What caused the Asian financial crisis? Right after it ignited in Thailand in July, 1997, the Asian economies were seen as the culprit, particularly by Western investors who suffered huge losses in Thailand, Korea, and Indonesia. In a remarkable about-face, many of the world's most sophisticated financial institutions and market pundits who had hailed the Asian economic miracle began complaining about Asian crony capitalism. Never mind that per-capita income soared seven times in Hong Kong and South Korea and 4 1/2 times in Malaysia, Thailand, and Indonesia during the previous 30 years--an unprecedented accomplishment in economic history. Never mind that these countries had followed textbook models of economic development, with balanced budgets, conservative monetary policy, high savings, and market liberalization.
Today, the "blame Asia" explanation has a decidedly hollow ring following Russia's dramatic default, the virtual disappearance of risk capital in emerging-market economies, and the near collapse of the hedge fund Long-Term Capital Management. Now that a global liquidity crisis threatens to throw the world economy into recession, attention is shifting from the structural weaknesses of emerging-market economies to the structural weaknesses of the international financial system. And criticism has shifted from the follies of borrowers to the follies of lenders.
PANIC ATTACKS. President Clinton has described the swift and unanticipated flight of private capital out of the emerging-market economies as analogous to bank runs on entire economies. This is an apt analogy in light of the fact that many of the economies that have suffered the greatest traumas are smaller than the global financial institutions that lent them billions in short-term money. With the benefit of hindsight, it is painfully obvious that there was nothing in the current international financial system to prevent either the excessive buildup of short-term borrowing when capital was pouring in or the credit crunch that strangled emerging-market economies when capital hemorrhaged out.
So what can be done to contain the recessionary forces that have now been unleashed and prevent future bank runs on whole countries? Given the precariousness of current conditions, the world community should heed the advice of James D. Wolfensohn, the head of the World Bank, to focus on efforts to ameliorate the immediate crisis. Although reforms of the international financial system are necessary, they will take considerable time to design and implement. The contentious discussions of preliminary proposals at the recent annual meetings of the World Bank and International Monetary Fund indicate that the reform process will be painfully slow.
PROMISING STEPS. Immediate action is warranted on several fronts: cuts on interest rates by the U.S. and Europe, an infusion of new reserves into Japan's troubled commercial banking sector, a further easing of IMF austerity conditions in emerging-market economies, and the extension of new loans. Recent decisions by both the Federal Reserve and the Bank of England to reduce short-term interest rates and Japan's offer to extend $30 billion in additional loans to the Asian economies are promising first steps. A credible adjustment package for Brazil would help rebuild investor confidence.
Two kinds of reform should receive top priority in remaking the international financial system. First, emerging-market economies must develop transparent, supervised financial institutions, monitored by either the IMF or the Bank for International Settlements. Developed countries should mount a program of technical and financial assistance to help in this essential task.
Second, as the U.S. has proposed, the international system must fashion some kind of contingency-loan facility that can be quickly mobilized by countries pursuing sound policies to resist sudden speculative runs. Admittedly, the wisdom of such a proposal hinges on prior agreement about what constitutes "sound policies" and "turbulent" market conditions. Reaching agreement on these controversial issues should be the first order of business. Had such a contingency-loan facility been available during the summer of 1997, the crisis that began in Thailand could have been contained instead of spreading and threatening the entire world economy. It is equally sobering to note that Japan's proposal for a new $100 billion fund to combat currency contagion in Asia last year, which Washington defeated, could have had the same effect. But there is no time to lament the might-have-beens of the past. The tasks of the future demand our attention.