South East Asia - A Major Call to Buy Emerging Asia

July 11, 1998

It has been our view that the economies of Thailand, Indonesia, and Korea would remain in serious trouble until the disastrous deflationary policies of the IMF and the US Treasury were abandoned. Our reasons for this are spelled out in our early 1997 piece, "A Long Run Perspective on Asia," and in our paper, "The Asian Crisis: The High Debt Model Versus the Wall Street - Treasury-IMF Complex." Our associate Robert Wade repeated our arguments in a recent "personal view" column in the June 23 Financial Times entitled "Asian Water Torture". In recent days we have seen the first moves toward a departure from deflationary IMF policies.

Indonesia is cutting interest rates despite high inflation and will have a budget deficit of 8.5% of GDP. Of greater significance has been similar moves in Korea to lower interest rates and cut taxes, thereby raising the fiscal deficit from 1% to 4% of GDP. SEOUL, July 8 (Bloomberg) - The South Korean government urged banks to cut lending rates to help stem bankruptcies and encourage companies to make investments that can revive a shrinking economy. "I understand many banks already mapped out plans to lower prime lending rates," said Chung Keun Yong, the head of the financial policy division of the Finance and Economy Ministry, speaking on Korean television. The proposal comes as banks have cut the annual interest they pay on deposits to as low as 12% while maintaining average lending rates above 17%. To help lower market rates, the Korean government will discuss ways to expand money supply as well as revise economic policies and targets during meetings with an International Monetary Fund delegation from today, a ministry official said. The government cut market rates to as low as 12% by the end of next month, local newspapers said. The IMF has said it is happy for rates to come down over time provided this doesn't weaken the currency and make it harder for Korea and its companies to repay its debts. The won strengthened 30% against the dollar in the past six months, prompting speculation the Korean central bank may sell won for dollars to stem its rise.

Lower rates will help stem a raft of corporate defaults by reducing the cost of repaying an estimated $600 billion of corporate debt and making it cheaper for companies to borrow more money for investment. Korea needs to boost spending to stimulate its economy, which may have contracted at an annual rate of at least 4% in the first half of the year, its deepest recession in four decades.

It appears that Korea has taken these steps without IMF approval. It also appears that the IMF is acquiescing. The Koreans and the IMF probably both now realize that the IMF and US Treasury policies have been disastrous. We do not fear that lower interest rates in Korea will weaken the Korean won. In a recent conference at the World Bank, chief economist Joseph Stiglitz argued that there is no empirical evidence that lower rates weaken a currency. In the case of South East Asia, it is now clear that high real rates, by creating bankruptcies and depression, have caused foreign capital to flee the region, thereby weakening local currencies. Interest rates in Korea have been falling for many months and the won has rallied from 1800 to 1300. The Koreans cut interest rates yesterday and the won rallied from 1330 to 1300. Yet lower interest rates in Asia will strengthen the Asian currencies.

We are surprised that Korea has made these moves. Kim Dae Jung was following the US Treasury line more closely than any other Asian leader. To us this shows that the need for reflationary policies is so obvious that they will be adopted, and to an increasing degree, in ASEAN and Korea. This is what is needed to generate a recovery in emerging Asia. We believe that the steps now being taken in Japan will have a more positive effect on the Japanese economy than market participants expect. Simon Hunt reports that China is now moving to increase its pump priming with the objective of raising economic growth above an 8% rate by late this year. The regional Asian economic environment should be more supportive of recovery in ASEAN and Korea as the year progresses.

There are additional reasons for expecting an abandonment of the disastrous policies of the IMF and US Treasury in Asia. We are seeing more and more open discussion in the editorials in Asian newspapers of the critique of IMF policies made months ago by Jeff Sachs, James Tobin, Martin Feldstein, Jagdish Bhagwhati and ourselves. UNCTAD's chief macro economist has recently published a paper with the same assessment. We have no doubt that, at the level of policy makers throughout Asia, this same assessment is being made. Faced with the disastrous consequences of their actions, the IMF and Treasury are slowly caving to this emerging new consensus about the Asian crisis.

This assessment was presented to Treasury Secretary Rubin on July 1st by the Korean Confederation of Trade Unions (KCTU). Their document was not a mere trade union position paper. It was extremely comprehensive and intelligently argued. A document of this sophistication could only be the result of a consensus among Korea's best minds in economic policy circles in government, universities, and corporations as well as the labor unions. This document also demonstrates how this new assessment with its critique of IMF/Treasury policies now dominates the thinking of grass roots political organizations that heads of states and policy makers in Asia are accountable to. When a new consensus runs this deep politically, it wins the day. We have been concerned that rising unemployment in Korea could create serious civil strife emanating from Korea's militant labor unions. The balance and intelligence of this KCTU document allays our fears over labor unrest in Korea.

Looking further forward, we expect more dramatic developments. In our January piece, "A Long Term Perspective On Asia", we argued that Asians know that the Asian development model works and that they would not abandon it as a result of pressure from the IMF and the US Treasury. Ultimately, this would require a regional balance of payments finance facility that would accommodate Asian financial structures rather than imposing Western (Basle) parameters of financial prudence. Last fall the Asian nations under Japanese leadership moved to create such a facility, only to be met by especially fierce US opposition.

Lastly, there is a need to recognize the unintended ill- effects---unforeseen aggravation---of the IMF's traditional prescription and mode of intervention in the Asian crisis. The Asian development model, while containing some of the key elements which gave rise to the current crisis, also contains the very dynamic elements which made the 'miraculous' growth over such a short period. The effort to consolidate on the unique positive elements---while making efforts to eradicate the negative aspects at the same time---can contribute to the balanced development in the world economy. The IMF policy regime, however, has overlooked---or it may lie beyond capacity to handle appropriately---the positive and dynamic elements in its virtual blanket disavowal of the Asian economy---especially financial---system and practice.

In this light, it may be important for Asian nations and peoples to develop and construct a basis of cooperation and mutual assistance and support---both material and spiritual---amongst themselves. It may be necessary, therefore, for Asian nations to build a body--- an Asian version of IMF or an Asian regional organization of the Fund which enjoys a significant level of autonomy---which can serve as an Asian monetary fund. If the US government supports the idea of a worldwide convergence based on the respect for cultural and regional differences, and, furthermore, recognizes that the potential of each member in a community can be maximized on the basis of the respect for diversity, then, it will be possible for the US to make a significant contribution---as she has in building up APEC---towards the creation of an "Asian Monetary Fund".

The Korean labor union confederation made the following statements on this issue to Rubin on July 1, 1998.

We expect that the issue of an Asian regional balance of payments finance facility will come up shortly and will eventually become a reality. When market participants perceive this, there will be a dramatic change in capital flows to Asia. Western bankers, fearful of losing the Asian markets to Asia, will fall all over themselves to lend to Asia once again. Portfolio managers, seeing an improvement in Asian currencies and financial access will run to get on board the new Asian recovery bandwagon. A hesitant currency and stock market recovery based on an economic recovery once the IMF-US Treasury noose is relaxed could quickly become a run on the part of Western short-term capital to get back into Asia before Asia closes its doors.

A one-ounce gold nugget is rarer than a five-carat diamond.