Testimony
Mr. Greenspan gives a testimony on the global financial system
of the Chairman of the Board of Governors of the US Federal Reserve System, Mr. Alan
Greenspan, before the Subcommittee on Foreign Operations of the Committee on
Appropriations of the US Senate on 3/3/98.
The global financial system has been evolving rapidly in recent years. New
technology has radically reduced the costs of borrowing and lending across traditional national
borders, facilitating the development of new instruments and drawing in new players.
Information is transmitted instantaneously around the world, and huge shifts in the supply and
demand for funds naturally follow, resulting in a massive increase in capital flows.
This burgeoning global system has been demonstrated to be a highly efficient
structure that has significantly facilitated cross-border trade in goods and services and,
accordingly, has made a substantial contribution to standards of living worldwide. Its efficiency
exposes and punishes underlying economic imprudence swiftly and decisively. Regrettably, it
also appears to have facilitated the transmission of financial disturbances far more effectively
than ever before.
Three years ago, the Mexican crisis was the first such episode associated with our
new high-tech international financial system. The current Asian crisis is the second.
We do not as yet fully understand the new system's dynamics. We are learning
fast, and need to update and modify our institutions and practices to reduce the risks inherent in
the new regime. Meanwhile, we have to confront the current crisis with the institutions and
techniques we have.
Many argue that the current crisis should be allowed to run its course without
support from the International Monetary Fund or the bilateral financial backing of other nations.
They assert that allowing this crisis to play out, while doubtless having additional negative
effects on growth in Asia, and engendering greater spill-overs onto the rest of the world, is not
likely to have a large or lasting impact on the United States and the world economy.
They may well be correct in their judgment. There is, however, a small but not
negligible probability that the upset in East Asia could have unexpectedly large negative effects
on Japan, Latin America, and eastern and central Europe that, in turn, could have repercussions
elsewhere, including the United States. Thus, while the probability of such an outcome may be
small, its consequences, in my judgment, should not be left solely to chance. We have observed
that global financial markets, as currently organized, do not always achieve an appropriate
equilibrium, or at least require time to stabilize.
Opponents of IMF support for member countries facing international financial
difficulties also argue that such substantial financial backing, by cushioning the losses of
imprudent investors, could encourage excessive risk-taking. There doubtless is some truth in
that, though arguably it has been the expectation of governments' support of their financial
systems that has been the more obvious culprit, at least in the Asian case. In any event, any
expectations of broad bailouts have turned out to have been disappointed. Many if not most
investors in Asian economies have to date suffered substantial losses. Asian equity losses,
excluding Japanese companies, since June 1997, worldwide, are estimated to have exceeded
$700 billion, at the end of January, of which more than $30 billion had been lost by US
investors. Substantial further losses have been recorded in bonds and real estate.
Moreover, the policy conditionality, associated principally with IMF lending,
which dictates economic and financial discipline and structural change, helps to mitigate some of
the inappropriate risk-taking. Such conditionality is also critical to the success of the overall
stabilization effort. At the root of the problems is poor public policy that has resulted in
misguided investments and very weak financial sectors. Convincing a sovereign nation to alter
destructive policies that impair its own performance and threaten contagion to its neighbors is
best handled by an international financial institution, such as the IMF. What we have in place
today to respond to crises should be supported even as we work to improve those mechanisms
and institutions.
Some observers have also expressed concern about whether we can be confident
that IMF programs for countries, in particular the countries of East Asia, are likely to alter their
economies significantly and permanently. My sense is that one consequence of this Asian crisis
is an increasing awareness in the region that market capitalism, as practiced in the West,
especially in the United States, is the superior model; that is, it provides greater promise of
producing rising standards of living and continuous growth.
Although East Asian economies have exhibited considerable adherence to many
aspects of free-market capitalism, there has, nonetheless, been a pronounced tendency toward
government-directed investment, using the banking system to finance that investment. Given a
record of real growth rates of close to 10 percent per annum over an extended period of time, it
is not surprising that it has been difficult to convince anyone that the economic system practiced
in East Asia could not continue to produce positive results indefinitely. Following the
breakdown, an increasing awareness, bordering in some cases on shock, that their economic
model was incomplete, or worse, has arguably emerged in the region.
As a consequence, many of the leaders of these countries and their economic
advisors are endeavoring to move their economies much more rapidly toward the type of
economic system that we have in the United States. The IMF, whatever one might say about its
policy advice in the past, is trying to play a critical role in this process, providing advice and
incentives that promote sound money and long-term stability. The IMF's current approach in
Asia is fully supportive of the views of those in the West who understand the importance of
greater reliance on market forces, reduced government controls, scaling back of
government-directed investment, and embracing greater transparency -- the publication of all the
data that are relevant to the activities of the central bank, the government, financial institutions,
and private companies.
It is a reasonable question to ask how long this conversion to embracing market
capitalism in all its details will last in countries once temporary IMF support is no longer
necessary. We are, after all, dealing with sovereign nations with long traditions, not always
consonant with market capitalism. There can be no guarantees, but my sense is that there is a
growing understanding and appreciation of the benefits of market capitalism as we practice it
-that what is being prescribed in IMF programs fosters their own interests.
The just-inaugurated president of Korea, from what I can judge, is unquestionably
aware of the faults of the Korean system that contributed to his country's crisis; he appears to be
very strenuously endeavoring to move his economy and society in the direction of freer markets
and a more flexible economy. In these efforts, he and other leaders in the region with similar
views, have the support of many younger people, a large proportion educated in the West, that
see the advantages of market capitalism and who will soon assume the mantle of leadership.
Accordingly, I fully back the Administration's request to augment the financial
resources of the IMF by approving as quickly as possible US participation in the New
Arrangements to Borrow and an increase in the US quota in the IMF. Hopefully, neither will
turn out to be needed, and no funds will be drawn. But it is better to have it available if that turns
out not to be the case and quick response to a pending crisis is essential.