Segment 1 Of 3     Next Hearing Segment(2)

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U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

    The committee met, pursuant to call, at 10:10 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.

    Present: Chairman Leach; Representatives Bereuter, LaFalce, Frank, Sherman and Lee.

    Chairman LEACH. The hearing will come to order.

    The committee meets this morning to begin three days of hearings on the extraordinary turmoil of whirling international financial markets imposing heightened risks on both the U.S. and world economy.

    Today the committee will hear from an exceptional lineup of private-sector witnesses, many of whom have agreed to testify on short notice, and one of whom who has come all the way from Singapore to share his insights with us. We are delighted to have each of you and look forward to your testimony.

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    As all Americans are beginning to understand, the global economy is in serious crisis. The issue now is the magnitude of that crisis, its potential effects on the U.S. economy and American national interests, as well as the response of policymakers in Washington and elsewhere around the globe.

    The global economy is faced with a very sobering circumstance. Much of the world is either in recession or close to it. Despite some positive signs in Korea and Thailand, Asia is in its worst downturn since the end of the Second World War. The world's second largest economy and historic engine of Asian growth, Japan, is struggling to break free from the grip of powerful deflationary sources and an enfeebled financial system. Indonesia, the world's fourth most populous country, has not only experienced economic collapse, but been beset by drought that has brought it to the edge of famine. In this country that seemed to be well on the way to economic uplift over an eight to ten year period, the new president recently asked its citizens to fast twice a week in order to conserve food supplies.

    Russia has sunk into an economic and political abyss that brings the terrible days of 1917 to mind. In mid-August the Russian government felt compelled to abandon the $28 billion IMF stabilization program. The ruble has lost much of its value. Banks have closed. The store shelves are empty. Voices from the communist past are clamoring for return of relative stability, of a state-directed economy, however inefficient, corrupt, and growth-stifling it may have been.

    Whether there is still time to reform Russia's corrupt market economy, it is really much an open question. President Yeltsin's nomination of Foreign Minister Primakov to be Prime Minister after the duma twice rejected the nomination of Victor Chernomyrdin should divert a constitutional crisis in the short term, but it leaves major uncertainties about Russia's ability to stabilize its economy. Crucially, it remains to be seen whether the new government will be committed to market mechanisms, macroeconomic and fiscal stability, banking reform, as well as the legal institutions essential to a healthy modern economy.
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    As the Federal Reserve Board Chairman Alan Greenspan recently suggested, the Asian financial contagion is simply not the kind of event from which even an economy as large as ours is immune. Our widening trade deficit and the gyrations of the stock market indicate that waves of crisis are now hitting our shores. And with new waves of financial uncertainty emanating from Latin America, where U.S. banks and corporations have by far the biggest trade and financial exposure of any industrialized nation, there is the potential for even greater shocks to come.

    The crises have created a backlash against globalization in some quarters. Some economists and politicians glibly argue that the IMF is to blame for the troubles in the international markets, including the collapse of Russia. For others, the principal villains are speculators and other portfolio investors.

    Malaysia's populist prime minister is responding to the crisis by firing his economic team, imposing sweeping new capital controls, and laying the groundwork for restrictions on political expression. In Hong Kong, perhaps the preeminent symbol of free market capitalism, authorities have increasingly resorted to market intervention, including highly unorthodox government purchases of Hong Kong equities, in an effort to revive the economy and defend against speculative attacks on the Hong Kong dollar.

    In this context it is crucial that the United States provide strong domestic and international leadership. As the world's largest economy and greatest beneficiary of an open economic system, the U.S. has a compelling interest in the restoration of international financial stability and in leading efforts to strengthen the architecture of the international financial system for the next century.
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    A review of the origin of the Asian crisis suggests those countries with prudential and transparent regulation have done well, but those without having found public treasuries jeopardized and economies in peril.

    With regard to the issue of corruption, the lessons are large. The best antidote to cultural corruption is a legal system where economic enterprise is decentralized and subject to as little control of the government as possible.

    The general level of corruption decreases as the degree of market competition increases. Free market systems are not only more efficient than statist models, but more honest.

    Just as this crisis has produced leadership tests for governments in developing, as well as industrialized economies, with the question of whether or not they have the will to address controversial problems in their societies, it has provided the leadership test for the United States, with the question of whether we can remain a global leader.

    I am convinced it is in America's national interest to promptly approve replenishing the financial resources of the IMF. At issue is not only the stability of the international financial system and the ability of the IMF to respond to future crises, but the broader question of whether the U.S. intends to be an engaged leader in global economic policy and multilateral diplomacy in general.

    Likewise, I am hopeful that the Congress will reconsider and approve Fast Track trade authority this fall. It is self-evidently in America's national interest to continue to open markets and shape international trade patterns to the advantage of our farmers and workers. It is also high time for Congress to reassess its lack of support for the United Nations by meeting our treaty obligations and helping to put the U.N. on credible financial footing, thereby facilitating serious efforts to revitalize that institution and advance realistic reform.
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    I also believe, from a humanitarian point of view, the United States should be prepared to increase food assistance to Indonesia and North Korea and potentially Russia. Whatever the world economic turmoil, people should not be allowed to starve.

    At the beginning of the year, Chairman Greenspan noted a small, but not negligible, probability that the upset in East Asia could have unexpectedly negative effects on Japan, Latin America, Eastern and Central America, that in turn could have repercussions elsewhere, including the United States. Top policymakers, particularly the Chairman of the Fed, have a tendency to understate.

    Today it is clear that a recession has taken hold of wide swaths of the earth, from St. Petersburg to Vladivostok, from Tokyo to Jakarta, with the prospect of slower growth or worse in Brasilia and Buenos Aires. The question is whether the powerful U.S. economy can remain insulated or whether tougher times are ahead.

    This is a time for restraining ideological and partisan approaches in Congress, as well as the White House. It is a dangerous time, requiring firm bipartisan American leadership. The honor and prosperity and security of the United States are at stake.

    Mr. Frank, do you want to make an opening statement?

    Mr. FRANK. Mr. Chairman, I am very appreciative of your calling these hearings. We often say that—and sometimes we mean it, but this is one of those times when I mean it very much. Nothing that we are talking about now approaches in importance this question of how we respond to the international economy. And I believe it is important, because we, I think, are very much in need of a change.
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    You alluded to some of the difficulty we are facing now with regard to the United Nations, with regard to the International Monetary Fund. The political, economic and intellectual models that have governed international economic policy are all very much in trouble right now.

    Politically people, I think, are just waking up now to what the loss of the Cold War as a factor has meant in terms of the consensus we have for international economic policy. There are people who were willing to support policies, because of the fear of communism, that are not willing to do that anymore. The reaction toward Indonesia today is very different than the reaction toward Indonesia thirty years ago when there was a threat of a communist takeover.

    People have to understand there has been a substantial shift in the American political situation with the loss of the Cold War as to the nature of the constituency you have there. And what you have here is, on the conservative side of the spectrum, is that a significant degree of support that you had for these international economic policies that was generated by anticommunism has largely dissipated. On the liberal side, there is an increasing concern with the equity and quality-of-life aspects. And the result, I think, is that we have had an intellectual model that has outlived its political support.

    The intellectual model was American policy should, essentially, be to facilitate the legal movement of capital. Technical factors have made it possible for capital to be much more mobile than it had been in a physical sense. And we have been told for years now that the important thing to do in our interest and the interest of other countries is to facilitate the legal mobility of capital and not to worry too much about other things.
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    The problem has been that we have created a situation in which, for a while, capital won all of the arguments. Concerns about equity, concerns about the environment, concerns even about democracy kind of fell. Some of us who objected to that on the equity grounds were trying to make the argument, but as long as that model appeared to be a great economic success, it was hard to get people to listen to the criticism. We now have obvious problems with that model economically, namely a model in which all you do is worry about the movement of capital. There are some serious problems with it.

    One problem has to do with owners of the capital. We have spent much of this year, the Chairman has, I have, the Secretary of the Treasury, everybody has said, ''We are not in the business of protecting investors,'' and we have said with regard to the IMF and elsewhere, ''We are not going to create a moral hazard, we are not going to bail out investors.''

    Well, investors may have gotten that message. They may have understood that they are not going to get bailed out, so they bailed out. We have not confronted this dilemma. If, in fact, you tell people that if they go and invest in what might be risky situations, they are on their own, they then may just decide to find other places to invest, and we have not, I think, owned up to that.

    But what that means, though, is if, in fact, we want to encourage investment in some situations where a prudent investor would see all the risk, if we say, ''We are not going to bail you out in this conventional way,'' then we either have to accept the fact that there will be diminution of investment, or we find some other mechanism involving governments to provide it. That is, there may have to be some guarantees of some sorts for investment, but not simply with the investor making a choice and then automatically calling us in.
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    The second problem we have is the ability to foster two things that always go together, the implementation of democracy in societies which have not been democratic, and the adoption of economic policies, which a substantial proportion of the electorate hates, at the short term. We ourselves have certainly not mastered the art of having public policies adopted which may be, in the long term, good for the society, but which the electorate does not like. And I think we have not looked enough at the dilemma that we create when we say to people, ''We want you to democratize, and at the same time we want you to adopt policies which will have short-run pain on the part of people.''

    And then we have the other dilemma of if, in fact, the major goal of every government is to attract capital, what does that do to equity and other considerations? My own view is that—I have said this before—we have to confront a serious gap here. In a world in which all politics is local and all economics is global, things are out of whack. And what we have got to do is to begin the process of formulating some international public policies that will deal with this that will use some public resources.

    To get people to implement austerity and other kinds of policies correctly, economic mistakes in the past, while at the same time insisting that they be fully democratic I do not think is going to happen without some outside resources. Getting people to invest in risky situations or telling them that they are entirely at risk probably is not going to work. And for many of us, concern about the rights of working people, equity considerations, environmental considerations, those also have to be there.

    So I think we are at a point where a fundamental reassessment of the intellectual model of circulating capital calling all the shots, and letting the contest for capital dominate is in trouble. It is in trouble politically, because both on the right and the left, there is a lack of support for the internationalism that you have. It is in trouble intellectually partly because it does not seem to be working very well and because of these dilemmas it has not addressed. And I hope these hearings are a beginning of an effort to conform a new consensus.
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    I think it would be very much a tragic thing if we wound up with no support for the IMF and no support for international investment. That is not something I want. But there is going to have to be a fundamental shift.

    From my standpoint, in closing let me say people have been told that if they wanted to be responsible in the international economic sphere, that they have to essentially adopt the model that means ''trickle-down'' on the international sphere. And people who have not accepted that domestically are not going to accept it internationally. There has got to be a new effort to build a consensus with some more role for a public sector in dealing with this.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much, Mr. Frank.

    Our panel this morning is extraordinary in their background. We have Mr. Gerald Corrigan, who is Managing Director of Goldman, Sachs & Co., and former Chairman of the New York Federal Reserve Board; Barry Eichengreen, who is Professor of Economics and Political Science at the University of California, Berkeley, and formerly a consultant for the International Monetary Fund; Mr. Robert Zoellick, President of the Center for Strategic and International Studies, formerly a top administration official; and Mr. Thomas C. Dawson, Director of the Financial Institutions Group of Merrill Lynch & Co.

    If there is not a prearrangement of the panel, I will just go in the order in which people were introduced.
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    Mr. Corrigan.


    Mr. CORRIGAN. Thank you, Chairman Leach. Good morning. And good morning to you, Mr. Frank.

    Mr. Chairman, since I have submitted to the committee a rather lengthy report entitled ''Sovereign Financial Crises: Facing Realities and Building a More Secure Future,'' my opening remarks will be very brief.

    I do want to mention, for starters, that the report I submitted to the committee consists, in fact, of two closely related documents. The second (in the order in which they appear) is entitled, ''The Dynamics of a Sovereign Financial Crisis: A Hypothetical Illustration.'' And the purpose of my writing this report was to seek to clarify some of the confusion and misinformation surrounding the events and circumstances typically associated with sovereign financial crises and, above all, to shed light on the realistic policy options once a crisis strikes.

    Insofar as the affected countries are concerned, the study concludes the following: Once a sovereign financial and liquidity crisis strikes, the short-run policy options available to the country are very limited. Essentially, those policy options reduce to one or more of the following: Substantial increases in interest rates; partial or comprehensive moratoria on external interest and principal payments; seeking to obtain fresh money from private sources; or seeking to obtain fresh money from official sources. That is it.
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    In thinking about these policy options, it is very important to keep in mind that, in the short to intermediate term, the current account deficit, which is almost always part of the picture, and therefore—and this is critical—the domestic savings gap must shrink unless there is a totally implausible surge in the capital account surplus that exceeds the current account deficit by enough to provide for a rise in reserves.

    Short of an act of God, I cannot see any way a country in a position described can avoid a sharp contraction in domestic economic activity. Indeed, as noted earlier in that study, the only question is whether an effort can or should be mounted to limit the fall of economic activity and limit the spillover effects of the crisis to other countries and to the international community more generally.

    The above is a long-winded and technical way of saying that once problems such as those we have recently witnessed in a frighteningly large number of countries strike, there is absolutely no easy or painless way out of the problem. That being the case, Mr. Chairman, the primary thrust of the first paper which I sent you is to outline some suggestions as to how we might improve crisis management, but, above all, how we might improve crisis prevention.

    Since I am sure those suggestions will come up in questions, I will not repeat them here. However, before returning briefly to the outlook for the United States and world economy, I do want to stress a couple of quick points.

    First, in looking across individual sovereign financial crises for common denominators—recognizing, of course, that each case has its own distinguishing characteristics—three factors leap out in virtually every case. They are: one, seriously troubled domestic financial systems together with underdeveloped institutional or legal systems needed to support contemporary banking systems; second, large concentrations of short-term foreign currency liabilities in either or both the public and private sectors; and third, and this is very important, a period of denial and paralysis as the crisis strikes or approaches.
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    While denial and paralysis only make things worse, in all of my years of dealing with companies or countries facing acute liquidity strains, I have never observed a situation in which these elements of denial and paralysis were not present to at least some degree. This, of course, is another reason why crisis prevention is the name of the game.

    The second general point I want to mention, Mr. Chairman, is that the costs, in terms of global economic well-being, associated with sovereign financial crises—especially when accompanied by the violent contagion effects we have witnessed in recent weeks—are of truly staggering proportions, especially for the countries in question. These costs ultimately constitute a major threat to the cause of open and free economic and political institutions around the world. Thus, these issues go right to the heart of the national interest of the United States.

    Third, the answers to these problems do not lie with unilateral debt moratoria, misguided capital controls, protectionism, or policy gimmicks. While these approaches may seem to provide some relief in the short run, they will only make things worse over time.

    Finally, we must have effective and well-funded multilateral official institutions, including the IMF and the World Bank. In this regard, Mr. Chairman, I am not saying that the respective roles of the Bank and the Fund cannot be redefined to take account of contemporary realities. I am certainly not saying that the Fund, in particular, cannot improve its ways of doing business. But I am saying that, in my view, it is urgent and unambiguously in the interest of the United States that the U.S. Congress promptly enact legislation to provide for the full U.S. Fund quota increase and the associated financing for the NAB.
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    With these observations in mind, let me close, Mr. Chairman, with a few summary observations on the economic outlook.

    Clearly, as both you and Mr. Frank have said, the recent events in Asia, including Japan, Russia and more recently in Latin America, have taken their toll on growth prospects for the world economy. Here in the U.S. and at this moment, I believe that the most likely outcome over the next several quarters is growth at or near the long-term trend of about 2.5 percent. On balance, however, the risks probably lie on the downside unless we quickly see some semblance of greater stability in other parts of the world and in the global financial markets.

    The outlook for continental Europe also remains reasonably good with near-term growth prospects similar to the outlook I have just described for the United States. In Europe as well, however, achieving that result also implies a more stable environment than we have witnessed in recent weeks.

    Recognizing that the United States and Europe combined constitute about one-half of global GDP, achieving growth in these two areas along the lines suggested above would provide some meaningful cushion against the global economy slipping into recession. However, the arithmetic of global GDP also brings into sharp focus the vital importance of Japan, which accounts for approximately another 20 percent of GDP.

    In that regard, Mr. Chairman, the outlook for the Japanese economy and the closely related matter of restructuring or recapitalizing the Japanese banking system remain in doubt. Obviously, if the Japanese economy were to grow even modestly in the period ahead, that would yield a situation in which something like 70 percent of global GDP would be in a relatively safe harbor. In those circumstances, the evident problems in other parts of the world would be less threatening than is now the case.
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    In this regard, I also want to stress, Mr. Chairman, that there are troubled countries in which real progress is being made in coming to grips with their problems, and there are other countries that are being buffeted by serious market pressures even though the policy fundamentals in those countries remain broadly satisfactory.

    In closing, Mr. Chairman, it is clear that the immediate setting brings with it an unusual, if not a very unusual, element of risk and uncertainty. Some of what we are seeing can legitimately be seen as a healthy correction in global debt and equity markets. Some of it reflects legitimate sources of uncertainty about economic prospects, especially in Japan. But even allowing for such factors, I personally believe that recent market events are overdone.

    At the end of the day, however, what I believe is irrelevant. What is relevant is the need for sensible and sound policies on the part of all and a heightened sense of vigilance, flexibility, and, above all, pragmatism on the part of policymakers, including policymakers at the multilateral official institutions.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Corrigan.

    Mr. Eichengreen.

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    Mr. EICHENGREEN. Thank you, Mr. Chairman.

    I do financial history for a living, and in my considered historical view, I think this may be the most dangerous international financial situation that we have seen in fully 70 years. This is not yet 1929, and, more likely than not, it will not become 1929. The U.S. banking system is strong. Monetary policymakers in particular know how to respond to financial problems. That said, I think there are very real grounds for concern.

    I assume that you will hear many analyses over the coming days of the Asian crisis, the Russian crisis, and the turbulence afflicting global markets. What I fear you will hear too little of is concrete proposals for improving the way we avert and manage these problems in the future. So I have made those questions my focus.

    My recommendations fall under three headings: Crisis prevention, crisis prediction, and crisis management. I will spend my few minutes here focusing on what I think is truly key, crisis management.

    There will always be crises, and there will always be a need to clean up after them. This, I believe, is where the existing international financial architecture is most obviously deficient. The international community has two ways of responding to crises: running to the rescue of the crisis country with a purse full of official funds, or standing aside and letting nature run its course. Both have been tried, and both have been shown inadequate.

    The first approach was tried in Mexico and in Asia. For two years following the Mexican rescue and for fully a year following the outbreak of the Asian crisis, the IMF was, as we know, subjected to a firestorm of criticism for bailing out governments and international investors. Its actions, in the view of the critics, only reduced the incentives for meaningful policy reform and, by shielding the private sector from losses, encouraged more reckless spending on the part of investors, setting the stage for future crises.
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    Then, in the summer of 1998, the Group of Seven countries and the IMF denied another loan to Russia. Its government then devalued the currency and suspended debt service payments, actions that had a devastating impact on the Russian financial system and alarming global repercussions. Confidence was destroyed, Russia's access to international capital markets was disrupted, financial markets were roiled in East Asia, Eastern Europe, Latin America, and even Europe and the United States. That clearly is not an experience that anyone wishes to repeat.

    One cannot avoid concluding that both alternatives—bailouts on the one hand, standing back and letting events run their course on the other—are unacceptable. All too often, if we resort to one of them, we resort to the IMF rescue package as the lesser of two evils despite the fact that we do not like it a bit. Thus, if we are to avoid ever-more-expensive IMF programs and the moral hazard problems they create, we have to develop a more orderly and efficient way of restructuring problem debt.

    Under present circumstances, restructuring is too difficult, too costly and too protracted. It should be difficult to some extent, of course, or borrowers would find it too easy to walk away from their debts. But my point is that the difficulties of restructuring are much greater in international than domestic markets and that this problem needs to be corrected.

    The way everyone puts it is that ''Capitalism without bankruptcy is like Catholicism without sin.'' But the sovereign bankruptcy option is simply too costly to contemplate under present institutional arrangements. Radical reform of those arrangements—creation of an international bankruptcy court, for example—is simply unrealistic. Discussing those ideas, I believe, is a waste of breath. Yet something must be done to create an acceptable alternative to massive international rescue packages.
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    In fact, a number of modest and realistic steps can be taken to make international debt restructuring a viable alternative. Majority voting and sharing clauses could be added to loan contracts. This would prevent isolated creditors from resorting to lawsuits and other means of obstructing settlements that improve the welfare of the debtors and the vast majority of the creditors alike.

    Syndicated bank loan agreements already have such provisions. The reason they are not also included in bond covenants is that William O. Douglas thought they were a bad idea in the 1930's. It is time, clearly, that this be changed. The addition of such clauses to bond contracts is the only realistic way of creating an environment conducive to flexible restructuring negotiations. This is more realistic than advocating the creation of some kind of super-national bankruptcy court for sovereign debts empowered to cram down settlement terms.

    In addition, standing committees of creditors could be created to provide better communication between lenders and borrowers, jump-starting negotiations and diminishing the information-asymmetries that cause the two sides all too often to fight a protracted war of attrition. The IMF could consider lending to countries that are in arrears on their external debts, providing the equivalent of the ''debtor-in-possession'' finance available to U.S. corporations under Chapter 11 of our bankruptcy code. Not only will this working capital keep the crisis economy running, but it would encourage the creditors to come to the bargaining table, again, working to speed restructuring negotiations.

    And when the problem is defaulted corporate and bank debts, the solution lies not in unrealistic designs for an international bankruptcy court, but in strengthening national bankruptcy statutes, reinforcing the independence of the national judiciary system administering them, and harmonizing those laws across countries.
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    Few of these recommendations are, in fact, new. Many of them were discussed in a Group of 10 report in 1996 entitled ''Resolving Sovereign Liquidity Crises.'' Unfortunately, those discussions were not followed by action. Officials then imagined that the markets would be so impressed by their insights that they would immediately amend loan contracts, form creditors committees, and endorse IMF lending into arrears.

    Predictably, little actually happened over the subsequent two years. No country is prepared to go first in adding sharing and majority voting provisions to its loan contracts, for example, for fear of sending a bad signal to the markets. Solving that problem requires everybody to move together.

    Regulators, led by those in the advanced industrial countries, must require that internationally-traded securities include majority voting, sharing, nonacceleration, and collective representation clauses. But, similarly, the markets are reluctant to form standing committees of creditors. They fear that deciding who should be on the other end of the line may make it too easy for countries in difficult financial circumstances to pick up the phone.

    The United States, the G–7 and the IMF now need to press market participants to form those committees, and I think the International Monetary Fund needs to test the market's reaction to its lending into arrears.

    Even together, these modest measures will not create the ideal orderly workout system. But if we wish to create a viable alternative to massive bailouts and devastating defaults, as we must, in my view at least, they are the only game in town.
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    Thank you.

    Chairman LEACH. Thank you very much, Mr. Eichengreen.

    Mr. Zoellick.


    Mr. ZOELLICK. Thank you, Mr. Chairman, Mr. Frank, and Mr. Bereuter. I am very pleased to be with you today. I am going to highlight four general observations on what I believe is at stake for the United States and then note six particular issues, and I will conclude with some suggestions for action.

    First, the experiences of 1998–1999 will be the epic event in the lives of a generation of Asians. Much of Asia's emerging middle class, families who built their livelihoods over decades, has been wiped out. Almost overnight, tens of millions found their expectations for a better life eclipsed by the specter of poverty. Just as America's actions in Europe fifty years ago established the foundation for a lasting transatlantic partnership, America's performance right now will shape Asian impressions for the next century.

    Second, the political and security repercussions of these economic events are far from determined. The extraordinary economic success of East Asia over the past thirty years was part of a much larger process of building nations out of colonies and establishing the legitimacy of regimes and leaders. That legacy is now in question. The initial assumption by some that the crisis would propel these countries toward greater openness, cleaner governments and democracy could turn out to be way off the mark. As economic consequences follow from financial upheavals, more people will lose their jobs, more companies will shut down, and more families will struggle to scrape out livings. Governments in Asia, Russia, and Latin America, like those in Europe and America in the 1930's, are going to be tempted to blame others. Harsh voices will demand protectionism, raise ethnic animosities, and stir the cauldrons of xenophobia and arch-nationalism. Rather than embrace Western or American models, people may attack them. The global trend toward democracy and market economics—the fruit of the Cold War victory—is now at risk.
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    Third, and of special interest to this committee, the crisis has underscored the critical function performed by banking systems in all societies. The failure of banking systems around the world is much more than an economic problem, it is a violation of public trust. Until that trust is restored, and until banking systems are recapitalized, people will not put money in banks, and banks will not be able to fulfill the critical role of intermediating between domestic savers and those who need the capital to make and market goods and services.

    Fourth, even in the midst of this economic and political tumult, the United States will have to keep an eye on the security context. Security is like oxygen; one only notices oxygen when it is in short supply, and then one cannot think of anything else. We are on the frontiers of trouble in a number of fronts.

    Turning next to the six specific problems I would like to bring to your attention.

    Number one, sadly, we are going to have to expect that Japan, representing about 70 percent of East Asia's economy, will not be the locomotive for growth in the region. The question now is whether Japan will take actions to begin its slow recovery, or whether it will slide further, dragging the rest of Asia with it.

    Two, China's growth is slowing, undermining the government's ability to create new jobs to replace those that are going to be lost when the state-owned enterprises are reformed. The huge bad debts in China's banking system could also overwhelm the moves toward markets. And since the Chinese government's political legitimacy today rests significantly on economic performance and nationalism, one could expect the government to balance reforms with the avoidance of social risks. I suspect China will continue to address the state-owned enterprise and banking system problems because the government recognizes the vulnerabilities created by them, but it will proceed much more cautiously with openings to the outside.
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    Three, the stakes are high in Indonesia, the fourth most populous country and the largest in the Muslim world. Indonesia, a country of over 13,000 islands stretching over 3,200 miles, is astride the primary route for oil to East Asia. Indonesia will not have an economic revival until there is political stability, and there will not be political stability if Indonesians cannot get food. That will be a serious risk this winter because of high prices, shortages, and breakdowns in the distribution system.

    Four, a great deal rests on the success of President Kim Dae Jung in Korea, a strategic peninsula where the interests of the United States, Russia, China and Japan all intersect. President Kim has initiated impressive reforms, but his highly personal approach to governing leaves him with a very heavy load to carry, and he has already borne a great deal of stress over his 70-plus years. Although some foreigners have invested in Korea recently, the rate of return on capital in Korea's heavy industries has been abysmal, suggesting that Korea's businesses are going to have to accept much lower prices for their assets if they are going to draw investors.

    Korea's economic revival also depends on the value of Japan's yen. Korea's basic business strategy has been to produce goods like those manufactured in Japan, but at 95 percent of the quality, to be sold at 85 percent of the cost. At some point between 140 and 150 yen to the dollar, the Korean producers cannot make it.

    Moreover, North Korea will add to the burden in the South. Despite an estimated two million or more deaths due to starvation or malnutrition out of a population of about 21 million, North Korea shows no signs of improvement. Its treatment of aid agencies is leading these groups to throw up their hands in frustration. There will be no ''soft'' landing in the North.
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    Five, as we have seen over the past months, the fall in commodity prices, especially for oil producers, and the retreat of skittish capital from emerging markets has begun to drag down Latin American governments, even these that have pursued respectable reforms. Despite difficult steps taken after the peso crisis in 1994, which helped Mexico bounce back, external forces are now dragging the country down. That slowdown will make it much harder for President Zedillo to work out reforms with Mexico's first opposition-controlled congress, especially with the approach of the presidential elections in 2000.

    In South America, Brazil, which has a presidential election next month, has hiked interest rates to hold off the assault on its currency, but the country's reserves continue to slip, and its persistently large budget deficits require financing. If Brazil is forced to devalue, the change will wreak havoc on Argentina because Argentina's substantial exports to Brazil will be hurt by the devaluation, but Argentina could not match the reduction because its currency is linked to the dollar's value through a currency board. So we can see a clash between the policy of regional economic integration and the policy of currency stability through the dollar link.

    The United States exports more to Latin America than it does to Asia, and U.S. banks are significant lenders in that region.

    Six, events in Russia have shown dramatically how the financial contagion will penetrate points of vulnerability, expanding the cracks until political and economic structures break. Although Russia pursued macroeconomic reforms to lower inflation and steady its currency, the country did not make sufficient headway on creating competition, effective property rights, or a fair system to generate revenue. Today, the average Russian associates markets and capitalism with monopolies and oligopolies, corruption, crime, the breakdown of society, and a vast gap between a very few rich and very many poor.
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    Moreover, President Yeltsin, ruling by decree, never built a political base through a national party or by negotiating coalitions with the duma. So when troubles hit, Yeltsin had no backing to mobilize. We are now witnessing a new struggle for power, which will be played out first in the weeks ahead and then, one hopes, in the duma and presidential elections of 1999 and 2000 respectively.

    Prime Minister Primakov's new economic team is the same economic team that I dealt with in 1991, and they are not going to make it.

    We have just seen a large reversal of fortune in countries where a vast majority of the world's people live, and the turmoil is not finished. If you consider the myriad implications of these conditions for the United States on your States, districts, constituents, I hope you will conclude that our country cannot afford to let events take their own course. The very interconnectedness of these topics will require the Executive Branch and the Congress to do a better job of fashioning responses. There is no other country that can play this role.

    In closing, I would urge the Congress to consider the following: The Congress should work with the Administration to develop a major humanitarian relief program for Indonesia. This initiative would send a powerful, symbolic, and practical message about America's concern about the plight of average Asians, not just officials and business magnates.

    Given the risks of further financial and economic turmoil while Congress is out of session, I urge you not to leave the IMF's coffers empty. If Members believe their questions about the IMF's performance or even its proper roles and missions have not been answered, you may wish to pass both the capital replenishment and establish a top-flight outside commission to examine these topics and report back to you. Such a commission might be an important step in rebuilding the IMF political legitimacy with the Congress.
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    The United States should be a force for trade liberalization to counter the inevitable impulses of protectionism that will arise. If America is unwilling to back open markets with deeds, how can one expect Asians, Latin Americans, and Asians to believe U.S. reform rhetoric? Therefore, I urge Congress to pass trade negotiating authority for the President.

    At this point, the most effective way to press Japan to pursue banking reforms and a growth package is probably to embrace Japan's legislative program in order to give it more momentum. In a break from the past, some Japanese diet members are now actually shaping policy. Many of you could offer useful advice from the U.S. experience to your Japanese colleagues on how to implement the new statutory authority effectively; for example, how to combine protection of depositors and preservation of credit services with the closing down of bankrupt institutions and the disposition of assets. Just as it took the United States years to launch the RTC, so the Japanese banking supervisors are far from ready, even if they get the proposed laws, to put them into practice.

    Finally, the United States should pursue policies at home that will maintain our dynamism, adaptability, and growth. As this committee knows well, market developments have been bypassing our Depression-era banking and financial services laws for almost twenty years now. If the Senate acts on the House's financial modernization bill this year, I hope the Congress will send a final bill to the President for his signature. This action will demonstrate to the world that the United States is willing to act on its own advice, and that America recognizes that the safest course in the world economy is to move forward, not stand still.

    I would be pleased to try to answer any of your questions.
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    Chairman LEACH. Thank you, Mr. Zoellick.

    Mr. Dawson.


    Mr. DAWSON. Thank you, Mr. Chairman. It is a pleasure to appear before the committee, and I will try not to duplicate the comments made by the other members.

    By way of background, I was for four years the U.S. Executive Director at the IMF, and for four years, from 1981 to 1984, I was the Deputy Assistant Secretary of the Treasury for Developing Nations, where I am happy to note that despite the talk about turnover in Congress, three of the four Members at this hearing this morning are people that I used to testify or come up and talk to the staff about. So there is some continuity.

    I would like to analyze the current situation in a little different context. I would like to address the question of whether the present crisis is so ''different'' that we need to change our basic belief on what works or need to rethink the ''architecture''—which is a common phrase these days—we use to deal with international financial issues. And finally, I would like to comment on a real-time public policy issue that I think needs to be addressed.

    How different is the present crisis? There is no doubt that the losses in the present situation dwarf what happened in the Latin American debt crisis of the early 1980's or the Mexican (tequila) debt crisis of 1994–95.
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    On the other hand, I have to say, in having observed certainly in the last two or three years, in some sense the present crisis was predicted or certainly feared by many, certainly by many more than the Tequila crisis was back in 1994–95.

    Why losses were as widespread and large as they were is something that I think both public and private sectors will be analyzing in great detail. Clearly, the development of modern capital markets in which news of developments in one region is transmitted instantaneously and in which investors trade and hedge between markets is new. The example of selling Brazil in order to cover your Russian losses, it can have perverse effects on countries that are not obviously the first target of opportunity. Yet I would argue that fundamentally the crises that we are going through at this point are about or are caused by policy, bad policy to be blunt.

    Excessive fiscal deficits and excessive sovereign debt were key to the genesis of the early 1980's debt crisis. The debt overhang from that era made necessary the Brady Plan approach of 1989 and later. More recently, excessive short-term debt, whether public sector in Mexico, the domestic financial sector in Asia, or public-sector debt in Russia, have been the catalyst for the present crisis. In some cases, good old-fashioned public sector deficits continue to play an important role in creating problems, and certainly the Thai situation last year and the present concerns over Brazil are cases in point.

    It certainly seems true until recently, as has been prominently as well as eminently argued, that the markets exuded an irrational exuberance in which classic risk-return relationships seemed to have broken down, but I would say no longer and indeed never in the first place.
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    What is certainly new is that once alerted, the markets punish bad behavior, perceived or real, far more quickly than in the past. This is a reality, but also one which, in my view, should be welcomed as providing needed discipline. It is interesting to see how quickly the Russian default changed the nature of the ''too-big-to-fail'' moral hazard debate that has been the rage of economists, analysts, and editorialists.

    Many have said, and there have been suggestions that in some sense the system needed a bad example to set things straight. That is arguably true, but I do not think that Russia is an example that many of us were wanting or expecting.

    There has been a lot of commentary lately that the model for economic policymaking needs to be changed. A case in point would be the view now that capital control should be viewed as an acceptable, even desirable, tool for managing a country's external relationships.

    First of all, capital controls have never really gone out of style. They have been common in many emerging markets. Indeed, Korea had extensive controls even going into the present crisis, which, interestingly, were removed, reduced as parts of their Fund program.

    Second, capital controls have long been accepted as a transitional element of overall liberalization policy—for example, Chile is often cited. But it wasn't so many years ago that Europe had capital controls, but as part of a process and in support of otherwise liberalizing policies. Unfortunately, lately, capital controls seem to have been seized upon as desirable in and of themselves. Such an attitude ignores the miserable record controls have had in recent years in the emerging markets.
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    In making this point, I am not advocating a hands-off attitude when it comes to capital flows. If anything, the lesson of the present crisis is that countries need stronger financial regulatory regimes—bank supervision and the like—than we presently have. This is true not only of emerging market countries, but developed countries as well.

    Several of the previous speakers have mentioned Japan; and, indeed, I think the analogy that Bob Zoellick made with regard to the United States and H.R. 10 is quite a valid one.

    What concerns me in the discussion of capital controls at this point is they seem to be focused more on symptoms rather than causes. Good policy, whether in macro-economic terms or in terms of regulation and supervision is the key. Controls may be effective in support of good policy, but they are certainly no substitute for it. And I think Professor Krugman may be a bit chagrined that the Malaysian authorities may have followed only part of the good advice given in his recent Fortune Magazine article.

    I would also agree with the comments by Mr. Zoellick and Mr. Corrigan on the Japanese situation as well.

    Mr. Frank made the comment about the end of the Cold War and implicit direction of the development of a more multipolar economic system. Certainly, Europe has been predicted to be coming together, and it is, I think, in many, many ways.

    There were some rather naive perhaps assertions that Asia would be acting more and more as a regional bloc. I think these weeks in crisis certainly disabused many of the idea of the Asian bloc acting together.
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    There is something to be said to Mr. Frank's and others' points that leadership is harder to find or to assert in such a multipolar environment. Yet I would not make too much of the point. As I will note later, the United States, in fact, has been exercising a key leadership role in the crisis of the last year. Some may not like the form or the substance of it, but leadership it has been.

    On the other hand, I would agree with the Chairman and Mr. Frank, as well as other speakers, that the delay on the U.S. side in terms of approving the ''increase'' is increasingly calling in the role of the U.S. and its leadership position, and I will touch again on that later.

    We have mechanisms developed over the last several decades in which international economic problems are dealt with. The G–7, quite often acting through the IMF and other international institutions, has been the linchpin for this effort. Much of the criticism and concern over the present crisis seems to stem from a feeling that this approach is no longer working. I would be a bit cautious about such a conclusion. The apparent greater volatility of markets may reflect not only the ''new era,'' but also policy failure on the part of individual countries which, as noted earlier, is now more quickly punished.

    It must be admitted that the existing mechanism has never been very good at forcing countries to adopt good policies until it is rather late. This weakness, as I say, has become even more apparent.

    Turning to the question of the new architecture, we in fact have ideas about abolishing the IMF, reforming the IMF, merging the World Bank and IMF, expanding the G–7, which actually, in a sense, is the G–8 for some purposes at this point. Over the weekend, if you may have noticed, Professor Jeffrey Sachs has proposed establishment of G–16.
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    I am skeptical on these counts. From the United States' point of view, and I understand this to be one of the important perspectives in which this hearing is being conducted, I think the present approach has generally served our interest rather well. I wonder why we want or need to start all over again. Even if new approaches are warranted, I think we do already have plenty of fora in which to discuss this.

    I think Professor Eichengreen raises a number of issues that need to be discussed in a forum. I can assure him the private sector is looking at some of these ideas not always as favorably, but they certainly are ideas that have been teed up and will hopefully go forward in terms of how to deal with the resolution of sovereign debt crisis.

    It is ironic the report he referred to of the G–10 deputies—I guess it is three plus years ago—had drawn the conclusion, of course, that the next crisis was going to be a sovereign bond crisis, and we were going to have to deal with that at least. In the initial stages, the last crisis was a banking crisis. So perhaps they weren't quite as efficient as they thought.

    But both aspects have to be dealt with and, indeed, some of Professor Eichengreen's suggestions are a comparability of treatment in developing a mechanism in some fashion. And I am sure we will be hearing a lot in particular on the lending into arrears question.

    There has been an awful lot of criticism of the IMF, the Chairman noted this at the outset, in particular for being either out of touch with good economic policy or out of U.S. control. I believe the Fund's record, including its willingness to adjust to changed circumstances, is much better than critics acknowledge; and I would commend a recent study by Bill Cline against the international finance in analyzing the IMF approach to the Asian debt crisis in particular that shows that the Fund, in fact, has adapted this approach to the circumstances of the country as well as to developments during the course of a program.
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    But, more importantly, I believe many, if not most, U.S. critics of the IMF overlook the fact that the IMF has responded consistently, some may even say too much so, to U.S. leadership. If one does not like the handling of the Mexican ''tesobono'' episode or more recent country problems in Asia or Russia, the U.S. Treasury is in a good position to explain what happened and why. It is a bit disingenuous for U.S. observers at least to blame an out-of-control IMF.

    The Fund, on the other hand, certainly should be more transparent though, again, I would argue it is more transparent than generally recognized, but there is a limit. There is a doctor-patient relationship of a sort, and its effectiveness depends in many areas on a mutual confidentiality. In some cases, blowing the whistle may be necessary, but the advice of the Fund will always or should always have a confidential element.

    Finally, the public policy issue which I alluded to earlier. The committee is to be commended for having been upfront in supporting the proposed increase in IMF quotas. I had the opportunity to testify in April in support of the increase and would only add that the need for funds is critical at this point. Indeed, the Fund is running out of money. There are serious issues regarding oversight and accountability, but I believe that can be, more easily than recognized—resolved between the Congress and the Treasury. Bob Zoellick's suggestion on the commission is certainly also an approach to go.

    In conclusion, while there is no denying the unprecedented elements of the present international financial situation, I remain of the belief that the causes and solutions are neither radical nor hard to fathom. While it is entirely reasonable to consider organizational and institutional changes to adopt to changed markets, I believe the present institutional setup has served and continues to serve U.S. interests rather well, and we would be well-advised to think hard before proposing, much less implementing, radical changes, whether they be bankruptcy code or something like that.
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    Finally, I think we should continue to support our existing international architecture, in particular the quota increase.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much, Mr. Dawson.

    An Asian-based American investment banker was recently quoted in the New York Times as expressing the concern that at the present time, and I quote: ''It's a very scary combination of events. The classical solutions to contain the Asian crisis have failed. Meanwhile, we have a series of political vacuums at a moment when the complexity of the world's economic and financial management requires leadership.''

    I would like you to comment on that, but first let me just stress, today, the President is speaking in New York, presumably about some of these matters before us today. Today, the Congress in this hearing is expressing a series of concerns, and I suspect you will see that the President's statement is in concert with some of the statements being expressed today on this panel. And given the difficulties the presidency may be confronted on other matters, I would like to simply make clear that it is very important that the Congress work with the Executive Branch on these very critical international economic situations at this time.

    And this committee worked on a very timely basis to produce, for example, IMF authorization. I have been dismayed at the tardiness of general congressional consideration, but I am very optimistic in the next three weeks that you could find a resolution of this circumstance in a very constructive way, and I think it is imperative before Congress recesses this year that we do deal with the IMF.
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    I would like to ask the panel how they assess this issue of political vacuum. Is it real? Is it a matter of perception that takes on an element of reality? Where is American leadership at this time and where is the leadership in certain other countries?

    Mr. Corrigan probably has followed the Russian economic situation as much as anyone, a great deal of disarray if not implosion. What is the role of political leadership in an international economic crisis of this nature?

    Why don't we begin with you, Mr. Corrigan.

    Mr. CORRIGAN. Mr. Chairman, that is probably the most difficult question that I can think of trying to answer. Clearly, it would be reckless to suggest to you and to the other Members of the committee that this leadership issue is not significant. It is. But I would stress a couple of things.

    First, there is not a leadership question nor is there a question of who is in charge that is uniquely associated with the United States. I think the prevailing view is that there is kind of a leadership vacuum in general, but not one that by any means is unique to the United States.

    Second, I think it is very important to keep in mind in assessing this question, and I think Mr. Zoellick referred to this before, that there are a lot of people around the world who, frankly, resent efforts at leadership on the part of the United States; and there are certainly people in prominent places throughout the world who would take the view right now that the United States borders on being arrogant in terms of its approach and attitude toward some of their concerns and some of their problems.
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    The third point I will make, and then I will answer your question, is that I think it is very important to recognize, notwithstanding what Mr. Dawson said, that the problems that we are seeking to confront in many of these countries, even in the European community, are deep, structural problems and deep weaknesses in institutions. Fixing these types of problems is a multiyear effort. It is not simply a question of reducing government spending.

    All of that feeds into this ''Who is in charge?'' question in a context in which the apparatus for international financial and economic cooperation is not as finely developed as I would like to see it.

    Now, having said all of that, I, for one, do believe that it is well in the capacity of the United States, including the President, the Secretary of the Treasury, the Chairman of the Fed, and others to provide what I would call constructive leadership and get us out of this immediate situation so that we can get on with the longer-term things we need to do to deal with all of the issues that people have spoken about here.

    Chairman LEACH. Does anyone else wish to comment?

    Mr. Dawson.

    Mr. DAWSON. I think Mr. Corrigan is absolutely right. One of the clear post-mortem analyses of the Russian situation has been the lack of institution.

    Mr. Chairman, you mentioned earlier the need for laws and bankruptcy and so on. That has not been an issue just in Russia, but the Fund has, for one reason or another, been asked to move into situations where there has been an institutional infrastructure that has been lacking. They made efforts to try to help develop that, but my own perspective, admittedly from having worked there, is that you could make the case that they have been asked to do things that go beyond what their real expertise is, but the international community, in a sense, hasn't found other mechanisms or other institutions that are able to provide that sort of assistance.
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    Chairman LEACH. Mr. Zoellick.

    Mr. ZOELLICK. Well, if there is any one point that I would like to leave with you today, it is that there is a lot at stake. And while in some ways it is a homily to trace this back to leadership, I really think that is going to be the core question going forward.

    All of you know from your political lives about public mood and confidence, and part of this is a confidence question. Now, confidence has to be dealt with through a combination of psychology and actions and trying to get those weaved together to be effective.

    While I agree with Mr. Corrigan's point that many people around the world find lack of leadership in many quarters, the United States is and will be the only key player. We have to do this if anyone is going to do it. I think this will require some sense of individual leadership backed by actions. We have talked about some actions today—IMF funding, humanitarian aid, Fast Track—and then how the United States should use those actions to mobilize others.

    The President, obviously, is in a wounded position. I compliment him for coming out and speaking today. I think that is an important step. I wish he had done it earlier, and I wish he had mobilized his Cabinet earlier, but nevertheless, he is doing it today. But I think he will have to be backed by others.

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    I know you are having Secretary Rubin later in these hearings. Secretary Rubin is one of the few people in the Cabinet who has the credibility and experience to play this larger role, and I hope he will step out of the traditional Treasury Secretary role to do that. And there may be others of his colleagues that can help him.

    Finally, this will be a congressional point. People around the world will look to the Congress and look to the senior Members of the Congress, well-known names, people who can convey a sense the United States recognizes this and is acting on this. It is obviously not the best time for Members in this body facing elections, but after those elections, I think if a few Members of Congress, preferably bipartisan, banded together on some of these points and made some of these statements around the world, I think that would help deal with the psychology, which, of course, has to be backed by actions.

    Chairman LEACH. Thank you.

    Mr. Eichengreen.

    Mr. EICHENGREEN. I focused before on long-term reform, because I think our options in the short run are quite limited. I think there are three: coordinated interest rate reductions; making monetary policy, in other words, with global as well as domestic conditions in mind; and, fortunately, there is no leadership vacuum at the Federal Reserve.

    A second possibility is stand-by lines of credit for Latin American countries facing serious problems; and, again, there is no leadership vacuum at the U.S. Treasury and at the IMF.
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    The third——

    Mr. FRANK. No leadership?

    Mr. EICHENGREEN. No leadership vacuum, it seems to me, at the——

    Mr. FRANK. Is it a good thing if there is no vacuum? You mean——

    Mr. EICHENGREEN. I think that Secretary Rubin and Mr. Greenspan are very much concerned, judging from their public statements, which is what I have to judge from, about these global conditions. But I think that the options they and other U.S. policymakers have available to them to deal with global conditions are quite limited. That was the point I was trying to emphasize.

    And, third, replenishing IMF resources, which is a decision to be made on Capitol Hill where, again, the question of a leadership vacuum, it seems to me, does not apply.

    Chairman LEACH. Well, I appreciate that very much.

    I have a series of other questions, but I want to go to the panel, and then we will come back.

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    Mr. Frank.

    Mr. FRANK. I appreciate that. I wouldn't agree with him, but I am glad you said what you said.

    If I understood you correctly, what you were saying was if there was a leadership vacuum that would be easy. You could ask for leadership. And I think this is my disagreement with Mr. Zoellick. You are asking too much of leadership in a democracy. And this is also my Cold War point. I meant it more narrowly I think than you meant it. There were a lot of people who would vote for this stuff because you could scare them that the ''commies'' were coming. Now that you can't tell them the commies are coming, they are less willing to defer.

    The domestic economic consideration, legitimate concerns about who is going to be hurt, who is going to be helped, have much more impact now that national survival has gone; and I think we have to adjust to that. The context of leadership, of the whole post-war wise men and that whole range of people, was made possible in part, I think, by a more deferential society, frankly, fifty years ago, but also by the Cold War. That was an extraordinary period in America where the fear of communism, which should be reinforced by this real scare we had from the Nazis and the Japanese, gave leadership some leverage. It is not there anymore, and this is the problem.

    I agree it is important for us to show leadership, and Mr. Zoellick is right. Elections are coming up. But, to be honest, nobody is running against me. It is easy for me. The problem is, though, we can lead as much as we want. We can't force people. And domestic considerations here and elsewhere are a bigger obstacle. You can't lead them out of existence. And I think that may be the difference.
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    It is, I think, just an error, almost a cultural lag, to look at the role of leadership twenty years ago even, and 15, and then try and project that to today. The consensus for the international economic situation has broken down, and people are not going to be supportive of this without more concern for the specific impact. That is why Mr. Zoellick said, and I was delighted to hear, of the advocacy of humanitarian relief in Indonesia. We have left that out. We have tried to kid ourselves we can do this with just investment and without some kind of subsidy.

    I do not believe you are going to be able to persuade electorates to support the kind of structural changes we are telling them they need without some money to help them over the short-term. Governments have got to understand that in a democratic society and democratic world painful transitions cannot happen anymore by fiat. I think there are very real limits on what leadership can do, and trying to pay people some compensation to get them through the transitions is very, very important because we continue to have these dilemmas.

    You have this dilemma of trying to mobilize electorates to give democratic support to programs that are going to be, in the short-term, unpopular. No leadership in the world is likely to accomplish that without some financial help.

    We have this problem of investors where, if we tell investors they are at risk—and people talked about countries that have made mistakes. Several of you mentioned the Latin American countries are being—the rain is falling on the just and the unjust alike. The reformed and unreformed are being equally hurt because investors are told there is no bailout, so they are reacting.
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    And then, finally, there are a set of equity concerns that many of us have, and you are not going to be able to build this consensus unless there is concern for equity. That is, people understand that capital being effectively deployed worldwide is the engine by which production is going to be increased. But there is going to be some concern about some of the equity considerations, the environmental considerations, labor considerations. They certainly are not going to be able to put that together.

    Last part, this is one—my question, because I was glad to hear Mr. Eichengreen mention it—one way you can do that, one of the things you are going to have to do, is make the American people feel a little bit better about this. Once again, you can talk about leadership, but there are limits to the extent to which you will get people to do what they think isn't in their interest. That is the issue of reducing interest rates.

    My sense is that the lowering of interest rates would be both economically and politically very useful in this regard. It would show a compassion and a concern for some of these problems that people worry about. It would show that the fear that they might be hurt by this is something people take into account. So I would just be interested because you talked about multilateral reduction of interest rates.

    Let me hear from the panels. What would be your view about trying to do some multilateral reduction of interest rates at this point?

    Mr. Corrigan, I will start with you.

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    Mr. CORRIGAN. Mr. Frank, I have systematically avoided making comments about interest rates in deference to my past, and I guess I will stick with that even now.

    Mr. FRANK. OK.

    Mr. CORRIGAN. I think the sentence at the end of my statement that calls for vigilance and flexibility and pragmatism speaks for itself.

    Mr. FRANK. Vigilence, flexibility, and pragmatism. The trouble with that, Mr. Corrigan, it doesn't just speak for itself, but speaks for so much other stuff. We don't know what it means.

    Mr. ZOELLICK. I wanted to try to deal with your first point briefly. Just a couple of thoughts on this. One is, spending a fair amount of time in this field, I try to look at the polls and focus groups about public attitudes toward the whole host of issues. And what comes up time and time again is, don't sell the American people short on this. They understand the inner connectedness of a lot of these issues. What is missing is the opinion leaders connection belt in that should help the public frame opinions.

    Second, having spent some time around the country, but also with Members of Congress over the past year on this, a lot of them do recognize the economic effects. They certainly recognize it in the farm belt. They certainly recognize it on the West Coast. They certainly recognize it in commodity interests. They recognize it in the gaming industries in Nevada. I think there are the interests there that could be mobilized.
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    But when I am talking about leadership then, I don't think we have to start with the Cold War experience. The United States is a country that has had these challenges of democracy before. These are the challenges of mobilizing, drawing people together. And maybe this is the same point, you are looking for different structures to do this.

    In the immediate context there will be no successor to the President to mobilize public interest and action. The President has to do that. But given the President's position, all I can suggest is that, as in the past, as in the past even with President Reagan in 1986 at the time of Iran-Contra, there were other Members of Cabinet——

    Mr. FRANK. Let me ask a question then. You are a Republican, and you have worked with them. If this is so easy, how come the Republican leadership of Congress doesn't do it?

    Mr. ZOELLICK. Do which?

    Mr. FRANK. Build this leadership and get this bill through. If the polls and focus groups, everybody out there—why don't they put the bill through?

    Mr. ZOELLICK. I will go back to the reverse experience. When the Reagan Administration dealt with the IMF increase in 1983, it was held up by the Democrats for a housing bill. It was a trade.

    You certainly know this body much better than I do, but my sense is there is going to be some trading going on here, and I hope at the end of the day——
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    Mr. FRANK. You are underestimating the task.

    First of all, I have to tell you this is a serious issue. Please don't put too much reliance on polls and focus groups. People tend to make that mistake.

    The second problem you have is this: Yeah, you probably would get a very large majority in favor of an IMF bill, but which IMF bill and which specifics? That gets into who is going to get helped, who is going to get hurt, and what about labor rights and what about environmental issues and what about these other issues? You are not going to persuade people to subordinate what they see as their specific concerns in this kind of broader general thing.

    I think you have a much harder job than one would infer from listening to you. If I were listening to you, I would say, again, how come it hasn't happened then?

    Mr. ZOELLICK. I certainly don't suggest it is an easy task. It never has been. I think in this point, in answer to the Chairman's question, is it going to be an important element for both the Congress and the Executive Branch, and I think it will be.

    I also stress it has to be a combination of actions with psychology.

    Mr. FRANK. I appreciate you answering the Chairman's question. How about mine on the interest rates?

    Mr. ZOELLICK. On the interest rates, I tend to think, actually, going back to the late 1980's experience, that a coordinated action would be very important for the psychology, and the question is, should the United States be lowering interest rates? I tend to favor that direction.
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    The only reason I hesitate, but that is the direction I would look to, is that the other key component here is that the United States' growth is critical to stopping this situation from really slipping out of hand. And my read of the inflation environment is such that you could have that coordinated rate increase, but I also recognize——

    Mr. FRANK. Decrease.

    Mr. ZOELLICK. Decrease, I'm sorry. But I also recognize that we are in varying circumstances now here with large-scale employment, very low unemployment numbers and that the Fed will have to balance that——

    Mr. FRANK. You are firm with Mr. Corrigan for flexibility, vigilance, and pragmatism.

    Mr. ZOELLICK. That is always a good place to be. I think I lean more toward a rate cut.

    Mr. DAWSON. I am somewhere between Mr. Corrigan and Mr. Zoellick on that point. But you raised a very interesting point on what I would call ''safety debts,'' which is when you go into some of these countries and are trying to have what people call ''austerity programs.'' We won't get into that semantic argument. And I think we probably have spent too little time making sure the burden is borne as much as is possible by those who can afford to bear it, and I think that has been a problem.

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    At the same time, when you talk about not selling people short, I think—I myself, as I think Bob Zoellick was, have been impressed by the number of new Members and new Senators—Chuck Hagel is a terrific example—of taking a leadership role in trying and understanding why this is in the general U.S. interest.

    I also would not sell short the people in the countries that are going through these difficulties as well. If you look at what has gone on in both Argentina and Brazil, those populaces have been willing to support a reformed program that was both tougher and much longer, particularly in the case of Argentina, than I would have expected. Now, part of that is, of course, they have the memory of how terrible things were with 1000 percent inflation. I think, you know, when they understand why something happened to them and they believe that their government is trying to work their way out, you will get support. I think the jury is still out in the case of Indonesia in that regard, and I think that is why in particular the social safety net emphasis is very important.

    But again, back to the point I made earlier, it is difficult to design these things, and I think I fall back again on saying we are probably asking the IMF in particular to do too much of that. There are other mechanisms that should be used for that.

    Thank you.

    Chairman LEACH. Thank you very much.

    I would like to turn to Mr. Bereuter. I feel obligated to stress again one of the reasons for this hearing is to underscore and orchestrate that this Congress wants to work with this President on these extremely important issues of international economics. And I am hopeful that you will see some greater Republican flexibility, and I am hopeful we will also see some greater Democratic flexibility on Fast Track which is an issue that has also been raised on this panel.
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    Mr. FRANK. When you are not too busy you can orchestrate a string quartet, Mr. Chairman.

    Chairman LEACH. Fair enough.

    Mr. Bereuter.

    Mr. BEREUTER. Thank you, Mr. Chairman.

    Gentlemen, thank you very much for your testimony. I am sorry I was not here earlier, arriving on Capitol Hill for my colleagues' opening statements.

    I would like to focus on the IMF. We never had, as long as I have been here, a straightforward up and down vote on the IMF alone on the House Floor. It has always been covered with a variety of other issues. It has never been a popular institution, all kind of ideological concerns about it and, more recently, other kinds of concerns. So it is an uphill battle for us to authorize additional expenditures and then to appropriate them.

    I recall late this winter when we had a candid discussion with the Administration about the kind of things that Congress would like to see, at least some of the leadership in the Congress with respect to commitments by the Administration to reform the IMF, to examine basic changes in the architecture of the IMF or some replacement institution. Those were not, I think it is fair to say, unreasonable kind of requests. In turn, this would be the reason for supporting the full funding request of the IMF, the 3.5 plus the 14.5. That has not happened and has not been the fault of the Congress in this respect. They are not willing to make those changes.
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    So I found many of the recommendations here to be interesting and one of them from you, Mr. Zoellick, is establishing a top outside commission.

    A couple of years ago, the Congress found that the Administration was not interested in examining missile threat technologies to this country so we created the Rumsfeld Commission, the Administration was hostile, but the Congress felt it was something that needed to be examined. So one of the things I have been looking at and perhaps hope to offer as an amendment, an appropriation bill, is a Rumsfeld-type commission which would cause, by appointment by the Congress and by the presidency and by the Executive Branch, a commission to examine fundamental changes in the architecture of the IMF.

    I think it is almost irresponsible for the Congress to authorize additional IMF resources to Russia today without some kind of commitment that there is a basic reexamination of the IMF and how well it has done its job. When I see how the IMF treated Thailand and the Republic of Korea like they were fiscal basket cases when that was not their problem at all, how the prescriptions were not only probably wrong, but destructive in their initial stages in particular, and when I see the IMF going to Russia and making demands for commitments that they should have known there is no responsible way—there is no way the Russians could deliver on those commitments, then I would say there are good reasons to raise questions about the effectiveness and the wisdom with which the IMF is being led.

    Now, I don't have any particular problem with the IMF being too much outside U.S. control. Given the kind of direction we have given it lately, I would like to see a degree of independence. But I would also like to see wise use of resources, and I don't think they have adjusted to the changes in our globe. So I would say this.
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    There has to be some reason for the Congress, in light of what has just been happening, in light of the way the resources have been, to some extent, in the case of Russia, wasted, this vast exploiting and stealing of national resources plus the international funds coming in by a few people, we have to have a reason to expect something is going to change so we have some confidence and we can for one more year provide the kind of resources requested.

    I am a person who has never voted against IMF funding. I would like to have, for example, Mr. Zoellick, put together a package for Indonesia. We found that the administration has the flexibility they need with the resources in Indonesia. If we bring it up here, we raise a whole range of concerns that various Members have had about the past Indonesia administration partially pushed by ethnic politics. So better to just let the administration do what it can do perhaps in raising the visibility on that issue, if I may just digress a second.

    Gentlemen, I would like to know what you think about the Administration's willingness to actually push for a fundamental reexamination of the architecture of the IMF, to examine all alternatives to it, if necessary, and how the Congress should be expected to just commit itself to additional resources without that kind of commitment from the Administration.

    Mr. Zoellick.

    Mr. ZOELLICK. Well, Mr. Bereuter, the Rumsfeld Commission was actually the exact parallel I had in mind. Because, as we know, sometimes these commissions are ways of putting off issues. But I think the performance of that one demonstrated that, when properly structured and charged, it can make an effective contribution.
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    I think there are different elements here. One is a performance question about the IMF which many people have raised from all across the spectrum, and I think that needs to be examined. But here I go back to some of Mr. Frank's points. I think with the end of the Cold War there is a question about the whole institutional role of the IMF and the political legitimacy of that.

    It was, obviously, first created for a fixed exchange rate system that ended in the 1970's. It then recreated itself in the 1980's with the Latin debt crisis and then recreated itself again dealing with the end of the Soviet Union and Warsaw Pact with a different type of economic problem. And now it is in the world of financial peacekeeping with all the perils politically that peacekeeping involves.

    I think it is totally appropriate that the Congress and the American people say, ''is this the right institutional role?'' I personally believe there is a valuable role for the IMF, but I think it needs to be examined and debated and understood by the Congress.

    As for the question of the Administration's willingness, obviously, these are going to be competing forces. On the one hand, any Treasury department is going to be worried about the unraveling of the IMF. On the other hand, I think if they recognize that it is a good-faith effort by people like yourself who have been committed to supporting the institution, that they will, ultimately, if this is the price of passage, go along with it.

    What I hope they will do, in addition to that, is to recognize that, for the long-term, this could be in everybody's interest. Because we are going to have to address these questions as the IMF starts to move into more intrastructural areas: What is the role of the World Bank? Should we have two institutions? Those are important questions to deal with. And if we are going to build for the next ten or twenty years I, frankly, think you will have to have the Congress on board, and this is a good starting point.
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    Mr. BEREUTER. Thank you, Mr. Zoellick.

    Mr. Dawson—and, by the way, I heard your reference to Bill Cline's article. I have not read it, but I will look at it as a result of your——

    Mr. DAWSON. It does make the point that they made adjustments. I think it is certainly true, as Bob said and I think was behind part of your question, that the Fund has been moving into new areas without sort of an explicit authorization in either a charter or a—in either a constitutional sense. Again, I think that is partly because it is been led in that direction. As I indicated, I think the U.S., for better or worse, bears a lot of the responsibilities for what has been going on there.

    Your comment on, I think, implicitly toward a partnership between the Congress and the Executive Branch in addressing that, I have to say, frankly, is something I have heard before, particularly in the last two or three years, and the dialogue—and I don't spend that much of my time inside the Beltway. That dialogue does not seem to be as vigorous and active as it used to be. Maybe a way to jump-start that, to force that to happen, is what Bob suggested in terms of some sort of a commission designed in a cooperative fashion.

    But I also would say and I have tried to make this point to my colleagues and friends at the Treasury is that they need to, I frankly think, spend a lot more time on the Hill on these sorts of issues. Part of the problem is the Fund has always been a black box, and there aren't very many people even within the Treasury who—I don't know many of the career people who, frankly, I would send up to talk that much on the Hill on the subject. I think they need to put more of an emphasis in it and have their own sort of dedicated effort to talk with you all.
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    Because when you hear a comment like that from you, Mr. Bereuter, who has been involved in this since I can remember, I think in 1983 perhaps I think when you came on the committee, and for you to have that attitude that, given what your background has been on this, is I think really disturbing.

    Mr. BEREUTER. Professor.

    Mr. EICHENGREEN. I would support, I think, the idea of a committee for hearings to examine the architecture of the IMF. That, after all, is how accountability occurs. I would observe that the Fund already has established its own external evaluation procedure where independent experts drawn from a number of countries are commissioned, and given free access to the institution and the policymaking process. And everything they report is then made public.

    I think they are engaged now in their second external review of the Fund's surveillance activities, which is really the fundamental way in which that institution tries to anticipate and avert financial crises.

    My prediction would be that such hearings would be unlikely to lead to proposals for radical changes in that architecture. I think the important changes to be made are not changes to the IMF, but rather changes in contractual provisions, bond covenants and the like, the establishment of creditors committees, the other changes that I tried to emphasize in my testimony.

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    Mr. BEREUTER. Professor, I am not sure either that they really call for fundamental changes in the architecture, but I think the performance has been so questionable with respect to Thailand and Korea, for example, or Russia. What I would like to see is a smarter IMF, one that doesn't create problems and one that does use its resources to get results. And do you think we have had that kind of policy, kind of actions on the part of the IMF or are you prepared to comment about that?

    Mr. EICHENGREEN. In my own view, the IMF has made mistakes in dealing with what have been unprecedented events, the kind of events with which no one has had experience. I think the fiscal advice to which you referred was erroneous. I think the Fund erred in the direction of too much fiscal austerity. I think bank closures were not handled well in a number of countries such as Indonesia.

    Having said that, I find it difficult to imagine that the Asian crisis would have taken a fundamentally different course had the IMF's fiscal advice been a little different and had the bank closure been handled a little bit better.

    Mr. BEREUTER. Do you think the problems, gentlemen, in Asia were generally unforeseeable? I think, Mr. Dawson, you said quite a few people were raising red warning flags. I certainly didn't see many of those flags.

    Mr. DAWSON. On Thailand, there were major warning signals being raised throughout clearly.

    To jump to the other end of the food chain to some extent, in Japan, the nature of the criticism of the Japanese policy has been the same throughout. The contagion clearly caught everybody by surprise, but you also have—even in the case of Korea, the concern about the financial sector had been expressed.
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    The reality is, and I mentioned this in my statement, we don't have a mechanism and I am sure that we need it, we should have one, that forces countries to act until they actually get to the crisis stage. This has been the history time and time again with the IMF as the countries delay coming into them until it is too late.

    Mr. BEREUTER. Mr. Corrigan.

    Mr. CORRIGAN. First of all, I think the proposition that we need broader support, particularly for people like yourself, both the United States and in other countries, goes without dispute. And as a corollary to that and as I said in my brief opening statement before you came in, I do think that this idea of a base review of both the role of the World Bank and the IMF is indeed overdue. There is no dispute there at all. How you do it is another question.

    The blue ribbon commission type of thing I think is a terrific idea, but we have to keep in mind that we are only one country that makes up the financial and other support for the IMF. We have to be careful about how we manage that. But if I thought a properly construed blue ribbon commission could be helpful in answering the questions that you are raising, I would say let's do it, but I would not want that to stand in the way. And indeed maybe there could be a kind of a compromise here with getting some additional funding for the IMF now, because I do think we need it.

    I do want to add something, if I can, with all due respect, with regard to Thailand and Korea. Both of those countries at the very highest levels, as you may know, approached me in late 1997 to go work with them as an unpaid advisor. So I think I have some intimate, almost hour-by-hour, blow-by-blow familiarity with what in fact occurred in both of those countries.
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    I think it is probably fair to say, contrary to what Mr. Dawson just said, that a lot of people, official and unofficial, were caught off-guard by the speed with which things developed in both of those countries.

    I think it is also fair to say that, in the case of Thailand in particular, the initial fiscal targets that were part of step one of the IMF program in Thailand were, in fact, too restrictive. The reason why they were that way is because the Fund foresaw the massive fiscal costs associated with cleaning up the banking system. And the fact of the matter is that those costs are turning out to be even greater than people thought at the time. So I think saying as you have that there were aspects of the early conditionality that perhaps could have been different and maybe should have been different, is fair play.

    But by the same token, I think it is also important to recognize that, had the Fund not been there, both Korea and Thailand and a number of other countries in that region literally would have run out of money.

    I was there right after Christmas Day in 1997, and that is where we were. So, again, I don't dispute the fact that there are areas in which improvements could have been made in dealing with this very difficult question of policy conditionality.

    The only other point I would add is that, on this question of transparency and disclosure, I do think the Fund has come a considerable distance. If you look at the material that is on the Fund's web site, there is a lot of information there, but at the same time, it wouldn't take me very long to think of some other things that should be there that are not. So I do think that meaningful progress has been made.
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    I think there is more work to be done, and if this notion that you and Mr. Zoellick have spoken about of this kind of blue ribbon commission could take your comfort level and, frankly, mine in certain respects up seven or eight or ten notches, do it.

    Thank you.

    Mr. BEREUTER. If I could have 30 seconds to respond, Mr. Chairman.

    Thank you, Mr. Corrigan, for your comment as well, and I did hear most of your opening presentation. I have no doubt you are right about the importance of the funds provided to those two countries at that stage. I do wonder why it is that we didn't have a better warning, a better analysis of conditions in those countries.

    One of the things that troubles me most in dealing with the finance administration in Korea in February of 1998 is when Senator Roth and I asked the Korean finance officers about the possibility of accelerating infrastructure to relieve the unemployment problems that were obviously coming, and the response by the Korean finance officers was ''Oh, I don't have that flexibility under the IMF. I specifically do not have the flexibility.'' This response was a shock and a discouraging comment to me.

    But I would conclude this by saying I would hope we might get some important recommendations we could implement out of a blue ribbon commission, but for the immediate sense, what I want is some justification to go to my colleagues and say, there is a reason, despite everything that has happened, for us to go ahead with the authorization and appropriation.
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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much.

    Ms. Lee was earlier, but it is up to you, Mr. Sherman.

    Ms. Lee.

    Ms. LEE. Thank you, Mr. Chairman, and thank you for holding this timely hearing. It is very important that we hear from experts such as yourself on these critical issues, beyond the headlines. So this has been very useful for me today.

    Last week, I participated in a subcommittee hearing and we looked at the impact of the IMF in Russia and some of its policies and some of the impacts of its policies. What struck me were a couple of things. One is the fact that the unemployment rate and the impact of IMF policies on women and children and the poverty rates and all of the types of human dislocation factors, much of what was said, could be related back to the IMF and many of its stringent measures.

    Also, we heard, with regard to the reports of criminal activity and corruption in Russia and that the IMF has not actually established procedures which would prevent IMF funds being used in criminal activities in Russia.

    So I guess I would like to ask Professor Eichengreen—and I am very happy to see you are from my alma mater, U.C. Berkeley, and from my district—that I am delighted to see that you have some very concrete and practical alternatives and proposals for solutions in terms of debt restructuring.
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    How would we restructure this debt, make sure that the measures that are imposed take care of some of the problems that we heard described last week in terms of unemployment, in terms of corruption, in terms of all of the other kinds of issues that we are dealing with now in Russia?

    Mr. EICHENGREEN. Thank you. I have to admit not being a Russia expert. Others will testify this afternoon who know that case better than I do.

    I fear that solving the deep social problems in Russia that you have described is fundamentally a problem to be solved by the Russians. I think the IMF has very limited leverage at the moment and very limited ability to help. The IMF has been criticized recently for becoming too involved in the internal social and political affairs of its program countries. Its Asian packages have been criticized for paying too much attention to issues like corruption, promoting capitalism, criminal activity.

    So one problem here is that we can't have it both ways. We can't both tell the international community that these are deep problems and then tell the Fund that it should ignore them.

    I think the kind of issues that you allude to, the need for a judiciary that is independent and that works, the need for a social safety net, the need for a workable system of corporate governance and the like, these are problems that individual countries have to solve for themselves. What the international community can do is identify standards for best practice for them to meet.
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    And I think the role for the IMF is to work with the relevant private sector body or the relevant self-organizing body of regulators in the bank regulation domain, the Bank for International Settlements to provide guidance, provide a model for the kind of practices countries need to establish at home. But at the end of the day, only they can put the relevant institutions in place.

    Ms. LEE. I agree with you that there is a fine line in terms of interfering in the internal affairs of a country, but when the IMF has spent billions of dollars around the world, especially in Russia, in supporting continuing funding for the IMF, how do we explain to the American public that they are getting the bang for the buck if, in fact, they see the economy in shambles, maybe not just relating to Russia, but other countries?

    We just held a hearing last week on Russia. But how do you explain to people here in this country that it is worth it when, in fact, we see unemployment and we see the negative impacts on people of these economies where the IMF is deeply entrenched?

    Mr. EICHENGREEN. I think it is critically important to remind people of what the situation might well look like in the absence of the IMF and to avoid the mistake of blaming all ills that we see in the present instance in emerging markets on the Fund. I agree, as I said, with some of the remarks said before about policy mistakes made by the Fund, but I think, given the present international financial architecture, we are dependent on the stabilizing influence of the Fund. It can be reformed. Its operations can be improved. But I think, just like we need a financial safety net at home in the form of a lender of last resort and deposit insurance, we need an international financial institution that gets us one small step in the same direction internationally, and that is the IMF.
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    Ms. LEE. Thank you very much.

    Thank you, Mr. Chairman.

    Mr. CORRIGAN. Could I just briefly, Mr. Chairman, respond to something that Ms. Lee raised? We have to keep in mind that the Russian case is a case that began seven years ago from not square zero, but from several squares behind zero in a context in which there was no experience, no institutional memory, no nothing as it pertained both to democratic political institutions and contemporary economic institutions. Under the circumstances, I think it was tragically inevitable that over the first seven years of the transition, many of the problems that you have referred to were going to be there.

    It is probably fair to say that maybe we could have done a better job of minimizing those problems. In that regard, if there was one thing above all others that I believe should have been and should now be priority number one in the international community, it would be to help the Russians develop a workable, equitable, functioning tax collection system. But that kind of effort, I can tell you, is sleeves up, in the trenches, with sweat on your brow. It is an incredibly difficult endeavor, but it requires more by way of human resources and technical assistance than it does hard money.

    So, again, I do think that there are immediate avenues in which the United States and the international community, the World Bank, could be extremely helpful. If I were to pick one, that would be the one I would pick.

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    Ms. LEE. Mr. Chairman, may I just have 30 seconds to respond?

    Chairman LEACH. Ms. Lee, you may.

    Ms. LEE. Thank you.

    In the case of Russia, one mistake I think that was made in this transition is that, first, the IMF didn't understand that you don't go from communism to capitalism in one swoop. And it just appears that the transition—that evidently they were not flexible enough in the policies during the transition period to allow for a transition. It was an either/or situation. And I guess the situation, as they mentioned last week in Czechoslovakia, may be an example of how the IMF did work in a more realistic way to help in the transition from communism to capitalism.

    But it is just very disturbing to me that in the Russian case now we are going to have to somehow convince the American people that the billions of dollars that we spent did make a difference as we move forward.

    Chairman LEACH. Mr. Zoellick, you want to respond to that?

    Mr. ZOELLICK. Ms. Lee, I would like to take a crack at answering the question as you posed it for your constituents.

    The first way I would suggest would be, particularly given your district, is the IMF played a critical role with Mexico, and certainly the people of California recognized an upheaval in Mexico affected them directly with immigration, narcotics, political instability, and all of these things are wrapped up into not only our own policies, but where the IMF can help stabilize the situation. And, frankly, Mexico did a pretty good job in bouncing back to about 5 or 6 percent growth, but now it is going to be under strain from a global system.
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    But to go beyond that one example, Thailand and Korea are doing the right things; you have a new president who has suffered his life as a human rights activist trying to open up democracy and the economic system in Korea. There are more things they can do, but I assure you he wouldn't have a prayer of a chance if it weren't for the IMF effort and also trying to pull together the debt structuring that made that possible.

    Now they are not out of the woods yet, in part because of Japan and other issues, but the IMF will play a critical role if they are going to have a chance to make it.

    Now in Russia, as I mentioned in my statement, I have some quarrels with the points of emphasis over the past years, but I don't mean to ignore the fact that these are terribly difficult problems for the point that Mr. Corrigan mentioned. This is a country who was under a communist system for seventy years and never had a breath of capitalism and, in that sense, it was also different from the Polish and the Czech and other experiences.

    I guess the other point I would make to the public would be to say this is a country with about 30,000 nuclear weapons. It is probably worth trying our best to support reformers to make that work. Now, it has not, and we are going to have to learn from that. And frankly, I think that the new team, as I suggested, is going to try to return to a combination of market and centralized planning and it will not work. So there is not much we can do directly until that team passes from the scene. But it probably will. And at that point, again, we are going to have to face the choice of is that country important enough to us in terms of political insecurity as well as economic issues for us to make a try. There is some record of success that would counter the idea that IMF help never works.
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    Chairman LEACH. Thank you, Ms. Lee.

    Mr. Sherman.

    Mr. SHERMAN. Thank you, Mr. Chairman, and thank you for holding these hearings.

    The foreign policy establishment has for quite some time said that the problem was basically a marketing problem, that the people of the country just were too ignorant to understand the importance of internationalization, that the Congress was too weak to carry out, obviously, necessary policies. I think it is clear that we have got a product problem here.

    The IMF has failed to achieve even the goals that the foreign policy establishment cares about. But just as important, no one I believe at this hearing has yet mentioned the enormous trade deficit that the United States runs with most of the affected countries. And I am excluding Russia from my discussion here since that was just the subject that Congresswoman Lee brought up.

    The trade deficit goes on and on. And when Asia is doing well, we are obliged to have our products excluded, because that is what they want to do and, ''Oh, we need them and we need to borrow their capital.''

    Ten years later, Asia is in trouble, we need to have even larger trade deficits. I have heard people in the foreign policy establishment celebrate the fact that in our trade relationship with China there is a $10 billion increase in their exports to the United States and a $1 billion increase in our exports to China, and they simply called it an $11 billion increase in trade. And I think it is unlikely that we are going to have the kind of support you would like to see for the IMF unless that is tied to hard and fast and enforceable rules that will guarantee a reversal of this trade deficit.
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    I have not had a chance to review all of the written testimony. I have heard most of the oral testimony. And the focus seems to be, here is what we need to do to bail out these other countries now and then we can go back to an unfair trading relationship, and there is not even a thought that perhaps a fair trading relationship would be a price that we would insist upon before committing additional Federal resources.

    With all that, it may surprise you to learn that I did vote for the $18 billion for the IMF that came before this committee. Mr. Bereuter pointed out that there has never been a vote on the House Floor to appropriate funds or authorize funds directly for the IMF in an unvarnished bill. He failed to warn me when I thought of joining this committee that I would have the opportunity to vote on such an unvarnished piece of legislation and commit myself during my first term.

    But at that time we were told by Secretary Rubin, who I have the very highest respect for, that this was it, that if we provided this $18 billion, that is all that Congress would be called upon to do, all that we would have to do to return the world to the prosperous relationship, or at least appearance, that it had a year or two ago.

    I wonder if you gentlemen could comment on that. Is this $18 billion just the first of many painful steps that Congress will have to take in an effort to search here and there for some answer to this international crisis, or do we have some assurance that $18 billion is the only tough vote we will have to take on the Floor?

    Mr. CORRIGAN. I would make two comments. First, I think it is important that we all recognize that the primary reason the United States has a big trade deficit is that our savings rate is now below 3 percent and that is the core problem with regard to the deficit.
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    Mr. SHERMAN. If I could interrupt here. The foreign policy establishment has been blaming Americans for the trade deficit and I will tell you, ten years ago, the official answer to that was that we have a trade deficit because we have a government deficit. It was the Federal deficit that was driving it. Now we have eliminated the Federal deficit, these other countries have larger deficits than we do. And again if you want to say that it is all America's fault and that you can ask us to provide these additional funds and that there will not be a change in the aboveboard and belowboard exclusionary policies that we are met with when we try to export to Asia, you can go right ahead and you can hope that you can convince the American people of that. But the ''blame America,'' I do not buy it and I do not think the country is going to buy it.

    Mr. CORRIGAN. I think whether one buys it or not, the arithmetic is clear. It is just that simple. I said that is the primary reason, however I think it is fair to suggest, as you have, that world trade is not a level playing field and I do think that we should do all that we can to try to address that through the WTO and other organizations. But as to your threshold question, will there be another $18 billion? I think the really important issue here, Mr. Congressman, is that we have to get on with the task of finding ways to prevent these crises from occurring with anything like the frequency with which they have occurred in the past. And that to me is the number one priority in the context of the immediate period going forward.

    Mr. SHERMAN. Just to respond to your comment, the total savings, private and public now, taking into account the fact that the Federal Government is not an extraordinary anti-saver, but in fact is running a Federal budget surplus, is far better now than it was ten years ago.
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    In spite of that, our trade deficit is far larger and I would say that is because we are far weaker in negotiating a level playing field than anyone is willing to acknowledge.

    Mr. CORRIGAN. That is part of it. But as I said, when you have a current account deficit of 3.5 percent of GDP, it is factually indisputable that that means that you have a domestic savings gap of 3.5 percent of GDP, not withstanding the fact that we now have a budget surplus.

    Mr. ZOELLICK. On your point about the trade deficit, in fact, I actually think that these circumstances have given us some opportunity to remove some of the barriers that are of justifiable concern.

    Deputy Secretary Summers of the Treasury Department made the point, and I think he was right, although not politic internationally, to say that the IMF program for Korea had done more in terms of reducing trade barriers than decades of negotiations. It is part of my point to Congresswoman Lee about why it is important that President Kim Dae Jung succeed because he is taking the effort with his own people to argue how opening is important.

    The reason why I have also argued to give the President trade negotiating authority is the downside of Secretary Summers' statement was that the Koreans thought, ''Well, is this just a tool that the United States is using to squeeze us.'' And so, if those liberalizing and open measures can be done in a context that is regional or global where everybody is stepping up to the table as part of a trade negotiation as overall liberalization, then I think you make it easier for people to make decisions and make them stick politically, which is ultimately what the challenge is.
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    Mr. SHERMAN. So if I can interrupt here, you are suggesting that we give the $18 billion, no strings attached except what the IMF wants to do, just pull that out of the American taxpayers, hand it to the IMF and then, without that bargaining chip, enter into trade negotiations, giving more authority to the President to put those trade negotiations on a fast track?

    Mr. ZOELLICK. No. First, Congressman, as you may know, we are not giving the IMF $18 billion to spend. As a budgetary matter, you have an asset on the books and it has no cost in terms of adding to the deficit. But moreover, if could I address your point on the trade deficit.

    Mr. SHERMAN. And I hope you understand, yes, I understand that argument. Just because I disagree with you does not mean that I am a step behind you in knowing the facts.

    Mr. ZOELLICK. No. I just did not understand, I guess, your focus on spending.

    Mr. SHERMAN. No, I simply disagree with you. I think we can kiss those $18 billion dollars goodbye.

    Mr. ZOELLICK. Well, as for the trade deficit, my real concern is that if these countries fail to grow, then you will see our trade deficit really explode. Because part of the problem is that if they do not grow, they will not buy from the United States. If we grow, we will continue to buy from them. And therefore, just as in the 1930's, when you had an overall decline precipitated by financial and trade events, then nobody grew. And, so, I think one point about the IMF in its support of these countries is if it can get them back on the road to growth, and we have had discussion on points where we agree and disagree with what the IMF has done, that will also help the United States with its growth and with its exports.
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    As for your last question about whether the $18 billion is the final stage, I think it is important that we all approach this with the recognition that in terms of coming back for IMF funding, it would probably be years before someone came back. But I would not suggest that the United States or certainly you gentlemen will be off the hook more broadly for the actions the United States must take. That is one of the burdens of being the most powerful and wealthiest country in the world. And then you will decide, in your wisdom, which of these actions to take. But people will continue to bring these back to you, in part as Mr. Frank said, because the international economic system will be dominated by a country which represents 25 percent of it, and at least in my point of view we have a lot at stake in security, political terms and the things we stand for. So people will be back to you raising these points.

    Chairman LEACH. Professor Eichengreen, did you want to say something?

    Mr. EICHENGREEN. I think Mr. Zoellick hit both nails on the head. Our trade deficit is ballooning and the reason it is ballooning is the crisis in Asia. They are having a depression. They cannot buy from us. They cannot export from within the region. They can only export here. So I think the first order of business if you're concerned with the U.S. trade deficit is to get growth there back on track.

    It is striking, given the severity of their crisis, how they have resisted protectionist measures so far. The protectionism of the 1930's was alluded to. In a crisis of this severity, policymakers seek to protect their own market first and foremost. And there has been remarkably little of that kind of behavior in Asia since the summer of 1997.
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    Second, I agree with Mr. Zoellick that $18 billion alone will not solve these problems. The $18 billion are important because global financial markets are growing very rapidly. So must the resources of the IMF. But I think other more fundamental reforms have to follow.

    Mr. SHERMAN. Mr. Chairman if I could have 30 seconds?

    Chairman LEACH. Of course.

    Mr. SHERMAN. I would just point out, gentlemen, that when America was in deep financial trouble and there was huge growth in Asia, our trade deficit grew. Now that the situation is reversed, our trade deficit grows. We are told that the first order of business in solving the American trade deficit, give a lot of money to the countries with whom we have a trade deficit with no strings attached.

    And you can compliment the Asian governments from not implementing protectionist measures. I would say that if you look below the table, you will see that that is because they have had enormous protectionist measures in place, knocking down American jobs not only now, but a decade ago when their economies were growing. They do not have to implement new protectionist measures, they have had them in place.

    Thank you, Mr. Chairman.

    Chairman LEACH. Mr. Dawson.
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    Mr. DAWSON. Just briefly. Bob Zoellick made the comment, I think quoting Larry Summers, about, you know, the Fund program for Korea being one that in fact, you know, reduced barriers. And it is always hard to figure out what your comparison is against. But the programs that I am aware of is the Fund at the very least made trade regimes more transparent and lowered average rates.

    Now, that certainly can get swamped in a recession when all of a sudden they are not importing anything or exporting. But I think the comments at the WTO talks last year did not accomplish what, in the case of Korea in particular, the Fund program did. I think that is a valid point that I support.

    In terms of coming back for more money, which I think is part of the underlying question, I mean that is certainly a concern. It was certainly a concern when I was advocating in 1991 and 1992 the quote increases when I was in the Government. And I think it is something that the Treasury and others take extremely seriously. And indeed, the Fund does not come back that often. I think it is something you Members need to be concerned about. But the reality is that the record has been that the Fund has, certainly since 1979, which is when I start dealing with this, the Fund has wound up coming back less often than was predicted at the time.

    I remember right when the 1983 increase was passed, there was a memo circulating on the Hill that the Fund adopted the numbers and they would be coming back in a year or two. They did not come back until 1992 for actual passage. They actually requested them in the 1990's, to be fair.

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    So I think it is good to be skeptical. I certainly am glad that the United States casts about 18 percent of the vote in the Fund and that an 85-percent vote is required for a quota increase because that does increase our leverage in the institution. But at the same time, I think that the Fund has a pretty good track record of not coming back for money as often as an out-of-control institution might be expected to.

    Chairman LEACH. Mr. Frank.

    Mr. FRANK. I just want to make a comment and let people comment on it. We have a real difference here, because I think you have a tendency to look on this as a problem as a very clear answer and what we need is, as you say, more political leadership in getting people to understand it. The problem is there is more disagreement than that and it is not just a technical leadership issue.

    Politics maybe should stop at the water's edge, but ideology does not. We have disagreement within this country about the extent to which some kind of public intervention is necessary to deal with equity as an offset to what some of us think is the excessive inequality that our capitalist system will bring. We all understand inequality is at the heart of it.

    Many of us feel that the description that has been in effect for years, reinforced by the anti-communist consensus, was let us make capital mobile and if we can get countries to be receptive to capital, if we can get them to attract investment, to treat the investors well, to protect the investors, the overall product will go up and that is the best way to go. And that has been, basically, the policy question. And questions of worker rights and of environment and now questions of regulation, the volatility of short-term capital flows, people have been told not to do those.
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    There was an effort earlier this year to get the IMF charter amended, which some us felt good about, and we pointed out to the Treasury that would sink any effort of getting the IMF to go through. They wanted to amend the IMF charter so that the absolute right of capital to go anywhere it wanted to whenever it wanted to was enshrined in the charter. That was going to be absolutely enshrined in the charter. And what you have got is a problem here because there is not a consensus that the mobility of capital without concern for other issues is the best way to go, so you are not going to get the leadership.

    Let me say specifically, I think the collapse of the anti-communist contribution to the willingness of the American people to do this, you are going to have to reconstruct that consensus, and to get a majority you are going to have to get some people who think that the model of simply relying on the efficient deployment of capital as the way to solve problems is not enough and there is going to have to be more explicit concern about worker rights, about the environment and other things. So let me tell you, it is not just the case of leadership.

    That is why, in this committee in a cooperative way, we came out with a bill that got over two-thirds of the votes because it included a number of elements involving those issues which some people I know think were irrelevant. But I will tell you, I do not think you get the majority without that. And that is probably because there are many of us who feel that the way in which our own society has worked in the last years has been to exacerbate inequality, that we have had growth, but we have not had growth with the kind of fairness we would like. And that really has to be addressed.

    And if you do not work with us in trying to inject some concern about equity into this, it does not go. That is why I was pleased at Mr. Zoellick's recognition, I think, of the relevance of a humanitarian relief piece for Indonesia. But that is going to have to be built in in a general way. I think it is also important because you are not going to get countries to vote in a democratic way enough. But there is that central ideological issue that has to be addressed.
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    And I guess to summarize, it is a mistake to think that the kind of ideological debates that we have about economic and social policy in this country are irrelevant to international policy, that we will have all those debates domestically, but then we will all have this international consensus. Right now they are the same issue and have to be addressed the same way.

    Chairman LEACH. Thank you, Mr. Frank.

    I would like to thank the panel. Before I do, let me make several notations.

    One, this afternoon we will begin at 2:30 with the second panel of some of the country's leading experts, particularly on Russia, as well as on other emerging markets.

    Second, just to put this in perspective, because sometimes we talk about the IMF without going through some of the aspects of it, I think we should understand this committee voted out a bill in support of the IMF.

    We also voted out a series of proposed changes and argued for international negotiations in such areas as accounting, domestic bankruptcy laws, corporate governments, financial disclosure. Then we took a stand suggesting that the IMF had an obligation to not undercut existing international laws relating to labor as well as to the environment.

    The IMF is an institution that requires U.S. assistance, but it is a lending institution. The $18 billion we will be supplying will be matched more than 4-to-1 by other countries. In fact, our percentage contribution to the IMF will go down to approximately 15.5 percent. So the IMF is an institution that lends money which has historically been repaid but whose future repayments may well be in greater doubt than they have been in the past.
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    In terms of radical changes in the international economic order, I would have some pessimism in the sense that the IMF in some ways is uniquely designed to have burden sharing, which many other institutions do not, with a rather low point of the United States participation, that is, if we go through with this 15.5 percent. And it is inconceivable to me that we could develop another scenario in which the rest of the world would allow the United States alone to have veto authority, which is a rather extraordinary circumstance.

    Having said that, I would like to review a comment that was made prior to the hearing with one of our witnesses that I think deserves certain serious review. We had umbrage with the Administration several years ago in a shutdown of the United States Government. If we fail to fund the IMF, we could be shutting down the world economic system; and I think that is something this Congress should seriously review.

    With regard, though, to the issues of trade deficits, which are very significant and growing in the United States, I think this Congress has to understand that one of the reasons that we seek international trade agreements is to open markets and that, relatively speaking, we have the most open market in the world and failure to pass Fast Track is an abdication of an effort to open foreign markets. And, for the sake of American workers, we are truly obligated to pass Fast Track authority.

    The irony that the Republican Congress would give this authority to a Democratic Administration and then to have the President's party object is very large. And I would also say that the irony that the President's spokesman this summer asked that we not do Fast Track prior to the election is very great, and I consider that to be something that is a leadership abdication on that particular issue in at least a timing sense. And I hope that the President today stands up for Fast Track, as well as I assume he is going to stand up for the IMF.
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    In any regard, let me thank you all. Your views are very profound and characterized, in my judgments, by a great deal of common sense. I thank you.

    The hearing is in recess until 2:30.

    [Whereupon, at 12:25 p.m., the hearing was in recess, to reconvene at 2:30 p.m.]

    Chairman LEACH. The hearing will come to order.

    Our second panel is composed of a group of the most distinguished scholars in America on Russian studies and developing markets, as well as abstract economics. It is composed of Mr. Marshall Goldman, the Katherine Wasserman Davis Professor of Russian Economics at Wellesley College, and Professor Goldman is also Associate Director of the Davis Center for Russian Studies at Harvard University. Dimitri K. Simes is President of the Nixon Center. Alan S. Blinder is Professor of Economics at Princeton University and a former Vice Chairman of the Board of Governors of the Federal Reserve System. Joyce Chang is Managing Director of the International Emerging Markets Fixed Income Research Department of Merrill Lynch and the firm's chief emerging markets debt strategist. Desmond Supple is Director and Global Head of Asian Emerging Market Economic Research at Barclays Capital, the investment banking arm of Barclays Bank.

    We will proceed in the order of introduction, and we will begin with Professor Goldman, whose—as a former student of Russian studies—works I have read for a number of years.
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    Mr. GOLDMAN. Thank you, Congressman Leach. It a pleasure to be here and I am delighted you are looking at questions of this magnitude and importance.

    I have a prepared statement which I have submitted, but to confuse the stenographers, I am going to speak from some notes that will be a little different than what I have in the prepared text.

    Chairman LEACH. Let me stop for a second. Let me inform the panel, without objection, all the statements of all the panelists will be presented in the record and any difference will be supplemented.

    Mr. FRANK. And in case of conflict, we will take the latter statement.

    Chairman LEACH. The more optimistic version.

    Mr. GOLDMAN. I am going to look at how it happened, the problem in Russia, the impact on Russia and the United States and the West, and what, if anything, can be done.

    The Russian economy, until this crisis occurred, on the surface looked very good, very promising. In fact, it had the fastest rising stock market in the world in 1997. If you had invested in December of 1996, by October of 1997 you would have made threefold your money, and the investment community generally, with some major exceptions, was doing very well, hiring lots of people, pooh-poohing those who warned there might be some difficulties. In January of this year there was even a money reform. They knocked three zeros off the ruble. It was that strong. It looked like it would be that promising.
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    Inflation had been brought down to 11 percent a year, and economic growth was just beginning. We can see the first signs of it at the end of 1997, and in the beginning at least, of the first two or three months of 1998.

    There was even a trade surplus of about $20 to $30 billion, relying primarily on Russia's oil, gas and natural resources, particularly metals. Our largest import from Russia was about $1 billion worth of aluminum. But this was all deceptive. The analogy I am using is it was like an egg: It was smooth on the outside, but inside it was rotten.

    What was happening is that the majority of business was controlled by crime, by criminal elements, maybe as much as 70 percent, according to some estimates. Corruption was rife. It was all over the country, particularly in Moscow. The industries had been monopolized. It was an exaggeration, but one of the bankers, Boris Berezovsky, claimed that seven bankers controlled as much as 50 percent of the country's assets. There was actually a decrease in the number of businesses, because they could not cope with the mafia, they could not cope with the corruption, the state regulation.

    Seventy percent, are some estimates, of the business transactions outside the retail sector were conducted in barter. There were overdue bills. People did not pay their taxes, they did not pay their wages, they did not pay their suppliers. In part this was because of high interest rates; they could make money instead of paying their bills. In part this was because if you did end up with any money in your bank, it was likely to be confiscated by the tax police for payment of tax bills, which were onerous. And there was poor corporate governance. Foreign firms found if they invested in Russia, they were likely either to be taken over by their erstwhile partner, or find that their assets had been drained out through transfer pricing that was unfair.
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    Now, all of this was brought to a head by the Asian crisis. But basically it was an unsustainable condition. I am going to make up the saying, but it is an old Indian saying perhaps, that ''In a strong wind even turkeys fly,'' and Russia was flying in that kind of climate, because around the rest of the world things were going very nicely.

    But when the Asian crisis hit, people began to look elsewhere. Are there similar problems in other countries? And sure enough, Russia had crony capitalism, hot money from foreign investors, the banks were relying on government securities. In fact, the percentage of revenue generated by the sale of government securities in 1994 was 2 percent of the GDP, and by midyear this year it had risen to where almost 15 percent of the budget revenue was coming just from selling foreign securities, not from collecting taxes. So the budget deficits were going up. In a sense it was a giant ponzi game and when the government securities turned out to be insolvent, to be worthless, the banks which had invested heavily become insolvent. And they began to run out of reserves as people became nervous and began to fly to the dollar away from the ruble.

    Now, what is the impact of this? Well, on Russia it has been devastating. This experiment, even if badly flawed, the experiment of moving toward the market, has failed, and it will be hard to convince the Russian public that this market that they have was not a western market. As far as they know, it is a market and all the markets are the same, and it is going to be very difficult to convince them they should go back and try again.

    All the achievements have been undone. The inflation no longer is being held down, the stable ruble is no longer stable, and people are beginning to look back and say that inflation, which looked so much under control, was under control in part only because wages weren't being paid. If you don't pay wages, it is going to be hard to spend money. So, in a sense, this was a suppressed inflation that really never was eliminated.
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    On the extremes of the country, politically, what you find now is increased strength of groups like the communists who pressured Yeltsin to bring into Prime Minister Primakov's government people like Yuri Maslyukov, the former head of Gosplan, and Victor Gerashchenko, the former head of the Central Bank, who was fired because he never saw an outstanding loan he didn't want to print rubles for. He and Maslyukov are back in power, and Maslyukov is certainly going to increase the amount of controls.

    There have been some positive consequences of this upheaval. I don't think we should think of it as all bad. Some of the consequences I say are positive, because some of the oligarchs, some of the people in control, have been wiped out, and now their assets have basically disappeared. There has also been some impact on the mafia, because some of their property, again, has been devalued.

    On the outside world, the potential could be very serious, particularly for the former countries of the Soviet Union, particularly Ukraine. The East Europeans may escape some of these difficulties because they have been looking more to the West. They decided that they didn't want to become too closely entangled with Russia and so they looked to the West instead.

    What we haven't yet seen is all the impact on Western Europe. Germany in particular has from $30 to $40 billion worth of credits which may not be paid. We should also pay attention to Austria. Austria has been kind of hidden by this, but the Austrian banks were particularly bullish about Russia, and lent monies, again, which they are unlikely to again see redeemed.

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    But it is not only the banks, it is also trade, because Germany had developed significant markets in Eastern Europe and in Russia. There is also considerable fear about an outpouring of refugees into Western Europe, and the last time we saw this we know that it gave rise to nationalist and in some cases fascist movements.

    As far as the IMF and the EBRD, the European Bank for Reconstruction and Development and the International Monetary Fund, the EBRD in particular, which was chartered to be supportive of Russia, will probably never see the money that they invested. They invested in banks, they invested in corporations, and they were proud of the fact they were lending money, but it turned out that many of these investments now have disappeared as well.

    As far as the United States, we do not know the full impact yet. Our banks are out about $7 to $8 billion, but it is the indirect effects that we can't anticipate. Some of the hedge funds have been hurt. Tomorrow, George Soros will be here. He acknowledged that his funds have lost $2 billion. Credit Suisse First Boston has acknowledged they are out one-half billion dollars. Some of them say they recognize they went into this very risky thing and now are prepared to take their hits, but some are not.

    As far as trade goes, Russia is almost insignificant in terms of our trade balance. We export about $3 billion worth of goods to Russia and import about $4.5 billion, but it is relatively small in the total picture. So why has there been such an impact? Why was our stock market hit so badly a few days ago?

    Well, Russia was another domino, and we have seen enough dominos. There was just no good news at the time. Moreover, we are still worried about the political implications and the fact that Russia is still a strong nuclear power. But as much as anything, it was a psychological impact. If in a strong wind turkeys fly, what happens when there is a down-draft? Will eagles crash? And that, I think, is what we are concerned about right now.
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    Let me examine briefly if anything can be done. The first thing I think we have to come to appreciate is there are no easy solutions. Everyone is looking for some golden answer or some silver bullet. The first thing I think we have to understand is if there is going to be any improvement, it has to be from within Russia. It has to come from the Russians. There is not that much we can do on the outside. Given their disappointment with the market, there are bound to be reversals, there are bound to be new price controls, as there already are, there are bound to be physical controls.

    What other country in the world can you think of where when one of the candidates for prime minister said he was going to introduce an economic dictatorship, that seemed to be welcomed? Only in Russia would that kind of atmosphere exist.

    What should they do? Well, I can tell you what they should do. It doesn't mean they are going to be able to pull it off. On the one hand they should increase government power to put more pressure on the mafia, and, on the other hand, they have to reduce government power to eliminate the controls, to eliminate the temptation for corruption that exists.

    At the same time, they have to do what they did not do before, and what was my criticism of the market reforms when they were first introduced, and that is to build up the infrastructure. There is no competitive infrastructure. There are no civil codes even now that are fully enforced. Sometimes these things get on the books, but then they are not implemented.

    They should encourage the development of new business and encourage the development of commercial codes. They need discipline. It may be that a currency board would work, but that seems to be only because there doesn't seem to be anything else out there.
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    Some people say, ''If only they print more money, everything will be OK,'' because they can then pay their back wages. What we forget it is not just a question of no money, but you have to have the will to pay when you do have the money. When the businesses, the oligarchs who are still there, or the mafia, have money, they don't pay it to the workers. They would rather take it and use it to buy dollars instead.

    What should we do? Well, again, there are no all-encompassing panaceas. I would emphasize that we have to look at the long run and think small. There are no grand bargains out there, as some proposed in 1991 and in 1992. They still lack the infrastructure. If you put money into a ''grand bargain,'' as was proposed in 1991, it will go right—as it did in August 1991—to the bankers and come right outside the country again. So that simply is not the way to go.

    So how do we think small? Well, I would give very little money if I had any to the central government, because I don't think they are capable of using it. I would focus instead on the provinces, in the regions. There I think is where you have to build up the infrastructure. And just as Alabama competes with North Carolina for industry, we should go to those regions and ask who will make it welcome for foreign investors? And we should increase that portion of our foreign aid program, which has been focusing on startup businesses.

    The USAID now has begun a program in the provinces where they come in with small cash registers and, for startup businesses and startup farms, they provide credit financing for the startup. If we are going to do anything like that, any foreign aid program, that seems to me what we have to do. This is the way to build up the infrastructure.
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    I must also say there may be another program we will have to resort to, and that is food aid, just as we did in 1991 and 1992. The harvest this year in Russia has been a disaster. It is down to about two-thirds of what it was last year, and in particular the potato crop, because of a very warm July and a wet August, has now had food blight. Just like in Ireland, the Russians are very heavily dependent on potatoes, and with that crop gone it could be devastating.

    Let me conclude. What I would like to get across, if I can, is that there are no instant cure-alls. If anything, it is going to be up to the Russians to work their way out over many years. They now seem to have reached a consensus, but it is not a consensus that I am particularly pleased with, but at least it looks like they have reached bottom. If they can move forward and move back to some of these reforms, that would be very encouraging. But I wouldn't hold my breath.

    There are still attractive investments out there, and, at some point, foreign investors will come back in again. But it is going to take them awhile. Some of them, as I say, have lost billions of dollars, and not all the lost money has been acknowledged. And when reform does come, I am afraid it will have to come from the private sector.

    Right now, the only thing I think we can do is to try to help with startups, try to help fund new business formation. That is what took place in Poland, and that worked beautifully, and Poland is now the fastest growing economy in Europe. Russia did not do that. They decided not to do it. Our advisers gave them the wrong advice, focusing only on privatization of the state sector and not on startups. It has to be a step at a time and that is going to come slowly.
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    In the meantime, I think we may see some growing chaos. This is reflected by the newest analysis of what options are open to the Russians. There are only two options—the ''miraculous option'' and the ''realistic option.''

    In one case, God assigns all the angels to Moscow. They arrange to pay back all the pensions, they arrange to pay back all the bills, they collect all the taxes, they work out a new tax code, they balance the budget, they increase the value of the ruble, they break up monopolies, they invest in agriculture, they bring back flight capital, and they increase government economic growth. The angels do it all.

    In the second option, the ''miraculous'' case, however, the Russians do it by themselves.

    Chairman LEACH. Is that the end?

    Mr. GOLDMAN. I am afraid that is the end.

    Mr. FRANK. Do those angels fly in a strong wind?

    Mr. GOLDMAN. Only turkeys.

    Chairman LEACH. I think that is the most interesting final comment of a presenter in my memory here. I am sure that Professor Simes will not have as optimistic a conclusion about angels.
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    Go ahead, Professor.


    Mr. SIMES. Thank you very much, Mr. Chairman, Members of the committee, it is a privilege to be here. Let me say at the outset I speak strictly on my own behalf and that my views do not reflect views of The Nixon Center, which does not take institutional positions on policy issues.

    Twenty-five years ago, just before I immigrated from the Soviet Union, I was summoned to see the acting director of my institute, who tried to dissuade me from leaving the Soviet Union. He made a strong case that, after all, the capitalist system was bound to collapse; maybe not right away, but at least in the foreseeable future. Meanwhile, the Soviet Union was on the right side of history. So leaving the Soviet Union for the ''decadent'' West, would be a very ill-conceived personal decision.

    The name of my acting director was Yevgeny Primakov. I am delighted to hear he is now Russian Prime Minister and that he clearly has a different view of what is appropriate for his country.

    Shortly after my meeting with Mr. Primakov, I was summoned to the Institute Komsomol Committee, where they tried to expel me from the Komsomol. They didn't quite manage to do it, because they could not decide whether there was anything in my conduct which was inappropriate for a Young Communist League member. My principal accuser, the chairman of the committee, was Igor Ivanov, who was just appointed Russian Foreign Minister. So I am glad that there are people with a great sense of history in key positions in Russia.
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    If Russia were not Russia, if it did not have thousands of nuclear weapons, if it did not have atomic stations, depots with chemical weapons, and some biological weapons; if it were not surrounded by newly independent states, some of which are very weak, unstable, and, indeed, in turmoil as a result of Russia's problems; if not for all of that, I would simply say, ''Let Russia be Russia; let's wash our hands, and let's give these people a chance to demonstrate that they are capable of helping themselves before we try to help them again.''

    Unfortunately, Mr. Chairman, I don't believe that we have that luxury. For the first time since Boris Yeltsin's confrontation with the parliament in October 1993, I believe we are facing real instability in Russia. There is a risk of civil war in a country with thousands of nuclear weapons. One doesn't need to elaborate why that would affect not only Russia, but also important American interests.

    Let me also say, much less apocalyptically, that if Russia becomes unfriendly, even if it is very weak, (and Marshall Goldman has made a persuasive case that Russia is not important for the United States economically), it could still destabilize its weak neighbors with minimal effort. And if ''Mr. Nyet'' became Russia's ambassador to the United Nations, it would complicate American policy from Bosnia to Iraq to Korea. When a country is a permanent member of the U.N. Security Council, what is happening there is of relevance to the United States, and it is difficult to walk away.

    I am also concerned—and I know it may sound almost preposterous—that one day, when Russia becomes stronger, (and I think one day Russia is bound to become stronger), we may find that our disengagement today contributed to creating a government, and even public opinion, that would not be friendly to American international objectives. I don't think that Russia has any chance to become a superpower again, but it does have a good chance to become a serious international player. Accordingly, I believe that abandoning Russia today would be an unforgivable luxury.
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    Having said all that, I think we have to understand the magnitude of the Russian crisis. It is not just a financial crisis, an economic crisis, or a crisis of the Yeltsin regime. It is a systemic crisis affecting all the institutions built in Russia since the collapse of the Soviet Union in 1991.

    I am concerned, Mr. Chairman, that for seven years we really lived in the world of illusion and to a large extent, self-delusion about what was happening in Russia. We were told that Russia was conducting radical economic reforms and that it was trying to build a free society.

    In fact, Russia was building a regime with a strong oligarchic component. To the extent it was building capitalism, it was building it without capital. To the extent it was trying to create a free market, it was doing it without any regulation. To the extent Russia had robber barons, they were not robber barons who were building steel mills and railroads; rather, they were distributing the huge Soviet pie among themselves, putting money in Swiss bank accounts, and buying real estate in London and Key Biscayne. We knew all that, the American Embassy in Moscow knew all that, the CIA knew all that, and a lot of students of Russian affairs knew all that. Those of us who attended meetings and seminars with senior members of the Clinton Administration certainly had an opportunity to express this point of view.

    It is really very difficult for me to explain how and why we could believe for so many years that we were seeing a serious experiment with democratic capitalism in Russia. It was a bubble which was bound to burst sooner or later. Of course, the Asian financial crisis and declining world oil prices affected Russia. But they also affected other neighboring states, including those like Kazakhstan, who depend heavily on energy production. And some of those states are doing considerably better.
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    What is happening today in Russia was triggered by the global economic conditions, but the roots of the situation were uniquely Russian. Although it was frequently portrayed in the United States as the best reformist government in Russian history, the previous government, led by Prime Minister Kiriyenko, was a big part of the problem rather than the solution. The Kiriyenko government never tried to have any meaningful dialogue with the parliament. But without the parliament it could not pass legislation, and without legislation, it was forced to conduct economic reforms by decree. That was not enough to impress foreign investors.

    Moreover, if you believe, as I do, that ultimately the United States should care more about Russian democracy, checks and balances, and non-aggressive foreign policy, than about interest rates and the rate of inflation, it is difficult for me to figure out how we could welcome a government in Russia which was openly contemptuous of democratic process and in which the prime minister, by his own admission, suggested to President Yeltsin before he was forced to resign, that Yeltsin sign a decree granting the government the right to fire democratically-elected governors.

    Incidentally, if there was a sure way to create political instability in Russia, and perhaps even to trigger a civil war, it would have been for a dramatically weakened President Yeltsin to go after regional governors, many of whom established strong ties with regional military commanders. Mr. Kiriyenko was playing with fire, and, accordingly, I think his departure from the political scene is good news.

    I completely agree with Professor Goldman that if, in the process of Russia's economic crisis, the oligarchy was a little bit weakened, it is also perfectly constructive. What is not constructive, of course, is that the Russian economy is in a terrible situation. At the same time, the Russian duma, which is not quite dominated by the communists, as they hold only approximately one-third of the votes, and, as you may know, the chairmen of the budget, international affairs, and armed services committees are reformers, have been corrupted by irresponsibility, by the contempt with which the Yeltsin government treated it, and by the endless perks which Yeltsin and his associates offered its members in exchange for compliance. Once the duma smelled blood, it ceased acting as a responsible partner to the new government.
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    Mr. Primakov is a very practical man. I think he understands that Russia negotiates with the West from a position of weakness. He may have strong reservations about the International Monetary Fund, and about radical reform, but he does realize that he needs subsequent installments of the IMF loan. He will have to engage in a delicate balancing act, reconciling the pressures of his communist sham allies, Grigory Yavlinsky and his Yabloko faction, (which actually initiated the Primakov appointment), the oligarchs, and the West. This is bound to produce a very inconsistent policy and a lot of zigzags.

    The best scenario is that his government will not rely entirely on the printing press as a financial instrument, that it will try to go to the duma with some reform package, and that we will see at least a good sense of direction; even if not good, immediate short-term policies.

    We will have to make some tough decisions regarding how to deal with Russia. I do not know, Mr. Chairman, what will work. But I know what is not going to work. More micro-management of the Russian economy is not going to work. Telling Russia how to conduct reforms will not work. Telling Russia who should be in its government will not work. Russia is not an American protectorate, and we do not have the resources, the will, or the power to make Russia an American protectorate. We should let Russia accept responsibility for its own decisions.

    I was strongly opposed to the IMF bailout of Russia. I thought this money would be wasted. When I was in Moscow in July and met, among others, with Mr. Nemtsov and Mr. Dubinin, I came to the strong conclusion that devaluation was inevitable, and that the longer Russia postponed it, the more money would be wasted trying to sustain that unsustainable rate of ruble, and the more difficult it would be for them to pay what they owe to foreign and domestic investors alike.
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    But the IMF loan is already a fact of life, and I do not know how you can cancel it altogether without having a devastating impact on Russia. Accordingly I think we should try to do the following. First, we should be open minded about what is happening in Russia and we should not have preconceived notions about any individuals in the Russian government. We should look at policies, not individuals.

    Second, I think we should insist on a reform package, not on particular policies. As long as this package is presented to the duma and we have reasonable assurances that the duma will approve it, we should be prepared to be more flexible in releasing subsequent installments of the IMF loan. In the past, more often than not, the IMF released credits based on Russian assurances rather than on actual performance.

    Third, I think that we have to encourage the Administration to proceed with creating the equivalent of the London Club to protect the rights of foreign investors who were treated very badly as a result of prior and current debt restructuring. This is not just a favor to foreign investors. I think it is a meaningful precondition to help Russia, because if foreign investors do not come back to Russia, we simply cannot afford to keep the country on a life-support system indefinitely.

    Finally, Mr. Chairman, I think we need IMF reform. I fully understand the importance of IMF as a fire brigade during current times of international financial turmoil. But when the IMF leadership acts very often not as leaders of a fire brigade, but as de facto arsonists, because of their ill-conceived policies, from Indonesia to Russia, we really have to ask ourselves whether it is possible to have any confidence that the IMF can lead an effort to help Russia and many other countries without serious changes.
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    Let me conclude by saying that I have a very limited confidence in the Russian government. I believe that at best we will have incomplete results with a lot of zigzags, but in my view, the stakes are too high not to make at least one last attempt to keep the Russian situation under control.

    Chairman LEACH. Thank you very much, Professor Simes.

    Professor Blinder.


    Mr. BLINDER. Thank you, Mr. Chairman and Members of the committee. I thought I was going to say that things are bad, but they are not quite as bad in most other countries as they are in Russia. Nonetheless, I do think the world as a whole, not so much the United States, is facing the most serious set of economic problems that we have seen in decades, probably since the 1930's. Once you leave the United States and Western Europe, you don't find many countries in which it is not the case that the situation is already grim or else teetering on the brink of becoming grim.

    Now, governments and the IMF together can't control this situation. But I do think that sound policies can ameliorate the problem somewhat and, importantly, ill-conceived problems can exacerbate them. It is terribly important that we pick the former rather than the latter.
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    We have been hearing about Russia, but these hearings have a very broad scope, so what I would like to do is make a few general observations on the world situation, and then focus more specifically on Japan, and finally end with a few remarks on what the U.S. might be able to do.

    On August 25th, which is just before the latest round of financial convulsions precipitated by the events in Russia, I published an op-ed piece in the New York Times on the world situation, which I furnished just today for the record. The theme of that article can be summarized in three very simple sentences:

    First, while the United States economy could hardly be in better shape, much of the rest of the world is fast becoming a dangerous place.

    Second, despite the unsettling events abroad, the outlook in the United States seems to me quite good, still.

    Third, if there is a key to the world's economic problems, it is not in Russia or Southeast Asia. I believe it is in fixing Japan.

    I would stand on those statements today, with the slight amendment that the world situation looks worse, and the potential dangers to American prosperity have ratcheted up commensurately with that.

    For purposes of today's hearing, to set the background, I would like to add three further general observations:
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    First, most of the countries that are in trouble today can be thought of as experiencing what in the old days would have been called a financial panic—exactly the thing that central banks were created to stem, inside the borders of a country.

    The three hallmarks of a financial panic are very evident: first of all, the collapse of confidence and the concomitant rush to safety, wherever safety can be found; second, severe contagion, as waves of selling roll from one financial institution or one nation to the next and weakness in one place begets weakness in another place; and, third: exaggeration, as you see markets move from their manic phase to their depressive phase, as they are wont to do.

    The second general point is that the present situation needs to be thought of as an emergency because so many national economies are now contracting, in some cases violently, and many others are under imminent threat.

    Declining GDP may be an abstract concept, but jobless, starving people are not. When the world found itself in a similar situation around 1930, too many governments either did nothing at all or made matters worse through foolish or neglectful policies. Those are errors we can't afford to make again.

    Finally, I believe that this emergency must be understood as macroeconomic in nature, and I emphasize that because I think too many people have been lavishing too much attention on microeconomic structural problems that doubtless exist in many of the troubled nations. Now, to be sure, some of those problems are quite serious. But they predate the crisis and didn't precipitate it, and addressing structural problems now, at least some of them, when the systems are under so much stress, may not be the best way out of the current emergency. A fundamental change simply takes too long, and the world can't wait that long for reflation.
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    With those general remarks as background, I would like to now turn to Japan and dwell a little bit more on the Japanese situation and what might be done to get that moribund economy growing again. The three main policy weapons are all obvious: monetary expansion, fiscal expansion, and cleaning up the banking mess, or maybe I should say the financial mess. But in each case there is some controversy over what can or should be done, and I would like to call some of those controversies to the committee's attention, starting with conventional monetary and fiscal policy.

    Economists have known for decades that when the problem is insufficient aggregate demand, central banks should drive down interest rates and legislatures should spend more and tax less. I do believe that inadequate demand has been the central problem in Japan for years now.

    Several objections to fiscal stimulus in Japan have, however, been raised. For example, some people worry that Japan already has a big fiscal deficit, which it does, and an enormous long-term budgetary challenge posed by an aging population, which it also has. Their Ministry of Finance has, for example, repeatedly objected to deficit spending, or deficits in general—including tax cuts, on those grounds.

    The points are correct, but I think this reflects pre-Keynesian thinking that ignores the fact that Japan is now in a true macroeconomic emergency. They will not solve their budget deficit problem while their economy is lifeless. So I do believe the Japanese government should be cutting taxes and raising spending, although others disagree.

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    When you come to conventional monetary policy, stimulating the economy by lowering interest rates, that is barely possible any longer in contemporary Japan, where short rates have almost hit—not quite, but almost—zero, and the sick banking system seems incapable of expanding its loan volume very much. They are in the 1991 situation of the United States, multiplied by 10 or 100.

    There is, however, another channel by which expansionary monetary policy can stimulate an economy, and that is currency depreciation. I believe the Japanese yen needs to go lower—maybe not dramatically lower, but certainly lower—to stimulate exports. I also believe, and this is important, that the super-low yen should not be viewed as a permanent feature of the world's economic landscape, but as a temporary measure designed to help lift Japan out of its currently depressed state. Like the budget, the yen will naturally improve as the Japanese economy improves.

    Now, as you no doubt know, quite a few people on both sides of the Pacific favor a stronger yen instead. They fear that a weak yen will invite further competitive devaluations in the Asian region, possibly this time including China. These critics have a point, though I think they exaggerate it.

    Only South Korea and Taiwan, among the Southeast Asian nations, compete directly with Japan in a wide variety of product lines. Most of the rest of the Asian countries aim much lower on the technology ladder. It is important to remember the object of this exercise is to stimulate growth in Japan. And if the Japanese can get Japan growing again, it will provide markets for its neighbors.

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    Furthermore, in the pantheon of world economic fears, and there are many these days, collapse of the Japanese financial system surely has to rank much higher than a devaluation of the Chinese yuan.

    The third controversy I would like to bring to your attention has to do with the banking problem in Japan. Everyone agrees that it needs to be resolved, there is no controversy over that. But there are quite a few Americans who insist that the job must be done our way: by shuttering moribund banks, paying off the depositors with public funds, kicking out the management, selling off the bad assets, probably by securitization, and restructuring the over-regulated Japanese financial system.

    I disagree. Not that I think this is a bad recipe in principle; to my American ears it sounds about right. But we in this country have a tradition in which bankruptcy, bank failures, and harsh Darwinian capitalism are the norm. Those are not the norms in many other countries, in many other financial systems, and certainly not in Japan. And even here in America we dithered for years before we finally bit the politically unpalatable bullet in the case of our own savings and loan debacle and did more or less what is prescribed in the American solution that I outlined a moment ago.

    I have two worries on this score. The first has to do with recent Japanese history. Last November, when Yamaichi Securities and Hokkaido Takushoku Bank went under, Japan suffered a huge shock to confidence. Forced bankruptcies of major brand name financial institutions in Japan, I fear, may seriously undermine confidence and spread panic, just at a time when the name of the game must be restoring confidence and limiting financial contagion.

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    My second fear is that insisting on a harsh American-style approach to the Japanese banking cleanup may actually delay what is already an agonizingly slow political process in Japan even further. If so, in my view it would be better to adopt a softer, more ''Japanese'' approach and get the job done faster. This is one of the things I had in mind when I emphasized a few minutes ago that structural reforms must not delay the response to a macroeconomic emergency.

    Finally, what can the United States Government do about all of this—about the world economic mess in general? My short answer is not very much. Few, if any, of the world's financial problems are of our doing, and none of them are within our borders. Knowing full well that what I am about to say falls way, way short of a cure, here are a few constructive steps I think the United States could take:

    First, Congress should pass the Administration's requested funding for the IMF. Now, having said that, I want to be clear that I share many of the criticisms of the IMF, especially its penchant for secrecy and its fascination with austerity, including in places where austerity doesn't belong. But you don't rebuild a fire house while the town is burning. You send out whatever fire trucks you have. After dousing the fire, the United States, I believe, should take the lead in reforming the IMF. I do agree that it needs reform.

    Second, it is imperative, and, I might add, urgent, that the U.S. and the IMF together, and anyone else who can help, stop this financial wildfire before it engulfs Latin America. Right now, Brazil is in imminent danger and both Mexico and Argentina are under threat. Even though the economic policies of those nations, while not perfect, have been, on balance, quite sound. If Brazil falls, other dominos in the chain will surely follow. A substantial financial war chest, I think, needs to be put in place for Brazil quickly—before the real crumbles, not after. There were some words in this morning's newspaper suggesting that something like that is in the works. I hope it is, and I hope it is put together as quickly as possible.
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    Third, and implicit in something I said just a few minutes ago, the United States should not oppose a weaker yen on the grounds that will raise our bilateral trade deficit with Japan, as we sometimes have done in the past.

    Fourth, and very important, we must not turn protectionist as our trade balance deteriorates. In a sagging world economy, a booming nation with big spenders—that is us—will wind up with a huge trade deficit. That is inevitable, and it seems to be our role. Providing spending in a world that is desperately short on aggregate demand is one of the things Americans can surely do well. You might say it is our comparative advantage.

    Beyond this, the United States, as the leading Nation in the world and home to many of the top global financial institutions——

    Mr. LAFALCE. If I may just interrupt, your first point was pass the IMF bill, and do not oppose a weaker yen and do not turn protectionist. What was next?

    Mr. BLINDER. Some kind of backup financial package to make sure this doesn't bring down Brazil and some other Latin American countries.

    The last thing I was going to say is that once the emergency has passed, it is certainly going to fall to the United States to take the lead, in the eventual debate which we should have, but not this week, over how to reconfigure the international financial architecture. This committee will probably play an important role in that debate. But I want to emphasize that those are matters for the future. For now, nothing should divert the world's attention from the current emergency and how to limit the damage to the world economy.
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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much, Professor Blinder. Thank you for coming down.

    Ms. Chang.


    Ms. CHANG. Good afternoon. It is a pleasure to be here this afternoon. What I would like to do is pick up on some of the comments made by Professor Goldman and also Professor Blinder. Professor Goldman passed the comment, ''will eagles fall'' and we need to do something to stop the wildfire before it hits Latin America. I am going to focus on recent developments in Latin America, only within the past month.

    For many months after the onset of the Asian financial markets turbulence, Latin America was seen as a safe haven. It appeared to be spared the worst of the contagion effects. However, what has happened since the events in Russia has been devastating to Latin America. I would argue the turbulence we are seeing now is worse than what we saw after the Mexico devaluation in 1995, in the first quarter, and that it is really a degree of volatility not seen since the 1980's Latin America debt crisis.

    I would argue these events that occurred are not really the fault of adverse policy decisions by Latin American policymakers or by a lack of transparency by the Latin American countries. But let me start with some statistics about what has happened in Latin America over the past month.
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    Since mid-August the stock markets in Latin America have fallen by 36 percent, led by a 57 percent decline in the Brazilian equity market. Telebras, the privatization that was highly touted and completed very recently, which was urged by many policymakers as a step for reducing the level of state-owned enterprise in Brazil and as a key that Brazil is moving forward, that stock is now trading at about 55, whereas it was about 125 when this privatization was completed only a few weeks ago.

    The U.S. equity market volatility has contributed to this financial markets turbulence as the Latin stock markets often track U.S. equity markets more closely than domestic fundamental developments. And last week we saw points that during one day in Brazil the stock market fell by almost 15 percent.

    The amount of turbulence in this period is much worse than what we saw last October after the events in the Asian crisis deepened. It is more severe than what we saw in the first quarter of 1995. In Brazil alone, we estimate that about $22 billion of capital outflows have occurred since the beginning of August. The Mexican peso over the past month has depreciated by 26 percent in just one month, despite the Central Bank last week intervening and one day alone using $500 million. On September 2, Colombia devalued its currency by 9 percent. This morning, Ecuador devalued its currency by 15 percent, and many people think that Venezuela is the next to go. So these events are coming very close to the U.S. economy, as they affect all countries in Latin America.

    One of the major U.S. credit rating agencies, Moody's Investor Service, downgraded about four different countries in one week just because of the contagion effect. Brazil and Venezuela were downgraded. Argentina and Mexico, which has been the most successful recovery, was put on review for downgrade, and the rating agencies themselves said this is not because of events that really have occurred in these countries, but because they cannot respond to global financial market turbulence.
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    This is going to increase the borrowing costs for these countries very greatly. In the first half of the year, we estimate that Latin American countries were able to raise about $30 billion on their own in the capital markets. This had dwindled to about $1.5 billion during the month of August, and I think it will be almost nothing during the month of September.

    To echo some of the things that Professor Blinder said, what our expectations are going forward in these countries, we expect extreme volatility in all sectors to continue, capped by extraordinary losses in Russia. I think one of the complaints that we have heard many times is that ''Well, investors don't lose money because of these bailout packages.'' But to give you some figures, with the $70 billion of debt in Russia that was rescheduled or for which a moratorium was declared, investors will probably recover well less than 10 percent of these investments. Russia also has, in addition to this, $40 billion in external debt that has lost 80 percent of its value this year.

    Second, I would say that we will continue to see a far greater level of financial contagion for the remainder of this year and next year than was seen in the case of Mexico. This is due to the much more widespread devaluations, depressed commodity prices, lower growth prospects and widening fiscal and external deficits for all emerging market regions.

    Third, I agree with Professor Blinder that we are looking at the deteriorating outlook for Japan and the possibility of a U.S. equity market correction as further really increasing these risks in Latin America, as these events would likely severely drive up private capital flows.
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    I would like to now just go through what we assess as the causes and the dynamics of the financial markets contagion and then talk specifically about what is going on in Latin America before I turn to what we see as what some of the possible solutions and remedies could be to some of these issues.

    We believe that four global themes will set the backdrop for emerging market countries and make raising capital very difficult: the global economic slowdown, global deflation, the global profits recession and the global credit crunch.

    Since the Asian crisis erupted a year ago, the time horizon for difficulties in emerging market countries has lengthened. Many of the policymakers thought initially that this crisis was similar to 1995, that they would face a period of perhaps two to three months of a severe liquidity crunch that they could respond to. They could raise rates, they could use reserves selectively if they needed to to intervene in their currency.

    What they have not been prepared for as emerging market countries is for this crisis to go on for a very prolonged period, and I think that it might go on for a much longer period, given the economic slowdowns in Europe and the United States which we will probably see in some of the official numbers soon.

    Some factors to consider as far as the backdrop for emerging market countries: The CRB commodities index has fallen to a 20-year low. For many of the Latin American countries, such as Venezuela or Peru, countries such as Colombia, Ecuador, more than 50 percent of their exports are commodities. These countries are going through a severe shock. U.S. long bond yields are at a near 30-year low. In Japan, the yen weakness and contraction of domestic demand continues. Merrill Lynch is actually forecasting the yen will probably weaken all the way to 170 over the next 12 months.
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    We have even seen that this crisis has hit some of the smaller industrialized countries, such as Canada and Austria. In Europe, even non-core EMU currencies, such as the Italian lira, have come under pressure, following Russia's decision to devalue.

    If you compare this to what happened in the post-Mexico period in the first quarter of 1995, what you had was technical selling pressures and the anticipation of a broader crisis which in fact did not materialize. The Asian countries were still miracles. Central and Eastern European countries were just being discovered. Nobody thought that the outlook in emerging market countries would really impact the outlook for the industrialized countries. The sharp downturn was a very much V-shaped recovery that was followed by a very rapid recovery of the Mexican economy and of financial markets.

    There are few expectations, however, just going back to the situation in Japan, that Japan will be able to provide the necessary backdrop for recovery in Asia. I think in the coming months market attention will focus on the sustainability of the currency regimes for Hong Kong and China, which will in turn continue to affect market sentiment toward Brazil and Argentina, as they are large economies with managed exchange rate regimes. Given the current market stresses, a change in one or more of these regimes cannot be ruled out. Even if they continue to hold, bouts of uncertainty are likely to recur.

    I would like to just for a minute now talk about why Russia has made such a dramatic impact on these countries. And I think that the financial, economic, and political troubles, as many of the other panelists have echoed, are of a much different order of magnitude than those witnessed by any other emerging market other than in Indonesia.
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    The large stock of financial obligations involved, $70 billion, has made Russia's crisis far more painful to investors, including banks that extended syndicated loans and credits. If you look at the Federal Reserve's tracking of numbers, U.S. banks had about $7 billion outstanding to Russia. The provisions taken against potential losses have been significant.

    What we have seen is that as investors look for things to sell to offset their losses, what they have been selling is Brazil and Mexico, which are two of the most liquid assets in the emerging market's universe, even though these countries have not changed policy stands. But just for mere liquidity reasons, we have seen these two countries probably have the worst effects as far as offsetting the losses that the banks and investors are feeling from the events which have occurred in Russia.

    I think the likely inability of default and devaluation to solve Russia's problems will limit future capital flows to emerging markets and keep interest rates high. Note that even in the devalued Asian assets now, these are still not perceived as being sufficiently cheap to attract foreign private capital. Furthermore, in spite of large Asian current account surpluses, foreign exchange reserves in Asia have not improved due to private capital outflows which continue to occur. Interest rates remain at very punishingly high levels to attract capital, despite widespread economic contraction and debt deflation in Asia.

    The third thing I would like to point out is that the investor base for emerging market assets is still not well developed. We do not believe that the selloff in Latin American assets is due to policy errors, or that everything just changed overnight in these countries over the past month, or that adverse events in the region themselves, in the vast majority of countries, set off these changes.
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    However, because most emerging markets are non-investment grade, they are still considered speculative assets, a large portion of emerging market assets have remained in the hands of more speculative investors who react sharply to market downturns due to their shorter-term investment and use of leverage. The lack of liquidity in times of market stress, combined with the use of leverage, has resulted in some huge losses for investors, where many of them are backing away from the market in a way that was not seen in 1995. Although the extreme market volatility that can come from such a reaction often, I think, overstates the amount of actual risk that is in a country, if this is sustained for a period of time, it becomes self-fulfilling and it can ultimately affect the country's ability to attract capital and refinance itself.

    This is what we are seeing in Brazil, that the time clock is ticking right now. There are 15 business days until the October 4 elections. The free market oriented president, President Cardoso, is very clearly the likely winner.

    Brazil has experienced almost $2 billion of outflows per day. The foreign exchange reserves for Brazil, which were $74 billion at the beginning of August, are now down to about $50 billion. And I think I would agree with Professor Blinder, one of the key things we see as necessary is that the U.S. and the IMF, perhaps other G–7 countries, will need to come up with a package for Brazil quickly, I think even before the elections.

    I would like to now turn specifically to Latin America and just go through some of the recent developments there. I will focus a lot of my attention and comments on Brazil, since with a gross domestic product of almost $800 billion, Brazil accounts for 40 percent of Latin America's entire GDP. The population of Brazil is 160 million people, and it is impossible, I think, to think of a scenario of stability in Latin America if Brazil goes through a severe crisis.
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    During the first ten days of September, Brazil had more than $10 billion of capital outflows, and even as it raised interest rates to 50 percent on Friday, it still had $1.7 billion of outflows on Friday despite doing the right policy measures of raising rates to keep capital in the country. This follows $12 billion of outflows during the month of August.

    External pressures may leave few policy options if outflows continue at the current pace. The ability of the authorities to prevent speculative attack is increasingly being questioned. The government has about $75 billion of domestic debt to roll over by the end of this year, and is facing presidential and congressional elections on October 4.

    The recent increase in rates, as I had mentioned, did not stem the outflows. The fiscal impact of the higher interest rates on Brazil is enormous. We estimate that the fiscal deficit is already about 7.8 percent of GDP, almost 8 percent of GDP, and that the extra interest rate increase that they did would cost them perhaps another 8 percent of GDP if these rates had to be in place for a full year. So this is clearly not a situation that is sustainable.

    This does matter to the United States. In terms of U.S. bank exposure to Brazil, according to the Federal Reserve's last numbers there is about $27 billion of exposure to Brazil as of March 31. This is the highest level of lending to any single emerging market country with the exception of South Korea. It is higher than the level of lending exposure to Canada, Italy, or Switzerland. Brazil is the United States' second largest export market in Latin America behind Mexico, receiving about 3 percent of all U.S. exports to the world.

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    These problems have started in Brazil, but Argentina, Mexico, and Venezuela are also facing significant pressures. Despite its own positive credit developments, Argentina remains particularly vulnerable to spillover from Brazil, as does Mexico. The Mexican peso has lost almost 30 percent against the U.S. dollar since the beginning of the year, with about 26 percent of that happening really in the last month, even though the country fundamentals have improved significantly in recent years.

    Mexico's growth rate is respectable at 4 percent. The fiscal deficit is small at 1.3 percent of GDP. Inflation has come down to below 15 percent. Export growth, even in the very depressed period of export performance, is almost 10 percent for the first seven months of the year, and Mexico is the United States' second largest trading partner after Canada. Mexico, as I think you all know, followed a very prudent liability management strategy and actually repaid all of its loans to the U.S. Treasury three years ahead of schedule. So these countries are not spared even if they are doing the right things.

    In the case of Argentina, we believe the government will be able to maintain convertibility, the currency board system that pegs the peso 1-to-1 against the dollar. However, Argentina's international capital market's financing needs are higher than those of any other Latin American country. Argentina needs to raise probably about $15 billion over the next 12 to 14 months. And I think that if access to the market is limited or prohibitively expensive, Argentina could face increasing pressures to tighten monetary policy further and reduce the current account deficit.

    I would point out if you look at where spreads have gone in the debt markets for some of these instruments, debt that was issued by Venezuela during the month of August at 824 basis points now trades at 2,500 basis points. Euro bonds that were issued by Russia in June at 650 basis points now trade at about 6,000 basis points. For all intents and purposes, the international markets are really closed for emerging market countries, even those who have done their job in managing the economy well.
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    Venezuela has experienced more volatility than any other Latin American country, and it is the largest provider of oil to the United States. The Venezuelan equity market has fallen by 70 percent since the beginning of the year. The price of oil is about 30 percent lower than it was at the beginning of the year, surpassed only by the 50 percent drop that occurred in 1986 in Venezuela.

    Former coup leader Hugo Chavez is favored to win the elections, and I think that volatility will remain very high there. The possibility of foreign exchange controls and/or devaluation remains a distinct possibility if external pressures persist.

    We are forecasting that in Latin America growth will fall to about 2.8 percent this year and 2 percent next year. This is compared to more than 5 percent growth in the region in 1997. This represents the lowest level of growth since 1995, following the Mexico devaluation, when there was about 1 percent growth in the region. The forecast for Brazil for next year is that we will have really close to zero growth. And I think that in Mexico, even, which had been one of the strongest success stories, growth will probably slow to 3 percent compared to 7 percent growth in 1997. At the same time, current account deficits are widening, and the trade deficits are widening as well.

    We believe that access to the markets for the Latin American countries will remain highly constrained, and this is a serious problem. If you look at what has happened since the Mexico devaluation at the beginning of 1995, Latin American countries were able to raise on their own about $170 billion of capital in the international markets, or almost two-thirds of all of the financing that was raised in the markets by emerging markets countries. A severe curtailment of this amount of financing will prove to worsen the conditions even further.
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    So what are the solutions in this kind of environment? I think that some of them have been stated by the other panelists. But just to reiterate four things: First of all, I do think the U.S. and the IMF, perhaps with the help of other G–7 countries, must do something quickly to address the problems that Brazil is facing. And this probably is something that in conjunction with an IMF package, with the Brazilian government themselves already having announced a fiscal package, they need to announce before the October 4 elections.

    Second, I think that the full amount of IMF funding needs to go through, not just the $3.4 billion. And I think that particularly in Latin America where the success of using the IMF programs has been tremendous, actually, if you look at what has happened in Latin America compared to other parts of the world under the IMF programs, the success stories are significant, with Mexico being one of the key ones. All of these countries have improved their level of disclosure to investors. I think they have a far greater level of disclosure than we see over Russia and Asia out of the past few months.

    Third, there would have to be evidence of Japanese banking sector stability and the emergence of a credible economic stimulus package in order to avoid the continued difficulties that are facing Japan.

    Fourth, I would say that we are looking very much at whether there will be lower interest rates in the G–7 countries that could ease some of the stress on emerging markets borrowers.

    Chairman LEACH. Thank you, Ms. Chang.
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    I don't know if there is anything for you to say, Mr. Supple, but you are welcome to try.


    Mr. SUPPLE. Yes, I should just say I agree and leave now.

    Thank you very much, Mr. Chairman, distinguished Members of the committee, for asking me to speak at this hearing, for the very nature of this hearing to me is encouraging. In essence, there is an emphasis on an awareness of the severity of these issues and the problems facing the global financial system at present. Also interesting is listening to the other panelists. There really has been a centrality of Asia within the crisis, how Asia has been a spark which is fed through emerging markets.

    One issue which has struck me throughout the whole Asian crisis is a degree to which it has been generally underestimated. Last year, in the middle of last year there was assumption Asia would have a dramatic loss of output. It could be a recovery, the V-shaped recovery which Joyce mentioned. Similarly, there was assumption that the crisis in Asia could be localized, it wouldn't affect other emerging markets.

    But all these assumptions have proved to be incorrect. Asia shows no sign of bottoming out in the short-, or even medium-term. The Asian crisis, through the transmission mechanism of trade flows, of G-10 banks and the losses contained in Asia affecting the appetite for other emerging markets, those transmission mechanisms have seen emerging markets globally come under pressure as a result of Asia.
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    These are the trends we have seen at the moment slow global growth, increasing feed-through of the emerging market crisis to the major markets. Part of this underestimation of the problem has been a failure generally to recognize the severity of the underlying problems within Asia, and for this, this is still the case. Whereas Asia is becoming more prominent in broad thinking, broad discussion issues even in the G-10, I still feel there is a danger to Asia. The severity of Asia in a global economy going forward could be underestimated still.

    One of the important things to stress is what the key issue is in Asia and how that will define the efficacy of any policy responses going forward. Now, on one level Asia is not different to many of the crises we have seen in other emerging markets, and indeed some major markets. Asia is a banking crisis. At heart that is what the banking crisis is, and the characteristics of that don't differ in any great degree from banking crises we have seen elsewhere, whether it be the domestic banking crisis committee you are so familiar with or other banking crises.

    But the big difference is the size of Asia's banking crisis and the impact this will have on economic growth trends and policy trends in the region going forward. Now, one way to define the size of a banking crisis and its shock on real growth is to get an estimate of the resolution costs of the banking crisis. How many resources, government, private resources will need to be brought to bear to ease systemic risk in banking?

    We can look at some of the past banking crises. We can see to date bailing out Mexico, easing systemic risk in Mexico, about 15 percent of GDP estimates; in Japan, 15 percent of GDP depending on the source. But in Asia the resolution costs really dwarf anything we have seen before. In countries such as Korea a multiyear time horizon of the cost of bailing out the banking sector would be 60 percent of 1998 GDP; Indonesia, 50 percent; Malaysia, Thailand, 40 percent figures. These are astronomical sums.
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    And this, the failure to recognize the problems in the banking sector, is one of the problems whereby there has been an underestimation of the impact of Asia on the global economy because of the scale of this banking crisis, severe implications for growth rates in Asia going forward, and the prospects of recovery.

    Traditionally when you have got a banking crisis, you get a domestic liquidity crunch due to the weak balance sheets of the banks. There is an aversion to extending fresh credit. Now this is happening in Asia with a vengeance, and given the severity of the problems, the credit crunch is far deeper than many people first anticipated.

    And the problem in Asia is compounded by the fact that there is no avenue for intermediation. Now in major markets if there is some degree of banking crisis, there are other avenues through which the corporates could obtain funds from investment, whether it be bond markets or foreign borrowing. In Asia, the bank is central to any economic recovery because there isn't this avenue for financing through other mechanisms.

    As yet Asia doesn't really have a bond market. The corporate sector in Asia is already saddled with more foreign debts than it can realistically repay so there is no avenue for foreign borrowers. There is not going to be recovery in domestic demand in Asia until the banks can be reformed and can once again function as mechanisms for transferring savings into investments. Given the scale of the problem involved, given the size of the banking problem, this is where the problems come into Asia's long-term growth trends. Recovery in the banks, resolution of a stable banking system, is going to be a very long process.

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    I would like to come to some of the policy options going forward. Now that is our key assumption in terms of Asia, the risk—the down side, restricted economic growth, is a result of the banking crisis, but the key issues are what policies are available to create an Asia which is once again growing, which can have a more benign effect on the global economy, and there are several alternative solutions.

    One, the first stated alternative policy option, before coming to the option which we feel most strongly is the path which Asia should follow, the first policy option really is a continuation of what we have seen at present. This is where you have IMF austerity measures being implemented.

    IMF austerity did serve a purpose in the early stages of the crisis, had a very beneficial effect in terms of moderating the global impact of the Asian crisis. We have seen the transformation of the current account positions in Asia from large deficits to extremely large surpluses. Asia as a whole this year is set to have a current account surplus of over $80 billion, U.S. dollars. There is strength in the balance of payments position of the region, strength in currencies, and it has prevented the large-scale public debt moratoriums and debt defaults which would have otherwise been seen potentially in a matter of weeks in some countries.

    But what is the failure with many of the IMF policies is we haven't seen follow-through in terms of structural reform. There is a growing danger that under the existing system of austerity, without the greater structural reforms of the banking system, the political will to implement market-friendly reforms would start to erode because we have not got the prospects of recovery as yet.

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    We have had a year of austerity, but the prospects of growth are as bleak as they were a year ago. The banks can't lend, the banks can't function, domestic demand cannot recover. So on that basis, the continuation of the status quo isn't an acceptable option. We do need greater focus in terms of structural reform, or else the political will which has underpinned a lot of the reforms will start to unravel, given there will be no expectations of recovery emerging over the short- to medium-term.

    An alternative policy option which has been proposed is the polar opposite of what we have seen so far. This is where we see expansion of policy, expansion of monetary and fiscal policies being implemented throughout the region. Again, this isn't the option which we would like to see in Asia, and we feel it would be ineffective in the region as a whole.

    In terms of monetary policy, the danger we have there is that the banks cannot function effectively. If liquidity is provided to a banking system, given the problems of the banks within Asia, they cannot transfer that into credit extension. Investment will remain low, consumption will remain low. And the danger, you see, is the liquidity provided to the banking system will move offshore, will move into safer investments which is government bonds, lower benchmark yields, weak encumbrances, the one significant follow-through in terms of domestic demand.

    And that currency aspect of expansionary policies becomes very alarming in the sense of the debt problems which Asia had. The risk is that you would see a default occur in Asia in which you saw another leg of currency depreciations across the Pacific region, again the expansionary elements. Monetary policy will be undermined by a degree to which corporates will face higher debt servicing costs, in the absence of large-scale debt restructuring across the region.
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    At the moment, the expansionary policies would not, therefore, be a desirable policy option in Asia, because it wouldn't lead to recovery in output. Instead, it could increase the transmission mechanism of the Asian crisis toward emerging markets as a debt default.

    One other solution which has been put forward is one which could prevent the currency aspect of expansionary policies coming into play. This is where you get the Plan B solution which has been proposed, where you have expansionary economic and fiscal policies, but there is a wall of capital controls. There is a wall. This Plan B is the approach where you have expansionary monetary and fiscal policies, there is a wall of capital controls implemented to try and keep that money within the country, to enable that money to have expansionary, inflationary effects on the economy.

    This is one of the dangers which we see in Asia in terms of creeping re-regulation which could be established in the absence of any signs of recovery, which is at present the case. But again this is something which is a danger which could diminish over time as we see the likely experiences of the first country to really pursue this plan, being Malaysia, because there is an inherent inconsistency in terms of this policy approach as a way of creating growth and stability within Asian markets.

    The policy is one whereby Asia would prevent capital flight through capital controls. The danger with that is it is a two-way thing. Capital will be less able to leave, but for the very reason of that risk premium, capital will be less willing to enter these countries. This is where we have a danger whereby in these countries which pursue capital controls, their balance of payments would largely break down in terms of the current account positions because of reduced foreign investments.
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    Then we have the problem whereby you actually see policies pursued aggressively in terms of expansion, policies designed primarily encouraging consumption over savings. If these policies are successful, then you see deterioration in current account positions. This leads to the inconsistency whereby you have balance of payments positions and loss of foreign exchange reserves in countries such as Malaysia.

    Malaysia is in this position, whereby if this policy is successful in terms of inflating growth, the current account position will start to deteriorate. That will lead to large-scale loss of foreign exchange reserves. That will lead to one of two solutions: repegging of exchange rates at lower levels, which undermines the initial reason for the capital controls being in place in the first place; alternatively, further deregulation of the economy to restrict capital outflows.

    Capital controls become exchange controls. It is corporate individuals who have the ability to purchase dollars reduced. That creates growing inefficiencies in the economy, which undermines long-term growth expectations. This is a trend likely to be seen in Malaysia, which again is going to provide—is going to help dissuade other countries from going down this path. You are going to see loss of reserves over the short-term in Malaysia. It is going to force either ringgit depreciation or devaluation or it will force further deregulation of the economy. This isn't a solution which is going to create a basis for sustainable growth in the Asian Pacific region.

    One other solution which has been put forward is the G–7, coordinated liquidity easing in the major economies. The U.S., Japan, Europe cut interest rates to try to provide some liquidity into emerging markets. Again, if this approach was adopted, theoretically it could support emerging markets. More liquidity in the economy could ease liquidity conditions and the credit crunch in some of these emerging market economies.
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    But the danger which we as a bank would like to highlight is the risk that is a risk of monetary policy. Say the U.S. been focused on anything other than domestic policy variables. The great danger is that monetary policy trends become desynchronized with underlying business cycle trends. In that situation you get increased growth and interest rate stability going forward, which is ultimately destabilizing for emerging markets.

    So any interest rate cut for beneficial emerging markets over the short-term must be allied toward—must be linked to the trends in domestic economy. We wouldn't like to see any U.S. rate cut until there were signs of some slack in the resource utilization in the U.S., some rise in unemployment, some demand shock caused by further fall in the equity markets.

    If you saw an interest rate cut on the basis of simply emerging markets, then we would actually see that as negative, medium-term, for emerging markets. But if we did see some slack in resource utilization which could justify a rate cut in G–3 or G–7, then it has to be put in the context of Asia. It would be supportive for Asia, and indeed emerging markets would create more liquidity in the economy.

    Some of that would fly to emerging markets, but it is not a sufficient or necessary condition for recovery in Asia, because the problem would still be there whereby the internal liquidity crunch, the internal credit crunch would still be in place, mainly the banking sector crisis. Money would flow into these economies, but there would be no multiplier effect. The banks still could not lend, and the G–3 easing which we saw would not provide sufficient liquidity injections into these economies to counteract the impact of the domestic banking crisis which we see.
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    Now we come to the final option, the final solution, which is one which we favor. This is where Asia has to pursue a grave structural reform. Recovery in Asia has to be internal. It has to be self-sustaining. We can't look for simple solutions, whether it be interest rate policy in the U.S. or whether it be capital controls.

    We have to see the basis of sustainable growth in the Asian Pacific region. On this basis, we have to see reforms take place to address the problems in the banking sector. This is inevitably going to lead to large government involvement in the entire banking sector. Balance sheets have to be cleaned up. Banks have to have a greater capacity to lend.

    Government has to absorb a lot of the non-performing loans of the banking sector in these economies, treat a large fiscal deterioration in the government, which is a reason why austerity in terms of fiscal position has been beneficial, in a sense that it prepares the governance for this large fiscal liability which would be taken on. Without structural reform, there not going to be any recovery in Asia. The problem which we see is over the short-term structural reform.

    Chairman LEACH. If I could ask you to summarize briefly.

    Mr. SUPPLE. Ultimately that would be my final summary. The approach we favor is structural reform with the banks. Any discussion which deflects away from there—people talk about the policy response on low interest rates in Asia, capital controls—deflects the main attention, deflects attention from the key issue, banking sector reform. Banking sector reform can be allied to some degree of easier managing policy, but it has to be central.
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    But if I could leave with one note, I just want to state the instability caused by Asia in global markets hasn't yet peaked. There are further downturns and further shocks to growth to come in Asia. If Asia does pursue the structural reform of the banks, that is contractually over the short-term. If they don't, then the greater danger is that Asia will not have the basis for a sustainable recovery for years to come. We could be talking about a lost decade of growth within the emerging markets of the Asian Pacific region. So Asia is going to be an increasing source of instability over the medium-term in terms of emerging markets.

    Chairman LEACH. This has been sobering testimony. A lost decade is a very powerful thought.

    I would like to turn first to Professor Goldman and Professor Simes. Of all the experiments that don't seem to work, there has been financial assistance through the Russian government, and so there is a great emphasis on this issue of decentralization. At the Library of Congress Professor Billington has suggested putting emphasis on Siberia. Several of you suggested putting an emphasis on regional approaches. There is an interesting model, in a way, with Poland and why it is that Poland has been successful.

    Tomorrow we are going to hear a panel of witnesses disproportionately on the subject of corruption, and Professor Goldman in particular mentioned it, and Mr. Simes did. Would you care to comment on either model of Poland versus Russia, on the corruption side, and is there a contrast, and why? And, second, a model of other ways of being involved with Russia that isn't simply through the Russian government.

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    Mr. GOLDMAN. Well, let me begin with Poland. First of all, there was a consensus of what the Poles wanted to do, and that was they wanted to turn West and they wanted to go to the market. Even now in Russia, as we have just seen, there is no consensus on which direction to head. So that was important.

    The second thing is that in Poland they never collectivized the farms, whereas in Russia they collectivized all the farms. It is not to say that the Polish farms were efficient, but at least they preserved the remnants of a market and they remembered what a market was. When they saw that the reforms were beginning and looked like they would be continued, the farmers then began to respond as if there was a market.

    The third thing is, there was also a private sector that had never been completely suppressed or repressed. So you had something in place.

    And then the fourth thing, and this was inadvertent, the fourth thing was that they said they would move immediately to privatization of the state sector, but they weren't able to do it. Only in the last two or three years have they been able to move, and by then they had that infrastructure in place.

    So you could resuscitate the market process in Poland. They remembered what it was like. They had institutions in place. They were close enough to Western Europe so they could actually send traders off, or traders could go off in the day to Berlin, bring back goods and exchange them. And there was also a partial debt moratorium, some support for this.

    So it worked quite well. It wasn't so much that it was a regional activity, but that the Poles themselves lifted themselves up. Foreign investment began to come in, but not as large initially as went into Hungary.
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    But the process has worked quite successfully because of all those factors. By contrast, if you go to Russia, almost every one of those four factors that I mentioned, was missing. They had just the opposite. And as a consequence, the Russians lacked a memory of what a market was. When they were given foreign aid, they didn't know what to do with it. It wasn't so much that we gave such large quantities of foreign aid, because our foreign aid to Russia really was quite moderate, and only now is $200 to $300 million. But there were no institutions in place which knew how to use the money that did come in.

    If I may just go back to the 1991 ''Grand Bargain.'' There was great emphasis on putting in as much as $15 billion a year, according to some analysts. And I was very much opposed to that, not because I didn't want Russia to succeed, but because if it had gone in, it would have all been stolen since there was no way to use it effectively.

    The Marshall Plan in Western Europe worked because people knew what they wanted to do. In Russia it wasn't the case, so now the only alternative is to try to find areas where you hope there will be less corruption, where there would be a willingness to put some of this money and aid to work, and where the local governors recognize if they can attract foreign investment, they could attract additional support from international organizations and put it to work building up an infrastructure and provide jobs. Then at least in that region things would improve.

    Chairman LEACH. Professor Simes.

    Mr. SIMES. Mr. Chairman, there is a very important difference between Russia and Poland. In contrast to Russia, Poland has a parliamentary system rather than an elected monarchy. And accordingly, in Poland Mr. Balcerowicz (the Minister of Finance), undertook shock therapy with the full support of the parliamentary majority. With the loss of the majority in parliament, there was a change of government. Reform was not at all by decree. It involved putting forward legislation which assured foreign and domestic investors alike of greater stability.
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    Second, as Professor Goldman mentioned, Poland had private agriculture, private shops, and millions of Polish-Americans returning there with money and expertise in helping to start small businesses. There was nothing like that in Russia. The Russian government just redistributed state assets instead of trying to build reform from the bottom up.

    Finally, you mentioned corruption. Of course, corruption happens in many places, in Poland, in Italy, and elsewhere. But what was unique about Russia was again connected to its political system. Without meaningful parliamentary oversight, without any legislation on private property, everything was legal and illegal at the same time. There were no rules. There was no one to enforce the rules when key members of the Yeltsin government and members of Yeltsin's family clearly benefited from privatization, and established relationships with oligarchs, which were unsavory by any minimally objective standard.

    The trouble in Russia is that there is no oversight. The media publishes stories accusing government ministers of corruption, but it is impossible to remove them as long as they are close to Yeltsin. So it doesn't have any impact whatsoever.

    The second point is that people become totally cynical. They don't care any longer whether allegations are true or not. All they care about is who is behind the allegations and who is going to prevail.

    Let me say something very simple and very provocative. What Russia needs now, of course, is fundamental restructuring. Russia needs a modicum of political stability, but they have to stop using stability as an excuse for undemocratic measures. Gorbachev was beginning to lead them down the road to start respecting the rule of law. They need a modicum of Jeffersonian democracy. They need a healthy suspicion of government institutions on one hand, and a healthy respect for the law on the other. In this sense, the Yeltsin era was a step back.
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    Chairman LEACH. Thank you very much.

    Professor Blinder, do you want to comment on this or not?

    Mr. BLINDER. On Russia, possibly as little as possible. To me, Russia has been a special case for a long time, for the reasons that Dr. Simes was mentioning before: its geopolitical significance, its nuclear weapons. I do agree with the sentiment you suggested in your question, that it seems extremely improbable that funneling more money to the Russian government is going to do any good. If I thought it would, I think I would favor it under the doctrine of ''too-nuclear-to-fail.'' We can't afford to have total chaos in a country like Russia. The question is, can we do anything to stop it?

    Chairman LEACH. Thank you.

    Mr. Frank.

    Mr. FRANK. Thank you, Mr. Chairman. This has been interesting. It makes it graphically clear how different the Russian experience is from the others. I am going to talk about the Asian and I think the broader capitalist sort of question.

    Mr. Supple, in your preferred outline, your preferred policy, and I appreciate the actual—pick a policy. Too often we get advice here which reminds me about the story about Groucho Marx was a coach of a softball team in Hollywood, and Jack Benny got up to bat. And Groucho Marx said to Jack Benny, ''Hit a home run,'' and Jack Benny struck out. And Groucho Marx said, ''I quit,'' because his team wouldn't follow instructions.
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    Telling us to be smart and be sensible and to be helpful, it is not helpful, but you have some specifics. But you quite honestly say in these specifics that the effect in the short-term is of course, I suppose, a couple of years—it is going to be very unpleasant for the people who live there. It is going to be contractionary. The government is going to have to spend a lot of money.

    You said in Asia, very significant, you were talking about banking reform, significant chunks of money are going to have to go there. What in your opinion will the citizens of these countries be doing while this is happening?

    Mr. SUPPLE. One thing that was interesting that was in the previous panel, one thing that came up was need for some broadening of involvement of the G-10 in the emerging market crisis.

    Mr. FRANK. I was at the previous panel, the one that met this morning. I mentioned your view of what is going to happen in Asia and these countries which follow your option.

    Mr. SUPPLE. I was coming on to the issue, because ultimately there is a social ramification for this. We are talking about contractionary aspects to policy. We are talking about continuation of the trends we are seeing, rising unemployment, falling real incomes. This is one of the dangers. There is a need for some deepening of involvement in the economies. There is some need for humanitarian aid of some of these economies.

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    The danger which I see, though, is Asia is in the critical period at the moment. We have had a year of——

    Mr. FRANK. I am sorry, but I really need you to focus. I know that. You said that. I have heard it. And I realize we need to do some things. But I appreciate you talking about humanitarian aid, because it is a problem. The voters and the citizens have too often been absent.

    One of the striking things that I appreciated in the conversation with Mr. Goldman, Mr. Simes, was electorates was a factor. The Polish, Russian, the difference in the composition of the citizenry and social structures, that was relevant.

    Now, the problem we have in much of Asia, we are simultaneously telling people we think they should democratize and telling them they should do things that democratic electorates on the whole think are a bad idea. I appreciate you talking about humanitarian aid, but that is what we have to address. I understand all the reasons for it. You are talking about programs that are going to have very severe contractionary effects on the countries. How do you get people to vote, to support governments that do that?

    Mr. SUPPLE. They are not mutually inconsistent, democracy and austerity. One of the trends we have seen in Asia——

    Mr. FRANK. Excuse me. How do you get people to support that? I understand that and I understand all the generalities. I think you are ducking the hard question. Do you think people are ready to vote for this? Are they going to vote for taking a substantial amount of taxpayer money to bail out some of the bankers, buy out the bad loans, and so forth, and it is going to have very negative effects on them? What do you do about that? Do you think they will vote for it?
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    Mr. SUPPLE. They have done in Asia thus far.

    Mr. FRANK. Where?

    Mr. SUPPLE. In Korea. We have had aggressive reforms, we had a continuation of reforms. Across the region as a whole there have been political ramifications of the economic crisis. Their structures haven't changed. There is exception as we see more degree of democratization in Asia. There is group of activities in terms of decisionmaking, the awareness of the need of——

    Mr. FRANK. I think there is a danger in referring too much to South Korea. We are very lucky that you have this hero, Kim Tae-chung. Obviously a lot has to do with people's acceptance of your bona fides. There are very few people who have put their life at risk for democracy. I think Kim Tae-chung buoys himself in South Korea a lot by his own history.

    I think you are underestimating the difficulty of getting people to be supportive of some of this short-term effort, although I do appreciate your talking about it. I think we need to be explicit about this. We have to buy people off. It is going to take some public money.

    You mentioned that reducing interest rates would be helpful. Ms. Chang was readier, I guess, than you to reduce interest rates. Professor Blinder, I think you are, as well. I say we will get Mr. Greenspan and Mr. Rubin before us. I think reducing it is going to be very important, because among the democratic electorates that are going to have to be persuaded to do some things that they don't necessarily like to do is this one. Accept a larger trade deficit. I guess this is the one point I want to make. We have a tendency when we talk about this, and it was different with regard to Russia and the Polish alternative, we have a tendency with other things to talk about these economic entities as if they were single entities, that they were single countries. Obviously an awful lot goes on inside.
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    I think much more attention has to be given to how you get democratic electorates to be supportive of these measures that will have some short-term negative consequences, so that notions of both humanitarian assistance and trying to increase liquidity I think are very important.

    Professor Blinder.

    Mr. BLINDER. I have one thought on that. One way to ameliorate both problems is not austerity, but in fact fiscal spending on social safety net purposes—which are generally very weak in those countries.

    Mr. FRANK. And getting weaker here.

    Mr. BLINDER. Yes. You both ameliorate misery and you create more spending in the society.

    Mr. FRANK. I think that we are talking about—if I could have just another minute or two, Mr. Chairman—there is an inevitable tendency to focus on the needs of capital. That is the dynamic and that is where the productive gain comes from and everybody is told to attract capital. Professor Goldman used the analogy, it is like North Carolina competing with Alabama. Anybody who runs a government anywhere, this or that, Russian region, everybody is told it is very important for you to give capital a high return, a sense of security, and so forth. Obviously it is.

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    But part of the problem is when we deal with the world in which there are no political institutions beyond the nation, and in some cases none even at the level of the nation, like in Russia, you have this problem where capital wins too many of the fights and that becomes the only value. And it is especially a problem if you are simultaneously trying to implement democracy and you are hoping some of these things will be supported, and I think we need to give more attention to both the moral and political need to ease that pain, to pay people, to get them through the transition.

    In part they are not going to respond. It is happening in the United States. I said this earlier. I am going to repeat it for this panel. The loss of communism as a frightening factor means that some of the support you used to have for international economic cooperation in America has gone away and it is going to have to be reconstituted. Some more concern for the equity consequences of the globalization process within societies is going to have to be part of that new consensus.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Frank.

    Mr. Bereuter.

    Mr. BEREUTER. Thank you, Mr. Chairman. Gentlemen, thank you very much for your testimony. Thank you. I am sorry I have been pulled away several times. Nebraska Farm Bureau and Nebraska Farmers Union are both here successively to tell me how important the Asian financial problems are in their life. And here of course we are talking about it in that area and other emerging markets.
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    I had a number of suggestions given to me about things we need to see done with respect to the global economic problems we have, and I would like to get your reactions to some of those suggestions. We need to look at regulating the sloshing around of global capital by implementing things like circuit breakers. The Bank for International Settlements needs to establish some global capitalization banking standards for capital reserves, for lending standards, for transfer procedures, for accounting rules, and we need some global bankruptcy standards.

    I wonder if any of you have anything positive or negative to say about those suggestions?

    Mr. BLINDER. I will take a crack at it.

    Mr. BEREUTER. Mr. Blinder.

    Mr. BLINDER. When the dust has settled, whenever that is, I think we do need to rethink some of the rampant advocacy of unmitigated sloshing around of global money, as you put it. There is a lot of distance between absolutely unfettered movement of short-term capital, putting things in a corset and banning capital movements across borders. No sensible person wants to do that. I want to draw the distinction between foreign direct investment and short-term portfolio capital, especially short-term portfolio capital. I think that needs some rethinking.

    Regarding the second thing you mentioned, BIS banking standards, I couldn't agree with you more. This is needed for the long term. We should do it. Had some of the Asian countries adhered to better banking practices, the problems wouldn't have disappeared, but they would have been less severe.
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    Mr. BEREUTER. Would that include bankruptcy standards?

    Mr. BLINDER. The last thing I was coming to was bankruptcy standards. I was in the Government at the time of the Mexican banking crisis. There was considerable talk about global bankruptcy standards then. I personally think it is a very good idea, but virtually impossible to do. Different countries have different bankruptcy laws which reflect different notions of what bankruptcy procedures should look like. Some, unfortunately, have none at all, which is not a very good solution. Should the world's governments deem it possible to negotiate a kind of a treaty which would homogenize bankruptcy rules around the world, I think that would be wonderful. I would be stunned if it could happen.

    Ms. CHANG. I would like to just add to Professor Blinder's comments. I think that first of all when you look at some of the statistics that come out of Japan, that there are 300 bank examiners compared to the U.S. having maybe 6,000 to 8,000 bank examiners, this points to some of the problems now that are occurring in the Japanese banks as far as oversight. There is not just the BIS standards, but just the role of banking examiner, I think, in Japan and in most of the Asian countries, has been one that has not been exercised.

    We found when we were looking at the Asian countries, for example, in a country like Indonesia if you did not report what your level of indebtedness to the central bank was, the penalty was something like the equivalent of $1.25. There were really no penalties for not reporting in to the central bank or in to any international body just for the amount of liabilities that were being accumulated.

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    I would say on the global bankruptcy standards, this is an increasing problem for investors. A lot of investors, as they look at contracts that are not being honored, rules that are changing, you don't want to look at these corporates as something they want to invest in longer term. This attracts more speculative investments in the currency; they are very short-term.

    I think it is almost impossible to think about how you would put global bankruptcy standards into place, but I think to the extent that the IMF is working with individual countries on a program that probably is some type of reform, that way should be part of that specific program. If there is, you know, a large portion of money from the U.S. taxpayers that is going to that, even if you can't do it on a global basis within those countries where there are active programs, there should be some kinds of standards that are being developed both on the global bankruptcy side and also on the banking evaluation side.

    I think that finally, on the whole point of how you implement circuit breakers, it is very hard to look at how you can use it effectively. Some of the Latin countries have done this quite effectively, such as Chile and Brazil. You have other interpretations such as what Malaysia has done which basically just, you know, tends to—you keep investment flows at abeyance in its entirety. So I think that there are countries that have successfully used capital controls in Latin America.

    I would also say that, even though Mr. Frank has left, that Latin America is one part of the world where, because they have gone through crisis and hyperinflation before, when there are crises such as this, usually the free market candidate comes out stronger. This has only come because these countries have seen crises and they see what happens when hyperinflation occurs.
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    Maybe the Asian countries haven't gone through that and maybe haven't learned that lesson yet, but clearly in Latin America you see the example where in Brazil you raise interest rates 50 percent, you announce a fiscal package that means there is zero growth, and the current front-runner in the polls, the current president who is very market-oriented has increased his popularity by 7 percent over the last ten days.

    Mr. BEREUTER. Thank you. Thank you very up much. Mr. Chairman, do we have time for a couple of questions on Russia or not?

    Chairman LEACH. Mr. Bereuter, you definitely do. Go ahead.

    Mr. BEREUTER. Thank you for your indulgence.

    Mr. Simes, I heard your comments about the rule of law and I agree with that. We spent quite a bit of money on encouraging rule of law from our country. It seems to me most of the bigger expenditures have not brought much results. Some people have suggested we need to focus what we do in that area at the grassroots level. Suggestions that also frequently arise from all directions, including the Russians, emphasize not giving any more money to the IMF—from the IMF to the central government, and also consider spending it with those governors that are doing some innovative things. Suggesting that we might have to do something as radical as having the IMF put international bureaucrats in key places within the central government structure, which is really radical, because promises are not implemented.

    I would like you and Professor Goldman in particular to comment on any of those things that you might care to, and that will be the conclusion of my remarks and comments.
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    Mr. SIMES. Let me start with the rule of law. The Clinton Administration paid lip service to the rule of law in Russia. I would not agree, however, that it was actually encouraging the rule of law in Russia.

    You may remember that in every conflict between President Yeltsin and the Russian Parliament, the advice from the Clinton Administration was not ''follow your intuition,'' or ''follow the rule of law.'' It was ''proceed with radical economic reforms as suggested by the IMF.'' And of course very often IMF acted essentially as a proxy for the Clinton Administration.

    In 1993, President Nixon sent a letter to President Yeltsin, whom he got to know quite well, advising him against confrontation with the Russian Parliament. This was not because President Nixon liked the communist-dominated Russian Supreme Soviet, but because he felt that the rule of law, dialogue, legislation, and building a national consensus had to have a priority over exactly what kind of economic reform was conducted.

    Several weeks later, President Nixon was in Yeltsin's office and I was accompanying him, and President Yeltsin said, ''You know, this is not the advice we are getting from President Clinton and his associates. They're telling us we should reform, and when we try to explain that we cannot get support in the parliament, they would always say, 'well, you have to do what is right. You have to find a way to do what is right,' meant disregard the parliament.'' Eventually, of course, Yeltsin had to use tanks.

    I think we have to start from square one. We have to put our money where our mouth is. We have to start understanding that what is ultimately important for us in Russia is its nonaggressive foreign policy, its stability, and the rule of law.
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    Now the comment about IMF. The IMF gave consistently bad advice to the Russian government. Once the IMF became engaged in Russia, it was not just a lender of last resort, it became a co-manager of Russian economy. I talked to a number of senior Russian officials who were told me they were getting not just advice, but essentially orders, from IMF officials. I was told about senior officials of the IMF and senior officials of the Clinton Administration telling President Yeltsin who should be in the Russian government in key positions, including positions like foreign minister, minister of finance, and even President Yeltsin's own foreign policy advisor.

    With a record like that, it is very difficult for the IMF, particularly as long as it has its current management, to have much credibility in Russia. Accordingly, we have to look for a new structure, maybe under the G–7, if we can put it together quickly.

    At the same time, the IMF has to be reformed. I understand how important the IMF is, and I understand the importance of sending fire trucks on time. But I also understand that the people who are in charge of fire brigade on occasion confuse themselves with arsonists. These people have to go before anything meaningful can happen.

    Finally, about regional governments. I think we should look for ways to work with regional governments. It would be very difficult and indeed very dangerous for us to stop working with regional governments if it means that we would ignore the central government.

    First, the central government cannot do much. It could thus be very effective to provide foreign assistance to regional governments.
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    Second, I don't think it is in the American interest to encourage centralization in Russia when the situation there may go out of control. This is a risky game. It is nice to have a Russia that is sufficiently decentralized not become dangerous once again, but this is not the moment to encourage Russian regions to go in different directions.

    Mr. GOLDMAN. Let me disagree a little bit with Dimitri on this. I think that we could provide aid for some of the provincial governments without necessarily setting into motion these decentralizing forces that he talks about. Because if we have to look at the situation and say, well, either we give money to the central government or we don't give money to anyone, then I think we are really kind of stuck, because I would hesitate at this point to be that supportive of the central government.

    I think the problem is not that we want to go to the local areas and say we want you to set up your own taxes and do things differently. My suggestion would be that what we try to do is encourage them to try to build their own infrastructure just as, you know, in agriculture in the United States, we have a system of county agents. What does a county agent do? He tries to come in and show an experiment, how it works, and then hope that along the way other farmers who have not been initially involved say, ''Hey, I like that and I want to do the same thing.''

    And that is why I use the analogy of Alabama and North Carolina, to compete on that kind of basis to attract investment and to attract new activities, to encourage this. Sister City programs even have been doing this. Rochester, New York, has one with the city of Novgorod. They have managed to undercut some of the mafia activities because some of the people coming from Rochester have worked with the local governor who simply says, ''OK, don't worry about the mafia, I'm going to take care of them in this particular instance.''
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    I should also try to make sure that we don't lean so far over backward that in the process we ignore the fact that some changes have been made. Some rule of law has crept in. For example, they have created something like the Securities and Exchange Commission, and the man who is in charge of that, a man by the name of Dmitri Vasilyev, is working hard to try to protect investor rights. He is fighting the whole system. It is not easy, but at least he understands what is happening and he is beginning to move this way.

    So while this is a very long process and it is going to take decades, I think that there is some motion. While we have spent lots of money on it, some of it has been useful. A lot of it has not been, and I recognize that.

    Just two other things and then I will end.

    What about the IMF? I don't think the IMF is the instrument to do this with the regions. I don't even think that that is legally possible. That might be something for the World Bank. That might be something for individual governments to work with on the side.

    But then the last point I want to make before we leave here, we should recognize, as I said before, that this year is probably going to be a very bad winter, given everything that has happened, and we may just have to come along and provide some material support just to prevent chaos. That is bad, because providing agricultural aid makes Russia more and more dependent on outside agriculture, not its own. But I don't see how we can avoid help this particular winter.

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    Perhaps someday we can wean them from dependance on the outside and that all we will have to do is backstop them. But in the end, they have to make the decisions. There is not enough money that is going to come from us, from the IMF, from the World Bank, from the G–7, the G–27, to make that much difference.

    Mr. SIMES. Mr. Chairman, if I may. While Professor Goldman disagreed with me, I agree with everything he said.

    Mr. BEREUTER. Mr. Chairman, I want to thank our excellent panel and thank you for two excellent panels today and the good sessions that you scheduled.

    Chairman LEACH. Thank you, Doug.

    One of the things that Mr. Bereuter and I have in common is that we understand one aspect of American goal. That is, we come from the heartland, and there has been a golden harvest, and actually we have surplus grains in relationship to the demand as relates to capacity to pay. And it strikes me one of the things that we may well want to be obligated as a Congress to look at very seriously is expanding dramatically traditional grain export programs to countries like Indonesia and Russia. And we also have some potatoes, which we may well need to be in the business of.

    With regard to the IMF, there are some theoretical issues that relate to how do you direct to middle-class people. And one of the other modest things in Russia, there is a sense that there has been maybe a million or two middle-class families established on top of the seven or eight ultra, ultra billionaires, and that is something to build on, too. And one aspect of the middle class the world over is concern for housing.
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    We have institutions in the banking sector that respond very brilliantly to America's housing needs. Then we have secondary institutions like Fannie Mae and Freddie Mac that serve a role. And it is not inconceivable to me that if the IMF can pinpoint as either national or regional initiative in the housing arena, that might be directed to a given class of people that is a great middle of Russia.

    Do you have any sense for that?

    Mr. GOLDMAN. Well, if I may, there have been some efforts this way.

    Chairman LEACH. Yes, there have.

    Mr. GOLDMAN. And if you look at the private sector that has started up, you know, the new startups, the things that I have been harping on all day, it turns out that in construction you have got a lot of new startups, because this is the kind of thing that you can just begin to do out of your car, or out of your bicycle even, and move from that.

    If you fly into Russia, any city that you go to, you will find this massive building of cottages. And some of these cottages are really mansions. But this is one of the striking things, because we know that outside Moscow conditions are quite poor, yet everybody is building this way. And there is a lot of activity.

    Some of it has been unfortunate as well. Some Americans have gone over to develop projects with a Russian partner, only to discover that the partner has pushed them out in a very crude, thuggish way. But certainly, I think there is a lot of opportunity, particularly if we can come up with a mortgage program, financial program, that would make sense in that direction.
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    Chairman LEACH. Well, there is a British rating agency called Fitch IBCA that estimates private investors will lose as much as $100 billion in Russia, and they have described this as the largest single credit loss ever suffered by the international banking community. I am not so sure it is larger than the Japanese lost in Tokyo real estate, but this is a very stunning number. And one has a sense of a people with enormous education, lot of engineering capacity, and yet it is the financial infrastructure that is the most lacking today in terms of integrity.

    Do you have any sense on what you do about that?

    Mr. GOLDMAN. Well, the sense that I have is that it is going to take a long time to repair that damage. This was a consequence of the declaration of the moratorium on debt repayment and the devaluation that took place. The banks were very heavily dependent on the GKOs, which were treasury bills so to speak, and they have all been reduced to about 19 cents on the dollar.

    And what happens, of course, is that you are blind-sided, because somebody has set up a pension fund and invested in Russia and it goes bad, but you did not realize that you had that kind of exposure. That is the damage that I think we have to worry about.

    What one does about it is, you are just going to have to start from scratch, and you are going to chase a lot of people away. But when you were talking earlier in this morning's sessions about moral hazard and moral risk in the Russian case, there are people that have taken a big hit. One of them will be here tomorrow, and you can presumably feel firsthand his pain.
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    Mr. SIMES. Mr. Chairman, if I may add a word about the Russian banking system. There are a lot of banks in Russia, but most of the banks have no money. Many of the banks are essentially pyramid schemes. They have acquired a lot of property which they do not know how to manage, and have never tried to manage.

    If we are trying to establish criteria by which we will judge the new government, how they handle the banking situation would be probably number one for me. The trouble is that while many of the banks are not real banks, and they are owned by corrupt oligarchs, these are the only banks Russia has. So it is difficult for them to use an axe. They have to use a more precise tool. They have to be selective. But if they do not allow some of the banks to go under, if they do not challenge the oligarchy and demonstrate that the government can make independent decisions, nothing will happen.

    Fortunately, here they can rely on some popular support, because the banks and the oligarchs are so unpopular. To an extent, making the banks a scapegoat, which they deserve, would be quite popular among ordinary Russians.

    Chairman LEACH. Thank you, Dimitri.

    Let me just end with a final question to Ms. Chang, because you are an expert on the burgeoning markets, particularly Latin America.

    As we all know, a decade-and-a-half ago, most of Latin America suffered from capital flight, the idea that you had a disproportionately small number of people that earned a fair amount of income and they, to protect themselves, would send money out of the country. Russia appears to have capital flight of quantum magnitudes larger. For all the aid going in, those that have swept the country of its wealth appear to be protecting themselves by taking it out.
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    Do you see this as a significant problem, and what is your answer to it?

    Ms. CHANG. Yes. The estimates for capital flight from Russia have been in the order of $50 billion and up. And I think that until there is a credible government in place, credible policies in place, I mean, much of this money is not going to come back quickly. In the case of Latin America, still some of that flight capital from the 1980's has not returned to the Latin America region.

    So I think that what you are seeing right now with the Latin capital that has returned, it can be very quick to leave. Brazil, $22 billion of outflows has not just been from foreign investors. Although the Brazilian authorities might like to say that it has been mostly foreign investors, there have been significant outflows from the domestic investors who started panicking after they saw what was happening with the outflows from international investors.

    So I think that as far as your capital outflows from Russia, I would not see, until there is a financial system that works, why any of that money would be going back very quickly. And I think that the losses, are they as devastating in the case of Russia, they are far more devastating than anything we have seen in Latin America recently.

    We did one calculation where we looked at a survey of just fund managers who had about 16.5 percent of their portfolio in Russia. This was compared to about 13 percent in Mexico, 11 percent in Argentina as the top three countries. And really, unless you had marked that down to zero, you had not marked it down enough, once you saw the conditions that the Russians have outlined for restructurings, the moratoriums that they had declared.
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    So I think that the ramifications for Russia, as far as using any other benchmark of what happened, has happened in modern-bond history, it just is not there. You have to look much more at perhaps some of the worst Latin American countries in the 1980's, like a Peru under Alan Garcia, and they are not even in the middle-income Latin American countries at this point, such as an Argentina, or a Mexico in the 1980's.

    Chairman LEACH. Professor Goldman.

    Mr. GOLDMAN. If I may just supplement what you said. Just to give you some measure, on the Russian stock market—this is not just the banks, it is the Russian stock market—at the peak in 1997, some estimate the valuation of the capital if you took all the stocks, may be as high as $200 billion; maybe not, maybe $150. Now it is down to about $10 or $20 billion. It has just disappeared.

    I cannot resist saying of those of us who watched and wondered about this and the people who went into this with the notion that, well, as Professor Blinder said, it is ''too-nuclear-to-fail,'' or it is ''too-big-to-fail,'' whatever it is, they were taking risks, but they knew that these risks were there, and they now have to pay the consequences. There is a certain pleasure, I have to say, that I see in this, which is probably really a very negative thing to say. Those investors knew what they were doing, and I feel that they should bear the consequences.

    Chairman LEACH. Well, I want to thank the panel. Let me say, tomorrow at 2 o'clock George Soros will be here to testify. He will be followed by a panel of representatives of academia, as well as the Federal Bureau of Investigation, to discuss the subject of corruption. And then Wednesday at 1 p.m., we will hear from Secretary Rubin and the Chairman of the Federal Reserve Board, Alan Greenspan.
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    I thank you all very much.

    [Whereupon, at 4:40 p.m., the hearing was adjourned.]

Next Hearing Segment(2)