I think there was a misperception based on a faulty analogy. When the crisis started in Asia, the first reaction was, this is Mexico all over again. And Mexico, in 1995, looked really bad at the beginning, but there was a pretty swift rescue. In the end, the problems in Mexico didn't spread to the rest of the world.

There was a second misperception, and that is a failure to recognize how the financial system is intertwined these days. It used to be that we would think of contagion of a financial disease spreading through trade. One country would have a problem, it would go into recession, it couldn't afford imports; therefore, somebody else's exports would dry up and that other country would be in trouble.

But this was a different kind of contagion because it rested on the notion that more and more money had been flowing into these countries from Wall Street, and the people who were investing this money weren't really differentiating among the countries. They just felt that there's a whole new class of countries called emerging markets, and these countries were providing very healthy financial returns. So when one went into the tank, these investors panicked and they started to pull their money from all the countries, because as far as they were concerned, whatever happened in Thailand could easily happen in Brazil. When, in fact, the two countries at that time were vastly different in terms of the nature of their economies.

So it was really the young trader or the young investor in a mutual fund in New York who caused the contagion as much as anything else, and when those problems arose in Thailand, no one really thought in those terms.

I've talked to several people who are critical of the reaction to the crisis, but one I'm thinking of specifically says that basically Wall Street failed in its responsibilities of due diligence in these countries. Does that make sense to you?

I think that everybody failed to look beyond the facade in terms of what was going on in Asia. The phenomenal growth masked a lot of problems, and people who were making money simply didn't want to upset the apple cart by looking too carefully. There was a feeling, and this is a feeling that always proceeds every financial crisis, that there was something about this environment that was different, that somehow the Asians had a different sort of system. That they had figured it out. It was inconceivable, because of the energy and the sheer drive of most Asian cultures, that the growth would slow.

So everybody really didn't do their due diligence. Certainly, the commercial banks, who have been there for a long time, they should have known much better. Then there was a second group of people who really deserve criticism, and those are the rating agencies. The agencies like Standard & Poor's, that rate countries for purposes of rating their bonds. They basically gave these countries top ratings until there was a crisis, and then overnight they gave them the worst ratings. You really have to wonder what everyone was doing in terms of the due diligence.

A third group was the international institutions, like the IMF and the World Bank. Here the picture is a little more murky. There is evidence that actually the IMF knew that there were big problems. But because of its relationship with these countries--it's a government-to-government type relationship--the IMF has pledged to confidentiality and they really couldn't announce that there were problems. I think it's probably half true, but in some cases they knew, or in some cases they knew half of what was going on, and the same with the World Bank.

But, you know, it's easy to cast blame after the fact. In every financial crisis, even the ones that we've had, like the stock market crash of 1987, you could say the same thing after the fact, that if you really looked carefully you would have seen it coming. Unfortunately, economic bubbles, financial bubbles, don't work that way. It's not a bubble until it bursts. So there was a lot to learn from this experience.

What about the criticisms of the prescriptions that the IMF and, to some extent the U.S. Treasury, came in with, once the crisis started rolling?

Well, if you don't diagnose the problem well enough, then the prescription is likely to be wrong. The IMF and the Treasury were doing the best they could given the situation. In retrospect, it is not real clear what they could have done differently or whether if they had done something differently, it would have worked better. But they certainly came in there and demanded a level of immediate austerity, which threw these countries into a tailspin.

I believe personally--now, a lot of people disagree with me--that they asked these countries to do too much at one time. It wasn't just to get their monetary policy and their trade policy in order, or their fiscal policy in order, but they immediately started to ask for wholesale restructuring of the economies themselves. While all of that had to be done, if you do it all at once, the social cost, the cost in terms of unemployment and, you know, the sheer human misery that is created--it was too much. But reasonable people can disagree on that, and it will need a few more years to see if these countries recover and recover in a very strong way. Then, maybe in the end, the pain was the right way to go.

Although the argument is that the signs of recovery right now are really just looking at the financial ...

There is, in the air, a sense that the crisis is over, and that is a big mistake. Even the countries like Korea and Thailand, which are starting to borrow again on international markets, they have a long way to go. A lot of the fundamental restructuring that is going to be necessary, particularly in the banking system and particularly with regard to separating finance from politics in the most sinister sense--cronyism--that is a long way off from really being addressed. So investors are looking for some hopeful signs, and they'll always see them, but this is going to be a long-term recovery.

And the recovery in the real economy beyond the financial?

Well, the recovery in the real economy will take at least another five years.

You are worried that we are going to say that the crisis is over; therefore, there's no need for much of anything to change?

Well, if you look at the history of financial crises, the lead-up is always the same. There's always exuberance and then everybody piles on, and then there's a change in sentiment, and everybody heads for the exits at once. Doesn't matter which crisis; they're all the same.

It's the same with the aftermath. At first, there's a flurry of activity to get the money out, and then there's a realization that these countries really need to recover and down the road, there will be more profit opportunities. Once the recovery is in sight, the memories of the crisis disappear.

My concern here is that a lot has to be done. This isn't just an isolated financial crisis. This is a crisis of the whole world economy. This Asian crisis, which grew to be much bigger, is really a reflection of a world economy that has yet to become a world economy. It's like the United States between 1860 and 1930. We had lots of stock market crashes. We had lots of panics. It was only until we had a Federal Reserve and a Securities Exchange Commission that we became a really solid national economy.

When we had rules, basically.

Right. Exactly. What the international economy is missing is what this crisis showed--common rules, common standards, a strong financial base--and all of that is still critical. So if people think, "Hey, this crisis is over," the hard work, the real roll-up-the-sleeves stuff--training banking regulators, putting in place new systems of oversight, financial disclosure, accounting rules--these are nuts and bolts, but they are absolutely critical. They take a lot of work and a lot of political will, and there's a concern that, if people think the crisis is over, we'll go right back to where we were and that would be a real tragedy.

Do you think it's dangerous?

Well, it will be dangerous. For an article that I wrote, I interviewed 20 top executives on Wall Street and in Washington. They disagreed on a lot of things, but the one thing they all agree on is that we're going to have another crisis. That it's baked into the cake, and that the best we can do is to make it limited and not have the kind of contagion that we had this time.

But there is nobody that I talked to who denies that the world economy is precarious. It's only as strong as the weakest link, and we have lots of weak economic links. And as this crisis showed, the political links count, too. If you have a government that cannot implement the right sorts of policies, that's a weak political link, but in the end that's an economic link, too.

So the global system is filled with all kinds of big potholes, and unless we fill those in, and that will take generations in any event, but unless that happens we're going to see more Mexicos, more Thailands, and this is going to be a recurrent theme in the world.

When does it start to affect us in the United States in more dramatic ways than it has thus far?

Well, the United States has been extraordinarily immune from these problems, and I don't think anybody would have predicted that so much of the world could be in recession and that our economy could remain so strong. It may be luck. It may be just a confluence of circumstances. I don't think anyone knows.

But we are becoming more and more intertwined with the rest of the world--our trade, the dollar, foreign investment, immigration, virtually everything. As a percentage of our economy, the international dimension is getting bigger and bigger. So it would really be pressing our luck to say the next time we'll ride it out as well as we did this time. Nobody knows.

I've always said that the world economy is too complex for any human mind to really wrap itself around it, but I do think we've been extraordinarily fortunate, and it would be a reckless gamble to conclude that somehow we're not linked.

The crisis hit when we were very well prepared: low inflation, almost no unemployment, a superb Federal Reserve which knew exactly what to do and when, and a business expansion that was fueled by new technology. But these are factors that have never come together before in quite the same way, and to say ... that they'll always be here, that doesn't make sense to me.

There is a huge debate going on around the world about what has happened and why. Many people outside this country basically say that the U.S. is standing in the way of real changes being made to the system.

Well, we are such a strong economy and so dominant that we are going to be the lightning rod for every conceivable criticism. The fact is that had the United States not been so strong, had we not imported so much and we continue to do so ... the 40% to 50% of the world that's in recession would be in deep depression. And I hope that people abroad give us credit for holding up the system.

It's not too much to say that we are the consumer of first, second and last resort. I don't think it's right to blame the United States for any of these problems. To the extent that we've made some mistakes, it may have been that we were a little bit too exuberant, not Greenspan-type of exuberance, but exuberant in our push for other countries to follow the American model.

When I entered the Clinton administration, there was a lot of excitement about what was going on in emerging markets. They were liberalizing their trade, they were opening up to foreign investment, they were adopting capitalism for the first time. We were very excited about it and we pushed even harder for more opening, and certainly, at least in my mind, I think probably in my colleagues' too, was the notion that an American-style economy was the best for anyone.

Maybe we pushed too hard, too fast without understanding or without taking the time to realize that we have a lot of underpinnings in our economy that took 100 years to build, 200 years. Many of these countries didn't, and so they were going through the motions without the right kind of regulatory systems. So I think it's legitimate to say we were trying to recreate the world in our image, but it was not malevolent. It may have been a bad judgment as to the pace.

But, then again, you never know in the end, because people can say it should be done slowly. It's not clear that it can be. It may be that there has to be a sort of revolution, and it creates a lot of disturbances. In the end it works or it doesn't, but the slow-motion revolution may in fact not get anywhere. It's a real hard call.

Describe to me a little more the early days when you joined the Clinton administration ...

Well, when I joined the Clinton administration shortly after the president came into office, there was a sense that the U.S. was stagnating both at home and abroad. In the area that I was involved in, the global economic arena, there was also a feeling that too much attention was being given to fighting with Japan and that, in fact, much more promising markets were outside. China, India, Latin America--they were all in the midst of incredible economic reforms, the kind that nobody would have predicted just a few years before that.

So we decided that this is an area that the U.S. should focus on, perhaps even more than Japan, although we didn't want to say Japan wasn't important. It's just that this is where all the new action would be, and we saw this as a real competitive battlefield for firms around the world. Many American companies were coming to us and saying, look what's going on in Indonesia. Look how Japan or Europe is helping their firms win these big contracts, big infrastructure contracts ...

So we got very geared up to help U.S. firms win market share, and that took a lot of forms--very aggressive trade policy, export promotion policy, and almost a partnership between the Clinton administration and American firms that wanted to do business overseas. We were quite convinced that what was going on was in everyone's interest, because the emerging markets that we saw wanted more investment, and their leaders were saying to us, "We want to liberalize. We want to open these economies. That's best for our own growth," and we thought we were pushing in exactly the same direction.

So, remarkably, in a Congress that was filled with all kinds of dissension, there was none that I could see around the stuff we were doing in emerging markets. I used to go around the United States and talk to large audiences all over, and they were very interested and very supportive of American firms investing and trading abroad and in the American government planning some kind of facilitative role.

So it wasn't really until Mexico had a big crisis that questions were raised. "Are these countries really as good as you say?" And we kept saying, "Look, there are going to be some ups and downs, two steps forward, one step back, but if you take a long-term view, emerging markets are going to be the fastest growing markets in the world, and American companies have to be there if they were going to be world-class companies."

How did the pushing for the open financial markets fit in with what you've just described?

Well, we took a very broad view as to what open markets were. It meant trade, it meant lowering tariffs and liberalizing restrictive regulations so that there could be more foreign investment. It meant opening up the financial systems and allowing our financial firms to set up, removing any restrictions of money going in and money coming out. It just meant that we didn't make a distinction between trade liberalization and financial liberalization ...

Was there any debate about just pushing right ahead with all of this?

I don't think there was much debate. I'm sure that there were times when an individual, particularly those that had great academic backgrounds, would raise a point about financial liberalization and the importance of making sure that there are some foundations and some institutions, strong central banks, and a good regulatory system. But we all knew that intuitively. But as the government policy goes, these issues that were raised never stopped. What was a very strong consensus was that we were living in a really unique time.

For 50 years, the U.S. fought the Cold War on certain principles, and one of them was we wanted to see capitalism and democracy spread, and most Americans make a link between the two. You have economic freedom that leads to political freedom and vice versa. So we were convinced that this was the time to push really hard, not because we dreamed it up, but because it was already happening.

You know, it was like a stream. It was moving and we were trying to make it move faster. We weren't trying to change it. I must say we met almost no resistance until the Asian crisis. But until then, all the government officials I met, either in Europe or Japan and especially in emerging markets, they were saying, "How do we do this faster?"

Because they wanted the money?

They wanted the money, and they were seeing the results very quickly. They were seeing that their economies were growing, and they were seeing whole groups in their societies who were becoming more entrepreneurial, creating new jobs, creating new opportunities.

The other thing that played was that the officials in emerging markets realized there isn't a good alternative. Certainly they weren't going to go back to Communism, and the halfway looked like Europe. At the time, Europe was having its own problems with very high unemployment, big social systems that they couldn't afford, so the American model in one way or another was it.

We certainly couldn't look at Japan, which was in a deep recession, for the entire 1990s. So any of these people looking around the world saying now, "Who's figured it out?" and "Who's got it right?"--they had to conclude that the United States was the only game in town. Only, neither they nor we, took into account that we're pretty unique, and it took us a long time to get to this, and we can have a more Darwinian system because we have a bigger cushion. And that's a lesson I hope we've learned.

The potential risks of going so fast were not really on the radar screen?

No, they weren't. In fact, when I left the government I wrote a book on emerging markets, and I wrote an article in Harvard Business Review which is called "Trouble Ahead in Emerging Markets," and it got a lot of attention because the emerging markets were booming and I was talking about all the problems down the road. But the one problem that I said would not happen would be a generalized financial crash.

I said that there were a lot of other problems, a lot of other risks, but we're too sophisticated for that, that between the knowledge in the central banks around the world and the sophistication of banks, this is one thing we didn't have to worry about.

Of course, I was dead wrong, but I think I may have reflected what most of us were thinking, and that is there could be a lot of problems, but they would be confined to individual countries. They would be problems of corruption or maybe revolution somewhere, but nothing like what happened when that problem in Thailand started to spread. It took everybody by surprise.

So what was your own reaction when you began to realize that it really was a panic, that it was a contagion?

I just felt extremely inadequate. I got it wrong. I felt like I had more experience than most people because I'd worked in these countries as an investment banker. I was humbled that this could happen and that it could happen so fast. In retrospect, I don't think I'm the only one who should feel that way, but I certainly felt that way.

You said money was already moving into these markets ... the combination of both this money moving from Wall Street, and the tremendous political influence that Wall Street has in our system. Talk a bit about that ...

Well, after the Cold War, there was a growing sense that what mattered most in the world or the American interest was increasingly centered on economic issues. A lot of the people in the early Clinton years felt that President Bush didn't give enough attention to economics, and that his foreign policy was still an extension of the old Cold War framework and that we wanted to do something different.

So we were keyed on--how do you expand trade? How do you expand international investment? How do you build up these emerging markets? That, in context, the principle actors became American companies and the Wall Street firms. One, they had more knowledge than anyone else. They were out there. Secondly, they became in a sense the surrogates for American influence and power.

So we were heavily influenced by their views. I won't say that we didn't sometimes disagree with them, but we felt it was in the United States' interest for a major company, whether it's a Proctor & Gamble or an AT&T, to be in China, and we saw it in quite broad terms. It was much less that they would earn profits there--although I don't want to discount that--but that they were the conveyor belts for American values and that our concerns with human rights and the rule of law and ... our goals would be furthered, if these companies were present in these countries. So we were extremely interested in the views of the financial and the corporate leaders. It is fair to say that they drove a lot of American policy when it came to non-security issues.

Now, the thing is, though, it's very easy and mistaken to exaggerate how much impact American policy had. These markets were growing, anyway, and a lot of people are saying, "Well, if the U.S. hadn't done this or the U.S. had done that." I think it is arrogating to us far more influence than we have, because investment was pouring into these countries from not just the United States but from Japan and from Europe and from other emerging markets ...

So ... Wall Street and corporate America were actors, but it's a much bigger drama. There were all kinds of trends and pressures and things happening, and we were part of the game, but we weren't determining it.

But if an AT&T or an IBM or a Merrill Lynch came to the government and said, "We're having trouble getting into Thailand," ... a part of all of this was saying, "Fine, we'll help."

Well, we wanted to help as much as we could, but it's important to realize we had some criteria, and the big one was not that it was just an American company, but that we could make some link between the company, the new investment that they were looking for, and jobs at home. We didn't, as a matter of course, help companies that were breaking into markets without some evidence that they would be a very tangible benefit in the United States.

Now, there were so many companies that this was not a problem, because a good number of them could show that if they won this contract there'd be more jobs in Illinois or more jobs in California or wherever. But we always asked that question, and we always put these companies through the best test we could to make sure that what they were doing we would have no ethical problems with it ...

Much of what you're talking about is foreign direct investment--investment in factories, in infrastructure projects. But isn't there a difference between that and opening the financial markets and the activities of the Treasury on behalf of firms wanting to get into the financial markets?

Well, one way to think about the financial liberalization is this. We wanted to see a lot more foreign direct investment that was investment in plants and factories. This is long term and it's acknowledged to be the healthiest for foreign countries; however, you could never get foreign investment unless there was some other kind of financial liberalization that would allow companies to bring money in and out. So on a second level, there was the issue of making sure you didn't have restrictions, and once that happened, money from Wall Street started to flow in. It wasn't direct investment. It was investment in the stock market and that money was very short term. It could go in, it could come out, but you couldn't really separate the two.

Then there was a third, which is where I think both the Commerce Department and the Treasury were active, and that was in helping American financial firms set up shop in these countries. Now, those firms would never have done that if there wasn't overall financial liberalization. But once they were there, that put a lot more pressure on the system to open even further because they had the technology to move money in very sophisticated ways.

So it's a bit artificial to say that you could have pushed one kind of investment and not the other. It was all related in some way, and it was related in the sense we wanted to see countries that were free traders and allowed money to go in and out, just like the United States.

The academics who were making arguments about pace, saying that instead of moving so fast we should have counseled some of these smaller, emerging markets about how to set up open systems, to measure things and to be prepared for this flow of capital?

Well, my recollection is that first of all, there wasn't much discussion of this, so I wouldn't say that this was a big debate. But to the extent points were raised, it was usually evidenced that a country that didn't have a sound banking system could easily find itself in big financial difficulties if it was overwhelmed by foreign money, even money coming in or money going out.

There's a lot of evidence to that, a lot of academic evidence, real-world evidence, that's reflected in academic literature or scholarly literature that goes back 100 years. So it isn't as though these people were saying something that all of us didn't know intuitively, but it looked to us, or I should say it looked to me, certainly, that the banking systems were getting much more sophisticated, even in a very short period of time, and that if you looked at the Korean banks or the Thai banks relative to where they were five or 10 years ago they seem to be in much better shape.

Now, we all deserve blame for not understanding how far they still had to go, but we understood the arguments. We just didn't pay enough attention to it. And I'll tell you this, that even if we had, even if we had said we're moving too fast, I'm not sure that the American system allows for that. This is an academic distinction. Should we move at five miles an hour or 10 or 15? Because once you make up your mind that you're pushing a certain kind of policy, you push it. If you don't push it vigorously, it's not a policy any more. It just disappears into the ether.

So I am quite sure that we overshot just to have some impact, knowing that on the other side there was always going to be some resistance. It might not be vocal resistance, but just resistance of people on the ground who were not so eager to change. It happens in any society ...

You've talked about in the real world you have these clients, these American corporations who are not interested in slowing down. They're interested in getting in there as fast as they can.

That's right. The constituency for pushing hard, it was very strong. And it is all of corporate America. I never ran into a company that said, "You're going too fast." A very powerful banking system and Wall Street, which has become over the last 10 or 20 years one of the real power centers in the United States. So certainly, to slow down would have been a major government decision and reversal of policy.

I'm not even sure it would have had an impact because I'm one of those people who think that whatever we did was pretty much at the margin, anyway, that it was the economic forces and the sheer torrential flows of capital that basically reduced American government to being a player, but not the key player.

So who are these markets? How do you describe how decisions are made in this new world?

Well, that's very interesting. These markets have a model, more of an Internet model than it is of a traditional hierarchy that we know from, say, the old General Motors. Millions of decisions being made around the world simultaneously, information crisscrossing, being interpreted different ways, a certain herd mentality. If somebody's doing it, everybody rushes to do it. When that organization decides or when some organization decides the game's up, everybody decides the game's up.

But there's no center. The only center that we have seen, the closest is the Federal Reserve, which is a center in the sense that what it does affects everybody. So when the crisis really looked like it was deepening and Alan Greenspan stepped in with some interest rate reductions, that had an incredible effect, probably more than anyone would have thought, and it was an effect on psychology as much as anything else. So that's a center, but that's in a sense a reactive center. That's a center that says when there's a real crisis, we'll try to put a floor under it. But in terms of a center for the future architecture, it's a much murkier picture.

Is it troubling to you?

I don't find it troubling, only because this is the reality that we live with, and we have to figure out how to deal with it. It would be very hard to change it. The analogy is more biological than it is anything else. This is like an organism that moves and grows and collapses, and we're doctors trying to examine what's making it tick. But we don't have full control over it.

... once a crisis begins the IMF, the U.S. Treasury come in to calm the markets. But it is all psychology and it seems that there is a gap between the policies that will calm the markets and what's being wrought in the real economies in these places.

Well, this is a special moment in history, when we will look back and say it was a major course correction, but the direction won't change. And it's quite significant that since the end of the Cold War, we're seeing this flowering of capitalism, and capitalism has within it the seeds of all kinds of temporary disasters. That's what it is, really. Markets go until they collapse, and then they recover and start again and we're seeing that played out. The best we can do is to build a stronger floor so that the collapse isn't as great and so it doesn't spread as much, and that will happen in fits and starts.

The result of this crisis will not be a new world economy that is immune, but it could be a world economy that takes the next crisis a little easier, and maybe there'll be fewer countries and maybe the severity won't be as great. But it's going to be very incremental, because no one's at the center, and no one has full control, and no one is a commander. But that's the nature of the markets.

... talk about the backlash that this crisis has created.

Well, I think there will be a slow backlash against liberalization that is too fast. It's hard to gauge because the backlash doesn't seem to me to be among top policy makers, but there is going to grow out of this another layer of politicians. We don't see them now, but they might be the governors, the mayors or business people who were really caught up in the crisis who will emerge and say, "American-style capitalism may be a great goal but it's not for us right now. We're going to have to put the brakes on as best we can."

Now, they may not be able to do too much. but it won't stop them from thinking in these terms. I think that probably the U.S. government will not resist understanding that a lot of damage was done. So I don't know that the backlash will put a monkey wrench into the system, but the tone will be a little bit different going forward than the exuberance that was expressed over the last five or six years.

You've said that not just "capitalism," but "democracy" has become a dirty word, which seems to be a very troubling outcome.

I alternate on this. The problem is that there is really no alternative. There's no other model. At one time there was a European model and at one time there was a Japanese model, but this frustration which is clearly building, has no real outlet so it may not last so long. I don't know. I think it really depends.

Now, this crisis isn't over. If there were to be a relapse, if Brazil were to really collapse, if China were to have some really big problem, if we had a stock market crash and our growth slowed and the whole world economy went into a tailspin, what happens is the seeds have already been planted for a great disaffection and they will grow. But on the other hand, if these countries do recover reasonably soon, and the U.S. stays strong, then maybe the backlash won't be very serious.

But if we do have a stock market slow down and crash before the rest of the world has recovered, we are potentially in deep trouble?

Well, there's always a crisis scenario around the corner, but people need to be humbled now by any prediction. What's really clear about the world economy is it's almost impossible to tell what lurks around the corner, whether it's a spurt of growth, a collapse of oil prices, a strengthening of the dollar or a collapse of the dollar, a Japan in recession or a Japan in recovery, a strong China or a weak China. It is almost beyond anyone to really predict. So we have to be prepared.

Fortunately, the U.S. is really well prepared. We can weather so much now because we're the only country that even approaches no budget deficit, such low inflation, no real employment problems, tremendous vitality in the business sector, so we are poised in the best position we possibly could be.

You've just laid it out economically. Do you think politically we are fulfilling the responsibility which we now have in this post-Cold War world?

Well, I think we could do more. We could take a little more responsibility in terms of trying to shape the rules of the world economy. But we're pretty active.

One of the problems that any administration is going to face is that we have a Congress that is quite inward-looking and it doesn't matter what party you're talking about. ... It's all well and good to say that the administration should be more active or exert more of a leadership role, but in the economic area you can't get too far out in front of the Congress, because in this area they have a lot to say. So I think the administration is doing almost as much as it can, given the cards it has.