There are moments in capitalism when financial plagues break out with such speed and intensity that the international economic community is astonished. The Asian financial collapse is one such event, as were the panic of 1907 and the failure of Austria's Creditanstalt Bank in 1931. In the first instance, J.P. Morgan stepped in and contained the infection. In the second, policy mistakes turned a serious recession into a long depression. Today, with a de facto debt moratorium in place and a recession under way, Asia is unleashing deflation into the world economy. Should China devalue its currency, the world could find itself in an agonizing slowdown.
The Asian crisis is a solvable problem. But serious blunders could allow it to spread in dangerous ways. Already, analysts have shaved as much as a full percentage point off their estimates for global growth for 1998. They have consistently underestimated the impact of the Asian crisis and it could get worse. The main trouble is that the aging Bretton Woods-era system, designed to counterbalance national trade deficits, is coming apart under the strains of hot-wired global capital flows. In the end, a commitment to changing the rules of the international economic game by all the players involved will be needed if serious trouble is to be avoided.
Plunging currencies and rising unemployment are quickly destroying the wealth of Asia, eroding the richest growth markets for Western exports and investments. There is a danger that Versailles-style austerity programs imposed on Indonesia, Korea, and Thailand by the International Monetary Fund and the U.S. Treasury are dumping all the pain of restructuring on Asia's businesses and middle class while Japanese, European, and American banks get off free. So far, an Asian backlash has targeted corrupt politicians and crony capitalists. But angry nationalism is growing, and the backlash can easily shift to anti-Americanism or even anticapitalism.
NO RISK ANALYSIS. The Asian crisis, like all previous panics, has not one but many causes. Double-digit growth was based on cheap credit to friends, family, and favored businesses by politicians or bureaucrats. Japanese banks in particular, facing low interest rates at home and unwilling to write off the bad loans of the 1980s, sought salvation by lending massive sums in the region. German and U.S. banks piled on, as did pension funds and emerging-market mutual funds. It was a funny kind of capitalism. Local banks lent on the basis of contacts, not risk analysis. Foreign banks, projecting from their Latin American experience, looked at positive government budget numbers but not at negative corporate earnings figures. Huge overcapacity resulted.
A rolling bank panic brought an end to the party. The end began in Thailand. Devaluations by China in 1994 and Japan in 1995 made Thai exports uncompetitive. The baht fell. U.S. hedge funds pushed the currency lower. The Thai central bank disclosed that it barely had any reserves left. Creditor banks were shocked and stopped rolling over short-term dollar loans to Thai companies. As each Asian currency came under pressure, new surprises surfaced. Indonesia's central bank had no idea what the country owed. Korean companies had quietly borrowed up to $150 billion short-term. Each crisis revealed more secrets. Credit dried up. Asia ground to a halt, dumbfounded.
What must be done now is clear. First, purchasing power and growth must be restored to Asia by restructuring the dollar liabilities of Asian corporations and banks. The IMF erred by first negotiating with Asian governments. It should have brought borrowers and creditors together immediately to bang heads. The IMF should have pressured the banking institutions to take a quick hit, securitize the bad debt, and extend short-term dollar liabilities to Asian corporations to stimulate growth again. Instead, the banks are now trying to offload their mistakes in extending bad loans to private Asian companies by getting governments and their taxpayers to, in effect, swallow a big chunk of the losses the banks themselves should take.
BOOST BUYING POWER. The most irresponsible player in this entire crisis has been Japan. To stem the currency slide, a lender of last resort should have immediately stepped forward. Japan is the natural choice to do this, just as the U.S. did in Mexico, but the Japanese Finance Ministry refused. Instead of providing Asia with backup credits in this time of crisis, it is being stingy. Amazingly, Tokyo is even depreciating the yen to gain advantage during the crisis, thus exacerbating it. Japan should be raising the value of the yen and cutting taxes to boost consumer buying power and absorb Korean and Thai exports.
Asia must realize that its old, secretive mercantilist ways have become the enemies of growth. The Japan model isn't working. If capital is to start flowing, there must be transparency to assess risk. Asia's central banks, like Mexico's, should publish honest numbers on their reserves on the Internet daily. Banks and mutual funds must insist on concrete numbers from Asian companies before they lend and invest. Rating agencies must get real. The high-octane global financial markets are clearly overshooting. Thanks to the lower cost of trading due to communications technology and the rise of derivatives and leverage, the magnitude and volatility of capital flows are rising. With enough data, markets can make the right decisions. Without it, capital flows can wreak havoc.
Washington must lead the effort to reform and rebuild the global financial system. There is a strong chance that the Asian crisis can act as a solvent, dissolving authoritarian governments and economic practices while spreading democratic market capitalism. These are values cherished by Americans and worthy of support by politicians, business people, and average citizens. The Thais say: "from bad comes good." This could be one of those moments.