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The long string of major financial crises that beset emerging markets from 1994 to 2002 was caused by a variety of factors, according to John Taylor, former U.S. Under Secretary of Treasury for International Affairs. Among those were countries trying to peg their exchange rates while inflation at home exceeded inflation abroad. “Essentially that means your exchange rate gets out of line or overvalued,” he said. “Eventually currencies depreciated. On top of that, many emerging-market countries had borrowed in dollars, but their earnings were in local currency. A sudden depreciation meant they had to pay a lot more dollars back, which led to a debt problem.” The International Monetary Fund’s unpredictable responses to the crises further complicated the problem, Taylor said.
Taylor, author of The Untold Story of International Finance in the Post-9/11 World, spoke at the inaugural Global Financial Markets Forum, presented by the Initiative on Global Financial Markets at the Hyde Park Center on January 17.
Obvious fundamental reasons contributed to the contagion of the crises, such as proximity of countries to each other, he said. However, less obvious “nonfundamental based theories” also appeared: portfolio managers strapped for liquidity pulled their funds out of markets, uninformed investors copied informed investors without reason, and unpredictable crises exacerbated the problem, he said.
Dispatched to Argentina in August 2001 to prevent a contagion similar to the Russian contagion of 1998, Taylor assessed Argentina’s three-year recession and its request for a third IMF loan. “The debt seemed unsustainable,” he said. “When you talked to the Argentineans, it was clear they didn’t have any sort of Plan B—nothing except monetary loans.”
If the IMF made the $8 billion loan, it seemed likely Argentina would default on it and cause a bank run, further devaluation of its currency, unrest in the country, and potential contagion elsewhere, Taylor said. “If you did provide funds, it would just provide breathing room and ultimately they would have to restructure their debt,” he said.
Taylor’s objective was to mitigate the global impact of the crisis, he said. His developed a policy that gradually and clearly signaled a country’s intentions during a crisis, and also offered assistance to policy-sound countries hit by crises, Taylor said. “After hundreds of calls and meetings, a decision was made to do one last $8 billion loan,” he said. “At the same time the idea was to be as explicit as possible that this was the last time.”
Reactions to international crises are unpredictable for a variety of reasons, Taylor said. The IMF is unclear about its bailout policies, the Clinton administration faced harsh criticism after bailing out Mexico in 1994, foreign policy complicates economic policies in emerging markets, and differing personalities and power structures blur the picture of who’s in control during such a crisis, he said.
To reduce the unpredictability, the IMF set limits on how much it would lend and developed a Plan B for countries in crisis, he said. Plan B created “collection action clauses” in bonds allowing a super-majority of the holders to change the financial terms of the bonds, if necessary, Taylor said.
—Phil Rockrohr
