Debate is raging and anxieties are mounting that emerging markets such as Turkey, South Africa, and India are about to repeat the financial crises that thwarted some of the world’s fastest-growing economies in the late 1990s.
As the author of books about those crises (in gory detail), I can only offer this advice: Remember Roseanne Roseannadanna.
Roseanne was the ditzy commentator played by Gilda Radner on Saturday Night Live, and the trademark phrase with which she ended her schtick was “It’s always something.” Those sage words should be taken to heart by professional investors, economic analysts and public officials alike. If one lesson shines through from a look back at past emerging market crises, it’s that the unforeseen, the unexpected, and the overlooked materialize all too often, turning seemingly harmless bouts of turmoil into economy-crushing catastrophes.
There are broad economic similarities and differences between the countries laid low in the 1997-2002 period and the ones beset by turbulence in recent weeks. As many observers have noted, excessive amounts of foreign capital poured into emerging markets both during the mid-‘90s and in the past couple of years. That rendered countries vulnerable to “sudden stops” when giant institutional investors such as pension funds and insurance companies began finding amply attractive returns on investments at home—and concluded that they no longer wished to assume the risk of keeping money in places like Latin America, Asia, or the Near East.
At the same time, emerging markets deserve widespread credit for having fortified themselves against the problems that led to the crises of yesteryear. With only a few exceptions, they maintain flexible currencies rather than the fixed exchange rates that provided speculators with fat targets to shoot at. Perhaps even more important, their governments have been borrowing mainly in their own national currencies. In the past, when they borrowed heavily in US dollars, they ran the risk that a plunge in their currencies would cause their debt burdens to soar—and in a number of cases, that’s exactly what happened.
Comparisons between past and present are essential and invaluable. What they omit are the additional, unique factors that have caused financial crises to erupt, and worsen, with extraordinary speed and fury—often to the utter stupefaction of the people whose job it is to detect such vulnerabilities in the first place.
Consider Indonesia’s implosion of 1997-98. As several of its neighbors, notably Thailand, underwent currency gyrations in the summer of 1997, Indonesia appeared to be a rock of stability at first. A report by the World Bank staff, submitted confidentially to the bank’s executive board, said the probability of a severe shock was “currently very low” and conceivable only if a host of political, social, financial, regional, and trade risks “all materializ[ed] at once.”
Applause for Jakarta grew louder—with the International Monetary Fund leading the cheers—when the Indonesians allowed their currency, the rupiah, to float with market forces. What neither Indonesian nor IMF officials realized was that many Indonesian companies had borrowed heavily in US dollars without hedging themselves against a currency devaluation. The rupiah began to sink, raising the prospect of massive bankruptcies in Indonesia’s private sector.
The situation went from bad to awful when the IMF gave Indonesia a “precautionary” loan, which a top IMF official explained was designed to “give a seal of approval to their policies” and “show the markets that [Indonesia’s] policies really make sense.” As a condition of the loan, Jakarta agreed to close a few banks that were closely linked to relatives and cronies of then-president Suharto—again, a much-lauded move, until it triggered a run on other banks, whose depositors figured that more closures must be in the offing. The financial carnage that ultimately ensued drove the rupiah to one-fifth of its pre-crisis level, and led to a 14% economic contraction in 1998.
Even more shocking: the fate that befell South Korea in late 1997. An IMF mission conducting the country’s annual checkup filed a report on Oct. 15, 1997, stating that “the situation in Korea is quite different to that in Southeast Asia,” and forecasting growth of 6-7% the following year. This assessment was so quickly overtaken by reality that it was quietly buried in the Fund’s files and never submitted to its board. Five weeks later, Korea’s then-president, Kim Young Sam, went on national television to announce that, with Korean markets sliding into chaos, the government was taking the humiliating step of seeking an IMF rescue. Koreans, he said, should prepare for “bone-carving pain.”
One reason for Korea’s travails was a surprise devaluation by Taiwan, whose manufacturers compete with Korean exporters. More crippling: a panicky pullback from Asia by many international banks, which were cutting off credit en masse to Korean banks and demanding immediate repayment on their short-term loans. The real killer was the fact that the short-term debt owed to foreigners by Korea’s private sector turned out to be nearly twice as large as initially thought, once the figure was adjusted to include the debts incurred by overseas units of Korean banks and companies. Neither the IMF, nor the Korean authorities, had realized that these overseas affiliates’ debt might pose a problem, since lenders had routinely renewed them every time they came due in the past.
None of this should be interpreted as casting aspersions on the intellects, dedication, or public-spiritedness of people who work at the IMF. As a rule, they are superbly able economists—and that is what makes their failures all the more disturbing. Despite their efforts to attain global perspectives on the workings of modern markets, they cannot discern, amid all the bewildering complexity, where and how crises are likely to arise; indeed, sometimes they unwittingly take measures that exacerbate crises.
Once jitters take serious hold among investors and lenders, behavior becomes much more unpredictable—and the every-man-for-himself mentality invariably increases the danger of a destructive run for the exits. That’s a good reason to establish international agreements making it easier to impose temporary stops on withdrawals of credit from countries suffering from panic conditions.
Of course, such agreements themselves could have unexpected consequences, by making jitters materialize faster. See how right Roseanne was? It’s always something.