Quack Cure
Sachs claims the IMF's medicine is killing
patients
By WILLIAM PESEK JR.
Jeffrey Sachs has been called the Indiana Jones of
economics. No fan of grading term papers, the Harvard
University professor has spent more than a decade
parachuting into economic hot zones around the globe in
search of a Holy Grail of sorts. It's not antiquities he
seeks, but the right mix of reforms to put developing
nations on the path to financial stability.
In the 1980s, there was Sachs crusading through Latin
America's jungle of hyperinflation and debt. In the early
1990s, there was the good professor scaring up a little
"shock therapy" in Eastern European then-basket cases,
like Poland. Earlier this year, he was seen whipping
through Southeast Asia, prescribing his own cavalier
brand of medicine for what ails economies like
Indonesia. More recently, Sachs returned to his old finds
in Latin America, excavating economic plans for
governments like Ecuador.
Admittedly, Sachs' lifestyle may not measure up to the
adventure-seeking character Harrison Ford has made
famous. And certainly, with his easy smile and boyish
charm, the 43-year-old academic hardly comes off as a
man who could shoulder-check the policies of
institutions as mighty as the U.S. Treasury Department
and the International Monetary Fund.
But in the 15 months since Thailand's economic
meltdown snowballed into the worst financial crisis
today's policy makers have witnessed, Sachs has been a
thorn in the side of a Clinton Administration and an IMF
struggling to win credibility for their rescue efforts around
the globe. At virtually every turn, there was Sachs
warning that Treasury Secretary Robert Rubin and IMF
chief Michel Camdessus were making matters worse by
advocating orthodox prescriptions for emerging
economies that he felt needed a new, less traditional
approach.
Rather than prescribing the usual medicine of tight
monetary policy and balanced budgets, Sachs argued
that embattled economies in Asia needed a more
unorthodox balance of easier monetary policy and debt
restructuring to restore stability. Without fundamental
changes in the policies the IMF brought to Asia in 1997,
Sachs warned, the region's financial crisis would turn into
a global meltdown. Much to the chagrin of officials in
Washington, he's been more right than most.
Now, with the inclusion of Brazil in the turmoil, Sachs
worries the world is on the precipice of an even more
devastating financial meltdown that could deal a blow
even to that oasis of prosperity known as the United
States. As with all types of financial crises, there comes
a point where problems on the periphery begin to drag
industrialized economies down with them. With the
turmoil in Brazil, Sachs believes that stage is being
reached. "It surely raises the stakes," he contends.
In a recent interview, there's an uncomfortably long
silence as Sachs considers whether there's any light at
the end of a tunnel that the global economy began
traveling through in the summer of 1997. Unfortunately,
few rays of hope are to be found. If anything, the
turmoil's steady march toward the Americas only
validates Sachs' fears that the IMF's bailout packages
and reforms have not done the job. "Not one of these
bailouts has worked in the last year," Sachs laments.
"They've spent around $140 billion now if you add up
Indonesia, South Korea, Thailand and Russia, and all
four of those countries are in absolute states of collapse."
Now, keeping Brazil from collapsing as well is crucial if
international policy makers are to halt the mushrooming
crisis, Sachs stresses. Brazil would bring other Latin
American economies -- particularly Argentina -- down
with it, leading to a region-wide deterioration that would
certainly deal a blow to the eight-year U.S. expansion.
While there's no "automatic link" between the crisis in
emerging markets and severe downturns in the U.S. and
Europe, Sachs thinks the world's largest economies are
becoming more vulnerable by the week.
"This isn't to say we'll avoid it, it's just to say we could
avoid it," he says.
For the time being, Sachs doesn't think problems in Latin
America will send U.S. growth into a tailspin. What
could keep the U.S. in relative balance is the Federal
Reserve's shift toward a more accommodative monetary
policy. Alan Greenspan and his colleagues moved in that
direction last week, cutting the federal funds rate by 25
basis points, to 5 1/4 %. "I still think U.S. monetary
policy has enough freedom to keep us out of trouble if
we choose to use it," Sachs predicts.
Still, Brazil's inclusion in the global crisis places the
turmoil in Washington's backyard. Any collapse in Latin
America's largest economy -- the ninth-largest in the
world -- would slam the rest of the region, which
accounts for nearly 20% of U.S. exports. And with Asia
still in the throes of crisis and Russia limping along, any
further losses in demand for U.S. goods will undermine
growth in the world's largest economy.
The stock market is another concern. Corporate profits
on Wall Street are already getting squeezed, knocking
the Dow Jones Industrial Average from record highs.
Sachs says he's long felt the stock market was
overvalued, but the steady deterioration of economies
near and far means a further correction would be quite
sensible, given historical norms on price/earnings ratios.
And the negative-wealth effect caused by plunging equity
prices would take a considerable bite out of household
and business spending. The economy would slow from
there.
For Brazil, and Latin America in general, to be saved,
Sachs argues, will require no less than a bold reversal of
the policies the IMF increasingly has advised since the
Mexican peso crisis of 1994. What continues to hamper
emerging-market economies, he says, is a policy of
pegging currencies to the dollar. Sachs believes many of
the problems Camdessus and Rubin now face could
have been avoided if currencies were simply allowed to
float. Instead, highly restrictive monetary policies were
pursued and investors ran for the exits.
"I basically see this as a financial crisis that's being
transmitted by a combination of panicked withdrawals of
loans from the emerging markets compounded by heroic
contractionary measures being taken ... to try to maintain
pegged exchange rates," Sachs explains. "So I see the
latter compounding what is already a serious problem."
In Brazil's case, Sachs thinks policy makers would be
better off allowing the currency, the real, to depreciate
and assume an independent monetary policy. But as the
IMF and U.S. Treasury cobble together a bailout
package of over $30 billion for Brazil, Sachs is already
anticipating the worst. With international policy makers
in Washington this week for the IMF's annual meeting,
it's likely negotiations with Brazil will accelerate.
What worries Sachs is that an IMF program that
requires reforms similar to those imposed on Asia --
which he views as terribly misguided -- will be thrust on
Brazil. Indeed, when Camdessus last week declared
that he was "certain" the IMF could save Latin America,
Sachs had some butterflies in his stomach.
By contrast, Deputy Treasury Secretary Lawrence
Summers, Sachs' former Harvard classmate and
sometime rival, says U.S. efforts would focus on helping
Brazil maintain the stability of its currency. In general,
U.S. and IMF officials have been pleased with the
tight-money stance Brazil has maintained since its
currency came under attack when Russia effectively
devalued the ruble and defaulted on government debt.
At the same time, IMF officials are worried that Brazil
hasn't plunged aggressively enough into reducing its
budget deficit, a move authorities think would reduce the
need for further loans. Ultimately, the prospective IMF
loans would be used to bolster the real.
The IMF, of course, thinks keeping Brazil afloat is
crucial because a collapse there would only increase
pressure on Argentina, Mexico and other developing
nations. But there's another reason why saving Brazil
has become the IMF's No. 1 priority: Because Brazilians
have dutifully worked to stabilize the real in a way that
the institution believes is a model for other nations.
Sachs, meanwhile, sees all of this as a recipe for
disaster. There's no getting around the fact that capital
flight into dollars has put pressure on Brazil's currency. A
real devaluation would make it more difficult for Brazil's
government and private sector to pay back their huge
foreign debt. At the end of June, Brazil's private sector
owed $140 billion to foreign lenders, while the public
sector's foreign debt totaled $86 billion.
Still, Sachs thinks by keeping monetary policy tight to
stabilize the currency, all Brazil would accomplish is to
strangle an otherwise viable banking system, cutting off
the supply channel whereby businesses can have access
to credit. "I don't believe they can save the real and
avoid a recession," Sachs says. "I think it's also very
unlikely that even if they tried what I regard as an unwise
policy to try to save the currency that they will even
succeed on that single objective."
A year ago, after the first wave of the emerging-markets
crisis brushed Brazil, the real was attacked in the
foreign exchange markets. In defense, Brazil undertook
what Sachs calls "dramatic fiscal adjustment measures"
and tight monetary policy to maintain the exchange rate.
But despite the attempt at fiscal tightening, the budget
deficit has soared from 4.5% of gross domestic product
to 7% of GDP, largely because of the jump in the
government's interest expense, which was the result of
the rate hikes to defend the currency. Adhering to this
monetary orthodoxy has exacted an enormous cost;
Brazil has piles of short-term loans to roll over, and with
local interest rates in the 50% range, that burden has
increased.
Sachs isn't the only IMF critic gaining attention these
days. But since the international community crafted a
bailout package for Mexico more than three years ago,
Sachs has emerged as perhaps the IMF's most vocal
critic. At press conferences in Asia and Latin America,
questions often begin with "Professor Sachs thinks ..."
The same is true in the U.S., where Rubin and Summers
at times are grilled by Congress about their reluctance to
embrace Sachs' views. Such was the case earlier this
month.
Rubin was questioned on Sachs' view that in the Asian
crisis, the IMF should have acted as a true lender of last
resort, making credit lines available to nations without
the insistence on major and painful structural reforms.
Rubin defended the IMF's policies and said the issues
facing Asia are far more complex than the arguments
Sachs and others had brought to the table.
Still, Rubin admitted that at least some of the complaints
aimed at the IMF are valid. Commenting on the fiscal
reforms the IMF initially imposed on Thailand and South
Korea, Rubin said, "I think they may have been
somewhat more stringent than they should have been.
But the fact is, the IMF ... has adjusted these." That's a
small victory for critics of the Fund like Sachs.
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