Testimony of Chairman Alan Greenspan
Before the Committee on Banking and Financial Services, U.S. House of
Representatives
November 13, 1997
Recent developments in world finance have highlighted growing interactions among national
financial markets. The underlying technology-based structure of the international financial system
has enabled us to improve materially the efficiency of the flows of capital and payment systems.
That improvement, however, has also enhanced the ability of the financial system to transmit
problems in one part of the globe to another quite rapidly. Doubtless, there is much to be learned
from the recent experience in Asia that can be applied to better the workings of the international
financial system and its support of international trade that has done so much to enhance living
standards worldwide.
While each of the Asian economies differs in many important respects, the sources of their
spectacular growth in recent years, in some cases decades, and the problems that have emerged
are relevant to a greater or lesser extent to nearly all of them.
Following the early post-World War II period, policies generally fostering low levels of inflation
and openness of their economies coupled with high savings and investment rates contributed to a
sustained period of rapid growth, in some cases starting in 1960s and 1970s. By the 1980s most
economies in the region were expanding vigorously. Foreign net capital inflows grew, but until
recent years were relatively modest. The World Bank estimates that net inflows of long-term debt,
foreign direct investment, and equity purchases to the Asia Pacific region were only about $25
billion in 1990, but exploded to more than $110 billion by 1996.
A major impetus behind this rapid expansion was the global stock market boom of the 1990s. As
that boom progressed, investors in many industrial countries found themselves more heavily
concentrated in the recently higher valued securities of companies in the developed world, whose
rates of return, in many instances, had fallen to levels perceived as uncompetitive with the earnings
potential in emerging economies, especially in Asia. The resultant diversification induced a sharp
increase in capital flows into those economies. To a large extent, they came from investors in the
United States and Western Europe. A substantial amount came from Japan, as well, owing more
to a search for higher yields than to rising stock prices and capital gains in that country. The rising
yen through mid-1995 also encouraged a substantial increase in direct investment inflows from
Japan. In retrospect, it is clear that more investment monies flowed into these economies than
could be profitably employed at modest risk.
I suspect that it was inevitable in those conditions of low inflation, rapid growth, and ample
liquidity that much investment moved into the real estate sector, with an emphasis by both the
public and private sectors on conspicuous construction projects. This is an experience, of course,
not unknown in the United States on occasion. These real estate assets, in turn, ended up as
collateral for a significant proportion of the assets of domestic financial systems. In many instances,
those financial systems were less than robust, beset with problems of lax lending standards, weak
supervisory regimes, and inadequate capital.
Moreover, in most cases, the currencies of these economies were closely tied to the U.S. dollar,
and the dollar's substantial recovery since mid-1995, especially relative to the yen, made their
exports less competitive. In addition, in some cases, the glut of semiconductors in 1996
suppressed export growth, exerting further pressures on highly leveraged businesses.
However, overall GDP growth rates generally edged off only slightly, and imports, fostered by
rising real exchange rates, continued to expand, contributing to what became unsustainable current
account deficits in a number of these economies. Moreover, with exchange rates seeming to be
solidly tied to the dollar, and with dollar and yen interest rates lower than domestic currency rates,
a significant part of the enlarged capital inflows into these economies, in particular short-term
flows, was denominated by the ultimate borrowers in foreign currencies. This put additional
pressure on companies to earn foreign exchange through exports.
The pressures on fixed exchange rate regimes mounted as foreign investors slowed the pace of
new capital inflows, and domestic businesses sought increasingly to convert domestic currencies
into foreign currencies, or, equivalently, slowed the conversion of export earnings into domestic
currencies. The shifts in perceived future investment risks led to sharp declines in stock markets
across Asia, often on top of earlier declines or lackluster performances.
To date, the direct impact of these developments on the American economy has been modest, but
it can be expected not to be negligible. U.S. exports to Thailand, the Philippines, Indonesia, and
Malaysia (the four countries initially affected) were about 4 percent of total U.S. exports in 1996.
However, an additional 12 percent went to Hong Kong, Korea, Singapore and Taiwan
(economies that have been affected more recently). Thus, depending on the extent of the inevitable
slowdown in growth in this area of the world, the growth of our exports will tend to be muted. Our
direct foreign investment in, and foreign affiliate earnings reported from, the economies in this
region as a whole have been a smaller share of the respective totals than their share of our exports.
The share is, nonetheless, large enough to expect some drop-off in those earnings in the period
ahead. In addition, there will be indirect effects on the U.S. real economy from countries such as
Japan that compete even more extensively with the economies in the Asian region.
Particularly troublesome over the past several months has been the so-called contagion effect of
weakness in one economy spreading to others as investors perceive, rightly or wrongly, similar
vulnerabilities. Even economies, such as Hong Kong, with formidable stocks of international
reserves, balanced external accounts, and relatively robust financial systems, have experienced
severe pressures. One can debate whether the turbulence in Latin American asset values reflects
contagion effects from Asia, the influence of developments in U.S. financial markets, or
home-grown causes. Whatever the answer, and the answer may be all of the above, this
phenomenon illustrates the interdependencies in today's world economy and financial system.
Perhaps it was inevitable that the impressive and rapid growth experienced by the economies in
the Asian region would run into a temporary slowdown or pause. But there is no reason that
above-average growth in countries that are still in a position to gain from catching up with the
prevailing technology cannot persist for a very long time. Nevertheless, rapidly developing,
free-market economies periodically can be expected to run into difficulties because investment
mistakes are inevitable in any dynamic economy. Private capital flows may temporarily turn
adverse. In these circumstances, companies should be allowed to default, private investors should
take their losses, and government policies should be directed toward laying the macroeconomic
and structural foundations for renewed expansion; new growth opportunities must be allowed to
emerge. Similarly, in providing any international financial assistance, we need to be mindful of the
desirability of minimizing the impression that international authorities stand ready to guarantee the
external liabilities of sovereign governments or failed domestic businesses. To do otherwise could
lead to distorted investments and could ultimately unbalance the world financial system.
The recent experience in Asia underscores the importance of financially sound domestic banking
and other associated financial institutions. While the current turmoil has significant interaction with
the international financial system, the recent crises would arguably have been better contained if
long-maturity property loans had not accentuated the usual mismatch between maturities of assets
and liabilities of domestic financial systems that were far from robust to begin with. Our
unlamented savings and loan crises come to mind.
These are trying days for economic policymakers in Asia. They must fend off domestic pressures
that seek disengagement from the world trading and financial system. The authorities in these
countries are working hard, in some cases with substantial assistance from the IMF, the World
Bank, and the Asian Development Bank, to stabilize their financial systems and economies.
The financial disturbances that have afflicted a number of currencies in Asia do not at this point, as
I indicated earlier, threaten prosperity in this country, but we need to work closely with their
leaders and the international financial community to assure that their situations stabilize. It is in the
interest of the United States and other nations around the world to encourage appropriate policy
adjustments, and where required, provide temporary financial assistance.
END
[Portions italicized for emphasis] |
