WTO and APEC to promote international financial liberalisation. As these policy instruments, alliances and the strategy of targeting East Asian markets were in place, the US Treasury was in a strong position to use the IMF to take advantage of the financial crisis through demands for financial liberalisation. This would allow for cheap US take-over in a region in desperate need of capital supplies.
AMF vs. IMF
Some East Asian countries, notably China, Taiwan, Hong Kong and Singapore had huge balance of payment surpluses and foreign exchange reserves. Like Japan, they had invested much of this surplus in Treasuries, especially in the 1990s. Regional central banks were major purchasers of Treasuries. By the autumn of 1997 the Hong Kong central bank alone held about 60 billion of its foreign exchange reserves in US securities, mainly in US Treasuries, while the Bank of Japan held a 170 billion dollars worth of US Treasuries.
But what would happen if East Asian central banks changed the rule of the game, and invested their reserves elsewhere? In August 1997 the ASEAN countries proposed a permanent regional Asian Monetary Fund (AMF) financed by the East Asian countries. The real initiative, though, came from Japan's Ministry of Finance. The idea was that the AMF should operate at the regional level to maintain monetary stability. Its total funding would be about US$ 100 billion with Japan as the main contributor.
Tokyo had a strong interest in stabilising the financial systems of the region. In 1996 Japanese banks had US$ 265 billion in outstanding loans to East Asian countries, and US$ 83.9 billion to the three countries which eventually would have to be bailed out, Thailand, Indonesia and South Korea. A regional financial collapse would enhance Japan's bad debt problem. Tokyo did apparently not trust the IMF to solve these problems. The AMF proposal also demonstrated Japanese willingness to take on regional leadership, and perhaps even to move towards a regional "yen zone". The initiator was Japan's powerful Vice Finance Minister of International Affairs, Eisuke Sakakibara. He had earlier argued that the "Asian model" was more favourable to developing countries than the liberal Anglo-Saxon model advocated by the IMF and the World Bank. The AMF would defend this "Asian model" as it would provide swift emergency credits without strict demands for reform.
Japan floated the AMF idea during a G7 meeting in Hong Kong in September 1997. The EU countries and the IMF immediately objected to the proposal. During the annual meeting of the IMF and the World Bank in Hong Kong in September/October, the then US Vice Secretary of the Treasury, Larry Summers, strongly resisted the initiative. During the meeting Japan's Sakakibara was summoning a number of East Asian top officials to discuss the AMF proposal without informing the Americans. When Summers found out that the naughty Asians had sneaked away to conspire on their own, he immediately left his own meeting and went into their room, sat down by their table and said "Now, where were we?" One should have been a fly on those walls.
The IMF, Summers and others argued that two rivalling monetary funds would create «moral hazard problems» by allowing countries access to emergency funds even if they failed to adopt tough economic reform. From the US Treasury's viewpoint the AMF was likely to reduce its influence on the adjustment processes and impede liberalisation of trade and finance. Concern about the US reliance on East Asian holdings of Treasuries may have been equally important. If regional central banks led by the Bank of Japan had sold out from their huge holdings of Treasuries to finance this costly operation, the interest rates on Treasuries and US long-term interest rates would probably have soared and halted the US economic upturn.
Treasury attempted to accommodate the East Asian countries by assuming a greater responsibility for the emergency funds in return for an abandonment of the AMF plans. Japan responded by withdrawing from the AMF proposal and the other East Asian countries gradually followed suit. The AMF initiative was abandoned in November 1997. APEC's meeting in Vancouver 23-24 November backed IMF's leadership in the financial rescue operation. Shortly afterwards Tokyo announced that its contribution to the regional emergency fund "only" would be about US$ 20 billion.
But the cost of blocking of the AMF initiative was high. The "contagion" from the financial crisis in Thailand might have been significantly reduced if the AMF agreement had been in place by September/October 1997. The foreign investors' knowledge of a US$ 100 billion defence line ready to be issued on short notice might had calmed down the market in a period when regional currencies, excepting the Thai baht, still were relatively stable. Instead, the Asian financial crisis reinforced the Japanese crisis in late 1997, and Japan became preoccupied with its own shaky financial system once again.
A backdoor AMF?
Despite the defeat of the 1997 AMF proposal there has been some new low-key efforts from autumn 1998. In October 1998 Japan's authorities launched a plan drawn up by Finance Minister Kiichi Miyazawa for a US$30 billion aid initiative at a G7 meeting of central bankers and finance ministers in Washington. The countries earmarked as recipients were Indonesia, Malaysia, the Philippines, Thailand and South Korea. Tokyo attempted to minimise resistance from Washington and the IMF by carefully couching the idea in the context of a broader aid effort involving the G-7 industrialised countries, as well as the IMF and the World Bank. The timing was favourable, since the IMF was running out of funds and the US Congress had still not approved the US$ 14.5 billion replenish of the IMF's funds. The Japanese initiative was even supported by the IMF. The US side was less positive, but this time Washington did not attempt to shoot down the proposal.
Loans made under the plan would be denominated in yen and tied to projects involving Japanese companies. By building up the amount of debt denominated in yen, Japan also hoped to internationalise its currency. Recently it has also been discussed in Japan to use yen aid loans to promote yen-denominated exports from poor East Asian countries to Japan. This would shield these countries from uncertainties relating to sharp changes of the yen exchange rate relative to the dollar, while also promoting the role of the yen in regional trade. These may be seen as cautious moves in the direction of an East Asian yen bloc, and the new proposal for currency swaps and emergency funds can be seen as steps in the same direction.
However, there are many stumbling blocs on the road. Much greater amounts of capital than those proposed so far will be required if the objective really is to establish a yen bloc, and it seems unlikely that the heavily indebted Japanese government is able to muster these funds. Japan's rival for regional hegemony, the People's Republic of China would not be very happy about a yen bloc. Tokyo itself may also be ambiguous, as it is concerned about its relationship with the United States. The US power to go against any form of regional economic integration which is contrary to its interests is as strong as ever. This strength is underpinned by the region's reliance on exports of finished goods to the United States, which is mirrored by a relatively low level of interregional trade. A yen bloc would require increased interregional trade based on increased consumption of finished goods in the region, while Japan would have to take on the role as the region's locomotive. All of this appears extremely remote for the time being, although the picture may change if the US financial bubble bursts.
Finally, it should be noted that there is at least one counter-argument to my discussion of the AMF events in 1997. Merill Lynch economist Ron Bevacqua argues that the Japanese AMF proposal was not sincere in the first place. Japanese authorities anticipated that the AMF initiative would be blocked by the United States, and that the United States then would be forced to assume a greater financial responsibility in the crisis. I would be grateful for any information which supports or refutes his claim.
* Kristen Nordhaug is an assistant professor at International Development Studies, Roskilde University, Denmark. E-mail: knord at ruc.dk