Wrong Medicine For Asia Essays - Stock Market Crashes, Money

Wrong Medicine For Asia The Wrong Medicine for Asia By JEFFREY D. SACHS CAMBRIDGE, Mass. -- In a matter of just a few months, the Asian economies went from being the darlings of the investment community to being virtual pariahs. There was a touch of the absurd in the unfolding drama, as international money managers harshly castigated the very same Asian governments they were praising just months before. The International Monetary Fund has just announced a second bailout package for the region, about $20 billion for Indonesia. That should, in principal, boost confidence. But if it is tied to orthodox financial conditions, including budget cuts and sharply higher interest rates, the package could do more harm than good, transforming a currency crisis into a rip-roaring economic downturn. In the Great Depression, panicked investors fled from weak banks in the United States and abroad. Since banks borrow short term in order to lend long term, they can be thrown into crisis when a large number of depositors suddenly line up to withdraw money. In the days before deposit insurance, individual depositors would all try to be first in line for withdrawals. In 1933, the Federal Reserve played it disastrously wrong. Rather than lending money to the banks to calm the panic and to show the depositors that they could indeed still get their money out, the Fed tightened credit, as financial orthodoxy prescribed. Confidence sank, and the banking system crumbled. The Asian crisis is akin to a bank run. Investors are lining up to be the first out of the region. Much of the panic is a self-feeding frenzy: even if the economies were fundamentally healthy at the start of the panic, nobody wants to be the last one out when currencies are weakening and banks are tottering because of the rapid drain of foreign loans. I t is somehow comforting, as in a good morality tale, to blame corruption and mismanagement in Asia for the crisis. Yes, these exist, and they weaken economic life. But the crisis itself is more pedestrian: no economy can easily weather a panicked withdrawal of confidence, especially if the money was flooding in just months before. The I.M.F. has arrived quickly on the scene, but the East Asian financial crisis is very different from the set of problems that the I.M.F. typically aims to solve. The I.M.F.'s usual target is a government living beyond its means, financing budget deficits by printing money at the central bank. The result is inflation, together with a weakening currency and a drain of foreign exchange reserves. In these circumstances, financial orthodoxy makes sense: cut the budget deficit and restrict central bank credits to the government. The result will be to cut inflation and end the weakening of the currency and loss of foreign exchange reserves. In Southeast Asia, this story simply doesn't apply. Indonesia, Malaysia, the Philippines and Thailand have all been running budget surpluses, not deficits. Inflation has been low in all of the countries. Foreign exchange reserves, until this past year, were stable or rising, not falling. The problems emerged in the private sector. In all of the countries, international money market managers and investment banks went on a lending binge from 1993 to 1996. To a varying extent in all of the countries, the short-term borrowing from abroad was used, unwisely, to support long-term investments in real estate and other non-exporting sectors. This year, the bubble burst. Investors woke up to the weakening in Asia's export growth. A combination of rising wage costs, competition from China and lower demand for Asia's exports (especially electronics) caused exports to stagnate in 1996 and the first part of 1997. It became clear that if the Asians were going to compete, their currencies would need to fall against the dollar so their costs of production would be lower. It also became clear that with foreign lending diverted into real estate ventures, there was some risk that the borrowers, especially banks and finance companies, would be unable to service the debts if the exchange rates weakened. After all, rentals on real estate developments would be earned in local currency, while the debts would have to be repaid in dollars. The weaknesses in the Asian economies