Robert Rubin: Boy Blunder

The Treasury secretary has been feted here, there and everywhere. But from a look at his recent record, undeservedly so.
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He saved the world.

That's what many year-end profiles are bound to claim about

Treasury

Secretary

Robert Rubin

.

Even though he didn't win

Time

magazine's "Man of the Year," as was rumored, he'll certainly receive accolades from other publications. The paeans will go something like this:

Rubin, with the dash and daring of a financial markets James Bond, has crossed the globe putting things right in 1998. The sly silver-haired fox single-handedly turned the yen/dollar market in his favor. At his behest, the hapless Japanese finally started reforming their depressed economy. He also neutralized emerging-markets contagion by ensuring that crisis-hit Brazil got a whopping defense fund from the International Monetary Fund.

To be sure, Rubin has not been sleeping on the job. Without him, the market would not have been able to sail so blithely through

President Clinton's

scandals. Even the most dyspeptic pundits agree that he, along with

Federal Reserve

Chairman

Alan Greenspan

, has helped create several years of virtual economic utopia in the U.S., characterized by low inflation, high job creation, budget surpluses and robust economic growth.

But that was until the past summer. In fact, historians may split Rubin's tenure into two periods divided by the events of July 1998. Before that month, he was Rubin the invincible. But since then, he's Rubin the inexplicable. The Treasury press office did not make Rubin available for a response to this article.

To see why, examine the first real black spot on his political career: Russia's disastrous devaluation and default in August. It's hard to understand why, but the 60-year-old former

Goldman Sachs

trader has escaped unsullied by the Russian debacle, even though that single event triggered the subsequent plunge in financial markets in September and October.

His handling of Russia in turn raises huge questions about the viability of the Brazilian bailout, which is looking shakier by the day. And, more profoundly, Rubin's Russian miscalculation underlines the quick-fix mentality behind some of his most important initiatives.

Rubin and Russia

Back in July, Rubin forcefully campaigned on behalf of the $23 billion IMF-led aid package for Russia. Defending it from skeptical Republicans, he said: "We have the opportunity to use the leverage of the IMF financing to help the Russian government take the myriad steps needed to put its finances on a sustainable path."

But as it turned out, Rubin the world financial leader was duped in a way that Rubin the Goldman arbitrager would have never allowed. The Russian government suddenly let the ruble float and reneged on its domestic debts in mid-August.

Nicholas Brady

, Treasury secretary under Presidents

Reagan

and

Bush

, tells

TSC

that he wouldn't have pushed the IMF to make the July loan to Russia. "Russia didn't have the structures in place to receive that money," he says.

Nor is it possible to argue that the IMF failed to warn Rubin of the dangers of lending to Russia. As

TSC

reported at the time, the U.S.-backed package apparently faced resistance among high-ranking IMF staffers.

If Rubin had directed the IMF to play hardball with the Russians from the beginning -- and refused to underwrite their unsustainable policies -- it's possible that the country would have faced up to its problems. And even if this tougher approach had not prevented a meltdown, the financial markets would not have been so surprised when the collapse came.

Instead, investors were given a false sense of security by the IMF's largesse. It's no surprise, then, that they recoiled in shock -- and dumped just about everything except short-dated U.S. government bonds -- when Western governments finally closed their purses to Russia after it devalued.

Brazil Blues

Despite this Chernobyl-sized screw-up in Russia, Rubin then swung his weight behind a similar $42 billion package for Brazil.

While Brazil, with its large, dynamic private sector and talented reform team, is not Russia -- in some ways, it's a lot worse off. At 8% of

GDP

, in fact, Brazil's fiscal deficit is much larger than pre-crisis Russia's.

What's more, unlike Russia, Brazil's leaders can't rely on executive-level decrees to get tough economic measures rammed through the system. Instead, important budget-trimming measures are being defeated or held up in

Congress

, which lost its sense of urgency once Brazil got the cash. Nor is it difficult to see why: Nearly half of the IMF cash can be drawn by early next year without the country meeting any target whatsoever.

Congressional foot-dragging means that the biggest single revenue-raising measure in the fiscal-savings program -- a hike in the financial-transactions tax -- will likely not be passed until July next year. As a result, it will raise only 4 billion reals ($3.3 billion) instead of the hoped-for 7.3 billion reals.

Fears concerning missed budget targets, a growing internal debt and painfully high interest rates have once again caused dollar outflows to increase. As a result, Brazil's stock and bond markets are still sickeningly volatile, with the equity market declining more than 20% this month.

Jawboning Japan

Rubin's dollar/yen policy -- for which he has received a huge amount of praise -- could in fact be damaging to Asia, as it essentially prevents Japan from rapidly reflating its economy. Instead, Rubin's push for a stronger yen appears to be governed as much by a shortsighted pursuit of U.S. interests -- particularly limiting the size of this country's current account deficit, which is now at a record $220 billion.

Many economists have long believed that Japan needs to massively boost the rate of growth of its money supply to pull itself out of the slump. But the fact is Japan can't aggressively expand money supply while Rubin holds the line for a stronger yen. Why? Because if it does so, some of the increased liquidity will leak abroad, thus bringing down the value of the yen.

And there's the rub: A cheaper yen would swell the size of the U.S.' politically charged trade deficit with Japan, something Rubin seems keen to avoid, says Charles Calomiris, a professor at

Columbia Business School

.

Instead, Rubin spent $2 billion intervening in the currency markets in June to prevent the dollar's continued ascent against the yen. It achieved its aim beautifully -- the dollar is still 20% lower than its 1998 peak -- primarily because Rubin's lightning strike caught the market unaware.

Rubin justified the intervention at the time by saying that it would help prevent Asian currencies from sliding -- and that it did. But by strengthening the yen in the short run, Rubin's intervention sacrifices Japanese needs for economic growth on the altar of U.S. trade imbalances.

Instead, Rubin has taken a different tack with the Japanese, asking them to focus their policies on banking reform and tax cuts. Yes, these are good things -- and they'll eventually add a lot of liquidity to the system. But they're unlikely to do so quickly, and growth may not come, as much of the money being injected into the banking system is going into insolvent institutions that are not lending. As a result, the most recent money supply indicators showed that broad money grew an anemic 3.2% year on year to the end of November.

Calomiris makes this fundamental criticism of Rubin's Japan policy: "Instead of jawboning the Japanese about fiscal policy, he should have told them to expand money supply."

Rubin is being myopic, as an overly large deficit would only be temporary. You see, once Japan's economy got going, its imports would pick up, thus making the trade deficit with the U.S. much less of an issue.

Ironically, over the long run, Rubin can't fight the yen's weakening fundamentals. When the Japanese government begins to monetize the costs of the bank bailout and tax cuts, the surge in money will cause further yen weakening next year. This, in turn, will probably help push the U.S. current account deficit up to $300 billion by the end of 1999 -- Rubin's strong yen policy or not.

Dollar Dive in 1999?

Rubin may soon have to contend with a new problem: the threat of a collapse in the dollar.

The bigger the current account deficit, the greater the chance that a nervous market seizes upon it as an excuse to dump greenbacks.

"A major issue for next year is the possibility of a dollar crisis," says Chris Iggo, chief international economist at

Barclays Capital

.

A plummeting dollar -- if it occurs -- would have effects way beyond the currency markets. It could spark mass selling of U.S. equities by foreigners. Europeans, who purchased $143 billion of U.S. stocks and other securities in the first half of this year, could be the first out of the door. The likelihood of this would be especially high if the euro looks like it's going to be more stable than the dollar and European economies show good growth.

An exodus by foreigners would be bad news indeed for the U.S. economy. A great deal of the recent extra strength in U.S. consumption has been financed by domestic households selling stock -- $210 billion over the past 12 months, according to

Credit Suisse First Boston

economists. Among the main buyers have been foreigners: When they stop purchasing, stocks fall, consumption shrinks and growth slows.

And don't rule out an interest-rate hike if the dollar weakness gets really bad. Doubtless Rubin has strategies in mind to prevent the greenback from entering a meltdown. Looking back at his moves over 1998, however, it's obvious that Robert Rubin -- like the rest of us -- is only mortal.