Mon, Jul 02, 2007 - Page 9 News List

The Asian crisis 10 years after

What lessons were there to be learned in the aftermath of the Asian financial crisis, how well have we learned them and will it happen again?

By Joseph Stiglitz

This July marks the 10th anniversary of East Asia's financial crisis. In July 1997, the Thai baht plummeted. Soon after, financial panic spread to Indonesia and South Korea, then to Malaysia. In a little more than a year, the Asian financial crisis became a global financial crisis, with the crash of Russia's ruble and Brazil's real.

In the midst of a crisis, no one knows how far an economy will drop or for how long. But capitalism, since its beginning, has been marked by crises; each time, the economy recovers, but each crisis carries its own lessons. So 10 years after Asia's crisis, it is natural to ask some questions: What were the lessons? Has the world learned them? Could such a crisis occur again? Is another crisis imminent?

Some similarities exist between the situation then and today. Before the 1997 crisis, there had been rapid increases in capital flows from developed to developing countries -- a six-fold increase in six years. Afterward, capital flows to developing countries stagnated.

Before the crisis, some thought risk premia for developing countries were irrationally low. These observers proved right: The crisis was marked by soaring risk premia. Today, the global surfeit of liquidity has once again resulted in comparably low risk premia and a resurgence of capital flows, despite a broad consensus that the world faces enormous risks (including the risks posed by a return of risk premia to more normal levels.)

In 1997, the IMF and the US Treasury blamed the crisis on a lack of transparency in financial markets. But when developing countries pointed their fingers at secret bank accounts and hedge funds, IMF and US enthusiasm for greater transparency diminished. Since then, hedge funds have grown in importance, and secret bank accounts have flourished.

But there are some big differences between then and now. Most developing countries have accumulated massive foreign currency reserves. They learned the hard way what happens to countries otherwise, as the IMF and US Treasury marched in, took away economic sovereignty and demanded policies intended to enhance repayment to Western creditors, which plunged their economies into deep recessions and depressions.

Reserves are costly, for the money could have been spent on development projects that would enhance growth. Nevertheless, the benefits in reducing the likelihood of another crisis and another loss of economic independence far outweigh the costs.

This growth in reserves, while providing insurance to developing countries, created a new source of global volatility. Especially as the dollar lost its sacred place as a store of value under the Bush administration, rebalancing these multi-trillion dollar portfolios entails selling off dollar holdings, contributing to weakening of the dollar.

Developing countries have also increasingly borrowed in their own currencies during the last few years, thus reducing their foreign exchange exposure. For those developing countries that remain heavily indebted abroad, an increase in risk premia would almost certainly bring economic turmoil, if not crisis. But the fact that so many countries hold large reserves means that the likelihood of the problem spreading into a global financial crisis is greatly reduced.

In the midst of the 1997 crisis, a consensus developed that there was a need for a change in the global financial architecture: The world needed to do better in preventing crises and dealing with them when they occur. But the US Treasury and the IMF realized that the likely reforms, as desirable as they were for the world, were not in their interest.

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