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(Part 2 of 2)
The Asian model
Talk of "the Asian financial system" is no doubt too simple. But many
countries in East and South-East Asia share enough features to make a
simple picture tolerably accurate. Above all, they save a lot compared to
western countries, and the savings are done mostly by households. Domestic
savings run at roughly twice the American rate, or more than 15 percentage
points of GDP higher. Households typically put most of their savings into
(low-risk) banks rather than into (higher-risk) equities. Corporate
investment is financed in large part by loans from banks.
This mechanism has delivered extraordinarily high rates of investment. In
America, by contrast, most household savings go to finance households' own
investment in housing, and most corporate investment in real productive
fixed capital is financed from depreciation and retained profits, with
less reliance on bank debt.
High levels of corporate debt must be buffered by long-term financial
relations between firms and banks, with the government standing ready to
support both firms and banks in the event of shocks that affect swathes of
the economy all at once (such as sharp rises in interest rates, or sharp
falls in demand). If long-term relations did not exist, such shocks would
prompt creditors to call their loans and liquidate firms; and where debts
are large, the failure of some firms propagates the failure of others much
faster than where they are small. This is the financial rationale for what
used to be called Asian "alliance capitalism", and has now come to be
maligned as "crony capitalism". It is also the rationale of the "convoy"
system of Japan, where strong companies support weak ones under various
kinds of official encouragement.
In some Asian countries, more household savings have been transferred to
the enterprise sector through equity markets. Singapore and Malaysia have
specialised institutions, such as pension and provident funds financed
partly by payroll taxes, which purchase large quantities of equities. In
Taiwan both government-and party-directed funds buy equities. However,
these are all forms of government-sponsored forced-investment regimes.
They share with the debt-transfer systems long-term relationships
connecting government, financial sector, and enterprises.
In a pure Anglo-American free-market regime, competition and short-term
profit maximising make high-debt structures unstable in the face of shocks
that interfere with debt-service payments. Creditors seeking to safeguard
their assets call in loans and liquidate firms. Bank depositors "run" on
banks that might be too exposed to defaults. This collective behaviour
causes the whole financial system to shrink, and this spills over into
price deflations and depressions. To avoid these outcomes Anglo-American
nations long ago agreed that the state had to create a lender of last
resort and a body of regulation that placed limits on the indebtedness of
private firms, banks and households. These limits of prudent indebtedness
were set far below the levels permitted in Asian alliance capitalism.
A larger truth
Alliance capitalism sounds like an invitation to corruption and insider
dealing. The crisis has shown the truth in this allegation, most
conspicuously in Indonesia. But there is a larger truth: until the
mid-1990s, Asian alliance capitalism generated the highest sustained
economic growth for any region in world history. It worked not only as a
"catch-up" strategy for countries far from the world technological
frontier, but also for Japan as it reached the frontier in the 1980s. To
describe it as "a free-market veneer over a state-managed economic
structure", which has "inevitably led to the investment excesses and
errors to which all similar endeavours seem prone", in the words of senior
officials at America's Federal Reserve, misses the point.
For a variety of reasons most Asian governments opened their economies to
foreign capital in the 1990s. Global banks and portfolio investors flooded
in. After 1995 the rise of the dollar and the depreciation of the yen and
the yuan led to a loss of export competitiveness in those Asian economies
whose currencies were pegged to the dollar. The capital inflows
exacerbated the real appreciation of the exchange rates and the loss of export
competitiveness, resulting in large, and out-of-character, current-account
deficits in Thailand and Malaysia. The inflows also contributed to
domestic-asset bubbles, credit excesses, and a growing fringe of bad
investments.
Foreign investors were providing funds to Asian firms with debt ratios and
long-term alliance relationships that would have been unacceptable in the
West. When the crisis hit, the violence of the outflow owed much to the
realisation that much of the capital should not have been committed in the
first place, according to western prudential standards.
Enter the IMF
When the Fund negotiated its programmes with Thailand, Indonesia and Korea
it demanded high real interest rates and fiscal restriction. This was
based largely on its experience in Latin America. There, fiscal deficits
tended
to be large and inflation chronic. Currency devaluations set off
hair-trigger inflationary expectations. The cure, quite plausibly, was IMF
-style austerity. High real interest rates could be tolerated because
corporate debt-to-equity ratios were quite low, because inflation kept
eroding the real burden of the debt.
In Asia, the Fund failed to see the danger of fiscal restriction where
budgets had long been roughly in balance. More seriously, it also failed
to see the danger of high real interest rates in economies with high levels
of private indebtedness and low inflationary expectations. Under those
circumstances, high real interest rates have disastrously deflationary
consequences, which give rise to capital outflows regardless of the
attractions of high interest rates.
Further, the Fund tried to strengthen weakened Asian financial structures
by imposing western measures of financial restructuring. Basle rules of
capital adequacy were to be applied. Highly indebted banks and firms were
to be closed. Labour laws were to be changed to make it easier to fire
workers, facilitating the closures. Regulations on foreign ownership were
to be lifted in order to allow foreign banks and firms to buy domestic
banks and firms.
Similar measures were applied in a narrower setting to solve the American
savings-and-loan crisis in the late 1980s-and they worked. But it is one
thing to undertake such reforms where real interest rates are very low and
indebtedness not high (as in America), and another to undertake them where
both real interest rates and indebtedness are high. In these conditions
the result is closures and lay-offs, with deflationary repercussions and
accelerating capital flight.
This is why the IMF 's strategy for Asia has failed. The currencies did
stop falling in early 1998. But by May deepening contraction, rising
unemployment and fear of unrest combined to produce a second wave of
capital outflows and renewed falls in currencies and stockmarkets. The
second-quarter resumption of the collapse is what finally forced Asian
governments to begin to turn away from the initial IMF strategy. They
began to cut interest rates and turn fiscal restriction into fiscal
expansion.
Malaysia slapped on exchange controls in September, the better to engineer
an expansion at home without risking further currency falls. South Korea
has used government funds to buy out bad loans and finance bank mergers.
Japan is seriously discussing nationalising the banks so as to break out
of its current trap, in which the attempt to maintain Basle standards of
capital adequacy while bank equity falls prevents the needed expansion of
credit. Japan is also discussing the reintroduction of exchange controls
to allow rapid monetary expansion without depreciating the yen (which might
destabilise other currencies in the region and make trade frictions
worse). China has suspended the restructuring of state enterprises and banks,
because of the deflationary consequences of restructuring in crisis
conditions.
There is a growing insistence in the region that Asian arrangements have
strengths which have been denied in the West-and which need to be built
upon to speed recovery. Asia is the world's great savings-surplus region.
Its governments' foreign-exchange reserves of almost $800 billion dwarf
those of all other regions. Virtually all of these reserves are claims on
America (Treasury bills and deposit holdings) and to a lesser degree
Europe. The private sectors of Japan, Taiwan and Singapore are also large
net lenders to the West. How ironic that a region with such massive
savings surplus and net foreign assets should be plunged into crisis by the
flight
of capital belonging to institutions that reside for the most part in the
United States, a massive net debtor with a savings deficit.
So try an AMF
An Asian Monetary Fund, or AMF , would build on Asia's savings surplus,
foreign-exchange reserves, and net-creditor status (including reserves,
Treasury bills, and the like). The most severely affected countries-South
Korea, Thailand, Malaysia and Indonesia-have gross external debt of
perhaps $400 billion, of which over $100 billion has long-term maturities and
favourable terms and does not need refinancing. The amount of debt needed
to be refinanced in order to stabilize the situation completely is small
compared to the aggregate net-creditor position of the region-less than
$300 billion.
The degree of economic interdependence within Asia that has built up over
the past decade means that crisis in one country hurts other Asian
countries above all. The all-too-evident neighbourhood contagion effects
give each creditor country a strong interest in pooling resources with
others in order to avoid further disruption.
The AMF would have core financing from subscriptions by member
governments. The fact that pledges of $100 billion were quickly secured
in August 1997 suggests that sizeable sums would be forthcoming.
Additional resources could be tapped by issuing World Bank-type
bonds on regional financial markets, guaranteed jointly by the members.
The fund would make quick-disbursing loans available to members in
difficulty, with conditionalities limited to stabilisation rather than to
IMF -type structural reforms. It would operate to reinforce the
demonstrated strengths of Asian-type financial systems, and not to
disavow them.
The AMF would save Asia money. At present the region lends much of its
savings to the West at American Treasury bill and deposit rates of 5%,
while it borrows from western creditors at 10% or more. With the AMF ,
Asian lenders would lend at slightly better than 5%, and Asian borrowers
would borrow at only slightly more, say 6%. The borrowing governments
could repay the more expensive western loans. Asia would then earn the risk
premium in the interest rate on emerging Asia's external debt that is now
paid over to western creditors.
Taking charge of Asias destiny
Would Asia not suffer by having western financial markets less involved in
resource allocation-as Robert Rubin, America's Treasury secretary, and
Alan Greenspan, chairman of the Federal Reserve, have been saying? No.
Western financial institutions have failed to discriminate correctly among
both sovereign and private borrowers. They piled in to fuel a speculative
bubble, and then stampeded out even in the face of high risk premiums,
cheap assets, and current-account surpluses. The economic performance
of the emerging Asian economies prior to the crisis suggests that Asian
governments and their financial institutions can allocate resources more
efficiently than that.
Isn't an AMF by now redundant? Aren't the current efforts-some bilateral,
some involving the existing mutlilateral machinery-quite adequate? No. The
existing machinery is based on a "bail-out of basket-cases" myth. The AMF
approach says that Asia is unique in having ample financial resources to
handle the external financial difficulties of its weakest regional members.
It calls on Asians to take charge of their own destiny, and even, in part,
to close the door to the West. The threat of closure may even encourage
capital flows back to the region, as western bankers try to retain their
Asian markets and as portfolio managers, now underweight in Asia, seek to
restore their positions and ride the recovery curve.
Of course the AMF would compete with the IMF . But the IMF wants
competitition for others, and should not be averse to it for itself. The
only serious losers would be the western speculators who extract a risk
premium they do not deserve.
(end of fwd)
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