The Magazine


Jan 12, 1998, Vol. 3, No. 17 • By DAVID M. SMICK
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IT IS THE MOMENT in the great late-1990s Asian financial meltdown for the inevitable Monday-morning quarterbacking. The stakes could not be higher. Since 1990, the countries of East Asia (excluding Japan) have accounted for half of the growth in world output, despite representing only 20 percent of world GDP An incredible two thirds of all world capital investment since 1990 has taken place in East Asia. The recent Asian meltdown could rob as much as one percentage point from the growth of the U.S. economy for 1998. Because the Asian economies have seen their currencies weaken dramatically against the dollar in recent months, at least one thing is certain: The new Asian game plan will be to try to export those economies out of the basement -- with America the global consumer of last resort. Some analysts are predicting $ 300 billion U.S. trade deficits in the next year or two.

What is most troubling is that the international community continues to avoid addressing the real issue. The IMF tinkers with stopgap financing schemes for the smaller Asian economies. But the reality is that Korea, Thailand, Malaysia, and the rest are a mere sideshow. There is one issue and one alone that must be addressed first: Japan. The Southeast Asian economies cannot truly recover until the Japanese financial system is restructured and the real-estate market revives. To talk about long-term IMF plans for, say, Korea is shortsighted, simply because Japan, the world's second largest economy, is so dominant in the region.

Consider the financial linkages within the region. Because of Japan's ailing banking structure, the Bank of Japan has been forced for years to set official interest rates at close to zero percent. This was an attempt to avoid a general credit crunch and, more important, to provide banks with a steady, government-issued profit stream (borrow for next to nothing and lend at a profit). The unintentional result: huge outflows of Japanese bank lending to Asian economies, creating a dangerous financial bubble of excess capital. It was not long before Japanese bank balance sheets, already bleeding badly from a growing load of nonperforming domestic assets, began hemorrhaging. Some banks now have loan/loss ratios of an incredible 20 to 25 percent on their Thai loans alone.

True, there is blame to go around. The IMF has hardly performed brilliantly in recent years. Its reports gave thumbs-up assessments to both the Thai and Korean financial systems as recently as last year. And what ever happened to that "early warning system" promised after the 1994-95 Mexican bailout?

The Clinton administration shouldn't break out the champagne either. There is the so-called moral-hazard dilemma and the important question: Did the Mexican bailout contribute to the Asian financial bubble? Note that back when the Mexican bailout package was being negotiated, European policymakers privately insisted that the holders of dollar-denominated Mexican public debt -- led by many large U.S. investment houses -- should suffer at least a minor loss lest a moral-hazard problem arise. The "heartless" Europeans were quickly overruled, but their concern had merit. Every fund manager worldwide was tempted to believe that the IMF and the G-7 would forever provide a safety net for large institutional investors, for fear of a risk to the entire international system posed by any failure. The Mexican bailout served as a green light for massive and sometimes foolhardy capital flows to Asia and other developing economies with little transparency. A dangerous precedent to say the least.

IMF officials respond that they have no choice but to chase markets to prevent systemic panic. While true in one sense, this suggests a serious misunderstanding of the issues at hand.

The Thai meltdown this fall, for example, was not started by George Soros and other hedge-fund operators who, as some allege, sucked liquidity out of the system with reckless abandon. The meltdown started when domestic investors with an intimate knowledge of the corruption, inefficiency, and stupidity within the Thai financial system were the first to sell out of their overvalued market positions. The same thing is happening in Japan, where domestic investors have been net sellers of the Nikkei 225 for more than five years. Indeed, after last month's much ballyhooed Hashimoto fiscal plan was announced, the stock market fell through the floor. The reason was that Japanese industrial investors, looking to get out of their cross shareholdings of Japanese bank stocks, sold on every uptick in the market. The result has been a disappointing downward trend.