Asia's 'Rational' Panic
CAMBRIDGE: Asia’s financial crisis amazes not only for its ferocity, but for its speedy dismantling of conventional wisdom. Six months ago, Asia’s economies were "miracles." Now, they are "basket cases." Prominent articles ask whether Asia will experience a "lost decade" comparable to Latin America in the 1980s. This new wisdom is not only wrong but dangerous, because it is potentially self-fulfilling.
Financial panic in Asia emerged after years of growth so high and steady that international lenders and domestic borrowers became complacent about financial risks. International banks lent hundreds of billions of dollars to Asian banks and corporations, much on a short-term basis. Borrowing fueled booming investment spending -- some wasteful, but most catalyzing rapid development.
High levels of short-term debt create what economists call "financial fragility." Even if debt levels are tolerable and economies well managed, high short-term debt exposes borrowers to the risk of rapid changes in market sentiment. Short-term loans are tied up in long-term projects. If many investors demand repayment, borrowers have a hard time meeting these demands, even if the long-term projects are sound.
"Rational panic" ensues. Every investor wants to be the first out, because existing short-term assets cannot cover short-term loans. The investors are "rational" individually, but their collective action leads to tragedy. This is the story of recent trouble in Thailand, Indonesia, Malaysia, the Philippines, Korea, and nearly all emerging markets.
The panic is now made worse by problems in Hong Kong and Japan. Investors withdrew funds from Hong Kong not because of credit risk, but because of exchange-rate concerns. Hong Kong banks, it is said, began withdrawing credits from elsewhere in Asia. A lingering crisis in Japan's banks pushed them to cash in claims throughout Asia, too.
The main danger now is that Asian economies will be forced to default on debts or cancel investment and kill growth. The IMF seeks to help, but its prescriptions might do more harm than good. The IMF usually deals with profligate governments. If it blindly applies its usual approaches -- pushing to tighten credit, cut spending, and close weak banks -- creditors might feel that growth is doomed for years. Panic might intensify. Early market responses to the IMF's intervention are worrying: stock markets in Indonesia and Korea declined 25% and 20% respectively.
In the depths of the Depression, Franklin Roosevelt told Americans that "the only thing we have to fear is fear itself." His success in boosting confidence was vital to America's political stability. Asia needs Roosevelt-style reassurance, not a misplaced financial orthodoxy.