Last October the international community was in Hong Kong for the Annual World Bank and IMF meetings and the discussion was about the collapse of the Thai baht and the potential spread of financial problems around East Asia. One year on, the setting for the meetings is Washington and the concerns are global.

The problems of Thailand spread rapidly to neighboring East Asian economies, and in recent months to Russia and to some extent Latin America. The situation has in turn worsened, and been worsened by, a further deterioration in conditions in Japan, which just recorded a third consecutive quarter of negative growth and is facing the largest problems in its banking system of any major industrial economy in recent memory.

I would like to spend most of my time today reviewing the approach we have taken to these crises and our efforts going forward, along the lines of Congressional testimony that Secretary Rubin, Chairman Greenspan and I have given in recent weeks.

I. Causes of the Crises

Economists will be debating the causes of these crises for many years to come. But there is growing agreement on what the important factors were:

• financial systems that did not channel capital efficiently, were inadequately regulated and created an illusion of security that could not ultimately be supported;

• exchange regimes that attracted capital but were not accompanied by the appropriate macroeconomic policies and created room for speculative pressures;

• a worsening global economic environment, especially in Asia, due to the evident economic problems of Japan;

• difficulties in some countries -- notably Indonesia and Russia -- in carrying out basic government functions, such as tax collection and bank regulation, with integrity;

• and substantial reductions in confidence, as investors began to think more and more about what other investors were thinking and less and about the underlying fundamentals.

Markets' tendency to excess is age old. The transmission mechanisms are not. If the Mexican peso crisis was the first 21st century financial crisis, the second has provided an even clearer illustration of the scope for the new information technologies and financial instruments to act with unprecedented speed and force. When we have now seen withdrawals of capital of more than 10 percent of GDP in the case of several of the Asian economies, and a doubling or more of bond spreads in many disparate markets, it is difficult to believe that the contagion and generalized flight from risk has not been exaggerated.

Containing these crises is critically important to America's core interests: it is about safeguarding American jobs, American savings and American national security. Already:

• exports to the economies in crisis are down by nearly one third, year-on-year and private forecasters are suggesting that the crises could add one half, or one percentage point to our current account deficit;.

• in recent weeks we have seen substantial declines in many companies' access to both the equity and debt markets and seen some evidence of contractions in bank lending. And for now, at least, the junk bond market is a thing of the past.

• and we have been reminded of the potential security consequences of severe financial problems overseas. One need only consider the potential fall-out from a prolonged financial crisis in Russia to see that containing these problems -- and preventing them from festering -- is forward defense of our core interests.

The goal is clear: to contain this crisis and help to restore growth and stability to the economies already affected. Let me now say a little about the means.

II. The United States Approach

Our response to this situation has rested on three pillars.

First, that no country will recover against a backdrop of regional deflation and weak demand. Strengthened policy is needed in the major economies of the region to support growth and confidence:

• the United States must continue to do its part, in particular, by preserving the budget surplus and thus reducing pressure on global capital markets and on our own trade deficit.

• as the Chinese have recognized, their continued commitment to addressing their financial sector problems and to maintaining a stable currency will also be very important;

• and Japan, which even today accounts for more than two-thirds of the Asian economy, has an especially critical role to play. Immediate and effective measures to strengthen the financial system and strong fiscal action in Japan that provides a substantial and sustained economic stimulus are urgently needed for Japan to resume the strong domestically-driven recovery that it needs -- and the world has long waited for.

Second, that while the external environment is important and international support can make a difference, countries shape their own economic destiny. A strong domestic response by the countries affected is the absolute first step toward restoring stability -- because any amount of financial support that goes into an economy will flow right back out if policies are unsound and governments are not credible.

Third, that conditioned international financial assistance can play an important part where policy makers are committed to reform but need financial breathing space to put reforms in place. Financial crises have elements of a self-fulfilling prophecy -- like bank runs, everyone expects failure or everyone expects everyone else to expect failure, leading to a rush to be the first one out and, thus, failure. Temporary, conditioned support gives countries a bridge to overcome this self-fulfilling prophecy and help restore stability. And here the IMF has a critical role.

This crisis is still a moving story. And there is enormous economic and social distress being felt in the countries worst affected. That is inevitable given the massive withdrawals of private capital that have occurred. But it is encouraging that in those countries that were first hit and where policy has been most determined there has been evidence of containment.

Countries that have consistently followed policies that the IMF were able to endorse and support -- specifically the Philippines, Korea and Thailand -- have begun to see signs of a return to stability. In Korea and Thailand the currencies have broadly stabilized, nominal interest rates are down in the low teens, and real interest rates have fallen to well below pre-crisis levels. At the same time these countries are now working to expand their fiscal policy to use the room provided by their sound policies for the fastest possible return to growth.

In debating these crises it is vital not to confuse the doctor with the disease. The distress being seen in Asia are not a consequence of IMF policies or IMF finance. These are, rather, attempts to palliate the true cause of the distress: the withdrawal of capital and decline in confidence that led to that withdrawal. In countries such as Indonesia and Russia, where governments did not carry through on their programs, inflation, interest rates and output losses will certainly be much higher -- and the return of confidence is now that much more remote.

To be sure, as countries choose their policies and the IMF makes judgments about what types of programs it is willing to support financially, difficult questions of balance have inevitably arisen and provoked vigorous debate:

• on the one hand, there is the legitimate view that structural defects of national economies relating to crony capitalism need to be addressed. On the other, people have noted that pushing too hard for large-scale restructuring risks generating a domestic backlash.

• on the one hand, there has been a concern for exchange rate stability, given what we have seen can happen when downward spiraling currencies go out of control. On the other, many will point to the potential costs of raising interest rates significantly at a time when the banking and broader financial system is seriously strained.

• on the one hand, there has been the urgent need to provide confidence at a time when contagion causing large withdrawals of capital and increases in interest rates in emerging markets. On the other, many have had legitimate concerns about moral hazard and irresponsible behavior by investors and governments as a result of this support.

These issues of balance will no doubt continue to be debated and there is no guarantee that the IMF will get it precisely right on every occasion. But the very breadth of disagreement among critics about what, precisely, was done wrong provides some confidence that in the bulk of cases the balance was struck right. I have no doubt the situation over the past year would have been much worse -- with greater devaluations, more defaults, more contagion, and greater trade dislocations -- without the programs agreed with the IMF and the finance it has provided.

III. The Way Ahead

Even in Hong Kong we noted that financial strains being felt in Asia could spread and have far reaching consequences for the rest of the world financial system. And certainly, financial strains have increased in recent weeks -- to the point where they may present what President Clinton has called the one of the most serious financial challenges facing the global community in 50 years. In this context, the President's remarks last month in New York and the G7 finance ministers and central bank governors' statement released at the same time showed clearly how our joint efforts should be carried forward:

First, recognizing that with inflation low or falling in most parts of the world, and the consequent shift in the balance of risk in the global economy, we are working with our G-7 partners in an enhanced emphasis on implementing policies to promote sustainable global growth. Going forward:

• it is especially critical that Japan swiftly infuse public money, on a substantial scale with appropriate conditions, into its banking system. In our judgment this is the only way both to maintain stability and provide for growth going forward;

• and for their part, the countries of the European Union, just now emerging from a long period of relatively slow growth and high unemployment, must also seize the baton of supporting regional and global growth, with policies aimed squarely at vigorous growth in European demand.

Second, we are working to reinforce the capacity of the international community to provide financing to countries that are pursuing sound policies and are nonetheless affected by contagion. Where contagion is a serious concern the emphasis must be on finding new ways to make liquidity available and restore confidence that do not raise undue moral hazard effects.

Adequate funding for the IMF is critical to this effort. Yet today the IMF's resources are at historic lows. And measures that would secure additional funding are still awaiting Congressional approval. Let me reiterate that at a time when the markets are looking to see if the international community has the capacity to deal with these crises, continued delay is a risk the United States can ill afford to run.

Third, alongside the international financial institutions and the countries in the region, we are looking at ways to accelerate the pace of comprehensive corporate and financial restructuring in countries where there is a systemic problem -- notably in Asia where the severe indebtedness of both the financial and corporate system is a serious barrier to recovery and where addressing the overhang of domestic debt is essential.

Fourth, we are also working with the Multilateral Development Banks to provide increased social safety nets in the countries in crisis to help the least advantaged citizens in those countries who are experiencing hardship. As the President said last week, "if we want these countries to do tough things, we have to protect the most defenseless people in the society and we have to protect people who get hurt when they didn't do anything wrong."

Finally, we need to give very serious thought to how the global financial system and its institutions function with respect to preventing and responding to crises such as these. This has been an important preoccupation since the Naples Summit in 1994 and has as a crucial element the bringing together of both traditional and newer players on the international financial scene.

Last year, under President Clinton's leadership, we intensified this effort by convening a meeting in April of a broader grouping of 22 countries, including key developing and emerging economies. At that meeting, finance ministers and central bank governors created working groups that will be coming up with concrete proposals early next week. In a speech in New York earlier today Secretary Rubin outlined some of the most important priorities:

• increased transparency and disclosure: for example, through the implementation by governments of international standards of transparency, and adherence by private firms to new international agreements on higher accounting and disclosure standards.

• strengthened domestic financial systems. As Secretary Rubin discussed, the key here will be both to provide governments with best practice standards to follow but to provide them with adequate support and incentive to implement those standards.

• more effective burden-sharing arrangements in the response to financial difficulties, in particular by reducing the scope for individual failures to become systemic failures, through better debtor-creditor and insolvency regimes in emerging economies.

• and, critically, reform of the international financial institutions. The IMF needs to be more transparent and accountable for its policies and programs. It needs to be in a position to deal with these new kinds financial crises, which stem from capital account rather than trade account problems. Its programs need to make growth the priority. And it needs to be focused on issues bearing on the safety and sustainability of capital flows.

Working with the rest of the international community we have made progress on all of these fronts in recent years. The release of the three Working Group reports we will take us even further toward our long-term goal: a stronger, more stable international financial system. And as we go forward this effort will continue to be extended and broadened. The number and variety of proposals for responding to the short and long- term challenges we face is not in question. What must now be considered carefully is their effectiveness and long-term durability.

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