25 years from the financial crisis in East Asia: 2 forgotten lessons

My friend Bert Hoffman, director of the East Asian Institute at the National University of Singapore, wrote an insightful account of the financial crisis in East Asia. On July 2, 1997, exactly 25 years ago, the Thai authorities devalued Bahat, causing a wave of economic crisis in East Asia, affecting other emerging economies, including Russia and Brazil.

Much has been written about the causes of the East Asian crisis and the policy responses of different countries. The crisis triggered a wave of structural reforms that undoubtedly strengthened East Asian economies to a point where they were relatively unaffected by the Great Depression of 2008 and 2009. This has encouraged a learning culture that seems to have spread to other regions: Asian experiences in managing SARS and avian flu outbreaks in 2003 helped establish their public health systems that were effective in managing coronaviruses.

Yet there are two lessons to the East Asian financial crisis that seem to have been forgotten, but they are relevant to today’s economic concerns.

The first lesson is that when economies are built on a flawed foundation, growth is not always beneficial. This can only lead to risk savings. In the case of East Asia, the crack in the foundation was that the pegging of the currency to the US dollar through a fixed exchange rate would not change much. These poles were not formal but were formal in the code of conduct. East Asian policymakers, with their export adaptations and strong links to the global supply chain, were generally described as “floating fears”. Banks, businesses and government policymakers have worked year after year on the assumption that any deviation from the US dollar in the bilateral exchange rate of their currencies will be minimal.

For all intents and purposes, “volatile resources”, businesses, financial institutions and many governments সহ including the developing world — are still increasingly exposed to fossil fuels. It’s dangerous.

The result was a huge buildup of currency discrepancies on the balance sheet. Large property and construction companies in the region have created real estate assets in financing by borrowing in US dollars. Banks and financial institutions use loans from abroad to expand loans to domestic businesses and small and medium enterprises. Governments use forward market transactions in the guise of the size of their net foreign exchange reserves against which domestic debt is being issued.

The consequence of this currency mismatch on so many balance sheets is that when the currencies were adjusted in the face of a dollar deficit, the economic losses were devastating. The exact timing of the crisis in Thailand and its spread to other countries is still the subject of considerable academic debate. I personally favor an explanation that revolves around the devaluation of the yen since 1995 that caused Japanese banks to shrink their balance sheets and reduce dollar debt exposure – a flight of $ 100 billion capital from the region in a matter of months. But the real point I’m saying is that an external shock had a huge economic impact, even in economies that were seen as strong performers.

What is the relevance today? Again, we see economies built on a flawed foundation – fossil fuels. We are in another energy crisis, but the response of a developed economy is to double oil and coal production, but also to accelerate structural reforms in a transformed economy on a more sustainable basis. For all intents and purposes, “volatile resources”, businesses, financial institutions and many governments সহ including the developing world — are still increasingly exposed to fossil fuels. It’s dangerous.

The second forgotten lesson from the East Asian crisis is that the onset of the debt crisis has more to do with weak institutions and low resilience than the debt index. Each of the affected East Asian countries had relatively strong macroeconomic fundamentals — low government debt levels, high growth, reasonable fiscal and current account balances, and low inflation. Yet when the crisis hit, governments had to take out large loans to bail out banks and businesses (and in some cases to secure a safety net for the poor). Their financial situation was not stable.

Today, we hear concerns that investments by governments in developing countries for resilience to climate risks are not affordable because of their high levels of debt. Changes from disaster response to disaster risk reduction are being prevented. Nature-based solutions and human capital investments that create resilience are being put on hold. It is a backward economy. The risk of a debt crisis in developing countries is increasing not because of excessive government spending, but because shrinking access to funding for key projects to build resilience.

So, 25 years after the East Asian crisis, let’s remember two things. When the economic foundation is flawed, it is not too early to begin the transition to a sustainable structure. Doing otherwise may support growth for a few years but when a crisis hits it it faces a much bigger recession. And let’s focus more on the resilience of public institutions and public finance when it comes to creditworthiness and less attention to numerical debt margins with little explanatory power when it comes to forecasting the debt crisis, when we evaluate the size and allocation of government spending. Ignoring these teachings is making the world economy weaker than it needs to be today.

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