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J. Bradford DeLong
Professor of Economics
January 26, 1998
approx 750 words
In 1996 international investors poured perhaps $100 billion into East Asia, as East Asia's economies were the darlings of the world capital market. Now capital is flooding out of East Asia at perhaps $150 billion a year, as investors from Frankfurt to Los Angeles to Jakarta try to get their money out the door before what they fear will be a worse crash. This sudden shift--impelled much more by the herd instincts of Wall Streeters than by any change in the fundamentals of East Asian economic development--means that demand for hard currency to purchase imports (and to finance capital flight) is suddenly much greater than the supply of hard currency earned by East Asia's exports. When demand exceeds supply, prices rise--the values of East Asian currencies fall. As currencies fall, the resulting financial disruptions and bankruptcies throw people out of work. Government attempts to boost exchange rates by raising interest rates help on one hand by reducing financial turmoil, but hurt on another as higher interest rates discourage investment and throw more people out of work.
East Asia faces a severe depression--like the U.S. after 1873, like Argentina after 1890, like the whole world after 1929--unless the IMF and others loan East Asian governments the hard currency they need to make the process of adjustment slower, steadier, and more manageable.
"But," say many critics of the IMF, "bailing out the governments and the banks this time will only encourage them to overspeculate more in the future. If they know that making overoptimistic speculative mistakes is costless, they will make more such mistakes in the future. We must make them--East Asian governments, New York banks, hedge funds--suffer." To loan to East Asian governments is to encourage "moral hazard."
Supporters of the IMF have had a hard time countering this argument in short soundbites, because it is not completely false. But it is largely false, for three reasons:
First, moral hazard cannot exist unless the bailout is a true bailout--a true payment of public funds to defaulters that is never repaid. The U.S. bailout of the Savings and Loan industry was a true bailout: the U.S. government did not get repaid: instead, the Treasury issued a fortune in bonds to finance the rescue of depositors.
The IMF very much intends to get repaid. The IMF is in the business of getting repaid. The IMF is being tough on East Asian countries--requiring that East Asian countries adopt policies to rapidly generate an export surplus even if they raise unemployment--because the IMF knows that if it does not get repaid its survival as an institution is at risk.
If the IMF gets repaid--as it almost surely will--then no moral hazard: moral hazard requires that the IMF pay out of its own pocket and never get repaid.
Second, almost everyone involved in the wave of capital flowing into East Asia already has suffered. East Asian governments have certainly suffered. Anyone who bought East Asian government bonds has seen their money dwindle as exchange rates have depreciated. Investors in East Asian stock markets either directly or through emerging markets funds have seen large chunks of their money disappear. Hedge funds that were long in East Asia have suffered. Investment banks have suffered--look at J.P. Morgan and Company's earnings report for the fourth quarter of 1997.
"But," say critics of the IMF, "one class of investors has not suffered: New York bankers who loaned to East Asia and demanded that their money be repaid in dollars have not yet suffered. It's not enough the governments, hedge funds, investment banks, mutual funds, equity investors, and national-currency debt investors have suffered. We must make everyone suffer!"
And it is at this point that I question the sanity--and the goodwill--of opponents of the IMF's actions. The difference between the severe depression in East Asia that threatens and the mild depression that will occur if the IMF programs succeed is some 20 million jobs. Is it worth throwing 20 million more East Asians out of work just to make sure that there is not even a possibility of encouraging "moral hazard"? Especially when the IMF's mind is already perhaps a little too focused on making sure that it gets repaid, in which case by the definition of "moral hazard" there can be none?
To try to seek political advantage and to delight in making East Asia's forthcoming depression as deep as possible seems to me to be the true moral hazard.
J. Bradford DeLong is Professor of Economics at the University of California at Berkeley, a Research Associate of the National Bureau of Economic Research, and Co-Editor of the Journal of Economic Perspectives. From 1993 to 1995 he served the Clinton Administration's Treasury Department as Deputy Assistant Secretary for Economic Policy. He is the author of, among other things, "The Case for Mexico's Rescue" (Foreign Affairs, 1996) and The Marshall Plan: History's Most Successful Structural Adjustment Programme (1993).
Professor of Economics J. Bradford
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