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1、2Understanding the Asian Financial CrisisJeffrey D. Sachs and Wing Thye Woo2.1IntroductionAt the height of the Asian financial crisis in the middle of 1998, pundits often pronounced that it would take three to five years for Asia to recover. American triumphalists loudly proclaimed that Asian capita
2、lism, just like Soviet socialism a decade ago, had come to the end of its economic logic. The Pacific Asian economies that had long been hailed by many analysts as models for the rest of the developing world were depicted by some of the same analysts during the crisis as unsustainable nests of crony
3、 capitalism.The Asian financial crisis is as puzzling as it has been far-reaching in its consequences. The sharp region-wide plunge in output after the devaluation of the Thai baht in July 1997 was unexpected,.See the empirical investigation in Woo, Carleton and Rosario (forthcoming). and the strong
4、 region-wide recovery in 1999 was equally unexpected. The World Bank and the International Monetary Fund have long shared a common policy framework, but they are now divided on the causes of the crisis, and on what the policy advice should have been given. All across Pacific Asia, the crisis has bro
5、ught about many fundamental changes: governments have changed, internationally well-known conglomerates have collapsed, the banking systems are paralyzed by large amounts of non-performing loans, and barriers to entry by foreign financial institutions have been lowered.Broadly speaking, there were t
6、wo initial explanations for the unexpected nature of the Asian financial crisis, the large number of economies that were hit, and the depth of the output collapse in some countries. The first explanation emphasized the common structural problems (“soft rot”) in the crisis Asian countries as the prim
7、ary cause of their sudden output collapses, and viewed their crises as “inevitable disasters that finally happened.” The second explanation emphasized the primary role of financial contagion in the crisis. Just as external creditors had been excessively optimistic about economic prospects earlier in
8、 199496,.When net private capital inflow to Indonesia, Malaysia, the Philippines, South Korea and Thailand increased from US$40.5 billion in 1994 to US$102.3 billion in 1996, the spread on the Eurobonds issued by these countries fell. they became overly pessimistic at the end of 1997. If irrational
9、exuberance exists, as warned by Alan Greenspan, then disconsolate melancholia must also occur occasionally.Over time, various synthesis views have emerged. However, many so-called synthesis views that admitted to the existence of panics by external creditors were actually soft rot explanations, beca
10、use they identified the “fallen” countries as the countries with the most severe cases of soft rot. A more balanced synthesis view would differentiate “fallen” countries into three categories: countries with advanced soft rot, countries that experienced the greatest bouts of financial panic,.For exa
11、mple, panic caused by domestic political problems. and countries where inappropriate IMF advice led to overly tight macroeconomic policies and badly designed and badly handled restructuring programs.The claim that the Pacific Asian economies had imperfect economic institutions (for example, inadequa
12、te banking supervision and collusive relations between big business and government officials) is surely correct, but to go on to claim that these flawed economic institutions reached breaking points simultaneously, and thereby ignited the region-wide economic crisis, is also surely incorrect. The se
13、cond claim would be like focusing exclusively on deforestation in Central America when discussing the damage wrought by Hurricane Mitch, while ignoring the damage from the hurricane itself. Policy failures matter, but they are only part of the story of Asias financial storm. As much attention should
14、 be paid to the financial “hurricane” itself, specifically, the tendency for international financial markets to overreact to both positive and negative news. It was financial panic among international investors that brought Pacific Asia to its knees in 1998. Fortunately, the underlying fundamental s
15、trengths of the region have brought about an economic recovery more quickly than was widely predicted. In general terms, we can say there were few specifically “Asian” features of the Asian financial crisis. Official Washington, led by the IMF, proclaimed the crisis to be one of Asian capitalism, bu
16、t the more generic character of the crisis became all too clear during 1998, as the crisis spread to Russia, South Africa and Latin America. Rather than an Asian crisis, the world is experiencing a type of global crisis that reflects the rapid arrival of global capitalism in a world economy not yet
17、used to the integration of the advanced and developing countries. The 199495 foreign exchange crises in Mexico and Argentina and, less severely, in the rest of Latin America via the “tequila effect” of 1995, were the high-profile precursors to the financial market crisis that hit Pacific Asia in mid
18、-1997. The Asian financial crisis is really another example of financial panic involving international creditors, though of course the onset of financial panic reflected some of the conditions specific to Asia in 1997. A less well-known, but also dramatic, precursor was the Turkish financial panic i
19、n 1994. The extent of economic devastation in each Asian country differs according to specific national structural conditions and policy reactions: for example, the amount of international debt; the proportion of international debt that is short term; the adequacy of financial sector regulation; the
20、 amount of foreign reserves available to the monetary authorities; the tenacity with which the country defended its exchange rate; the degree to which IMF-style high interest rates and bank closures were implemented (with adherence to IMF programs often doing more, rather than less, short-term damag
21、e); and the ability of the political system to preserve social stability while coping with economic shocks. The solutions to the crisis require responses at both the international level, to address shortcomings in the nascent global capitalist system, and at the regional and national levels, to main
22、tain and improve Asias competitiveness in a globalized economy. Naturally, professional opinion remains deeply divided about the sources of the crisis (national versus international), the reasons for Asias extreme vulnerability (poor policies versus private-sector instabilities), the appropriate pol
23、icy responses (IMF-style financial orthodoxy versus financial heterodoxy of various forms), and the best ways to guard against a recurrence of crisis in the future (national level reforms versus a new global architecture). We review the arguments here and stake out our own position on the basis of t
24、he evidence in this volume. In our view, the crisis was built on national weaknesses that were greatly magnified by a flawed international financial system. In addition, the initial policy recommendations from Washington, especially suggestions to raise interest rates sharply and to close a large nu
25、mber of financial institutions, were deeply flawed and made matters worse, not better. Long-term crisis prevention requires actions both at the national and international levels, including a basic change of strategy in exchange rate management and recognition of the inherently destabilizing risks of
26、 short-term capital flows. The most general and important point is that global capitalism has to be understood better by global policy makers, national political leaders, and business people in all parts of the world. All of these participants in the new global economy have to recognize the types of
27、 shocks that have been magnified and rendered more common by the processes of deep economic integration and of institutional harmonization that are key forces of global capitalism. Only with a better comprehension of the new realities will the world community be able to take true precautionary measu
28、res to head off a future crisis, and will Asia be able to make a swift recovery from the deep crisis which engulfed the region. In short, we need to rise to the challenge of developing new policies and new business strategies that are appropriate for global capitalism.Our analysis is organized as fo
29、llows. Section 2.2 offers a conceptual framework to understand the onset and evolution of the 199798 financial crisis. As explained below, the crisis resulted from the interaction of (1) problematic macroeconomic policies (especially exchange rate policies) in the emerging markets, (2) shortcomings
30、in the financial sectors of the borrowing countries, and (3) intrinsic instabilities in the global financial markets. These problems interacted with some deeper weaknesses in Asian competitiveness to trigger the sharp financial crisis. Section 2.3 outlines the different stages in the recovery proces
31、s, relates the 199798 crisis to earlier financial crises in developing countries, and presents our assessment about the sustainability of the ongoing recovery in the Asian crisis countries. Section 2.4 discusses a wide range of policy options for the reform of international financial architecture, i
32、ncluding macroeconomic policy design in developing countries; the regulation of international capital flows; the revision of the roles of the IMF, the United Nations agencies and other institutions; and the redesign of international financial assistance itself, including accelerated debt reduction.2
33、.2Understanding the Asian Financial CrisisA Theoretical FrameworkBefore we delve into the specifics of the Asian crisis, we need a general theoretical understanding of how international capital markets workand fail to workin the new global capitalist system. Thus, we start with some general theoreti
34、cal ideas, and afterward focus on the Asian experience.Emerging market financial crises, such as in Asia in 199798, are characterized by an abrupt and significant shift from net capital inflow to net capital outflow from one year to the next. These crises typically reflect a three-stage process that
35、 hits a developed country engaged in large-scale international borrowing. In the first stage, the exchange rate becomes overvalued as a result of internal or external macroeconomic events. In the second stage, the exchange rate is defended, but at the cost of a substantial drain of foreign exchange
36、reserves held by the central bank. In the third stage, the depletion of reserves, usually in combination with a devaluation, triggers a panicked outflow by foreign creditors holding short-term claims. The trigger in most cases is the devaluation itself, resulting from the exhaustion of reserves. The
37、 panicked outflow of short-term capital leads to macroeconomic collapse, characterized by a sharp economic downturn, soaring interest rates, depressed equity prices and a plummeting currency.Some observers have attributed such crises to currency devaluation, because the panics have almost always fol
38、lowed a movement in the currency. This was certainly the case in Asia: the Asian crisis followed soon on the heels of the unexpected devaluation of the Thai baht on July 2, 1997. Similarly, Koreas extreme crisis came in December 1997, following the devaluation of the Korean won. Generalizing from th
39、ese instances, and from the earlier case of Mexicos devaluation in December 1994, these observers have concluded that currencies should be fixed in value and never allowed to weaken. We disagree. In our view, it is not the devaluation, but rather the defense of the exchange rate preceding the crisis
40、 that opens the door to financial panic. A gradual weakening of the currency by itself is not harmfulas exemplified by the successes of many countries with flexible exchange rate arrangements, including Chile, Canada, Australia and New Zealand. The real damage comes from the depletion of foreign exc
41、hange reserves while trying to defend an overvalued currency. A devaluation that follows the depletion of reserves can indeed trigger a panic, but the lesson is to allow the currency to weaken before the reserves are depleted. When foreign reserves are depleted, short-term inter-bank credits in part
42、icular become subject to an abrupt, self-fulfilling loss of confidence. In summary, the devaluation signals the depletion of reserves; the depletion of reserves signals the inability of the central bank to act as a lender of last resort vis-vis foreign creditors; the short-term foreign creditors fle
43、e in panic; and the macroeconomy collapses as a result of the creditor flight. Creditor PanicThe ubiquitous feature of recent emerging market crises is that the exchange rate defense, typically ending in a devaluation, has often been followed by a rapid and ferocious withdrawal of credits by foreign
44、 investors. It is the panic, not the devaluation itself, which leads to the acute damage to the emerging market and to the creditors. Typically, some key segments (e.g., banks, non-financial enterprises and government) of the fast-growing Asian economies are heavily in debt to foreign investors, inc
45、luding international banks, hedge funds and other investment funds. Much of this debt is short-term, i.e., with maturity under one year. Additionally, much of the debt has trigger clauses, such that repayment is immediately accelerated in the event of a contractual default by the debtor to other cre
46、ditors. The borrowing, in general, is converted into long-term, relatively illiquid investments. As a result, total short-term debt is often significantly greater than the available short-term assets that might be mobilized to repay creditors in the event of a withdrawal of new lending.The level of
47、central bank foreign exchange (forex) reserves is crucial because the central bank is widely, and rightly, understood to be the lender of last resort not only to the banks, but to the government and corporate sector as well, in the event of an external creditor panic. Suppose that foreign banks begi
48、n to withdraw credit lines from domestic banks, demanding repayment of outstanding loans. This immediately leads to financial distress in the banking system, since the banks have transformed the foreign loans into long-term investments. The bank may, to some extent, use liquid domestic assets to pur
49、chase dollars in the foreign exchange market, but even so, the bank is unlikely to have sufficient liquid assets on hand to meet a large-scale withdrawal of funds. Thus, the central bank will almost surely have to extend credit, either directly as foreign exchange loans, or as domestic credit which is then sold in the forex market. In the latter case, of course, the exchange rate will depreciate in the absence of official intervention. Once forex reserves have been depleted, the
