[Congressional Record Volume 144, Number 151 (Wednesday, October 21, 1998)]
[Extensions of Remarks]
[Pages E2301-E2303]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




 GEORGE SOROS DISCUSSES THE INTERNATIONAL FINANCIAL SYSTEM AT BANKING 
       COMMITTEE HEARING--U.S. ACTION AND ASSISTANCE IS ESSENTIAL

                                 ______
                                 

                            HON. TOM LANTOS

                             of california

                    in the house of representatives

                      Wednesday, October 21, 1998

  Mr. LANTOS. Mr. Speaker, last night this House approved the Omnibus 
Appropriations Act which included funding for the International 
Monetary Fund (IMF). Earlier this month, the IMF and the World Bank 
held their annual meetings here in Washington, D.C., against a backdrop 
of international financial turmoil and serious concern about the 
economies of a number of key countries in the world and about the 
ability of the international financial system to deal with the crisis. 
The IMF has not been successful in resolving the economic problems in 
East Asia and in Russia thus far.
  Just a few weeks ago, Mr. Speaker, George Soros, the international 
financial genius, appeared before the House Banking Committee to issue 
a somber warning to the Congress of the United States--Unless Congress 
is willing to support the IMF and take supportive action in dealing 
with the faltering international financial system, the disintegration 
of the global capitalist system will have dire consequences for the 
United States economy because we are at the center of that system. We 
cannot by and do nothing while other countries face economic crisis.
  The instability and enormous losses that have been suffered on Wall 
Street in the past few weeks are just the latest indications of the 
scope and gravity of this crisis. While this initial impact upon our 
own country has been limited so far to our financial markets, the 
consequences of further deterioration would be felt throughout our 
economy with consequences that would be felt by all Americans.
  Mr. Speaker, George Soros told the Banking Committee that the 
Congress has an extraordinary responsibility and obligation to assure 
the success and the continued viability of the IMF and the 
international financial system. Mr. Soros also told the Committee that 
``I am convinced that the attitude of the Congress was already an 
important element in the failure to deal with Russia'' with all of the 
serious consequences that could bring.
  Mr. Speaker, I regret that there was destructive dithering and 
dallying on the part of the leadership of the Congress earlier this 
year, but I welcome the fact that the essential funding for the IMF was 
included in the Omnibus Appropriations legislation that we adopted last 
night. This important reversal in policy is in no small part due to the 
thoughtful and weighty arguments that George Soros advanced in 
testimony he presented at the Banking Committee hearing a few weeks 
ago.

[[Page E2302]]

  I ask, Mr. Speaker, that Mr. Soros testimony before the House Banking 
Committee be placed in the Record, and I urge my colleagues in the 
House to give it the thoughtful consideration that it clearly deserves. 
The matters that he discussed, which are of great significance for all 
of us in this body, have not been resolved. Further important decisions 
await the Congress, and George Soros' thoughts are important for all of 
us as we consider our nation's economic future.

Testimony of George Soros--Committee on Banking and Financial Services, 
                           September 15, 1998

       This hearing is very timely because the global capitalist 
     system which has been responsible for the remarkable 
     prosperity of this country in the last decade is coming apart 
     at the seams. The current decline in the US stock market is 
     only a symptom, and a belated symptom at that, of the more 
     profound problems that are afflicting the world economy. Some 
     Asian stock markets have suffered worse declines than the 
     Wall Street crash of 1929 and in addition their currencies 
     have also fallen to a fraction of what their value was when 
     they were tied to the US dollar. The financial collapse in 
     Asia was followed by an economic collapse. In Indonesia, for 
     instance, most of the gains in living standards that 
     accumulated during 30 years of Suharto's regime have 
     disappeared. Modern buildings, factories and infrastructure 
     remain, but so does a population that has been uprooted from 
     its rural origins. The Japanese banking system is in deep 
     trouble. The world's second largest economy just reported an 
     annualized 3.3% decline in economic activity for the second 
     quarter. Currently Russia has undergone a total financial 
     meltdown. It is a scary spectacle and it will have 
     incalculable human and political consequences. The contagion 
     has now also spread to Latin America.
       It would be regrettable if we remained complacent just 
     because most of the trouble is occurring beyond our borders. 
     We are all part of the global capitalist system which is 
     characterized not only by free trade but more specifically by 
     the free movement of capital. The system is very favorable to 
     financial capital which is free to pick and choose where to 
     go and it has led to the rapid growth of global financial 
     markets. It can be envisaged as a gigantic circulatory 
     system, sucking up capital into the financial markets and 
     institutions at the center and then pumping it out to the 
     periphery either directly in the form of credits and 
     portfolio investments, or indirectly through multinational 
     corporations.
       Until the Thai crisis in July 1997 the center was both 
     sucking in and pumping out money vigorously, financial 
     markets were growing in size and importance and countries at 
     the periphery could obtain an ample supply of capital from 
     the center by opening up their capital markets. There was a 
     global boom in which the emerging markets fared especially 
     well. At one point in 1994 more than half the total inflow 
     into US mutual funds went into emerging market funds.
       The Asian crisis reversed the direction of the flow. 
     Capital started fleeing the periphery. At first, the reversal 
     benefitted the financial markets at the center. The U.S. 
     economy was just on the verge of overheating and the Federal 
     Reserve was contemplating raising the discount rate. The 
     Asian crisis rendered such a move inadvisable and the stock 
     market took heart. The economy enjoyed the best of all 
     possible worlds with cheap imports keeping domestic 
     inflationary pressures in check and the stock market made new 
     highs. The buoyancy at the center raised hopes that the 
     periphery may also recover and between February and April of 
     this year most Asian markets recovered roughly half their 
     previous losses measured in local currencies. That was a 
     classic bear market rally.
       There comes a point when distress at the periphery cannot 
     be good for the center. I believe that we have reached that 
     point with the meltdown in Russia. I am not making any 
     predictions about the stock market, but I am ready to assert 
     that we have reached that point. I have three main reasons 
     for saying so.
       One is that the Russian meltdown has revealed certain flaws 
     in the international banking system which had been previously 
     disregarded. In addition to their exposure on their own 
     balance sheets, banks engage in swaps, forward transactions 
     and derivative trades among each other and with their 
     clients. These transactions do not show up in the balance 
     sheets of the banks. They are constantly marked to market, 
     that is to say, they are constantly revalued and any 
     difference between cost and market made up by cash transfers. 
     This is supposed to eliminate the risk of any default. Swap, 
     forward and derivative markets are very large and the margins 
     razor thin; that is to say, the value of the underlying 
     amounts is a manifold multiple of the capital employed in the 
     business. The transactions form a daisy chain with many 
     intermediaries and each intermediary has an obligation to his 
     counterparties without knowing who else is involved. The 
     exposure to individual counterparties is limited by setting 
     credit lines.
       The sophisticated system received a bad jolt when the 
     Russian banking system collapsed. Russian banks defaulted on 
     their obligations, but the Western banks remained on the hook 
     to their own clients. No way was found to offset the 
     obligations of one bank against those of another. Many hedge 
     funds and other speculative accounts sustained large enough 
     losses that they had to be liquidated. Normal spreads were 
     disrupted and professionals who arbitrage between various 
     derivatives, i.e.: trade one derivative against another, also 
     sustained large losses. A similar situation arose shortly 
     thereafter when Malaysia deliberately shut down its financial 
     markets to foreigners but the Singapore Monetary Authority in 
     cooperation with other central banks took prompt action. 
     Outstanding contracts were netted out and the losses were 
     shared. A potential systematic failure was avoided.
       These events led most market participants to reduce their 
     exposure all round. Banks are frantically trying to limit 
     their exposure, deleverage, and reduce risk. Bank stocks have 
     plummeted. A global credit crunch is in the making. It is 
     already restricting the flow of funds to the periphery, but 
     it has also begun to affect the availability of credit in the 
     domestic economy. The junk bond market, for instance has 
     already shut down.
       This brings me to my second point. The pain at the 
     periphery has become so intense that individual countries 
     have begun to opt out of the global capitalist system, or 
     simply fall by the wayside. First Indonesia, then Russia have 
     suffered a pretty complete breakdown but what has happened in 
     Malaysia and to a lesser extent in Hong Kong is in some ways 
     even more ominous. The collapse in Indonesia and Russia was 
     unintended, but Malaysia opted out deliberately. It managed 
     to inflict considerable damage on foreign investors and 
     speculators and it managed to obtain some temporary relief, 
     if not for the economy, then at least for the rulers of the 
     country. The relief comes from being able to lower interest 
     rates and to pump up the stock market by isolating the 
     country from the outside world and squeezing short sellers. 
     The relief is bound to be temporary because the borders are 
     porous and money will leave the country illegally; the effect 
     on the economy will be disastrous but the local capitalists 
     who are associated with the regime will be able to salvage 
     their businesses unless the regime itself is toppled. The 
     measures taken by Malaysia will hurt the other countries 
     which are trying to keep their financial markets open because 
     it will encourage the flight of capital. In this respect 
     Malaysia has embarked on a begger-thy-neighbor policy. If 
     this makes Malaysia look good in comparison with its 
     neighbors, the policy may easily find imitators, making it 
     harder for others to keep their markets open.
       The third major factor working for the disintegration of 
     the global capitalist system is the evident inability of the 
     international monetary authorities to hold it together. IMF 
     programs do not seem to be working; in addition, the IMF has 
     run out of money. The response of the G7 governments to the 
     Russia crisis was woefully inadequate, and the loss of 
     control was quite scary. Financial markets are rather 
     peculiar in this respect: they resent any kind of government 
     interference but they hold a belief deep down that if 
     conditions get really rough the authorities will step in. 
     This belief has now been shaken.
       These three factors are working together to reinforce the 
     reverse flow of capital from the periphery to the center. The 
     initial shock caused by the meltdown in Russia is liable to 
     wear off, but the strain on the periphery is liable to 
     continue. The flight of capital has now spread to Brazil and 
     if Brazil goes, Argentina will be endangered. There is 
     general panic in Latin America. Forecasts for global economic 
     growth are being steadily scaled down and I expect they will 
     end up in negative territory. If and when the decline spreads 
     to our economy, we may become much less willing to accept the 
     imports which are necessary to feed the reverse flow of 
     capital and the breakdown in the global financial system may 
     be accompanied by a breakdown in international free trade.
       This course of events can be prevented only by the 
     intervention of the international financial authorities. The 
     prospects are dim, because the G7 governments have just 
     failed to intervene in Russia, but the consequences of that 
     failure may serve as a wake-up call. There is an urgent need 
     to rethink and reform the global capitalist system. As the 
     Russian example has shown, the problems will become 
     progressively more intractable the longer they are allowed to 
     fester.
       The rethinking must start with the recognition that 
     financial markets are inherently unstable. The global 
     capitalist system is based on the belief that financial 
     markets, left to their own devices, tend towards equilibrium. 
     They are supposed to move like a pendulum: they may be 
     dislocated by external forces, so-called exogenous shocks, 
     but they will seek to return to the equilibrium position. 
     This belief is false. Financial markets are given to excesses 
     and if a boom/bust sequence progresses beyond a certain point 
     it will never revert to where it came from. Instead of acting 
     like a pendulum financial markets have recently acted more 
     like a wrecking ball, knocking over one economy after 
     another.
       There is much talk about imposing market discipline but, 
     imposing market discipline means imposing instability, and 
     how much instability can society take? Market discipline 
     needs to be supplemented by another discipline: maintaining 
     stability in financial markets ought to be the objective of 
     public policy. This is the general principle that I should 
     like to propose.
       Despite the prevailing belief in free markets this 
     principle has already been accepted and implemented on a 
     national scale. We

[[Page E2303]]

     have the Federal Reserve and other financial authorities 
     whose mandate is to prevent a breakdown in our domestic 
     financial markets and if necessary act as lenders of last 
     resort. I am confident that they are capable of carrying out 
     their mandate. But we are sadly lacking in the appropriate 
     financial authorities in the international arena. We have the 
     Bretton Woods institutions--the IMF and the World Bank--which 
     have tried valiantly to adapt themselves to rapidly changing 
     circumstances. Admittedly the IMF programs have not been 
     successful in the current global financial crisis; its 
     mission and its methods of operation need to be reconsidered. 
     I believe additional institutions may be necessary. At the 
     beginning of this year I proposed establishing an 
     International Credit Insurance Corporation, but at that time 
     it was not yet clear that the reverse flow of capital would 
     become such a serious problem and my proposal fell flat. I 
     believe its time has now come. We shall have to establish 
     some kind of international supervision over the national 
     supervisory authorities. We shall also have to reconsider the 
     workings of the international banking system and the 
     functioning of the swap and derivative markets.
       These issues are beyond the competence of Congress. There 
     is, however, one issue which is very much within its purview. 
     That is the request to authorize an increase in the capital 
     of the IMF. I am aware that Congress was greatly influenced 
     by the testimony given by George Schultz opposing such an 
     increase. I hope my remarks will serve to contradict that 
     testimony.
       George Schultz argued that it is better if markets are 
     allowed to look after themselves than if they are looked 
     after by regulators. There is an element of truth in his 
     argument: regulators do make mistakes. The IMF approach 
     clearly did not work, otherwise we would not find ourselves 
     in the current situation. But that does not mean that 
     financial markets can look after themselves. Everybody 
     looking out for his or her self-interest does not lead to 
     equilibrium but to what Alan Greenspan called irrational 
     exuberance and afterwards panic.
       George Schultz inveighed against the moral hazard of 
     bailing out irresponsible investors and speculators. Here he 
     has a valid point. Bailouts did encourage irresponsible 
     behavior not so much by speculators--because we know that we 
     have to take our lumps when markets decline--but by banks and 
     other lenders who could count on the IMF coming in when a 
     country got into difficulties. The IMF imposed tough 
     conditions on the country concerned but it did not impose any 
     penalties on the lenders. This asymmetry in the treatment of 
     lenders and borrowers is a major source of instability in the 
     global capitalist system and it needs to be corrected. It has 
     to be a focal point in the soul searching that the IMF must 
     undergo, but I am glad to say that the IMF is learning fast. 
     In its $2.2 billion program in Ukraine, it is imposing a new 
     condition: 80% of Ukraine's treasury bills have to be 
     ``voluntarily'' rescheduled into longer-term, lower yielding 
     instruments before the program can go forward. This is a long 
     way from the Mexican bailout of 1995 where the holders of 
     Mexican treasury bills came out whole.
       The moral hazard now operates in the opposite direction; in 
     not enabling the IMF to do its work when it is most needed. 
     Congress bears an awesome responsibility for keeping the IMF 
     alive. I am convinced that the attitude of the Congress was 
     already an important element in the failure to deal with 
     Russia. As you probably know I have foundations in many of 
     the formerly communist countries. Some of these countries are 
     badly hit by the fallout from the Russian collapse. Countries 
     like Moldova and Romania have no one else to turn to but the 
     IMF. The IMF is perfectly capable of assisting them. It would 
     be tragic if it ran out of resources.
       Replenishing the capital of the IMF will not be sufficient 
     to resolve the global financial crisis. A way has to be found 
     to provide liquidity not only at the center but also at the 
     periphery. I believe there is an urgent need for the creation 
     of Special Drawing Rights which can be used to guarantee the 
     rollover of the already existing debt of countries which 
     receive the IMF's seal of approval. If there is no reward for 
     good behavior, meltdowns and defections will multiply. But 
     such radical ideas cannot even be considered until Congress 
     changes its attitude towards international institutions and 
     the IMF in particular.
       So far our stock market has escaped relatively unscathed 
     and our economy has actually benefited from the global crisis 
     but make no mistake: unless Congress is willing to support 
     the IMF, the disintegration of the global capitalist system 
     will hurt our financial markets and our economy as well 
     because we are at the center of that system.

     

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