CIAO DATE: 1/99

Collective Management of International Financial Crises: The Japanese Government in the Pacific Rim _*

Saori N. Katada

Center for International Studies University of Southern California
July 1998

Introduction

The world has experienced many financial crises. Despite numerous research and policy efforts in prevention to present them at of large scale, the global economy has not seen economists’ (and investors’) Nirvana of financial globalization without the occasional crises. ₁ On the contrary, the increasing dynamism and changing nature of financial flows across national borders seem to have created a larger number of new problems for creditors, debtors and international financial institutions. That has typically been true for middle income countries in Latin America and Asia and, very recently, in Eastern Europe, which have been integrated into the international financial system. During the two decades between the late 1970s and the late 1990s, three major sets of financial crises originated from those middle income countries, intensifying concerns for international financial stability.

Financial difficulties, be they debt repayments or sudden currency devaluation and capital flight, demand timely and appropriate crisis management by at least one of the major creditor countries in order to minimize the damage caused by the crises. Globally, such crisis management is important in avoiding further repercussions and international financial disaster. The key question then is whether or not such crisis management, particularly in the form of adequate rescue packages, would be assembled smoothly by the state actors involved. There are several reasons why state actors who possess the ability to assemble and to contribute to such rescue packages would prefer to avoid getting deeply involved.

The first reason is the disincentive arising from collective action in crisis management. It is difficult, given the fungibility of added liquidity through “bail-out” operations, to assure those particular actors who contribute to the crisis management receive their proportional benefits. In these circumstances, the incentives to free ride is high. In addition, although the major creditor countries who want to stabilize these debtor economies and improve their external balance might emphasize the global repercussion and the systemic risk arising from the crisis, there is always suspicion that the creditor government is promoting the idea of “public goods” (in this case, the stability of international financial system), while actually trying to secure its “private goods” (economic recovery of its major trading partner and resulting security for the creditor’s investment or loan repayments). This suspicion is even stronger when the creditor governments are concerned about their relative gains vis-á-vis other governments, which discourage cooperation. ₂

The second factor that discourages state actors from getting involved in active management is the uncertainty and criticisms associated with the impact of such rescue packages. Those who are against financial rescues argue that the rescue operations by public institutions, the creditor governments and the international financial institutions (IFIs), create a typical case of a moral hazard problem. The “bail-outs” would invite moral hazard problems of debtors as well as the lenders and investors. On the debtor side, the crisis management and “bail-out” packages can often reward problem debtors. They mismanaged their economies, severely indebted themselves, and have not committed seriously to the country’s economic reforms or its repayment obligations, both of which are often politically difficult. Even on the investors’ side, such rescues may end up encouraging those investors and transnational banks to take repeatedly high risks in their investments. By creating the perception that they will be bailed out every time the financial crisis gets out of control, many argue, these bail-out packages reduce financial institutions’ risk consciousness, thus increasing the likelihood and the magnitude of the future financial crises. ₃

Finally and quite obviously, financial rescue packages provided by governments require financial resources, either in the form of direct participation using the country’s official funds or in increased capital contributions to IFIs like the IMF and the World Bank. In many countries, taxpayers in general will object to measures of financial “bail-out” packages designed to help the debtors, to which they have no strong affinity or commitment, or to assist home country investors, who, in their view, misjudged their investments.

With the collective action problem, prevalent uncertainty and moral hazard problems, as well as resistance from domestic taxpayers, one would expect that those creditor governments that do not have strong enough “private” interests in the financial rescue of the indebted countries would be very reluctant to participate in the crisis management. Under these circumstances, even though the creditor governments are aware that cooperation among them makes such crisis management much more effective than the country-by-country approach, inducing others to comply seems to be a difficult task. ₄

The close collaboration of the Japanese government with the United States during the Latin American debt crisis, particularly in its solution phase of the late 1980s, provides a puzzling cooperation case in the financial crisis management. As discussed in the following sections, the Japanese government was quite willing to support U.S. debt initiatives throughout the 1980s which were geared toward not only maintaining international financial stability, but also disproportionately satisfying the U.S.’s own self-interests. Furthermore, the Japanese government provided a large financial contribution for the 1989 Brady Plan to Mexico in sum, which ultimately made the deal possible and successful. The theory on Japan’s foreign policy behavior known as “reactive state” would argue that the Japanese government is often ready to react favorably to the U.S. demands due to Japan’s high dependence on the U.S. market and on diplomatic and military support as well as Japan’s own fragmented decision-making structure. ₅ But this theory does not hold too well, however, because, in the case of the series of Latin American currency crises which began with Mexico in December 1994, we did not observe such a close collaboration between the United States and Japan. The Japanese government cooperated with a very low profile and in a limited way in the efforts to rescue Mexico. No financial commitment was made for a long while, and the rescue only came in the forms of private financial sector commitment and in the Japanese government’s support of the U.S. position in the IMF. The Japanese government, nevertheless, helped Argentina in its smaller crisis through direct financial assistance.

A further question is whether or not the analysis of such collaboration in financial crisis management between Japan and the United States can be extended to the recent Asian currency crisis, starting with Thailand in the summer of 1997. From the accounts of the rescue packages for these crises, it is clear that some degree of cooperation has existed between the United States and Japan in dealing with the Asian debtors, particularly by using the IMF forum and its new emergency funding mechanisms. On the other hand, present in the first Thai rescue case and in the debate of a so-called “Asian Monetary Fund” idea was some degree of tension between the two major powers over the modality and conditions of emergency loans, particularly in relation to IMF conditionality.

This paper arises from a larger study that I am conducting on financial crisis management between the United States and Japan. In this larger study, I empirically examine such questions as: In what cases or why do some creditor governments decide to get engaged in the active financial crisis management? Why do they avoid or become involved to a lesser degree in others? What has motivated the involvement of the Japanese government? What are the underlying forces that engage Japan to help manage these crises and to pay fairly high costs?

This paper, however, has much more limited scope and objectives. It is an analysis of the “dependent variable.” The paper traces the management of financial crises in Pacific Rim developing countries conducted between Japan and the United States. The crises cover a period beginning with the Latin American debt crisis of 1982 and extending through the 1997 Asian currency crisis. It focuses on the Japanese government’s behavior and the motivation of the Japanese government to not only actively engage in the management of the Latin American crisis, but to also go along with the “pro-Washington Consensus” scheme of rescue packages in the Asian crisis. As the result of this dependent variable analysis, and by focusing particularly on the dynamics and relationship between the United States and Japan, I construct hypotheses as to why the collective crisis management has been possible in most cases, but not so forthcoming in others. My hypotheses are two-fold. First, the interests of Japan’s transnational financial actors have played a major role in influencing the Japanese government to collaborate with the U.S. government in financial crisis management. When interests were lacking, the Japanese government’s motivation to cooperate decreased. Second, each regional financial crisis has impacted the economic health of respective regional powers. Due to the high degree of economic integration and interdependence between the United States and Japan, the creditor government from outside of the sphere of crisis has become motivated to intervene to support the major power affected by the crisis.

The first section of this paper examines the Japanese position and behavior in management of the Latin American debt crisis. The second part applies the same focus to the Japanese government’s behavior in the currency crises of the 1990s ranging from those that occurred in Mexico (with repercussions to Argentina) to those that occurred in 1997 in various Asian countries. In the third section and as a conclusion, I schematize those crises and their respective management. My goal here is to analyze forces that have influenced the Japanese government’s behavior, particularly in terms of collective action with the United States and IFIs. Overall, this paper focuses on the dependent variable -- cooperation and non-cooperation between Japan and the United States -- of my larger analysis -- motivation for cooperation in the financial crisis management. The last section summarizes the hypotheses inductively constructed from the empirical puzzle, and it indicates the direction of my broader research on the analysis of the causal relationship.

 

Japan and the Latin American Debt Crisis

The debt crisis of the 1980s, which began from Mexico in August, 1982, was a major economic crisis that had the potential to destabilize the international financial system. Unlike many other financial crises before in which core countries unilaterally affected those on the periphery, this crisis was triggered by the developing countries’ debts and pulled in major creditor countries due to these creditors’ loan exposure. ₆ Short-term and medium-term crisis management occupied creditor country policy-makers for almost a decade after the Mexican announcement of interest payment suspension in 1982. Most attention focused on helping many middle income debtors, most of them in Latin America, get back on their feet economically, but at the same time, pay back their outstanding debt. An abundance of economic and political science literature analyzes the debt crisis in Latin America ₇ but very little of this research examines Japan’s involvement in the Latin American debt crisis and its role in helping to alleviate the adverse impact and resolving the crisis in collaboration with the United States. ₈ The following section outlines Japanese involvement in the Latin American debt crisis throughout the 1980s.

Japanese financial flows to Latin America before the debt crisis.

Due to the long distance and a lack of historical interaction, most of Latin America was an unfamiliar region for the Japanese until recently. In addition, the Japanese government considered the region to be within the U.S. sphere of influence and refrained from competing directly with U.S. economic interests. The first stage of interaction between Japan and Latin America was dominated by immigration and bilateral trade. The history of Japanese immigration to Latin America began with the migration of poor Japanese farmers to Brazil in the 1920s and 1930s. Paraguay, Peru, Mexico and other Latin American countries have also accommodated Japanese immigrants. Latin America currently has the largest Japanese population outside of Japan, which is estimated at 1.5 million. ₉ 25,000 Japanese chose to go to Latin America throughout the first half of the 20th century, which constituted 56 percent of the total of Japanese emigration.

Trade relations became relatively important in the 1950s, when almost ten percent of Japan’s exports and imports were with Latin America. However, Latin America’s importance in trade has declined slowly but surely over time. As noted earlier, total Japanese trade with Latin America looks much less impressive than Japan’s trade relations with industrial democracies or countries in Asia. As Table 1 shows, Latin America (South, Central America plus the Caribbean countries) only began importing more from Japan than they exported in the 1980s.

Japan’s trade with Latin America, 1950-1996

This stable but declining trade picture between Japan and Latin America is quite different from the one depicting the long-term financial flows between the two. Japanese investment activities in the region followed a similar path to those of the United States during the large influx of foreign direct investment (FDI) in the 1950s: Latin America was an attractive direct investment site because of its abundant minerals and natural resources and relatively large but traditionally closed markets for manufactured goods. Japan followed the American example, but its firms arrived late in Latin America; their direct investment did not become significant until the 1970s. Balance-of-payments restrictions imposed by Japan’s still capital-poor position limited Japanese FDI, and even then Japanese FDI was concentrated in very few countries, mainly Brazil, where 251 Japanese subsidiaries were established, Panama (58), and Mexico (35) by 1990. ₁₀

The main characteristic of Japanese foreign direct investment during these early years, particularly after 1973, was that these investments took part in so-called “national projects.” A “national project” is the unofficial name for those development projects, defined by the following criteria: (1) projects are directly related to Japan’s national interests, particularly in natural resources, (2) Japanese companies participate as a group, and (3) Governmental Organizations support the effort directly or indirectly. The support from the government came mostly in the form of public co-financing for the Japanese private financial sector. The projects were usually developed by Japanese trading companies and discussed with the host governments, which requested financial support from the Japanese government. An arrangement to finance the project was then engineered between Japanese public financial organizations, such as the Overseas Economic Cooperation Fund (OECF) or the Export-Import Bank of Japan (JEXIM Bank), and Japanese commercial banks. ₁₁ Many Japanese banks were also involved in financing these projects. A banker noted that “[the banks] felt that we were contributing to Japan’s national interest by investing in these projects. We felt proud to work for the benefit of our country, since there was a sense of urgency to secure the source of minerals and oil through these projects.” ₁₂ Although the bankers’ feelings of patriotism spurred their involvement in these “national projects,” the accompanying public financing also reduced their risk. For the Japanese government, these projects became one of its policy instruments to influence the private sector capital allocation in the developing world. For Japanese commercial banks, the government provided additional money for potentially lucrative but highly risky investments in natural resource extraction industries. However, Japanese economic interaction with Latin America was limited until the middle of the 1970s. This is reflected on Japan’s economic relationship with the rest of the world aside from industrial countries, especially the United States, and Asia.

By contrast, the internationalization of Japan’s economic activities since the mid-1970s led Japan to be more actively engaged in Latin America. Heavy lending by commercial banks marked the start of this period from the latter half of the 1970s and continued until the early 1980s. As with FDI, Japanese banks were again latecomers in the game. Japanese banks began increasing their lending to Latin America and other developing countries during the mid-1970s. During these years, Japanese banks internationalized rapidly in conjunction with the deregulation granted by Japan’s Ministry of Finance (MOF). They started to participate in syndicated loans with American and European banks to Latin American and other governments.

Japanese banks’ eagerness to extend loans abroad had the same roots as the global lending boom itself. Petrodollars that accumulated in the foreign exchange accounts of some newly enriched oil exporting countries were recycled and found their way into Japanese bank deposits. Hit both by the slump in domestic demand after the oil shock and the increased internationalization of the Japanese manufacturing sector, many banks saw no other option but to seek customers overseas. At this time, the Japanese government believed it was necessary to diversify its sources of raw materials, particularly oil, from countries other than OPEC and beyond Asia. In the 1970s, after a brief period with a balance of payments deficit caused by the oil crisis, the Japanese economy managed to overcome the chronic balance-of-payment problems and was in the position to allow some outflow of capital from Japan.

As a policy instrument, the government encouraged Japanese banks to lend to developing countries. To enable Japanese banks to extend their loans abroad and under pressure from those banks, the MOF eased its foreign exchange controls in the 1970s. These controls were originally placed in 1948 through Foreign Exchange and Foreign Trade Control Law prohibiting all capital transactions except those specifically approved by the MOF, and were temporarily enforced by the Japanese government between 1974-76 and 1979-1980 to protect Japan’s external balances. ₁₃

Profit-maximization calculations and medium and long-term economic considerations of Japanese banks also led them to proceed with lending to sovereign entities. ₁₄ Japanese banks followed the lead of American banks in forming syndicates and eventually became managers (leading banks) in syndicated loans. The Bank of Tokyo handled $753 million as the leading bank by 1981, and other less internationally experienced Japanese banks began to play the role of the leading bank in the latter half of 1981. Sumitomo Bank increased the number of syndicated loans it led from one worth $50 million to seven worth $617 million, and the Long-term Credit Bank of Japan led its first three such loans, worth $217 million, during this period. ₁₅ The banks’ behavior was partly a response to the MOF’s guidance, which encouraged them to be the leading banks in syndication. ₁₆ It is not entirely coincidental that the Japanese banks began serving as leading banks less than one year before the Mexican announcement; American banks relied increasingly on relatively inexperienced Japanese banks for syndicated lending, because well-informed American banks like CitiCorp stayed away from new Latin American lending before the disaster struck. ₁₇

The Japanese government’s overall development policy was the third reason for the increased lending in Latin America. The government played a major role in facilitating private lending to developing countries, particularly to booming but traditionally foreign Latin America. ₁₈ In a collection of his speeches from the late 1970s, a MOF senior official, Masao Fujioka, discussed the banks’ important role in transferring finance from Japan to developing countries:

Now Japan wishes to transfer incoming funds to the countries in distress and thereby to facilitate a proper international recycling of money. To this end, we are encouraging floatation of yen-dominated foreign bonds, and since last autumn (1976), we have resumed a policy of encouraging the Japanese banks to provide medium- and long-term financing abroad. ₁₉

The “policy of encouraging the banks” to lend abroad comprised various instruments to influence the Japanese private sector to allocate financial resources abroad. The instruments at the government’s disposal included: the JEXIM Bank’s highly focused lending policies, the Ministry of International Trade and Industry (MITI)’s export insurance program, the ability to designate overseas “national projects”, and the occasional provision of official foreign currency reserves to fund commercial transactions. ₂₀ The semi-privatized or quasi-public “hybrid flows” were a form of surplus fund recycling employed by the Japanese government. These financial flows consisted of JEXIM Bank and OECF loans. These flows also served as inducements designed to redirect some of the profit-motivated private flows into a policy-guided, publicly desirable direction. ₂₁ The public sector allocated these flows, but their decisions influenced private flows because banks considered them to be the indication of the government’s interests.

As the political problems resulting from Japan’s trade surplus with the United States increased following the first oil crisis in 1973, the Japanese government started to realize the major banks’ important role in offsetting external economic and political pressures in terms of rising yen and the U.S.’s “Japan bashing,” and extending Japan’s economic interests in various spheres. Commercial loans could be used for projects that secured supplies of natural resources, or promoted financial relations with countries of special economic or political significance to Japan. In fact, the former high ranking official of the MOF, Fujioka noted that the government preferred portfolio investments (in this case, including commercial bank lending) to direct investment, since “direct investment could, if mishandled, create friction and conflicts between investing and investment-receiving countries.” ₂₂ “In contrast, capital and financial cooperation is comparatively free from such potential friction, and there is ample room to increase financial cooperation with the developing world.” ₂₃ The fungibility of capital is significantly greater in portfolio flows or commercial bank lending, making this type of financial transaction less overtly political for the recipient countries.

Consequently, two major sources of pressure influenced Japanese banks’ behavior -- the government and the manufacturing firms. “In essence, this general pattern has called for private Japanese industry to execute a given overseas project, relying on the Japanese government and a syndicate of Japanese commercial banks to provide a major share of the necessary financing.” ₂₄ Furthermore, one needs to consider the significant relationship between trade and financial flows. The role of trading companies is crucial in this respect. On one hand, because of Japan’s lack of natural resources, especially oil, a good part of Japanese investments or loans were provided to secure such raw material imports. Japan’s “national projects”, joint ventures between the Japanese government, banks, trade and manufacturing companies, were developed in the 1960s and 1970s to expand access to natural resources. Financial instruments such as export credit or tied aid were also frequently used to expand Japan’s export markets for its manufacturing goods. Hence, there were reasons for the positive correlation between trade, in terms of both exports and imports, and financial flows.

Finally, the presence of the United States is a crucial factor in explaining Japanese banks’ international behavior, particularly in the Latin American debt crisis. Japanese private bank and government involvement in the debt crisis and their efforts to help resolve it led Stallings to argue that Japan went along with the U.S. strategy on developing country debt, which was clearly designed to serve much more of U.S. interests than those of Japan. ₂₅ Nevertheless, she concluded that, “Japan’s actions with respect to Latin America, both during the heavy lending period up to 1982 and the debt crisis period after 1982, represent a move well beyond the traditional boundaries with which that country is most familiar and comfortable.” ₂₆ Although Japan has generally acted in support of the interests of the United States, pressure from the United States is only a necessary, but not sufficient, condition for Japanese action, ₂₇ for Japanese banks were also heavily exposed to Latin America.

Inter-bank politics are important in determining the volume and allocation of private capital flows. Devlin stresses that before 1979 those seeking loans (i.e., developing countries) faced a nearly flat commercial loan supply curve in Latin America. This flat supply curve is produced by the competitive nature of banking and follow-the-leader psychology among banks:

Concentration of the debt crisis in Latin America may not be unrelated to market structure. The leaders in the oligopolistic market, especially in the initial phase of the 1970s expansion, were U.S. banks. These institutions have traditionally been most comfortable in Latin America. To the extent that the credit market was subject to interdependent decision-making and follow-the-leader psychology, Latin America may have been the developing region subject to the most intensive marketing pressures of the banks. ₂₈

In the evolution of syndicated bank loans, “upstart banks relied heavily on the participation of other relatively inexperienced banks.” ₂₉ Furthermore, these smaller or inexperienced banks, voluntarily or involuntarily, adhered to the rules of the game set by big banks under the sovereign debt rescheduling. ₃₀ Japanese banks’ involvement in Latin America increased and they began taking a leading role in syndicated loan operations more often in the later 1970s and early 1980s, in spite of the signs of impending disaster seen by many.

The Japanese government following the U.S. initiatives (1982-1985)

As the debt crisis struck major third world debtors, the government role in international finance changed. On August 12, 1982, Mexican Finance Minister Jesus Silva Herzog informed the U.S. government and the IMF that Mexico would not be able to service interest payments on its debt. This sudden announcement shook the world of finance because of the magnitude of the creditors’ debt exposure in Mexico, which stood at $80 billion, and from fear of its repercussions on other major debtors like Brazil and Argentina. Smaller debtors like Bolivia and Ecuador also requested debt rescheduling in the fall of 1982. As the crisis hit, the policy-makers in the creditor governments scrambled to get emergency loans as well as new lending to Mexico and other developing country debtors to alleviate their liquidity crises.

Mexico’s rescue package was immediately assembled by the United States and the IFIs; the first $2 billion from the United States was transferred on August 15, half in the form of PL-480 food credit and the rest as advance payments on future U.S. oil purchases from Mexico using the Treasury’s Exchange Stabilization Fund. Negotiations among the creditor countries’ central bankers took place at the Bank for International Settlements (BIS) headquarters in Basle, Switzerland on August 18 to assemble an international rescue package. Due to the potentially destabilizing effects of the Mexican crisis on the international financial system and on the financial sector of their countries, central bankers from most creditor countries were sympathetic to the idea of an urgent rescue package. They agreed to provide $1.85 billion (including the portion from the United States) as bridge loans until the IMF agreement shaped up. ₃₁ The agreement between the Mexican government and the IMF was finally reached in November of 1982. The Mexican government agreed to cut its budget deficit drastically by lowering subsides and raising taxes in exchange for $3.7 billion IMF standby credit. By the end of the year, the formal rescue package for Mexico amounted to $8.25 billion. ₃₂

In addition to the official channels that had provided an international lender of last resort, the Managing Director of the IMF, Jacques de Larosière, practically twisted the arms of major transnational banks such as Bank of America, Citicorp, Chase etc., to commit $5 billion of the new money that would be needed to help cover Mexican balance of payments shortfalls in 1983. When the Letter of Intent for the IMF loans arrived on his desk, he insisted that there would be no IMF loans to Mexico without the commercial banks’ commitment to that amount. Although his strategy received an angry response from commercial banks, it helped make commercial banks in the debt solution.

As noted in the previous section, with the minor exception of “resource diplomacy,” Latin America has never been a critical region for Japan’s foreign policy. As one governmental official confided to a prominent scholar on Latin America, Peter Smith:

it is “comfortable” to be involved in Latin American policy, since there is little interference from other ministries, from the Diet, or the Prime Minister’s office. “We have no policy toward Latin America, though there are goals to be pursued through incremental gains.” ₃₃

Nevertheless, the lending boom of the late 1970s and into the 1980s and the following debt crisis that hit Latin America most severely attracted the Japanese government’s attention, at least during the time that the crisis was threatening the international financial system’s health directly or indirectly.

During the first phase of the Mexican rescue, the Japanese government followed the consensus of the creditor community led by the United States and the IMF. When the $1.85 billion rescue package was assembled through the BIS, the then-governor of the Bank of Japan, Haruo Maekawa, “promptly obtained the approval of the Japanese government to participate on a scale second only to the United States.” ₃₄ Furthermore, the Japanese government also prevented Japanese commercial banks from exiting Mexican and Latin American outstanding debt in these early months. Nihon Keizai Shimbun reported on December 15, 1982, that when Japanese commercial banks refused to roll over part of their short-term lending to Mexico, the U.S. Federal Reserve Board, the Bank of England and the Mexican government pressured the Bank of Japan to make banks do so. The Japanese MOF agreed with the strategy of the United States and Great Britain in order to avoid financial panic.

The outstanding claims of Japanese commercial loans never, in fact, decreased significantly for several years after 1982 and the banks seldom defected from agreements under Bank Advisory Committees (BACs) set up after the Mexican debt crisis nor exited from bad loans (see Figure 2). The reasons may be that the banks’ asset base in Japan was expanding rapidly during the period that they also possessed significant hidden assets, and the yen was getting much stronger against the dollar. ₃₅ These factors made it somewhat easier for Japanese banks to maintain a high level of exposure in Latin America. However, from the MOF standpoint, Japanese banks were still less competitive than other major banks in the world, thus they should be protected through MOF’s tight rein so that they did not have to accrue huge losses and possibly create a financial panic. In return, the MOF made various gradual concessions domestically in the form of increases in the tax-deductible rate on debt losses. ₃₆

In terms of capital flows from the Japanese private financial sector to the Latin American region overall, Japanese bank capital flow was fairly steady and positive until 1989. In addition, the size of official flows increased between 1986 and 1990, when overtaking those from the United States (see Figure 2).

Despite repeated debt relief agreements between the major debtors and private and public financial institutions between 1983 and 1984, there was no definite solution in sight. By mid-1984, Bolivia and Ecuador announced their debt payment suspensions and Peru stopped meeting its debt obligations. In June of that year, eleven Latin American debtors met in Cartagena, Colombia to discuss the issue. The meeting raised fear among some creditors of possible collective action among the debtors. Although the conference adopted a declaration that supported the creditors’ debt relief strategies, debtor frustration over prolonged economic difficulties due to their debt overhang was visible. ₃₇

At the IMF/World Bank Annual Meeting in Seoul, South Korea in October 1985, the Baker Plan, named after then-U.S. Treasury Secretary James Baker, was announced. In this plan, 15 of the most heavily indebted countries, ten of which were in Latin America, were targeted and three policy themes announced: (1) a continuing adjustment effort by these heavily indebted countries to produce economic growth, (2) greater collaboration between the IMF, the World Bank and other regional banks to provide $27 billion over the following three years to these countries, and (3) increased lending from private banks, rising to $20 billion over the following three years. ₃₈ The Baker Plan represented the U.S.’ recognition that more aggressive measures were required to provide adequate financing to allow Latin American countries to recover from debt overhang. The Plan required a greater flow of new money to heavily indebted countries. Japanese and European banks responded to the Baker Plan somewhat reluctantly and with suspicion. As noted, ten of so-called “Baker 15” countries were in Latin America (and 12 out of the 17 expanded heavily indebted countries) where American banks had the most exposure. The banks had already provided significant amounts of “new money” through involuntary lending to these high risk countries. Despite these considerations, 14 Japanese banks issued a statement to the World Bank on December 12, 1985 supporting the Baker Plan. ₃₉

Due to the changing environment of the world economy and other factors involved, it is hard evaluate the impact of such debt relief plans. According to some analysts of Latin American debt problems, the Baker Plan was somewhat of a disappointment because it did not lead to any significant recovery of the Latin American economies. The plan failed partly because the new money package did not restore large enough capital flows and partly because productive capacity did not expand. ₄₀ Within U.S. policymaking circles, some began to doubt the effectiveness of debt relief plans that presupposed the problems of the major debtors were illiquidity. They began to advocate some type of debt forgiveness. Senator Bill Bradley, for example, was skeptical about the Baker plan’s effectiveness and full payment of outstanding loans by the major debtors. He advocated a 3-percent interest cut on private and official loans for selected debtors that implemented successful structural adjustment led by the IFIs. Many Japanese bankers, at this stage, were not favorable to the debt reducing nature of Bradley’s proposal and emphasized market-oriented solutions to the debt problem. Nevertheless, the idea of debt reduction resonated among some policymakers. ₄₁

Re-emergence of the debt problem 1986-1987.

The payment crisis deepened once again for major Latin American debtors like Mexico and Brazil between 1986 and 1987. First, due to the decline of oil prices and increasing capital flight, the Mexican balance of payments, which had showed some signs of recovery, worsened in mid-1986. Mexico’s international reserves decreased by $3 billion during 1987. It was reported that Mexico would require $9 to 10 billion in new loans in order to get the country’s economy back on its feet. The IMF agreed to provide an emergency stabilizing loan package of $1.6 billion to Mexico, which was part of a $12 billion multilateral rescue package to Mexico. Rescheduling agreements between the Mexican government and commercial banks in September 1986 averted the worst outcome. The second major blow to the Latin American debt crisis solution was the Brazilian announcement of a moratorium on its $67 billion commercial debt on February 20, 1987. The Brazilian balance of payments had also worsened during the latter part of 1986.

By this time, the sense among policymakers in creditor countries had shifted. Previously, they understood (and promoted the understanding) that the developing country debt crisis should be characterized as a liquidity crisis, where more money was needed to resolve balance of payments problems. It was also understood to be temporary and short-term. After the series of setbacks during 1986-87 despite efforts by creditor banks, creditor governments and the IFIs, policymakers gradually became convinced that the problem was not merely a liquidity crisis and that they should acknowledge that these government insolvency could be the fundamental problem.

The payment difficulties of these major debtors also triggered increased loan-loss reserves of American commercial banks, which had high exposures to Latin America. The most influential response came from CitiCorp in May 1987, which announced that it had set aside $3 billion loan loss reserves to stabilize its position in response to the Brazilian crisis. In December, Morgan Guarantee announced a plan to retire up to $20 billion of its Mexican debt through the exchange of outstanding loans for government bonds at a 50 percent discount. This scheme converted part of the Mexican bank debt into 20-year bonds whose principal would be backed by US government securities. In this way, Morgan Guarantee exited from large outstanding claims, and Mexico reduced its debt by persuading the banks to exchange their loans for U.S. government guaranteed bonds at the discounted rate of 2 to 1. The Morgan Guarantee approach was endorsed by Secretary of State, James Baker. It constituted a model for future debt reduction schemes.

The changes in perception and commercial banks’ exposure positions were also reflected in the 1987 modification of the Baker Plan. At the IMF/World Bank Annual Meeting, Secretary Baker called for a “menu approach” that enabled commercial banks to select from various options of the menu when participating in support of debt relief. The options ranged from trade and project loans to some debt reduction measures such as debt swaps (with equity or for environment) and exit bonds.

The Japanese government responded to the re-emergence of the payments crises among major Latin American debtors by increasing its official financial commitment to the solution of the debt crisis, particularly by using its current account surplus. Following the announcement of Mexico’s economic difficulties, the Japanese Finance Minister announced, in October 1986, a $10 billion Capital Recycling Program over the next three years: the Japanese government contributed $2 billion to establish the “Japan Special Fund” in the World Bank, $3.6 billion to the IMF, $3.9 billion to the International Development Association (IDA -- a soft credit window of the World Bank) and the Asian Development Fund (a soft credit window of the Asian Development Bank). This Program was expanded to $30 billion in May 1987, after the Brazilian moratorium shock, Prime Minister Nakasone announced that an additional $20 billion would be allocated among various IFIs ($8 billion), committed for co-financing by the OECF and the JEXIM Bank with the private sector and IFIs ($9 billion), and disbursed as untied loans from the JEXIM Bank ($3 billion). ₄₂ This $20 billion was announced as an “omiyage (gift)” on the occasion of a U.S.-Japanese bilateral meeting. In the United States, it was reported to be primarily targeted at Latin American countries. ₄₃ The $30 billion Capital Recycling Program was well received at the Venice Summit in June of that year.

In this first stage of Japan’s active initiative to recycle its current account surplus, the recycling funds were targeted to increase the capital inflows to Latin American countries in particular. For this purpose, untied loans from the JEXIM Bank as well as co-financing arrangements with the IFIs were used with the goal of enhancing private capital flows to those states which were heavily indebted. Although capital recycling plan included activities of the OECF, the agency that deals with Japan’s foreign aid loans, the OECD faces some constraints in providing official capital resources to some Latin American countries because its basic law does not allow it to provide concessional yen loans to countries with relatively high per capita GNP. Therefore, the Japanese government needed a new funding instrument to recycle capital to Latin American countries with relatively high per capita GNP. ₄₄ The MOF envisioned that at this stage, approximately $4 billion of capital flows should take place between Japan and Latin America and the Caribbean countries. ₄₅

Japanese commercial banks behaved similarly to those in the United States. They wanted to “exit” from the prolonged and never-ending trauma of the Latin American debt crisis. Japanese banks felt locked in and forced to contribute to debt relief for various reasons. First, Japan’s regulations on loan loss reserves and the tax deductibility of such reserves were more stringent than those of their European or American counterparts. That, in turn, made it difficult for these banks to accumulate reserves or write off debt. ₄₆ Japanese banks fought the MOF to change the system from the outset of the debt crisis. The second reason was the pressure of the agreements produced by the BACs with various major debtors in Latin America. Japanese banks were obligated to follow the BAC agreements for rescheduling or providing new money in spite of their desire to exit. In this process, the Bank of Tokyo, the traditionally outward-looking foreign exchange bank with largest exposure to Latin American debt, with the help of the MOF, served as a major channel of pressure among the transnational bank community all carrying loan exposure. ₄₇ Finally, the strong peer pressure among the closely knit group of city banks led them to stick to the rules. The Bank of Tokyo, as a leading international bank, served as a key coordinator of international cooperation for debt relief. ₄₈

A compromise solution came about in March 1987 for Japanese “city banks” exposed to Mexican debt. The Tax Finance Bureau of the MOF, which had been vehemently opposed to any tax deduction of loan loss reserves, finally agreed to go along with the formation of JBA Investment, Inc. This holding company would have an $84,000 initial capital base contributed by Japanese banks. It would buy the banks’ Mexican debt at a discount and losses would be tax-deductible. The equivalent of 5 percent tax deductibility on reserves was tailored to reflect the bank demands. ₄₉

In the first five years of the Latin American debt crisis, commercial banks, creditor governments and IFIs strove to contain this international financial problem and later to support the recovery and economic growth of the Latin American debtors. Although the debt crisis affected developing countries in other regions, it was obvious that the United States’ biggest concern was its neighbors’ problems, because that was where U.S. bank exposures were the highest. The Baker Plan and its modification to a menu-approach were targeted mostly at Latin America, and all plans tried to restore private capital inflow to the debtors with some help from the IFIs. The deterioration in 1986 and 1987 of the balance of payments conditions of the two largest debtors, Mexico and Brazil, shifted the perspectives and strategies of commercial banks and led them to prepare for their “exit.”

The Japanese government, which had quietly supported U.S. initiatives during these first five years, began to show increased commitment to the solution of the Latin American debt crisis, particularly by providing increased official lending to the region. The $30 billion Capital Recycling Program was instituted on its capital contribution to the debt crisis solution.

The Japanese government’s initiatives in debt crisis management (1988-1991)

Mexico’s and Brazil’s recurring payment problems between 1986-1987 influenced the tone and attitudes of commercial banks and public institutions. Commercial banks hoping for a financial solution without significant loss, shifted their preference to more debt write-offs to free themselves from bad debts, even at a loss. They began voluntarily reducing their debt by resorting to the menu-approach of the modified Baker Plan ₅₀ and took advantage of the secondary markets. By 1988, according to an estimate by the Institute of International Finance (IIF), $26 billion in external debt of the Baker 17 countries had been eliminated by such voluntary debt reduction, $17 billion of which came in the year of 1988. ₅₁

Despite various debt reduction instruments made available to commercial banks to convert their outstanding loans, many doubted that even the reduced part of their claims would be fully honored by the debtor governments. This doubt created an obstacle for banks to engage in these conversions. In addition, major debtors still needed foreign exchange income to support the smooth operation of the debt conversion. Cline notes that “[o]ne important potential change in the strategy over the medium term would be joint action by banks and the public sector in industrial countries to provide effective guarantees to exit bonds.” ₅₂ The idea of increased creditor governments’ financial involvement in the solution of the debt crisis was discussed, but received a cold reception. Arguments against such action included: political considerations regarding creditor country taxpayers’ response to “bank bailout by public money”; the moral hazard problem that public involvement creates for poorly-behaved debtors and free-riding banks as they get bailed out with such support; and the budget implications of a large bailout plan, particularly for the U.S. government in the latter half of the 1980s.

In this context, the Japanese government first took an initiative to resolve the lingering debt problem. The so-called Miyazawa Plan, which included debt reduction schemes with public financial support, was informally introduced at the IMF Interim Committee in April 1988, and then privately discussed among the G-7 Finance Ministers at the Toronto Summit that June. Finally, the Plan was formally announced during the IMF/World Bank Annual Meeting in Berlin in September 1988. This plan contained three major components: (1) Debtors would reach an agreement with the IMF on a structural adjustment program promoting economic growth; (2) The flow of bilateral and multilateral public funds for structural adjustment would be increased; and (3) Banks and debtors would voluntarily convert a portion of debt to bonds and reschedule the remaining debt under suitable conditions once the structural adjustment program had been carried out. The debtor nations could securitize their debt by establishing a reserve account related to the proportion of debt converted to bonds and the proportion rescheduled. The management of this reserve would be entrusted to the IMF. ₅₃

At the same time, analysts and policymakers believed that the Japanese government would supply parallel lending to debtor countries, which would provide the reserves required for collateral for exit bonds, thus creating official financial support for exit bonds. ₅₄ Japanese Prime Minister Takeshita’s announcement at the 1988 Toronto Summit that the Japanese government would begin a five-year (1988-1992), over-$50 billion ODA program along with the $5.5 billion debt relief package for severely indebted countries lent support to this interpretation. ₅₅

The idea of debt reduction itself was included as part of the “menu approach” of the latter half of the Baker Plan, but what was new about the Miyazawa Plan was that it included heavy involvement of the IFIs’ guarantees supported by the financial contribution of major creditor countries, especially Japan. This scheme, according to Fujikawa, was one way to burden share among the three parties involved in the debt crisis: e.g. the debtors, commercial banks and the creditor governments (including the IFIs). While debtors had to abide by stabilization and structural adjustments written in IMF agreements, commercial banks had to accept some reduction of their debt or debt service. On the other hand, the public sector had to become the supplier of new money in case commercial banks had difficulty in doing so. ₅₆

Although this Japanese initiative was welcomed by a few countries, including France and Canada, and it earned some support from scholars of the debt issue, ₅₇ the Miyazawa Plan received a cold reception from the other creditor governments. Some argued that the plan looked too much like “the public bailing out the banks” particularly using the IMF as a “debt purchasing facility.” ₅₈ For Washington, this debt underwriting function through the IMF was considered too ambitious and expensive. Due to the strained condition of the federal budget, the U.S. government was not in a position to make a new infusion of money to the IFIs, but it was not ready to relinquish its voice in these international organizations. In addition, the concept of a public “bail-out” would be resented much more in the United States than Japan give the U.S. political system with much stronger scrutiny over the government’s use of taxpayers’ money. ₅₉ Some commercial banks joined in the criticism of the plan, arguing that it would distort the market and lead to moral hazard problems on the part of the badly behaved debtors that might benefit from the debt reduction. ₆₀

During a visit by Japanese Prime Minister Takeshita to Washington right after President Bush took office in February 1989, Takeshita confirmed that the United States and Japan would collaborate in their economic assistance efforts, particularly in Latin America and Middle East. Referring to the allocation of Japan’s ODA and support for debt relief, the Prime Minister noted that “Japan would like to expand the coverage of its ODA from the concentrated allocation to countries like China and the Philippines to a more widespread allocation toward Latin America and Africa.” ₆₁ President Bush was willing to revise the Baker Plan and promised that his administration would respond to the debt problem with flexibility. The prolonged debt problem and slow (or negative) growth of the heavily indebted countries were becoming major concerns for Washington, because of the negative impact on national security arising from those countries economic and social instability, and on prospect for the democratization of some Latin American countries, which were to hold elections during 1989-90. ₆₂

The resulting debt strategy by the Bush administration came in the form of the Brady Plan on March 10, 1989. The plan was formally called “The strengthened debt strategy” or “The new debt strategy”; it took on the name “Brady Plan” from Treasury Secretary Nicholas Brady. This debt reduction plan was targeted at heavily indebted middle income countries by forgiving debt service to commercial banks and/or compressing the debt’s principles. The plan conserved the principals of the Baker Plan, including the goals of (a) economic growth of the indebted countries, (b) structural adjustment of the debtors, (c) new money inflows from abroad, and (d) a case-by-case approach. However, the Brady Plan also emphasized debt reduction through various menu items, and the remaining portion of debt and new bond instruments were to be de facto guaranteed by the IMF and the World Bank. The plan also included penalties for commercial banks that did not abide by the Brady Plan; where banks would have their interest and principal payments suspended for three years. The debtors, on the other hand, were to take measures to decrease their debt overhang by restructuring their economies, promoting capital inflows and repatriating flight capital.

The Brady Plan very closely resembled the Miyazawa Plan. The Japanese government and the U.S. Treasury held consultations before its official announcement. At the end of February, a Treasury official, Charles Dallara, came to Japan and informed the government that the United States wanted to accept the Japanese proposal. The details of the plan were then discussed by the two governments. ₆₃ When the Brady Plan was announced in March, Japan’s Finance Minister Murayama told reporters that:

I would like to welcome the amply strengthened debt strategy just announced by Treasury Secretary Brady, and would like to support this new plan proposed by the United States that includes voluntary market-based debt and debt-service reduction and repatriation of flight capital. We have been in close consultation with the U.S. monetary authority on this issue, and this new American proposal incorporates fundamental ideas put forth by the Japanese government previously. Japan will collaborate closely with the United States and other governments concerned to implement this new debt strategy..... ₆₄

The G-7 governments accepted the plan in April. The plan was also supported by the heads of states at the Paris Summit in July. Japan was the strongest supporter of all. During the IMF meeting in April, the Japanese government promised to provide $4.5 billion through the JEXIM Bank in parallel financing with the IMF to support the Brady Plan. ₆₅ As a few debtor countries like Mexico, the Philippines, Costa Rica and Venezuela entered negotiations with the IMF by the early summer of 1989, the Japanese government announced an additional $35 billion contribution to the already committed $30 billion Capital Recycling Program of 1986-87. This contribution increased the total of the Capital Recycling Program to $65 billion over fiscal years 1987-1991, $10 billion of which was committed toward debt relief. ₆₆

The first debt reduction negotiations commenced in April 1989 between various groups of creditors and the Mexican government. They reached agreement in July and concluded the details in September of that year. In the agreement, donor governments rescheduled their $2.6 billion official loans, the IMF and the World Bank provided $4.1 billion through the $1.6 billion Extended Fund Facility (EFF) and $2.6 billion Sector Adjustment Loans (SECALs) respectively, and the JEXIM Bank provided new untied loans totaling $1.9 billion, $1 billion in parallel financing with the IMF and $0.9 billion in co-financing with the World Bank. On the other hand, $48.5 billion of medium and long-term commercial bank debt was to go under the debt reduction scheme. Overall, 41 percent of the total debt negotiated ($19.9 billion) was reduced through discount bonds (reducing the principal by 35 percent), 49 percent ($23.8 billion) through par bonds (interest reduction to 6.25 percent per year), and only 10 percent ($4.8 billion) as new money equivalent to a quarter of the old debts loanable in four years. ₆₇

During the seven years between 1987 and 1996, the JEXIM Bank alone provided $11 billion or 23.6 percent of untied loans to Latin American through the Capital Recycling Program (and its successor, Development Initiative program). Mexico (1989), the Philippines (1989 and 1994), Venezuela (1991) and Argentina (1993) benefited from JEXIM Bank’s untied loans parallel to the IMF agreement and concluded successfully their Brady deals (see Table 2).

JEXIM support to Brady Plan with timing and account inserted here

Between 1988 and 1991, the Japanese government took an unprecedentedly strong initiative in helping resolve the debt crisis, initiating and supporting debt reduction schemes both politically and financially.

In sum, Japan demonstrated an increasing presence in financial crisis management of the developing world particularly as a source of development finance. Even Latin America, which was traditionally outside Japan’s sphere of interest and did not have strong economic links with Japan, developed more ties with Japan, particularly on the financial side of economic exchange. Finally, Japan’s active involvement in providing official financial support to resolve the debt crisis, beginning in the mid-1980s, made the Japanese government appear as an important leader in financial crisis management.

Many heavily indebted countries in Latin America succeeded in reducing their debt through the Brady Plan deals and other debt reduction measures. In turn, they began to attract private (mostly portfolio) investment based on their bond issuance and privatization. The so-called emerging markets of Latin America started booming in the early part of the 1990s, and the Latin American financial crisis appeared to have finally been solved.

 

Currency Crises in the 1990s: Mexico and beyond.

Mexican Peso Crisis, 1994-1995.

It will take many more years to evaluate the full effectiveness of the Brady Plan for Mexico and other heavily indebted middle income countries. By 1992, however, the prospect of Latin American recovery looked bright. David Mulford, who pushed the Brady Plan through in 1989 as Undersecretary for International Affairs at the U.S. Treasury, wrote triumphantly in the Wall Street Journal that the U.S. economy had benefited from restored economic growth in the Latin American region, and that the United States had begun to expand its new Western Hemispheric trade partnerships. ₆₈ The Economist was also cautiously optimistic about the positive outcome of the Brady Deals, noting that “[t]he Brady gamblers win, for now.” ₆₉

Good times continued for most Latin American countries in the early 1990s, with international investors becoming increasingly attracted to bonds and equity issues by these ex-debtors, ₇₀ and the Mexican economy started to become even more integrated with North America than before thanks to the successful negotiations of the North American Free Trade Agreement (NAFTA) which came into effect in January 1994.

This fast growing and booming economy in Mexico did not last long. On December 20, 1994, the Mexican government was forced to leave the band within which the peso had fluctuated against the U.S. dollar. The Mexican peso was devalued by 15 percent, changing the ceiling of the exchange rate band. Two days later, on December 22, Mexico was forced to allow the peso to float. As Mexico abandoned its pegged exchange rate and moved to a floating currency, the peso continued to come under attack, with corresponding effects on its stock and bond prices. Investors withdrew capital from Mexico during the first few days of the peso devaluation, leaving Mexico’s foreign exchange reserve as low as $6 billion. ₇₁ At the same time, Mexico’s dollar-denominated short-term bonds Tesobonos (Bonos de la Tésoreria de la Federación) were maturing -- January through March 1995 -- and many feared that Mexico could exhaust its dollar foreign exchange reserve in only a few weeks. ₇₂ Over the next few months, the Mexican stock market dropped by 68 percent in dollar terms (between December 19, 1994 and its low on March 9, 1995). ₇₃ The speed and magnitude by which portfolio capital flows exited from Mexico in 1994 especially sent shock waves through the international financial community.

On December 24, Financial Minister Jaime Serra Puche from Mexico’s new Zedillo administration, which was inaugurated less than a month before, flew to New York and Washington to calm investors and request support from the United States and the IFIs, particularly the IMF. ₇₄ An international rescue package for Mexico, led by the United States and the Bank for International Settlements (BIS), was negotiated during the last few days of 1994. On January 2, 1995 the package was expanded to $18 billion, including $6 to 9 billion of the U.S. swap facility, ₇₅ $5 billion through BIS, about $1 billion from Canada and $3 billion from commercial banks. The U.S. Treasury was quoted as stating that Japan was to contribute “$0.6 to $1 billion” through the BIS arrangement. ₇₆

To the distress of the Mexican authorities and the creditor governments that agreed to contribute to the $18 billion rescue package, the peso continued to drop during the first few weeks of January 1995, pulling down the Mexican stock market. “Contagion effects” were felt in various emerging markets of other middle income countries, like Argentina, Brazil and the Philippines. ₇₇ . The threat of possible systemic effects of the Mexican crisis to the international financial world led President Clinton to request Congressional authorization on January 12 to provide Mexico with $40 billion in the form of loan guarantees, and at the same time to call for expanding the $18 billion rescue plan to $25 billion.

The Clinton administration faced two stumbling blocs. First, the U.S. Congress itself, which was not easily persuaded by the President’s call to rescue Mexico and further burden on the U.S. budget, which they wanted to balance, in this manner. In addition, Congress insisted that Japanese and European creditors participate in the expanded Mexican rescue plan if they were to authorize the $40 billion rescue package. ₇₈ Second obstacle is that the other creditor governments, especially in Europe, had become increasingly resentful of the Clinton Administration’s attempt to ram the Mexican package down their throats. ₇₉ This prolonged debate in Congress and resistance from the other industrial countries negatively influenced the Mexican peso and its stock market.

Finally, the IMF was placed at the center of the Mexican rescue package as it announced $7.8 billion in 18-month stand-by credit for Mexico on January 26. The first stand-by arrangement was equivalent to the maximum of the Mexican cumulative limit (equivalent of its 300 percent quota). All waited for the U.S. Congress to pass the $40 billion loan guarantees in due time. However, doubts about the Congress authorizing the $40 billion package became more and more evident during the last week of January, and the market was responding negatively to Mexican and other efforts to restore credibility. The last weekend of January, the Mexican external balance became dangerously low. The Mexican authorities informed the United States and the IMF that they might not be able to hold on any longer, and must default on some of Mexico’s payment obligations. In response, President Clinton and the IMF’s Managing Director, Michel Camdessus, stepped in with unprecedentedly strong rescue initiatives. The Clinton Administration announced a $48.8 billion multilateral assistance package to manage the Mexican financial crisis, including up to $20 billion in currency swaps and securities guarantees from the U.S. Treasury’s Exchange Stabilization Fund. The $48.8 billion package also included an increase of the IMF’s 18-month stand-by arrangement to $17.8 billion. This amount was equivalent to 688.4 percent of Mexico’s IMF quota, the highest proportion allowed to any member country. The Clinton Administration and the IMF also counted on $10 billion through the BIS (i.e. double of what was originally discussed) and $1 billion from Canada. In addition, the Administration was hoping for $1 billion in currency swaps from Argentina, Brazil, Chile and Colombia (but this did not materialize). Three billion dollar in new loans from commercial banks were also promised (but never called upon by the Mexican government). The World Bank and the Inter-American Development Bank (IDB) also extended a total of $3 billion in loans. ₈₀

The Japanese government responded to the calls for action, but expressed reservation similar to those of several European governments. These governments viewed the 1994-95 Mexican financial crisis as a problem for the Americans, who had by far the largest stake both in terms of investments and the legitimacy of NAFTA, and security concerns with illegal immigration and drugs flowing from its economically depressed southern neighbor. ₈₁ As noted above and due to “private” nature of the Mexican financial rescue, several European countries also were not happy with the way the rescue package was hastily assembled by the United States.

Japan, at least, appeared ready, however, to collaborate on the U.S. initiatives. During a meeting of finance officials from the G-7 countries on February 1, 1995, a Bank of Japan official was quoted as saying that Japan had decided to provide $1.3 billion for the BIS aid package to Mexico. ₈₂ In addition, four Japanese commercial banks, Bank of Tokyo, Industrial Bank of Japan, Sumitomo Bank and Fuji Bank, were requested by the U.S. banks to contribute the total of $1.2 billion to the package arranged by commercial banks, led by CitiCorp and Morgan Guarantee. The final commitment that these four Japanese banks accepted on January 25 was, however, only $0.4 billion.

As the Mexican crisis wound down in mid-1995, the Bank of Japan and the commercial banks contributed very limited support to the Mexican rescue package. The BIS loan package was in effect only available on paper and there were high repayment guarantees needed and stringent restrictions on its use. In any case, the Mexican authorities did not use the package assembled by the commercial banks (March 1995) or the BIS (June 1995). The loan package from the IMF and the United States was apparently large enough to calm investors.

There were a few gestures of support by Japanese actors for the Mexican rescue during the summer of 1995. For example, the Japanese trading companies extended $0.5 billion in loans to the Commercial Bank of Mexico (Bancomext) with the support of trade insurance by the Ministry of International Trade and Industry (MITI). ₈₃ The JEXIM Bank resumed their loans to Japanese companies intending to invest in Mexico. ₈₄ The Mexican government floated bonds, and four major Japanese banks (Bank of Tokyo, Fuji Bank, Industrial Bank of Japan and Sumitomo) bought $20 million each. In addition, a development project through OECF began in the fall of 1995 including that on Mexican sewage treatment. However, it is striking that Japanese involvement in the Mexican peso crisis was very limited, especially after Japan’s significant financial support of the Brady Plan implemented for Mexico. It was not until June 1996, during Japanese Prime Minister Hashimoto’s visit to Mexico, that the JEXIM Bank extended its untied loans to Mexico, promising $0.5 billion for Mexico’s export promotion. ₈₅

The Mexican peso crisis severely curtailed Mexico’s domestic economic growth, but thanks to the lowered peso and U.S. efforts, both in terms of the rescue operation and increased imports, the Mexican external balance stabilized by early 1996. On January 16, 1997, Mexican President Zedillo announced that Mexico repaid its entire debt with the U.S. Treasury and thus concluded the major part of its financial obligations that had been needed to stabilize its balance of payments.

Contagion Effect in Argentina, 1995.

The Argentine currency and stock market came under attack as a part of the contagion effect of the Mexican currency crisis. Argentina signed the Brady Plan agreement in April 1993 after more than a year of tough negotiations with the IMF and commercial banks. The JEXIM Bank again supplied $0.8 billion of the $3.2 billion funds by IFIs to support the purchase of zero-coupon bonds. There was a strong similarity between Mexico and Argentina in the way that the balance of payments was maintained during these booming years. The Convertibility Plan inevitably made the Argentine peso expensive, thus making it harder to export and easier to import. ₈₆ This, along with the booming economy, led to a significant current account deficit, but that deficit was compensated by inflowing capital from international investors attracted to Argentina’s bonds and equities (thus turning Argentina’s capital account positive). As U.S. interest rates rose after February 1994, such external capital flows began to dry up and gradually made Argentina’s current account deficit hard to sustain. The Mexican Peso crisis of December 20, 1994 severely affected the Argentine external financial balance. The contagion effect, often called “Tequila Effect,” was strongly felt in Argentina. Foreign capital flows were reversed and its international reserves dwindled from an already low $16 billion in December 1994 to $11.2 billion in May 1995. ₈₇

Facing election for a second presidential term in May 1995, Carlos Menem and his administration began crisis management immediately after the Mexican crisis. They applauded the economy’s good health and demonstration of their strong commitment to the Convertibility Plan of a fixed nominal exchange rate. They also provided domestic financial institutions various safety nets to prevent bank closures. These measures did not work as expected, and the attack on the Argentine currency and stock market continued during the first few months of 1995. Finally, Argentina turned to the IMF and other public institutions for help. On March 13, 1995, Argentina’s Economy Minister, Cavallo announced that Argentina had agreed to receive a $4.7 billion loan package from the IMF ($2.4 billion), the World Bank ($1.3 billion) and the IDB ($1 billion). The IMF portion came in the form of a 12 month extension of Argentina’s already established March 1992 $6.3 billion EFF credit. ₈₈

To solicit additional bilateral support, Economy Minister Cavallo flew to Tokyo on March 31 to request a $1.2 billion rescue package from the JEXIM Bank and six Japanese commercial banks (Bank of Tokyo, Daiichi Bank, Sumitomo Bank, Fuji Bank, Industrial Bank of Japan and Long-term Credit Bank). ₈₉ The JEXIM Bank responded favorably to the Argentinean request. The two parties signed a letter of agreement in June, through which the JEXIM Bank pitched in $0.8 billion in untied loans parallel to the IMF’s EFF on June, 22. In addition to this multilateral and bilateral financial support, the Argentine government privatized hydroelectric dams, nuclear power installations and petrochemical plants raising $1 billion. It also subscribed a $2 billion “Argentine bond” arranged by thirty transnational commercial banks. Among Japanese banks, only the Bank of Tokyo participated in the scheme arranging $50 million. ₉₀

1995 Contagion Effects in Asia and the 1997 Asian Currency Crises.

As the Mexican peso crisis, called by some the “first financial crisis of the twenty-first century,” induced the Clinton Administration to act quickly to contain it and its contagion effects in other emerging markets, the Japanese government and businesses were more concerned about Asia than Mexico. Throughout the late 1980s and early 1990s, Japanese businesses and investments have had an increasing presence in East and Southeast Asian countries (Table 3 with statistics). As many Japanese commercial banks exited Latin American debtors in those same years, and with limited investment opportunities in their domestic economy, many Japanese capital outflows, in terms of bank lending, foreign direct investment as well as portfolio flows, were directed to booming Southeast and East Asia.

Japan’s FDI and bank lending to East and Southeast Asia in the 1990s

The contagion effect of the Mexican currency crisis shook some currencies in the Asian region around the second week of January, 1995. The Hong Kong dollar, Thai baht, Indonesian rupiah and Philippine peso were all affected, though not to the same magnitude as the Mexican or Argentine currencies. The MITI-affiliated research institution, Institute of Developing Economies (Ajia Keizai Kenkyujo), quickly published a study emphasizing that the Mexican peso crisis would not have a significant effect on the Asian currencies or their economies. ₉₁ The report emphasized that the economic fundamentals and conditions of Southeast Asian countries were different from those in Latin America in general and Mexico in particular. Some experts have pointed out, however, that Southeast Asian countries do have various things in common with Latin America: their current account deficits, their reliance on external capital (less in the form of portfolio flows compared to Latin America, but still a high proportion), their pegged exchange rates, and their weak domestic financial sectors.

Some preventive measures to ensure against a replay of the Mexico-type currency crisis were needed. In September 1995, as the aftershock of the Mexican crisis were still felt in some emerging markets, the Chairman of the Australian Federal Reserve Bank, Bernie Fraser, advocated an Asian version of the BIS, a stronger coordination mechanism among the Asian central bankers than what currently existed, and with a bridge loan facility, to prepare the region for financial emergencies. By November of the same year, East and Southeast Asian countries including Thailand, Indonesia, Malaysia, Hong Kong and Singapore (in December) joined in an agreement for mutual cooperation in cross support of their currencies. ₉₂ The IMF, for its part, established exceptional procedures that would enable it to respond promptly and prudently to serious financial crisis. The new IMF facility was called the Emergency Financing Mechanism. ₉₃

These ideas and mechanisms were put to the test when the Thai currency was attacked in May 1997. The Thai central bank spent billions of dollars to defend its pegged currency, but by May 15 the authority had no alternative but to impose informal exchange controls to defend the baht. As promised, the central banks of Singapore, Malaysia and Hong Kong also supported the baht in the currency market on May 14, but the attack continued. With its weakened economy, the Thai Central Bank could not help but let the baht float on July 2, 1997. The currency came under a severe attack on that day and lost about 17 percent of its value against the U.S. dollar. Contagion effects were again a prominent feature of the crisis. Within a few weeks, the Philippine peso and Malaysian ringgit were forced to devalue, and ripple effects were also felt in the currency and stock markets of other Asian countries. ₉₄

The Philippines was the only country that immediately turned to the IMF, for it had already had an IMF program agreed several years ago. Applying the newly established “New Arrangements to Borrow” under the Emergency Financing Mechanism, the Filipino government obtained an agreement with the IMF for $1 billion financial support in the form of EFF credit and other financial programs on July 18, only a week after its peso came under severe attack. ₉₅

The government of Thailand was initially reluctant to resort to IMF financial support, which comes with stringent conditionality. Thailand’s new Finance Minister Thanong Bidaya and Central Bank Governor Rerngchai Marakanond visited Tokyo to meet with 21 Japanese commercial banks to explain the current economic situation in Thailand on July 17 and 18, 1997. They also met with Japan’s Finance Minster Mitsuzuka. During that meeting the Japanese government agreed that it would intervene in the foreign exchange markets to defend the baht. Even at this point, Thanong was reportedly explicit that he did not intend to request financial support from the IMF. ₉₆ As the attack on the Thai currency and outflow of foreign capital continued in the last week of July, the Thai government had no other alternative but to shift its policy and turn to the IMF. By August 4, 1997, the government of Thailand and the IMF reached a basic agreement. An international conference met in Tokyo, led by the IMF, seeking to hammer out concrete terms for the Thai bailout package. Japan’s MOF was supportive of Thailand as it reached agreement with the IMF. The rescue package finally assembled totaled $17.2 billion. Japan ($4 billion through the JEXIM Bank untied loans) and the IMF ($4 billion) contributed the largest components. Many Asian countries also contributed to the package as did the World Bank ($1.5 billion) and the Asian Development Bank ($1.2 billion). ₉₇ The United States was the one significant party that did not take part in this rescue package. Although its delegate was present at the IMF-led conference in Tokyo, the U.S. government did not commit any financial support at that time.

From the Thai currency crisis and rescue in the summer (July/August) of 1997 through the Indonesian currency crisis and rescue in the fall (October/November), an interesting tug-of-war emerged between “Asian Monetary Fund” advocates and the IMF-centered Western coalition that opposed this idea. In stark contrast to the 1995 American-led Mexican rescue package, Thailand’s rescue package demonstrated collaborative action among Asian financial authorities, with solid Japanese initiative and in the absence of U.S. leadership. This rescue package was seen by many as a “precursor of future standard arrangements” for this type of crisis in the region. ₉₈ By August 18, the Thai foreign minister was reported saying that he would like to propose the establishment of an ASEAN Monetary Fund (the name was tentative) to support Asian currencies against foreign speculators. ₉₉ The Finance Secretary of the Philippines picked up the idea in September at an ASEAN Finance Ministers Meeting. The Asian Fund scheme was considered as a counterpart to the IMF, with Japan as the major contributor. Japan’s Finance Minister Mitsuzuka, at that time, mentioned Japan’s interest in collaborating if Asian governments put forth such requests. ₁₀₀ Mitsuzuka finally put the idea of an Asian Fund on the table at the IMF/World Bank Annual Meeting in Hong Kong on September 21. In his meeting with ASEAN financial ministers, he proposed the establishment of a $100 billion fund (tentatively called the Asian Fund) that would be financed and run by Asian countries to help the region’s governments cope with currency crises. The arrangement would be based on the Thai rescue package put together by the Asian countries along with Australia. He also suggested that the IMF be the model for the operation of such fund. ₁₀₁

The reaction from IMF supporters in the United States and Europe and the IMF itself was cautiously negative and skeptical. Although overt objection was limited in public, it was clear that the governments of the United States and Western Europe as well as the IMF did not want relinquish its power to push the “Washington Consensus” via the only international financial institution that can assist balance of payments problems. They were also worried about constructing a divided authority in international monetary matters. ₁₀₂ The IMF deputy managing director Stanley Fischer criticized the proposal, stating that it could undermine the authority and effectiveness of the IMF itself. In addition, Congressional constraints faced by the Clinton administration in allocating large fund to such a new organization have made the U.S. critical of the idea of new fund, which, without the U.S. active contribution, would threaten the U.S. influence in Asia. ₁₀₃

The IMF and major creditor countries, other than Japan, were also agitated further because the G-7 finance ministers had recently reached a compromise agreement to increase the IMF capital base by a more-than-expected 45 percent precisely to prepare the IMF to address possible currency crises in Asia and other emerging market countries. As a result of this capital increase, the voting powers of Japan and many Asian countries, including South Korea, Malaysia and Thailand, in the IMF were expanded. ₁₀₄

This Asian Fund issue was continuously debated during October and November as many Asian currencies became the targets of speculative attacks, including those of Indonesia and South Korea. The Japanese government maintained its support for the idea pushed by the Asian governments to counter “foreign speculators,” the emergence of whom many believe is due to the IMF and U.S. led liberal economic prescriptions. ₁₀₅ One of the most influential officials in Japan’s MOF, Eisuke Sakakibara, has been quite vocal in deploring the damages that the so-called “Washington consensus” on development has caused. This consensus centers its economic philosophy on the promotion of financial liberalization, exchange rate adjustment, privatization and deregulation under strong fiscal discipline. ₁₀₆ Although there has been no explicit mention that an Asian Fund will be more lenient on the countries under crisis, Sakakibara emphasized the “flexibility” that such Fund could bring in the operation of emergency funding. ₁₀₇

The Japanese support to the regional financial arrangement, however, was not unanimous. As early as mid-September, Japanese bankers were negative to the idea and quoted as saying that “such fund as the financial last resort creates a psychology of dependence.” ₁₀₈ Even those who are not directly engaged in finance noted that it is dangerous to provide easy money in the name of Asian rescue, because it can undermine the reform and adjustment opportunity that the IMF provides. ₁₀₉

The Asian Monetary Fund proposal was finally put to rest at a meeting of APEC finance ministers in Manila held on November 18-19 before the APEC annual meeting in Vancouver. Although the participating finance ministers agreed to the “need and desirability of a framework for regional cooperation to enhance prospects for financial stability,” they basically concluded that the emergency funding scheme should be based solely on the IMF. Additional financial assistance would be possible for the countries in financial distress only after they fully negotiate the conditionality with the IMF. ₁₁₀ This marked the end of the debate (for now). Actually, Tokyo gave up the idea even before this meeting, and ASEAN senior financial officials who met in Kuala Lumpur on November 30 affirm that “at this level, [the proposal] is in the backburner.” ₁₁₁

The U.S. government changed its attitude toward Asian currency crises from the passive reluctance demonstrated during the first major rescue package for Thailand to more active participation. This change came, on one hand, as a response to the emerging “regional” schemes to address the Asian economic problem, and on the other hand, from the U.S. policy-makers’ realization that Thailand was not going to be an isolated case and there was a high risk of contagion effect from this crisis. ₁₁₂ As Indonesia’s currency came under attack and the Indonesian government, after repeated attempts to avoid the IMF involvement, finally turned to the IMF (an agreement was reached on October 31, 1997), the U.S. government promised to contribute $3 billion of the $14 billion bilateral contribution pledges. This bilateral contribution is considered as the “second line of defense” in case the first line defense consisting of $10 billion from the IMF, $4.5 billion from the World Bank and $3.5 billion from the Asian Development Bank (ADB) fails to stop the run on the Indonesian currency. ₁₁₃ The Japanese government’s financial contribution made Japan one of the two biggest bilateral contributors to the Indonesian rescue. Along with the Singapore government, the Japanese authority contributed $5 billion dollars. In addition to such financial contribution, the Japanese and Singaporean monetary authorities stepped into the Singapore currency market in early November to prevent the Indonesian rupiah from falling further. ₁₁₄

The last major IMF-led rescue package (as of March 1998) was assembled for the government of South Korea, the country that is the 11th largest economy in the world. By November 1997, with a vicious attack on its currency and plummeting stock market, it was seen that Korea needed some kind of financial help. ₁₁₅ The Korean government and its policymakers, however, vehemently denied the speculation that Korea would go to the IMF. ₁₁₆ An attempt to arrange rescue packages directly with Tokyo failed. And as Korean Won dropped below 1,000 to the dollar and its financial stabilization package, announced on November 19, did not succeed in restoring overseas confidence, the Korean government turned to the IMF asking for $20 billion from its emergency loans on November 21, 1997. Its deputy Prime Minister Yim Chang-yol called, the same day, on the Japanese finance Minister Mitsuzuka requesting additional financial support from Japan. ₁₁₇

Facing the biggest economic threat ever among the series of the Asian crises, and acknowledging Korea’s disposition to go to the IMF, the Japanese government responded quickly and positively. On November 24, during the APEC forum in Vancouver, Japanese Prime Minister Hashimoto met with South Korean President Kim Yong-sam and promised to assist South Korea financially in cooperation with the IMF. Furthermore, various high ranking officials from South Korea visited Japan in the end of November to increase the chance and the amount of emergency funding from Japan. It is reported that the Korean government was hoping for $20-30 billion commitment from Japan. ₁₁₈ The $57 billion South Korea rescue package, the largest ever assembled, was agreed with the IMF on December 3 including $21 billion from the IMF (which constitutes 1,939 percent of Korea’s quota), $10 billion and $4 billion from the World Bank and the Asian Development Bank respectively as the first line of defense against Korea’s financial crisis. In addition, a second bilateral line of $20 billion came from Japan ($10 billion), the United States ($5 billion), and other OECD countries. ₁₁₉ South Korea also got some break from external financial pressure as it secured agreements with foreign commercial bankers and investors to reprieve the repayments of $15 billion loans by the end of December, and started to convert some of its short-term loans to bonds with long-term maturities. ₁₂₀

In both the Indonesian and South Korean cases, the U.S. government’s plan and desire have been clearly behind their IMF agreements. Unlike the case of Thai rescue package, the United States also committed the second largest bilateral financial commitment, next to Japan, as a “second line of defense” if the crises are to deepen. Moreover, the Clinton Administration has put significant pressure on the Japanese government to support the ailing Asian economies both directly -- by contributing financially to these countries and letting some repayments to delay -- and indirectly -- by stimulating its own economy in recession with stimulus fiscal package and buying more from those countries in crisis.

In the face of the U.S. re-assertion of its role in the Asian currency crises, the Japanese government’s less independent position, particularly after the failure of the Asian Monetary Fund scheme, has been quite striking. On one hand, the Japanese government demonstrated strong leadership and significantly supported the rescue plans for Thailand, Indonesia and South Korea. On the other hand, however, the Japanese government has given up its independent initiatives and has insisted that reluctant Asian countries go through the IMF before Japan commits itself to help them financially. And the Japanese government, particularly the MOF, pushed for the increase of the IMF capital base in September, which also enhanced Japan’s voting power within the IMF (which is linked to the amount of capital subscription to the organization).

In sum, the Japanese government, whose political and economic interests are obviously much higher in Asian region than in Latin America, has still been inhibited from acting independently in assisting countries in the financial crises that have shaken the region. Even though the Japanese government showed strong initiative in the first Thai rescue case and has often committed a large financial resources, the Japanese government has preferred to cooperate extensively with the IMF (and the United States behind it) to support its rescue packages with stringent conditionality, to pursue alternative solutions. Concerned about the detrimental economic (and political) implication of such conditionalities, the government of these countries in crisis hoped for such alternative solution led by the Japanese, but it never materialized.

 

Conclusion

Despite the widely discussed difficulties with collective action that prevent cooperation on the international level, the history of two decades of financial crises in the Pacific Rim indicates that there has been a fair amount of cooperation in economic crisis management between the United States and Japan. In most cases, the Japanese government supported U.S. initiatives to resolve those crises that could have threatened the international financial system. The dominance of a cooperative relationship between the United States and Japan, particularly the follower and financier role of the Japanese government, provides a challenge to the theory of relative gains in which the benefits from cooperation are judged in relative terms, not absolute terms, and thus creates an environment that inhibits cooperation. ₁₂₁ On the other hand, U.S.-Japanese interaction seems to support the “Japan as a reactive state” thesis, in which the Japanese government, because of its strong dependence on U.S. support in various issue areas and because of its fragmented decision-making structure, often reacts to U.S. demands in defining its foreign policy. ₁₂₂

It is important, however, to note that there are a few critical variances and puzzles in the way the Japanese government cooperates with the United States in individual cases of financial crisis management. First are the cases in which Japan did not cooperate with the United States -- most prominently the 1994-95 Mexican peso crisis. If Japan is a reactive state and would readily responds to U.S. demands, this Mexican crisis is precisely the kind of case for which U.S. government wanted Japan’s cooperation, through a large financial contribution, but that the Japanese government was not so forthcoming in contributing.

Secondly, the two sets of Pacific Rim financial crises cases contribute to the understanding of regionalization trend of the 1990s. It is very clear that the United States has had a higher stake than Japan in the Latin American debt crisis, and the Japanese government has taken the Asian crisis as its primary concern. Then, it makes sense to assume that the United States would take a lead in managing the Latin American debt crisis, with the Japanese government following. On the other hand, in the case of the Asian crisis, the initiative should be taken by the Japanese. However, with a hint of the exception of the Thai currency crisis, the Japanese government was not able to formulate the crisis management structure that could have enhanced its influence and power in its region (such as the “Asian Monetary Fund” or unilateral and direct rescue packages without the IMF or U.S. involvement). In the Asian crisis, the affected governments all first went to Japan for emergency funding without IMF involvement. The Japanese government, however, responded to these requests by insisting that these governments go through the IMF first. In this sense, the Japanese government’s position appears to be more global than regional.

Finally, and in complement to the second puzzle, it is important to note that economic downturns of major powers have often coincided with the respective region’s crisis. A possible exception is the Mexican peso crisis, which occurred as the U.S. economy was starting to recover from the recession of the early 1990s. Both the Latin American debt crisis (mostly in its solution stage) and the Asian currency crisis occurred as the respective regions’ economic “hegemons” were in a relatively weak position. The observations from U.S.-Japanese cooperation in the Pacific Rim crises seem to indicate that there is a close linkage between the economic and budget conditions, the trade and financial interdependence between the two countries, and the increased possibility of collective action between the two governments. Such linkage is particularly important when the regional financial crises themselves have increased economic damage to the major economic powers facing recession or weak external balance. The scope of this paper allows me only to indicate the existence of such linkage; the issues of causality is being investigated further in my broader study mentioned in the introduction.

Comparison of the Pacific Rim financial crises and the response by the United States and Japan

Table 4, constructed from the historical accounts of the Pacific Rim financial crises described in this paper, suggests two major hypotheses from the analysis of the variance in the dependent variable. These hypotheses help us understand the Japanese cooperation in financial crisis management with the United States (and, to a lesser extent, the U.S. cooperation with Japan).

The first hypothesis concerns the role of the transnational financial sector in influencing the Japanese government, and in most cases, in leading it to cooperate with the United States to create a unified front vis-á-vis debtors in the developing world. The “Washington Consensus” on development, which Japanese government officials have occasionally challenged, is supported not only by U.S. and European governments and by private sectors, but also by many actors within Japan’s internationalized and politically powerful financial sector. Crisis management is not only a way for them to protect their lending and investment (which was a stronger force in the Latin American debt crisis case), but it is also a way for them to impose their “sound” economic fundamentals -- a trend seen more and more as portfolio flows become an influential category of cross-border investment. For these purposes, I hypothesize that the Japanese financial sector, with extensive links to transnational banks and other financial institutions in the United States and Europe, tends to lean toward the “Washington Consensus” and pressure its home government to act accordingly. The lack of Japan’s responsiveness in the case of the Mexican peso crisis, provides a good counter-example supporting this hypothesis. That is, the small presence of Japanese financial interests in Mexico at the time of the 1994 crisis led to Japan’s limited cooperation with the United States in managing this crisis.

The second hypothesis is the importance of the bilateral connection between the United States and Japan. Particularly important are the Japanese government’s concern over the major financial and economic crisis in the United States in the mid- to late-1980s and the associated “Japan bashing” (due to Japan’s high trade surplus vis-á-vis the United States), as well as the interests of Japanese bankers and investors with high stakes in the United States. These factors made the Japanese government’s involvement in assisting the Latin American countries more likely. In the case of the 1997 Asian financial crisis, one notes consistent mention in the United States of the impact that the Asian crisis could have on Japan’s weakened economy. The U.S. government, meanwhile, expressed concerns about the implication on the U.S. economy, not only in terms of repercussions on the U.S. stock market and exchange rate, but also in terms of its trade balance in Japan’s favor under a weakened yen.

Through the analysis of financial crisis management between Japan and the United States over the past two decades, one finds various examples of Japan’s cooperation with the United States despite direct economic and political interests that might have led both governments to act otherwise (e.g. the case of “leadership” in the Asian Monetary Fund). This finding casts a doubt on existing theories of cooperation and non-cooperation, particularly on the realist perspective of relative gains. Japan was much more willing to support the U.S. initiatives despite obvious relative losses that such support incurred. The analysis of the Japanese government’s cooperative behavior also calls for modification of the “Japan as reactive state” thesis and of Japan’s “unique” state-led policymaking. The accounts of each financial rescue operation in which the Japanese government was an active supporter of the U.S. initiatives indicate that these were cases that most served the interests of Japan’s financial sector, benefits that were shared with financial sectors of other advanced industrial countries. The transnational coalition of Japan’s financial sector in the international arena and its domestic policy influence have established the basis for the Japanese government’s decision-making.

Having analyzed, in this paper, the dependent variable -- collective financial crisis management behavior between Japan and the United States in the Pacific Rim for the past two decades -- my larger study analyzes the sources and motivations of the Japanese government to engage in supporting U.S. financial crisis management strategies in some cases but not others. First, I investigate the involvement of the Japanese financial sector in the crises and the political influence of Japan’s financial sector on the Japanese government’s foreign policy decision-making. Second, the mutual economic dependence between the United States and Japan, and the impact of regional financial crises on the respective region’s major power are examined. In addition, the analysis establishes the linkage between the level of cooperation in financial crisis management between the two governments and the implicit support such management provides to the economic recovery of the counterpart. The final analysis consolidates the two aspects and emphasizes the importance of transnational actors, their global interests and their domestic influence.

 

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Endnotes

*: Conference draft, please do not cite. Comments and suggestions are appreciated. I thank Benjamin Cohen, Michael Fry and Timothy McKeown for their helpful comments on my earlier draft. I also thank Andrew Manning for his excellent research assistance in preparation for this paper. Back.

Note 1: The newest of the discussion on how to prevent financial crisis via the IMF, see Stanley Fischer’s article in Financial Times, March 30, 1998. Back.

Note 2: See Joseph Grieco (1988) on the theory on the relative gains. Back.

Note 3: Incidentally, some argue that the action of creditors (particularly the U.S. government) in the 1995 Mexican peso rescue encouraged the investors to be more aggressive in Asian investments and thus invited the 1997 Asian financial crisis. Further discussions on the problems with the rescue packages, see Goldstein and Calvo (1996). Back.

Note 4: In his article, Frieden argued that due to the fungibility of foreign loans, collective action among the creditor countries were necessary to make the debtors follow the rules of repayments. Jeffry Frieden, (1994). Also see Lisa Martin (1992, 1993). Back.

Note 5: Kent Calder (1988). Back.

Note 6: For a comparison of this debt crisis with early periphery financial crises, see Angus Maddison (1985). Back.

Note 7: Economists writing on this topic include Jeffrey Sachs, Daniel Cohen, Robert Devlin, Jonathan Eaton and Mark Gersovitz, Jack Guttentag and Richard Herring, Paul Krugman, Suel Özler, and Jeremy Bulow and Kenneth Rogoff. Political Scientists addressing it include Miles Kahler, Benjamin Cohen, Robert Kaufman, Charles Lipson, Robert Wood and John Williamson. Back.

Note 8: An article by Stallings is one of the few written on this subject in English: Barbara Stallings, “The Reluctant Giant: Japan and the Latin American Debt Crisis,” Journal of Latin American Studies, Vol.22, part 1, February 1990: 1-30. There are a few books in Japanese including Yoshiro Tokunaga (ed.), Ruiseki-saimu Mondai to Nihon-keizai: Nihon-shudo no Saimu-menjo wo Teian-suru (The Debt Problem and the Japanese Economy: A Proposal for Japanese Initiative in Debt Forgiveness), Toyo keizai shiposha, 1988; Toru Yanagihara (ed.), Keizai-kaihatsu-shien toshiteno Shikin-kanryu (Capital Recycling in Support of Economic Development) Ajia keizai kennyujo (Institute of Developing Economies), 1989; Toshihiko Kinoshita, Developments in the International Debt Strategy and Japan’s Response, (Translation), EXIM Review, Vol.10, No.2, 1991; and various publications from the Japan Center for International Finance. Back.

Note 9: Iyo Kunimoto (1997). Back.

Note 10: Kotaro Horisaka (1993: 54). Back.

Note 11: Interview, Tokyo, Spring 1993. Back.

Note 12: Interview, Tokyo, Spring 1993. Back.

Note 13: The Foreign Exchange and Foreign Trade Control Law was amended in 1980 to gradually allow most of international capital transactions. For details see Frances McCall Rosenbluth (1989) and Kent Calder (1997). Back.

Note 14: Interview, Tokyo, Spring 1993. Back.

Note 15: Nihon Keizai Shimbun, January 16, 1982. The statistics are from Capital Loan Data Service, Ltd. of England cited in the article. Back.

Note 16: The MOF seemed to be in favor of the Japanese banks becoming leading banks, since the banks could earn more commission fees this way, which could offset the low profit margin of overseas lending. In 1980, a qualitative guideline introduced by the MOF favored that the banks be leading banks in syndicated loans. Back.

Note 17: Robert Devlin (1989: 154). Back.

Note 18: Hanabusa notes that the Japanese government and its private sector are “partners in development” when dealing with Japan’s economic activities in the developing world. Masamichi Hanabusa (1991: 90). However, one has to note that Hanabusa is an official from the Ministry of Foreign Affairs who, naturally, would see the situation from the government point of view. Back.

Note 19: Masao Fujioka (1979: 181). Emphasis added. Back.

Note 20: Andrew Spindler, (1984: 182). Back.

Note 21: Terutomo Ozawa (189: 41). Back.

Note 22: Fujioka, (1979: 222). Back.

Note 23: Fujioka, (1979: 248). Griffith-Jones (1984: 68) notes that “banks are on the whole willing to lend to different types of political regimes, as long as they are firmly established,” therefore, it was quite compatible with Japan’s apparent “division of economics and politics doctrine.” Back.

Note 24: Spindler (1984: 162). These are usually called “National Projects”. Back.

Note 25: Barbara Stallings (1990: 1). Back.

Note 26: Stallings, (1990: 26). Back.

Note 27: Stallings, (1990: 27). Back.

Note 28: Devlin, (1989: 122). Back.

Note 29: Devlin, (1989: 154), emphasis added. Devlin continues with an example: “Wells Fargo drew heavily on Japanese banks which contributed approximately one third of the funds raised in syndication by this institution.” Back.

Note 30: See Charles Lipson (1985: 200-225). Back.

Note 31: Joseph Kraft (1984: 18-19), and Volker & Gyohten (1992: 201). Back.

Note 32: This $8.25 billion consists of $3.625 billion from the United States, $925 million from the BIS, and an additional $3.7 billion from the IMF. Calculation from Lustig (1996) Table 1. Back.

Note 33: Peter H. Smith (1990: 29). One of my interviewees also said that if the Director of the Latin American Bureau in the Ministry of Foreign Affairs is a career official trained in Spanish, this makes Latin American issues somewhat more important to the Ministry since he (almost always he) would have more familiarity with the situation and attachment to the region’s problems, and he will push the Latin American agenda within the Ministry. Back.

Note 34: Volker & Gyohten, (1992: 201). Back.

Note 35: In Latin America, their total debt is composed of about 60 percent US dollars, around 6 percent Japanese yen, and the rest other European currencies. Back.

Note 36: Interview, Tokyo, Spring 1993. Back.

Note 37: Yomiuri Shimbun, June 23, 1984. Back.

Note 38: The formal name of the Baker Plan is “Program for Sustained Growth.” The 15 countries in the Plan are: Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay, Venezuela, Cote d’Ivoire, Morocco, Nigeria, the Philippines and Yugoslavia. The coverage of the countries labeled as heavily indebted was later expanded to 17, including Cost Rica and Jamaica. Back.

Note 39: Asahi Shimbun, December 13, 1985. The banks emphasized that their support should be accompanied by the same effort by the debtor governments, creditor governments, international organizations and other financial institutions. Back.

Note 40: William R. Cline, (1989: 176-193). See also Benjamin J. Cohen (1992: 156). Back.

Note 41: Eileen Marie Doherty, “Japan’s Repose to the Latin American Debt Crisis,” JEI Report, No. 29A, July 31, 1987, p. 4-5. Back.

Note 42: For a good summary of the details of the first two programs, see Tetsuma Fujikawa, “Maware maware Okane ha tenkano mawarimono: 300 okudoru ijo no shikin kannryu sochi (The money goes around: More than $30 billion Capital Recycling Program)”, Fainansu (The Finance), March 1988, Vol. 23, No. 12, p. 48-58. Back.

Note 43: Washington Post, April 23, 1987. Back.

Note 44: The level of GNP and restrictions of OECF lending. Back.

Note 45: Fujikawa (March 1988: 52). Back.

Note 46: Stalling, (1990: 20-12), Nihon Keizai Shimbun, November 26, 1983. Back.

Note 47: Interview with a banker from the Bank of Tokyo, June 1997. Back.

Note 48: Stallings, (1990: 19). Back.

Note 49: Stallings notes that although the banks got what they wanted at that point, the JBA, Inc. formula did not expand significantly to apply to other Latin American country debts. Only some Argentine loans were sold to it in connection with the 1987 rescheduling. Stalling, (1990: 21 ft. 57). Back.

Note 50: The Mexican government with the support of the US government aimed to reduce its $100 billion debt in late 1987 by converting a part of it to dollar denominated bonds, which are implicitly guaranteed by the US Treasury’s zero coupon. Back.

Note 51: Institute of International Finance, “The way Forward for Middle-Income Countries,” Report by the Broad of Directors of the Institute of International Finance, Washington D.C. 1989, p. 22, cited in Cline, (1989: 185). Back.

Note 52: Cline, (1989: 185). Back.

Note 53: Kinoshita, (1991: 70-71). Also see JEI Report, No. 38B 1988, p. 3-4. Back.

Note 54: Cline, (1989: 186). Back.

Note 55: Mainich Shimbun, June 14, 1988. Back.

Note 56: Fujikawa, Raten America Jiho, March 1990, p. 13. Back.

Note 57: Cline, (1989: 186). Back.

Note 58: US news articles on the response to Miyazawa Plan. Back.

Note 59: Rosenbluth (1991: 679-80). Jeffrey Sachs also mentions the same idea in his article (1989: 29). Back.

Note 60: Interview with a Bank of Tokyo banker, June 1997, Tokyo, Japan. Back.

Note 61: Asahi Shimbun, February 3, 1989. Back.

Note 62: President-elect Bush’s speech on the debt problems and strategies on December 19, 1988 cited in Fujikawa (1990, March: 15). Back.

Note 63: Nihon Keizai Shimbun, March 11, 1989. Back.

Note 64: Quote from Japanese Finance Minister Murayama, cited in Fujikawa, (1990: 16), translated by the author. Back.

Note 65: At the same IMF meeting, the United States reversed its previous position regarding an increase in Japan’s IMF quota. It supported such increase, which would move Japan’s position up from the fifth-largest quota. JEI Report, No. 15B, April 14, 1989. Back.

Note 66: Kinoshita, (1991: 72) and JEI Report, No. 28B, 1989. Back.

Note 67: Kinoshita, (1991: 73). Also see JCIF Tokubetsu repoto No. 25. “Bei koku no shin saimu senryaku to detto maketto”, May 1990, p. 16-26. $9.7 billion of Japanese commercial bank debt was included in the $48.5 billion, but Japanese banks overwhelmingly preferred principal reduction (83%) and took no new money options. Back.

Note 68: The Wall Street Journal, August 21, 1992. Back.

Note 69: The Economist, February 13, 1993, p.79. Back.

Note 70: For discussions as to whether these private capital flows of the early 1990s were caused by pull factors (i.e. attractiveness of Latin American assets and their healthy economic conditions) or by push factors (i.e. lower interest rates and lack of attractive assets in the United States and major OECD investors), see Eduardo Fernandez-Arias, (1996: 389-418). And for an extensive discussion of various cases, see Ricardo Ffrench-Davis, et. al. (1995). Back.

Note 71: Bankers Trust Research, “Mexico floats the Peso”, Emerging Markets, December 23, 1994. The official figure from the Bank of Mexico stated that by December 16, 1994, its foreign exchange reserves dropped to around $11 billion. Lustig, (1996: 19). Back.

Note 72: Wall Street Journal, February 3, 1995 reports very low currency reserve Back.

Note 73: For a good summary, evaluation of and lessons from this Mexican Peso crisis, see Edwin M. Truman (1996: 199-209). Back.

Note 74: Finance Minister Serra’s visit was not well received in New York, which forced him to resign in a few days later. Guillermo Ortiz became the new Finance Minister after Serra’s resignation. Back.

Note 75: After the assassination of Mexican presidential candidate Colosio in March, 1994 and as pressure on the peso increased due to political instability, U.S. Treasury Secretary Bentsen and U.S. Federal Reserve Chairman Greenspan set up a $6 billion swap line. In April, the three parties of NAFTA signed an agreement to make this $6 billion swap agreement permanent in the form of the North American Framework Agreement (NAFA). Lustig, (1996: 21-22). Back.

Note 76: Nihon Keizai Shimbun, January 4, 1995. Emphasis added by the author. Back.

Note 77: Truman, (1996: 203), Charts 1 and 2. Truman explains that such contagion sales of assets arises from at least two types of forces: “First, as perceived risks rose and expected returns fell, individual investors were induced to disinvest. Second, institutional holders such as mutual funds faced with actual or threatened redemption were led to liquify their holdings not only of Mexican paper but also of the papers of other countries especially if they could do so while limiting their capital losses.” Truman, (1996: 202). Back.

Note 78: Nihon Keizai Shimbun, January 25, 1995. Back.

Note 79: The European governments’ resentments were presented when Germany, the United Kingdom, Switzerland, the Netherlands, Belgium and Denmark abstained from supporting the IMF’s $17.8 Mexican rescue package on January 31. Nihon Keizai Shimbun, February 4, 1995. Back.

Note 80: For a good summary of the U.S. initiative in assembling the Mexican rescue package (both in 1982 and 1995), see Lustig 1996. The General Accounting Office (GAO) has an official record of the U.S. assistance. GAO (1996), especially in Chapter 4. Consult also IMF Press Release no. 95/5. Back.

Note 81: Lustig, (1996: 34). The same sentiment was expressed by various Japanese interviewees both from the commercial banks and the government, Interviews in Tokyo, May 1996. Several interviewees noted that although Mexico’s Foreign Minister Jose Angel Gurria flew to Tokyo to calm Japanese investors on January 9, 1995, he was telling the Japanese investors that Mexico was in solid shape and there was nothing to worry about, and he did not have the attitude of one requesting help. Japan’s Foreign Minister Yohei Kono was reported to have rejected the Mexican Foreign Minister’s request to use governmental influence over private banks to extend additional credit to Mexico (Kyodo, January 9, 1995). Back.

Note 82: Kyodo News, February 1, 1995 via Foreign Broadcast Information Service (FBIS). Back.

Note 83: Nihon Keizai Shimbun, July 13, 1995. Back.

Note 84: Nihon Keizai Shimbun, April 19, 1995. Back.

Note 85: Export Import Bank of Japan Press Release, September 1, 1997 (NR97-11). Back.

Note 86: The Convertibility Plan is the key component of President Menem’s economic strategy which was launched in March 1991. This plan pegs the Argentine currency to the dollar at a one Argentine peso to one U.S. dollar rate and Argentinean money supply is determined by its dollar reserve (otherwise called “currency board”). This powerful policy instrument proved effective in coping with inflation, improving expectations of international investors, and enforcing fiscal discipline in the public sector. The plan, however, did not prevent the currency traders from attacking the Argentine peso, thus affecting its stock market when the financial environment became less favorable. Back.

Note 87: For explanation of Tequila effect, see footnote 77, and also Calvo and Reihard (1996). Back.

Note 88: IMF, Press Release No. 95/18, April 6, 1995. Back.

Note 89: Nihon Keizai Shimbun, April 1, 1995. Back.

Note 90: Nihon Keizai Shimbun, April 29, 1995. Back.

Note 91: Institute of Developing Economies (IDE), (1995). Its conclusions were reported in Nihon Keizai Shimbun, February 16, 1995. Back.

Note 92: Nihon Keizai Shimbun, May 15, 1997. Back.

Note 93: IMF Press Release, No. 95/51, October 8, 1995. Back.

Note 94: The Economist, July 26, 1997. Back.

Note 95: IMF Press Release, No. 97/33, July 18, 1997. This EFF credit came in the form of an extension of the on-going three-year EFF initiative on June 24, 1994 that was due to expire on July 23, 1997. Back.

Note 96: The Thai government was reportedly hoping to receive significant financial support from Japan without resorting to the IMF, but the Japanese government was strongly insistent on having the agreement with the IMF as the pre-condition for Japan’s additional financial support. Bangkok Business Day, July 31, 1997 (FBIS). Back.

Note 97: Nihon Keizai Shimbun, August 12, 1997, IMF Press Release No. 97/37, August 20, 1997. Asian contributors to the package were Australia, Malaysia, Singapore and Hong Kong ($1 billion each), South Korea, Brunei and Indonesia ($0.5 billion each), and later China ($1 billion). Back.

Note 98: Quoted from the Japanese IMF deputy managing director, Sugisaki, (Bangkok the Nation, via FBIS), August 12, 1997. Back.

Note 99: Nihon Keizai Shimbun, August 19, 1997. Back.

Note 100: Hong Kong AFP, September 18, 1997 (FBIS). Nihon Keizai Shimbun, September 23, 1997. Back.

Note 101: Nihon Keizai Shimbun, September 22, 1997, and the Economist, September 27, 1997, p. 80. For analysis of why the Japanese government engaged in this unusually active and controversial initiative, see Eric Altbach, “The Asian Monetary Fund Proposal: A Case Study of Japanese Regional Leadership,” JEI Report, No. 47A, December 19, 1997. Back.

Note 102: Very similar debate took place more than twenty years ago between the IMF and the Financial Support Fund idea presented at the OECD. See Cohen (1997) especially p. 14. Back.

Note 103: Eric Altbach, op. cit., p. 9-10. Back.

Note 104: Nihon Keizai Shimbun, September 22 and 23, 1997. Some even note that the very reason why the Japanese government pushed for the Asian Monetary Fund scheme was to maximize its leverage in seeking more influence within the IMF. Anthony Rowley, “International Finance: Asian Fund, Rest in Peace,” Capital Trends, December 1997, Vol. 2, No. 1. Back.

Note 105: The most vocal advocate of this view is Malaysian Prime Minister Mahathir. Nihon Keizai Shimbun, September 14, 1997. Back.

Note 106: On “Washington Consensus,” see John Williamson (1990: 59) in which he coined the phrase. Also see Barbara Stallings and Wolfgang Streeck’s chapter (1995) on the controversy between Japan and the United States on the models of development. Back.

Note 107: Eric Altbach, op. cit, p. 8-9. Back.

Note 108: Asahi Shimbun, September 20, 1997. Back.

Note 109: Asahi Shimbun, November 6, 1997. Interview article with Mr. Yu Hayami, former president of Nissho Iwai (a Japanese trading company). Back.

Note 110: Anthony Rowley, op. cit, p. 1. Back.

Note 111: First news comes from Kyodo, November 10, 1997, and the second from Hong Kong AFP, November 30, 1997, both on FBIS. Back.

Note 112: I thank Benjamin Cohen for point out the latter issue. Back.

Note 113: The first line of the Indonesian rescue package will consist of loans from the IMF ($10.1 billion), the World Bank ($4.5 billion), and the Asian Development Bank ($3.5 billion). The second line of defense is being constructed by bilateral funds including Japan and Singapore ($5 billion each), the United States ($3 billion) and Australia ($1.43 billion). New York Times, October 31, 1997. IMF Press Release No. 97/50, November 5, 1997. Back.

Note 114: Indonesia’s unwillingness to adjust its macroeconomic policies according to the IMF agreement has caused its currency to continue its problematic course in the early months of 1998. The IMF Managing Director and many of U.S. top officials including Treasury and Defense went over to Jakarta to convince President Suharto to follow the agreement. Back.

Note 115: Feldstein notes that the Korean financial crisis does not share the same nature as other crises of Southeast Asia during the fall of 1997. Feldstein (1998). Back.

Note 116: Various sources including The Korea Times, November 15, 1997 (FBIS). Back.

Note 117: Asahi Shimbun, November 22, 1997. Back.

Note 118: Asahi Shimbun, November 29, 1997, and The Korea Times, November 30, 1997 (FBIS). Back.

Note 119: IMF Press Release No. 97/55, December 4, 1997, also Financial Times, December 4, 1997. Back.

Note 120: New York Times, December 30, 1997. Back.

Note 121: Grieco (1988). Back.

Note 122: Calder (1998), and also see Schoppa (1993) on the influence of “gaiatsu” (foreign pressure) on Japan’s economic policy. Back.