How Bill Clinton Proposes To Spend The ‘Surplus’: Bailing Out Foreign Governments — And Their Western Underwriters

(Washington, D.C.): If the Clinton Administration has its way, the government-private sector
cronyism that contributed importantly to the present meltdown of currencies, banking systems and
economies throughout Asia by subverting the workings of free market mechanisms — a
phenomenon that will likely burst forth in China and Russia, as well — will be treated, ironically,
by a cronyist prescription: Led by Treasury Secretary Robert Rubin, the Administration
hopes (among other, higher profile objectives) to protect his former Wall Street colleagues
and their counterparts overseas by off-loading their cascading debt crises onto U.S. and
other Western taxpayers.

‘Moral Hazard’

The latest manifestation of such cronyism can be found in the recent announcement by the
South Korean government that it is prepared to guarantee short-term private sector bank
debt. We are told that Seoul must take such a step in order to persuade foreign creditors to
extend maturities on the approximately $92 billion in combined private sector and sovereign obligations due over the next year. In point of fact, it was
the predictable product of a Clinton Administration strategy that initially offered levels of
assistance (through the International Monetary Fund and via direct “standby” loans) that were
predictably inadequate to staunch the hemorrhage of foreign capital from South Korea’s and other
“emerging markets.”

Matters are made worse by the stealthy manner in which these initiatives are being promulgated.
The absence of transparency with regard to the true magnitude of the problem — let alone its
ultimate implications for U.S. taxpayers — actually invites more of this costly cronyism.

Let’s be clear: The U.S. Treasury Department knew, or certainly should have known, that
the initial $57 billion International Monetary Fund package for Seoul would not restore
market confidence in South Korea, particularly given the structural character of the
problem. Low-balling the bail-out amount that would be required for Korea served two
troubling purposes, however: 1) It reduced somewhat the “sticker shock” with which the
Congress and the American people would react to the bail-out; and 2) it put South Korea in
extremis. The latter enabled Rubin and Company, the Japanese banks and other Western
creditors to euchre Seoul into extending government guarantees for the obligations of private
Korean banks, thus minimizing the exposure of U.S. and other Western creditors.

The Sound of Other Shoes Dropping

Unless it is stopped forthwith, this sort of creeping multilateral socialization of largely private
sector debt and investment is certain to be replicated throughout the region and beyond.
Thailand has already sought to renegotiate its $17.2 billion IMF package and tried to secure a
rescheduling of its short-term debt, an entirely understandable reaction to Seoul’s success in
renegotiating the size and terms of its deal.

A front page article in today’s New York Times suggests that Indonesia may be about to follow
suit with regard to its own $40 billion rescue package. Jakarta seems intent, however, on going
beyond where the South Koreans and Thais have dared to go. In so doing, it is telegraphing the
manner in which bad-debt-ridden nations like China and Russia can be expected to conduct
themselves: Rather than simply seeking a relaxation of IMF conditionality, debt rescheduling
and/or larger infusions of Western taxpayer-guaranteed cash, the Indonesians are simply
ignoring the IMF’s required economic and financial milestones. For example, as the Times
noted, “President Suharto said his government would increase spending by 24% next year despite
pledges of austerity.”

Here Comes China

The next shoe to drop in Asia is likely to be China. Notwithstanding the stunning absence of
official warnings or media commentary on this prospect, there is evidence that China’s banking
industry is nearing financial meltdown at a time when its much-touted reserves are judged to be
heavily encumbered. As the Casey Institute noted on 23 December 1997⁽¹⁾:

“…The highly regarded DRI/McGraw-Hill Global Risk Service during the second
quarter of 1997…warned that as much as ’20-40% of China’s outstanding stock of
loans, valued at $600 billion can be classified as non-performing. So far, the
problem has been contained. However, should things go wrong in China’s banking
sector, the ramifications in developing Asia could be huge.'” (Emphasis added.)

Even one of the principal proponents of Sino-U.S. economic entente — Robert Zoellick,
Under Secretary of State for Economic Affairs and Deputy White House Chief of Staff in the
Bush Administration — was obliged to observe in an appeal for greater American assistance to
Asian economies published in yesterday’s Washington Post: “…The United States should work
closely with China to defuse another economic time-bomb: the bad debts of China’s state-owned enterprises piling up year after year, and now totaling a shocking 25 percent of
China’s whole economy.” (Emphasis added.)

The only problem is that the cronyism that afflicts China is not simply a mutation of a free
market system, but the core structure of Beijing’s so-called “market socialist” system. This
reality may explain the deafening silence with respect to China’s impending addition to the rolls of
Asia’s “financially challenged”: If the cure is seen to require disentangling the government
from what passes for China’s “private sector,” there is no hope as long as the PRC remains,
in key respects, a centrally controlled economy with a communist political system. However
much the current Chinese leadership might try, like Mikhail Gorbachev before them, to abscond
with the lexicon of market capitalism, China will not be able to prosper over the long haul absent
wholesale political as well as economic structural change.⁽²⁾

Then There’s Russia

Also waiting in the wings is Russia — a nation whose smaller markets and financial requirements
may help it remain lower on the radar screen for a time. But the Kremlin’s hybrid
socialist/market/kleptocratic economy has already produced successive requests for IMF
interventions, to say nothing of a roughly $100 billion rescheduling of Western government and
bank debt to the former Soviet Union accomplished within the past few months. As Martin Sieff
reported in a front-page article in the Washington Times on 23 December:

“One Moscow-based financial analyst said the government was building a shaky
financial pyramid ‘like a drunken poker player who can’t read the cards.’ In all, Russia
has issued around $58 billion in three- and six-month GKOs [short-term government
bonds], of which $15 billion is held by foreigners. That is more than double Russia’s
$28 billion debt when Mr. Yeltsin was re-elected 18 months ago….The country has
been able to avoid a collapse in part because of fresh infusions of money from the
International Monetary Fund, which lends to Moscow at highly favorable
interest rates. ” (Emphasis added.)

In other words, the only reason Russia has not been a candidate for a new emergency
bail-out initiative by the IMF — and the Clinton Administration and other Western
governments assiduously politicizing it — is that there is already one underway. That
politicization, like the multilateral cronyism now so much in evidence in Asia, is ensuring that
Russia continues to receive disbursements from the IMF under its existing $10 billion standby
agreement, long after such outlays should have been suspended due to the Kremlin’s non-compliance with the IMF’s conditionality (particularly with regard to tax-collection).

What the United States Must Do — and Not Do — Now

If the United States is to avoid making further mistakes that are not only costly for the American
taxpayer but that are strategically harmful, important changes must be made by both the executive
and legislative branches:

Organizing the Executive Branch for Security-minded Economic Policies: On 4 January, the
New York Times reported that President Clinton has only recently begun to huddle with his top
foreign policy and national security advisors in the White House Situation Room to develop a
more comprehensive and integrated view of American policy options and equities in the
management of the Asian financial debacle. If such a grievous oversight is appalling, it is
hardly surprising, given the Clinton Administration’s studied inattention to the nexus of
economic, financial, energy and technology issues and traditional national security
concerns.⁽³⁾

The Center for Security Policy has long argued that this nexus will be at the heart of the foreign
policy and defense challenges this Nation is likely to face in the 21^st Century.⁽⁴⁾ Indeed, its William
J. Casey Institute was established in March 1995 expressly for the purpose of advancing public
awareness and official understanding of these increasingly complex problems — the sorts of
problems to which the distinguished public servant and Wall Street financier for whom it is named
devoted most of his professional career.

It is gratifying that there is growing awareness in some quarters of these realities. As the Times
put it on 4 January: “The newfangled financial crises that destabilize huge economies in a single
day appear increasingly connected to old-time political and security crises. In fact, there is
growing fear that 1997’s market calamities could beget 1998’s security crises.” Unfortunately,
the resistence exhibited by the Clinton Administration to addressing the national security
implications of economic, financial and related decisions is now not simply embarrassing
evidence of strategic myopia; it is a practice that the Nation simply can no longer afford.

The Reagan Model

A model for avoiding such costs to both U.S. national interests and to the Treasury can be
found in the Senior Interdepartmental Group — International Economic Policy (SIG-IEP)
operated by the Reagan Administration between July 1982 and April 1985.⁽⁵⁾ This Cabinet-level
interagency mechanism had several characteristics that would stand the present U.S. government
in good stead:

• The Department of Defense, CIA and National Security Council were charter members
  of the SIG-IEP, bringing to bear their respective insights and resources in addressing policy
  matters brought before the Group. These agencies also participated regularly in the working-level interagency entities that supported the SIG-IEP.
• Although the SIG-IEP was chaired by the Treasury Secretary, it reported to the President
  through the National Security Advisor, assuring that the President was faithfully afforded
  both economic and security perspectives on pending issues. Decisions for which no consensus
  recommendation could be found were generally considered at full National Security Council
  meetings chaired by the President.
• Pre-crisis planning was an explicit part of the SIG-IEP’s mission and featured
  prominently on its agendas.

In the present environment, a mechanism like the SIG-IEP would equip the U.S. government
with an alternative to reactive policy-making. It would also assist in devising policies that
differentiate between the help that can reasonably be provided by the United States to key allies
(e.g., South Korea) and that available for nations whose behavior requires that they continue to be
regarded as potential adversaries (e.g., China and Russia).

Establishing Principles that Should Guide Congressional Action: To the Congress falls the
responsibility to determine the full implications for American interests and taxpayers of the
Clinton Administration’s response to the present financial crisis. Urgent hearings are required in
both the Senate and House banking and foreign affairs committees. A priority item on the agenda
of such hearings should be the U.S. Markets Security Act (S.1315) introduced last October in
the Senate by Sen. Lauch Faircloth, Chairman of the Financial Institutions and Regulatory Relief
Subcommittee of the Senate Banking Committee, and in the House by Rep. Gerald Solomon,
Chairman of the House Rules Committee. This legislation would strengthen disclosure and
reporting requirements, specifically with regard to foreign governments and government-controlled entities seeking to enter the U.S. debt and equities markets.

Congress should also take steps to ensure that American policy is guided by three precepts so as
to minimize the strategic and financial costs of the present — and prospective — financial
meltdown in Eurasia:

• First, the Treasury Department’s Exchange Stabilization Fund (ESF) was designed for
  largely overnight currency stabilization needs and foreign exchange swaps — not to be an
  Executive Branch slush-fund for medium-term loans to foreign governments. The use of
  the ESF should be restricted by legislation and all U.S. financial commitments and
  disbursements to these, in effect, defaulted sovereign borrowers should require advance
  approval by the Congress.
• Second, the American taxpayer should no longer be subjected to the sort of “moral
  hazard” involved in the recent Mexican bail-out and now in prospect in this one —
  where private sector investors and bankers were repaid in full, in some cases with profit,
  by the American people. As Lawrence Lindsey, a former Federal Reserve governor who is
  now a Fellow at the American Enterprise Institute, put it to the Washington Post on 22
  December: “…One of the reasons we have Asia is that we bailed out Mexico. We signaled to
  creditors around the world that you could feel free to lend in Asia, and the U.S. Treasury and
  the IMF would bail you out if you got in trouble. Now if we bail this one out, we’ll have
  established a second precedent, and the next time, it will be bigger and arguably something we
  can contain less easily.”⁽⁶⁾

These private investors and bankers understood the risks involved in the higher-risk
emerging market economies. They, not the American taxpayer, should be obliged to
absorb the totality of their losses.

• Third, the U.S. should not engage in even a limited bail-out — including the IMF/World
  Bank variety — for foreign governments engaged in activities harmful to vital U.S.
  national security interests (e.g., Russia and China). Foes of freedom need to know they
  cannot — and will not — have it both ways.

The Bottom Line

The fierce competition to increase Western exposure in the “emerging markets” has now evolved
into a contest by the sovereign managers of — and players in — those markets for ever-larger
taxpayer-underwritten bail-outs and less stringent repayment obligations. This profoundly
changed circumstance is giving rise to myriad recommendations that generally fall into two
camps:

On the one hand, some contend that the IMF has been monstrously transformed from its modest
beginnings as a valuable international monetary coordinating and supervisory body into a tool of
“corporate welfare.” According to this view, the IMF is now little more than a slush-fund for a
club of cronies — international bankers, politicians and capital market players. This perception is
feeding a growing demand to abolish the International Monetary Fund in order to return to
genuine free market capitalism.

On the other, there are those who see in the present crisis an opportunity to promote new and far
more insidious impediments to the workings of the international marketplace. Notably,
international financier George Soros wrote on 31 December 1997 in the Financial Times that
“International capital movements need to be supervised and the allocation of credit regulated by
an international authority.” His proposal: the creation of an International Credit Insurance
Corporation to police the world-wide flows of capital — a breathtaking new milestone in the
creeping multilateralism that is increasing impinging upon market forces and U.S. sovereignty.⁽⁷⁾

There is, of course, a sensible middle ground between disestablishing (as opposed to significantly
reforming and de-politicizing) the IMF and instituting global capital controls. Its ingredients are
to stay true to market forces — so long as doing so does not undermine U.S. national security
interests — and allow imprudent governments, bankers and investors to pay the price for ill-advised decision-making and crony capitalism.

There can be instances in which it is in the interest of the United States to offer indirect or
direct financial assistance to friendly governments struggling with legitimate liquidity
shortfalls (i.e., those catalyzed by forces other than crony capitalism and/or corruption). In
such instances, U.S. aid must be provided in a transparent manner, calculated to bridge the
recipient nation into renewed solvency and genuinely free market economic vitality. Disciplined
progress toward these objectives can only be assured, however, by matching disbursements
against clear performance milestones, so that all parties understand that the agreed “workout”
can — and will — be interrupted if such milestones are not met.

Finally, some fifty years after the Congress adopted legislation organizing the executive branch for
national security — involving, among other things, the creation of the National Security Council —
the legislative branch should take similar steps to ensure that the Nation is equipped with
the interagency mechanisms needed to deal with the dynamic economic and financial
security challenges evident today and likely to be even more threatening in the future.
President Reagan’s SIG-IEP offers a proven model for an effective Economic Security Council
(particularly in contrast to the feckless Clinton National Economic Council) that should be
promptly mandated by statute.

Should the United States fail to take these steps, it risks squandering not only whatever federal
“budget surplus” may now be in prospect but vastly more in terms of American economic
interests, national security equities and taxpayer resources.

– 30 –

1. See the Casey Institute’s Perspective entitled The Dog That Didn’t Bark: Moody’s, Et. Al.
Fail Investors in Asian Markets, Miss Warning Signs in China and Russia (No. 97-C 200, 23
December 1997).

2. See the Center’s Decision Brief entitled Kow-Towing to China: Clinton’s ‘Engagement’
Policy Means Joining Beijing in Stifling Human Rights in America (No. 97-D 198, 18
December 1997).

3. See the Center’s Transition Brief entitled Putting the Security into the New Economic
Security Council (No. 92-T 140, 9 November 1992).

4. See the following Center papers: An Ominous Strategic Development: “Perestroika
Bonds” and Soviet Entry into U.S. Securities Markets (No. 89-P 67, 28 October 1989), When
Deutsche Bank Talks Soviet Debt Default, The Bush Administration Should Listen (No. 91-D
113, 13 November 1991) and ‘Stop Payment’: The Case for Supporting Yeltsin by not
Disbursing Another $2.5 Billion Blank Check (No. 93-D 86, 4 October 1993); as well as the
following Casey Institute papers entitled: Dangerous Upshot of Clinton-Gore’s China
‘Bonding’: Strategic Penetration of U.S. Investment Portfolios (No. 97-C 47, 1 April 1997)
and Russian Bonds Rocked by Second Senate Hearing in a Week Focusing on Undesirable
Foreign Penetration of U.S. Markets (No. 97-C 169, 10 November 1997).

5. The now-declassified National Security Decision Directive (NSDD) 48 that established the
SIG-IEP in July 1982 should be required reading for those in the Clinton White House, Congress,
the media and allied capitals who are serious about economic crisis resolution and pre-crisis
planning.

6. Mr. Lindsay authored a powerful elaboration of this thesis entitled “The Bad News About
Bailouts” which appeared in the New York Times on 6 January 1998.

7. See the Center’s Decision Brief entitled Will 1998 Be the ‘Year of Surrendered
Sovereignty’? (No. 98-D 1, 5 January 1998).