Why did the IMF step in to rescue Thailand?

Last weekend, the Federal Reserve Bank of Kansas hosted its annual conference for central bankers, academics and private sector economists at Jackson Hole, Wyoming. This conference, held in a stunning if somewhat incongruous setting, has become one of the key events on the central banking calendar each year, not least because it always results in a collection of excellent practical papers by academics and official economists.

This year, the focus was on financial crises and how to handle them, with particular attention on the developing crisis in South East Asia. This column will address three linked questions that arise from this crisis. First, could it have been predicted? Second, what effect will it have on the rest of the world? And third, was the IMF right to lead a bail- out operation for Thailand?

The question of whether the crisis could have been predicted is of obvious importance to international investors, but it is also critical for policy- makers. From the point of view of the IMF, a predictable crisis is one that could potentially have been avoided by taking appropriate policy action at an early stage. So there are obvious lessons for the future, involving the possibility of more pro-active intervention by the IMF to achieve timely policy changes. And, if the crisis was predictable, there seems less case for mounting a bail-out operation in order to save the skins of private sector investors who continued to make imprudent investments despite clear warning signals.

Morris Goldstein of the Institute for International Economics in Washington presented an excellent paper at Jackson Hole which claimed, in effect, that the Thailand crisis could have been predicted, using a set of economic indicators which had been developed from a systematic analysis of previous currency crises. The key indicators, according to Dr Goldstein, are: real GDP growth, the change in exports, the rise in the real effective exchange rate, the decline in equity prices, the rise in real interest rates, and the ratio of domestic money to international reserves. Each of these indicators was flashing at least a year before the Thai crisis exploded this summer. So why did both the market, and the IMF, fail to take corrective action early enough?

One cynical interpretation, expressed at Jackson Hole, is that accurate analysis was held back from the market because the main purveyors of such information - the global investment banks - deliberately chose to place an optimistic spin on the evidence in order to win financing business from the countries concerned. From my vantage point as the chief economist of just such an organisation, this accusation does not ring true. Not only did the Asian economists of Goldman Sachs predict the onset of the crisis several months in advance, but they made this clear to clients the world over in written reports early in 1997.

Admittedly, this was a controversial conclusion at the time, but if by then it had been a consensus view, the crisis would already have happened. By the laws of chance, there will always be some commentators who can claim, in retrospect, that they were ahead of the pack. What this episode shows, though, is that Dr Goldstein is right to argue that there were plenty of publicly available warning signals well in advance of the crash. Certainly, more timely information on the true state of the central bank's reserves, and on the health of the banking sector, would have been highly valuable to investors - and the IMF is right to press for better information in future - but whether this would have prevented the crisis is a moot point.

A more likely explanation for the general failure to see the crisis coming is that markets, since time immemorial, have chosen to take advantage of the "easy" money available in fixed exchange rate systems until the very point at which they collapse. Thailand was no exception to this rule, since many investors, choosing to believe in the Thai government's obvious determination to maintain the currency peg, increased their exposure to the baht as interest rates rose in the early days of the crisis. At times such as these, markets often appear to lose their ability to accurately assess risk against return. But this particular variant of a private sector financial "bubble", painful though it may be for the participants, does not seem sufficient to justify costly intervention by the IMF.

What about the impact on the developed economies? Could this be so severe that it is in our own self-interest to bail out the worst-impacted Asian economies? With the possible exception of Japan, the answer seems to be no. The table shows the impact on the developed economies of a huge economic shock in Asia - a shock which forces the Asean countries (Thailand, Indonesia, the Philippines and Malaysia) to improve their trade deficits by 4 per cent of GDP in one year, and forces the rest of Asia to do the same by 2 per cent of GDP. This is about the most extreme shock which could be imagined, and is several times larger than anything which has happened so far. Yet even in these unlikely circumstances, the depressing impact on the US and the European Union would only be about a quarter per cent of GDP, not normally enough to raise a flicker of interest among economic forecasters. Only in Japan, where the GDP impact could be two or three times as large, and where there are also important banking sector exposures, is there a self-interested case for the bail-out.

Yet Japan in effect refused to lead the rescue operation for Thailand, and threatened not to help at all except under the auspices of the IMF. This was understandable from a Japanese political point of view, and the bluff worked. The IMF stepped in, much more speedily than it had done in several earlier crises. The question is - why?

The IMF's explanation is that there is plenty of evidence of contagion from one currency crisis to similar crises in other countries which would otherwise have not suffered any problems at all. This contagion effect justifies collective action, since all countries have an interest in protecting themselves from the danger of such fall-out. But it is rather hard to claim that the major developed economies, which have contributed the lion's share of the financial assistance to Thailand, would be the main losers from such contagion, so this explanation is not watertight.

We are left, therefore, with the final explanation, which is that the world community has a moral duty to prevent the 60 million people of Thailand from suffering as a result of the policy mistakes of their government. This, too, was suggested at Jackson Hole. Yet this justification places the IMF action squarely in the realm of a global package of humanitarian aid. And, as the ever-sparky Jeffrey Sachs of Harvard insisted, there is absolutely no case for offering such a huge package of instant support for the relatively rich Thais, when the IMF has done so little for so long to help the truly impoverished countries of sub-Saharan Africa.

IMF and central bank officials left Jackson Hole still certain that they were right to help Thailand. Exactly why was not so clear.

Start your day with The Independent, sign up for daily news emails
Voices
Barn owls are among species that could be affected
charity appeal
Sport
After another poor series in Sri Lanka, Alastair Cook claimed all players go through a lean period
cricketEoin Morgan reportedly to take over ODI captaincy
Life and Style
food + drink
Voices
John Profumo and his wife Valerie Robson in 1959
voicesWard committed no crime, and the truth is still being covered up, writes Geoffrey Robertson QC
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
News
news... you won't believe how bad their skills were
News
people

Arts and Entertainment
Mark Wright and Mark Wright
tvStrictly goes head-to-head with Apprentice
Sport
footballPremier League preview: All the talking points ahead of this weekend's clashes
News
i100
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Sheridan Maine: Commercial Finance Manager

Up to £70,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Sheridan Maine: Regulatory Reporting Accountant

Up to £65,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Ashdown Group: Marketing Services Manager - (communications, testing, DM)

£32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

Guru Careers: Finance Account Manager

£Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

Day In a Page

Homeless Veterans appeal: 'You look for someone who's an inspiration and try to be like them'

Homeless Veterans appeal

In 2010, Sgt Gary Jamieson stepped on an IED in Afghanistan and lost his legs and an arm. He reveals what, and who, helped him to make a remarkable recovery
Could cannabis oil reverse the effects of cancer?

Could cannabis oil reverse effects of cancer?

As a film following six patients receiving the controversial treatment is released, Kate Hilpern uncovers a very slippery issue
The Interview movie review: You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here

The Interview movie review

You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here
Serial mania has propelled podcasts into the cultural mainstream

How podcasts became mainstream

People have consumed gripping armchair investigation Serial with a relish typically reserved for box-set binges
Jesus Christ has become an unlikely pin-up for hipster marketing companies

Jesus Christ has become an unlikely pin-up

Kevin Lee Light, aka "Jesus", is the newest client of creative agency Mother while rival agency Anomaly has launched Sexy Jesus, depicting the Messiah in a series of Athena-style poses
Rosetta space mission voted most important scientific breakthrough of 2014

A memorable year for science – if not for mice

The most important scientific breakthroughs of 2014
Christmas cocktails to make you merry: From eggnog to Brown Betty and Rum Bumpo

Christmas cocktails to make you merry

Mulled wine is an essential seasonal treat. But now drinkers are rediscovering other traditional festive tipples. Angela Clutton raises a glass to Christmas cocktails
5 best activity trackers

Fitness technology: 5 best activity trackers

Up the ante in your regimen and change the habits of a lifetime with this wearable tech
Paul Scholes column: It's a little-known fact, but I have played one of the seven dwarves

Paul Scholes column

It's a little-known fact, but I have played one of the seven dwarves
Fifa's travelling circus once again steals limelight from real stars

Fifa's travelling circus once again steals limelight from real stars

Club World Cup kicked into the long grass by the continued farce surrounding Blatter, Garcia, Russia and Qatar
Frank Warren column: 2014 – boxing is back and winning new fans

Frank Warren: Boxing is back and winning new fans

2014 proves it's now one of sport's biggest hitters again
Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

Jeb Bush vs Hillary Clinton

Karen Tumulty explores the power dynamics of the two first families
Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

Stockholm is rivalling Silicon Valley

The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

Crucified Santa: Urban myth refuses to die

The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

The Boy in the Dress: On set with the stars

Walliams' story about a boy who goes to school in a dress will be shown this Christmas