Finance and the real economy: theoretical implications of the financial crisis in Asia

Finance and the real economy: theoretical implications of the®nancial crisis in Asiaq

Michael Webber *

Department of Geography and Environmental Studies, The University of Melbourne, Vic., 3010, Australia

Received 22 June 1999; in revised form 22 June 2000

Abstract

This paper o�ers a preliminary assessment of some implications of the Asian ®nancial crisis for theories about the development of

a global economy. The paper (i) draws together some of the available evidence about the history of the crisis, and (ii) identi®es some

current diagnoses of its cause before (iii) arguing that the central implication of the crisis is that it enables us to identify the manner

in which the ®nancial and real economies are linked. While the evidence about the chain of events and causes in this crisis still

remains scattered, most diagnoses point to the particular economic and political characteristics of the speci®c countries involved: the

®nancial crisis re¯ected real conditions. By contrast, it is argued that the crisis was driven by ®nancial considerations, that re¯ect the

mode of operation of the global ®nancial system not the characteristics of east Asia. Ó 2001 Elsevier Science Ltd. All rights reserved.

Keywords: Asia; Finance; Crisis; Globalisation

0. Introduction

Between mid-1997 and mid-1998, the currencies ofIndonesia, South Korea and Thailand each lost over athird of their value; the currencies of virtually all othercountries in the Asia-Paci®c region lost over 20% oftheir value. Some South American currencies were fall-ing and Russia was about to default on its loans. Eu-ropean banks, currencies, and stock markets were badlya�ected. The sharp decline in worldwide economicgrowth brought commodity prices to a historical low.As the Asian Development Bank (1999) observed a yearlater, the threat of a global recession loomed over theworld economy in mid-1998. Yet at the end of 1999,European and North American economies and ®nancialmarkets seemed una�ected by this crisis in Asia; andwithin the Asian-Paci®c region itself, recovery is un-derway (World Bank, 1999) ± the ADB expects Korea's

GDP to have grown by over 8% in 1999, a lead followedby Taiwan, Singapore, Malaysia, Philippines and Thai-land (though Hong Kong and Indonesia remain in thedoldrums).

Despite the speed of this apparent recovery, despitetoo the manner in which the crisis has been con®nedspatially, the ®nancial crisis in Asia is one of the keyevents of our time.1 The crisis is so important for threemain reasons.

First, for many people in east and Southeast Asia, thecrisis is likely to be a de®ning event of their lives (Leeand Rhee, 1999). Throughout the region the incidence ofpoverty has increased signi®cantly, with some countriesexperiencing signi®cant declines in households' access toboth health and education services for the poor (WorldBank, 1999; Levinsohn et al., 1999). Divorce and suiciderates in Thailand skyrocketed after the crisis; the num-ber of infants abandoned after birth or placed in or-phanages increased; there has been a rise in the numberof arrests for drug-related criminal activity and propertycrimes (World Bank O�ce Thailand, 1999). Within In-donesia people are continuing to be killed in riots trig-

Geoforum 32 (2001) 1±13

www.elsevier.com/locate/geoforum

q The paper was presented at the 95th Annual Meeting, Associa-

tion of American Geographers, Honolulu, 24±27 March 1999; a

revised version was presented at the conference, The Asia-Paci®c

Economy in 1997 and into the 21st Century, Hitotsubashi University,

Tokyo, 18±20 December 1999. I am grateful to participants at both

conferences for their comments on earlier drafts of this paper.* E-mail address: [email protected] (M. Web-

ber).

1 I use the phrase ``®nancial crisis in Asia'' to signify that it remains

an open question whether the crisis is a crisis of Asia (as in `Àsian

®nancial crisis'') or merely a crisis in Asia (a crisis of the global

®nancial system that has ``touched down'' in Asia).

0016-7185/01/$ - see front matter Ó 2001 Elsevier Science Ltd. All rights reserved.

PII: S 0 0 1 6 - 7 1 8 5 ( 0 0 ) 0 0 0 3 6 - 1

gered by economic collapse. If this started as a ®nancialcrisis, then it is clearly now real: social and economicspaces are being rede®ned.

Governments have been ejected and political powerwithin the region has also been substantially realignedas the crisis has forced changes to the political econ-omy of the Asia-Paci®c region. The IMF has become adominant force in world politics: the $US110 billion®nancial assistance to Indonesia, Korea and Thailandthat the IMF brokered has enabled it to demand avariety of reforms in those countries. The ADB, bycontrast, has been virtually ignored and the WorldBank's concern about poverty and sustainable devel-opment (Wolfensohn, 1998) has carried little weightagainst the demands for market reform. Similarly,despite the magnitude of its assistance to the region,Japan has lost authority in comparison to the USAand China: Japan remains mired in recession even asthe USA booms; the market that draws forth exportsfrom east Asia is the US market and not the Japanese;the Japanese government appears in 1997 to haverejected an approach from Thailand for assistance; andthen Japan's proposal for a regionally orientedapproach to the crisis, an Asian Monetary Fund, wasderided by the IMF and the USA.

Finally, ideologies have gained and lost too. By theargument that the cause of the crisis is local, the entireidea of a miracle system has been dismantled (seeGreenspan's statement of this interpretation in Sanger,1998). By Japan's own inept management, the wholeidea of state-led development is ridiculed. To the IMF,to most of the western world's economists and press, thecrash in east Asia was not simply a change in the rates ofgrowth, but was equally the signi®er of the failure of adevelopment model. The localisation of the social andpolitical institutions that sustain markets by regulating,stabilising and legitimising them is ignored under therush to impose American styles of economic gover-nance. And yet the world's institutions of economicgovernance sadly misread the future of the countries inthis region: both the World Bank's The East AsianMiracle (World Bank, 1993) and the Asian Develop-ment Bank's even more recent Emerging Asia (AsianDevelopment Bank, 1997) were full of praise for thedevelopment model followed by countries in the regionand projected rapid and continuing increases in livingstandards. And at last, after decades of radical criticismof IMF Structural Adjustment Policies for countries inAfrica and Latin America, some mainstream economistshave begun to question the relationship between IMFintervention and the subsequent collapse of the Indo-nesian economy and much of its social structure (seeRadelet and Sachs, 1998). The crisis seems to havereinforced once more the fact that the existence ofmoney at a world scale needs also government of moneyat a world scale.

It is clearly important that we understand this crisis.In this paper, I seek to accomplish three tasks. First, Iremind ourselves of the key events in the chronology ofthe crisis, illuminating the sequence of countries in-volved and the manner of that involvement. The chro-nology involves data on exchange and interest rates, forthese are the prices that have been most dramaticallya�ected and that are empirically most robust.2 It alsotraces some of the central political events of the crisis,including the manoeuvring of the IMF, national gov-ernments and banks. Secondly, the paper identi®es thecentral explanations that have been advanced for thecrisis, and elucidates some of their characteristics. Theseexplanations focus on the immediate, medium-term andlonger-term causes of the crisis. However, these expla-nations all focus on the characteristics of east Asiancountries themselves rather than on the characteristicsof the ®nancial system. So ®nally, I seek to draw specialattention to the growing independence of ®nancialmarkets from real economic and social conditions. ThisI take to be the central theoretical implication of thecrisis: that the ®nancial events have come to dominatethe real.

1. Chronology

Figs. 1±3 provide the basic history (see, too, Roubini,1999 for a listing of political, social and economicevents). In the ®rst half of 1997, Hanbo Steel and SammiSteel both collapsed, as the government of Korea sig-nalled that it would not support such ailing companiesinde®nitely.3 These two collapses followed two yearsduring which the value of the Korean stock exchangeindex had consistently fallen. In Thailand, ®nancecompanies collapsed (including the largest ± FinanceOne), the government refusing to buy their bad debts. InMay 1997, global investors began to sell east Asian

2 Data on GDP re¯ect little about living standards within economies

that are only partially commodi®ed. Data on unemployment mean

little in economies where many still work in agriculture. However,

exchange rates, even if they ¯oat, are manipulated by countries' reserve

banks (Taiwan in particular had this capacity).3 However, the IMF claims that

the region's problems began in Thailand, where there were

numerous signs of impending crisis. . . the real exchange rate

had appreciated substantially; exports growth had slowed

markedly; the current account de®cit was persistently large

and increasingly ®nanced by short-term in¯ows; and external

debt was rising quickly. These problems, in turn, exposed

other weaknesses in the Thai economy, including substantial,

unhedged foreign borrowing by the private sector, an in¯ated

property market, and a weak and overexposed banking sys-

tem (Ouattara, 1998).

These are disputes about the timing of the onset of the crisis rather

than about the timing of the underlying causes of the crisis (even

more problematic).

2 M. Webber / Geoforum 32 (2001) 1±13

currencies, and in turn, the Thai, Philippines, Malaysianand Indonesian governments widened the bands withinwhich their currencies could trade. Despite rapidly risinginterest rates, currencies fell sharply in those countriesand in Singapore. The Hong Kong dollar also cameunder attack, but was rigorously defended by the Chi-nese government. In October 1997, the crisis spread toArgentina, Brasil and Mexico. By November, as it be-came clear that eight of Korea's 30 largest chaebol wereeither bankrupt or ®nancially strained, the Korean wonwas being forced downwards. And on 17 November1997, the Hokkaido Takushoku Bank collapsed, sig-nalling that yet another government in the region was

standing further back from corporations than it had inthe past. By early 1998, the currencies of Australia andNew Zealand had been drawn into the vortex. As late asAugust 1998, the Hong Kong dollar and renminbi wereboth subject to speculation. Though it hardly ®gures inthe ®nancial histories of the past two years in the region,the Taiwanese dollar ($NT) has been falling steadily too.

The subsequent political-economic history of thesecountries has di�ered widely. Apart from the much lessopen economies of Cambodia and Myanmar, the onlycountry that has thus far largely escaped the turmoil isChina (see also Liu, 1998). The other countries in theregion have been a�ected to a greater or lesser degree.

Fig. 1. Exchange rates of east Asian currencies against the $US, 1990±1999. Note: exchange rates are expressed as an index; the maximum rate in the

period is 1.0. Sources: International Monetary Fund monthly International Financial Statistics Washington: IMF. Additional data for Korea from

Bank of Korea; for Philippines from http://www.nscb.gov.ph/dysymryrt/prdofollar .htm; and for Taiwan from Directorate-General of Budget,

Accounting and Statistics, Exective Yuan Monthly Bulletin of Statistics of the Republic of China and http://www.dgbasey.gov.tw/dgbas03/english/

bulletin/l8.htm.

M. Webber / Geoforum 32 (2001) 1±13 3

Australia, New Zealand, Singapore and Taiwan havesu�ered relatively little. By mid-1999, it had becomeclear that the crisis was having little e�ect on the rates ofgrowth of output. In all four countries, exchange rateshave fallen by 20±30% from the values of 1995/96. Theirshare markets have declined moderately. In Australiainterest rates are at long-term low levels, but NewZealand, Singapore and Taiwan have all used interestrate policies to help defend their currencies: interestrates in Singapore rose in 1998 to twice their long runaverage. Though a 20% decline in exchange rates ishardly insubstantial, any severe impact of the crisis onthese countries is likely to be transmitted through me-dium-term trade and investment ¯ows rather than short-term currency and interest rate ¯uctuations.

More deeply a�ected have been Hong Kong, Japan,Malaysia and the Philippines. Though the Hong Kongdollar has been defended by its Monetary Authority,that defence has included (temporary) high interestrates, a halving of the value of the stock market and a30% or so fall in property prices. Output was stagnantthrough 1999. Japan's stock market has been declinesince 1990 and its currency since mid-1995: by late 1998,the yen was worth only 60% of its mid-1995 value. Japancontinues, under tremendous pressure from the USA, tostimulate its economy and to attempt to reform itsbanking system; it is also under continuing pressurefrom the WTO to open its economy to internationalcompetition. The Malaysian ringgit has also lost about40% of its earlier value leading the government to im-pose capital controls (though some of the more stringentcontrols over foreign capital have more recently beenrelaxed). The Philippines, too, has seen the peso fall by40% or so and the stock exchange index halve. Unem-ployment is rising and rates of growth of output falling,

though the Philippines has avoided direct interventionfrom the IMF.4

But the most deeply a�ected countries have beenThailand, Korea, Lao and Indonesia (in that order). InThailand and Korea,5 currency values have almosthalved, though since late 1998 there has been some re-valuation of both currencies. In Lao and Indonesia,currency values are now only 20% of their 1990s' peak. 6

Thailand, Korea and Indonesia have all sought IMFsupport: Thailand negotiated a package of $17B inAugust 1997, Indonesia of $40B in November and Ko-rea of $57B in December. The IMF prescribed ®rst itstraditional austerity program me: raise interest rates andslow the growth of money supply; reduce governmentbudgets by cutting social programmes, public infra-structure spending and subsidies.7 Secondly, the IMFhas pressed these governments to reform their ®nancialsystems by closing insolvent banks and enforcing capitaladequacy standards. Thirdly, the IMF has sought toopen up the economies of the three countries, by urgingthat governments dismantle monopolies, privatise statemonopolies, reduce trade barriers and open ®nance andinsurance sectors to foreign investment. The IMF's

Fig. 2. Index of share prices, selected east Asian stock markets, 1990±1999. Note: Index is set at 1991� 1000. Sources: As Fig. 1.

4 In fact, the Philippines was due to emerge in 1997 from an existing

IMF program, which was only slightly augmented in July 1997.5 Like Japan, Korea's economy began to exhibit problems before the

currency crisis: the share market, for example, began falling in early

1995.6 However, I have found no article on Lao ®nancial circumstances

between early 1997 and mid-1998 in the major English language

®nancial press. Likewise, North Korea is regarded as outside the

(®nancial) region of east Asia. The IMF publishes little accessible data

about Vietnam, which has therefore to be excluded.7 The IMF has since the ®rst negotiation of these programmes

allowed governments greater freedom to spend above receipts.


Managing Director and its Deputy Managing Directorshave made speech after speech since mid-1997 extollingthe virtues of open and transparent government. (InKorea, the IMF has also pushed for changes in labourlaws that make it easier to lay workers o�.)

This chronology has identi®ed a far larger east Asianregion than is commonly analysed in most theoretical orempirical analyses. The common foci are the countriesthat were the direct objects of ®nancial speculation:principally, Hong Kong, Indonesia, Korea, Malaysia,Philippines and Thailand. But Lao has been draggeddown too. However, other countries have been a�ected,presumably either by association (`Ìt's all Asia'') orthrough trade linkages (Australia, China, New Zealand,

Singapore and Taiwan are the principal cases).8 Finally,Japan has been one of the principal movers within theregion: a slowly growing focus for regional productionand marketing, a principal source of regional capitaland a font of aid.

This ``large'' east Asia, all countries implicated in thecrisis to a greater or lesser degree, is obviously not ho-mogeneous: a single cause will not apply to all thecountries in the region. A ®rst cut at explaining the crisismust therefore di�erentiate the direct objects of specu-lation from those that were guilty by association. But

Fig. 3. Index of interest rates in east Asian countries, 1990±1999. Note: The average rate of interest for the entire period equals 1.00. Data are money

market rates (row 60b of IFS), except Australia after 1995 q1, Lao, New Zealand, Philippines (which are treasury bill rates), PRC and Cambodia

(which are short term ®nancing of private sector) (row 60p). Sources: As Fig. 1.

8 And Cambodia seems to have totally escaped so far.


were conditions in Korea, Hong Kong and Thailandreally similar (and di�erent from conditions in allcountries that avoided the crisis)? And what are thesimilarities in ties between Australia, New Zealand,Singapore and Taiwan on the one hand and the othercountries in crisis? What are the links between thesegroups of countries and Japanese economic conditions?A central theoretical question is thus whether the similaroutcomes were caused by similar conditions within thecountries in the groups or by the perception of similarconditions. How have similar geographic locationstranslated into perceptions? How, then, was Paci®c-Asiaconstituted as a region in this crisis?

2. Real interpretations

Most explanations of the ®nancial crisis in Asia arereal, in the sense that they identify characteristics of eastAsian economies and societies to which investors re-acted. Most commentators agree that the sharp with-drawal of funds by investors was panicky (Wade, 1998).Once a single investor withdraws and currencies fall, itbecomes rational for each investor to disinvest if s/heexpect others to withdraw and the currency to fall fur-ther. Such a panic represents a coalescence of expecta-tions in a chaotic follow-the-leader process. In thissense, crises are overreactions to events. Nevertheless,real explanations of the ®nancial crisis identify realevents to which investors may overreact. By a real ex-planation, therefore, I mean an explanation that startswith events or conditions in the real economy: some-thing wrong in east Asia causes investors to change theirbehaviour (and perhaps panic) and that in turn causesadditional changes in real conditions in each Asia. Thechain of causation runs: east Asia ! ®nance system !east Asia.

What, then, were the economic events during the yearor two preceding the crisis that triggered a change in theexpectations or the panic? This leads to a subsequentquestion: what were the underlying social conditions ofeconomic governance that themselves permitted (or en-couraged) those events? Gri�th-Jones (1998) compre-hensively reviews theories of the crisis.

2.1. Triggers

Perhaps the most common explanation of what wentwrong in an immediate sense is that current accountde®cits widened, thereby causing exchange pressures tomount. According to Sugisaki (1998), the east Asiancountries had attracted large in¯ows of foreign capitalduring the early 1990s, a large proportion of which wereshort-term. The in¯ows were encouraged by relativelyweak economic growth in Europe and Japan in the early1990s and by excellent growth prospects. Furthermore,

private capital ¯ows were facilitated by ®nancial liber-alisation, which was itself encouraged by the IMF (in-cluding the creation of the Bangkok InternationalBanking Facility; the newly granted access of Korean®rms to international ®nancial markets; the relaxationof foreign borrowing limits in Indonesia and in Malay-sia) and by exchange rate pegs (Reisen, 1998): both bankand non-bank foreign liabilities exploded.9 Many ofthese resources were invested in property and equity.

Many of the currencies of east Asia were pegged tothe $US. As the value of the $US began to rise in rela-tion to the yen after mid-1995, the story goes on thatthese countries lost competitiveness10 and their currentaccount de®cits rose.11 Once doubts about the solvencyof the borrowers arose, investors began to withdraw theshort-term ®nancing and exchange rates fell. Once theeconomies came under pressure, the property and equityinvestments lost value. The pegs became the target ofspeculation, facilitated by ®nancial liberalisation whichmade it easier for speculators to take advantage offalling currencies. The bursting of this bubble started inThailand in 1995 (property), 1996 (stock and baht) and1997 (baht). Only after exchange rates had come underpressure did the authorities abandon the pegs and letexchange rates ¯oat.

2.2. Economic conditions

Some of the most politicised interpretations of thecrisis have focused on the second question. These in-terpretations have driven the calls for reform that haveemanated from the IMF and some western govern-ments.

One of the most in¯uential of the politicised inter-pretations might be called ``the failure of governance''.This thesis takes several forms. The ®rst is a storyabout homegrown vulnerabilities ± lack of transparency,

9 In Malaysia, for example, there were crucial changes to the

organisation of the ®nancial system between 1989 and 1992 (Jomo,

1998), including the separation of the Kuala Lumpur stock exchange

from the Singapore exchange and the establishment of a new Securities

Commission.10 Thus, at the end of 1996, all but two of the 30 largest chaebol in

Korea had debt: equity ratios that exceeded 2.5 and 13 of them made

net losses over the year (Corsetti et al., 1998).11 Contrast the Reserve Bank of Australia:

neither Indonesia nor Korea had large current account de®-

cits in the 1990s (including in 1997), nor did either the UK

or Italy in 1992. The celebrated case in the opposite direction

is Singapore, which ran a current account de®cit which aver-

aged 15% of GDP for a decade during the 1970s without a

currency crisis (Macfarlane, 1998a).

Data in Corsetti et al. (1998) indicate that only Philippines had a

current account de®cit of over 5% of GDP in 1997; only Ma-

laysia, Philippines and Thailand had any such de®cits during the

1990s. Both Singapore and Taiwan were running current account

surpluses through the 1990s.


insu�cient bank regulation, personal in¯uences oncredit allocation (see Wade, 1998, for a discussion of thegovernance stories).12 Greenspan and the IMF are themost prominent exponents of this view. In AlanGreenspan's (Greenspan, 1998) account, the crisis rep-resents the failure of credit allocation planning. That is,as the economies of east Asia matured technically andsought to become more open to world competition,governments could no longer successfully mandate asigni®cant proportion of production. The second is astory about moral hazard - the belief by western banksthat Asian banks and corporations were in e�ect guar-anteed by their governments, so the risks were at gov-ernment rather than private levels (see Krugman,1998a,b,c, for a theory of crony capitalism).13 The IMFsubscribes to this view too. Corsetti et al. (1998) alsoobserve that international banks lending to east Asianinstitutions seemed to neglect sound risk assessment.However, the east Asian institutions were e�ectivelyunregulated and made loans that were excessively riskyand that drove up the prices of assets in east Asia (seetoo Lane et al., 1999). The asset bubbles burst after aslump in the semiconductor market and after the yen'sfall caused regional current account de®cits to widen.Together. these two forms of argument identify a failureof governance, both state and corporate.

Despite a lack of evidence about this interpretation(and counterevidence in Radelet and Sachs, 1998), it hasunderpinned the IMF's conclusions about the crisis.Thus, the Managing Director of the IMF:

countries must take great care to ensure that theira�airs are conducted in an irreproachable andtransparent manner and that all forms of corrup-tion, nepotism, and favoritism are shunned; yet,over time in Asia, these a�ictions took hold andoverpowered systems that were otherwise remark-ably successful (Camdessus, 1998a).

To the IMF, internal structural factors were at theheart of economic problems (Sugisaki, 1998):

The ®nancial sectors in Indonesia, Korea, andThailand lacked proper prudential standards andsupervision. For instance, ®nancial institutionshad been allowed to borrow from abroad becauseof inadequate prudential controls on their foreignexchange exposure. The sizeable capital in¯owshad given rise to investment in equity and propertyand the risks associated with price bubbles. In thecase of Korea, foreign borrowing ± channelledthrough the banks ± had ®nanced excessive invest-ment of the conglomerates, the so-called chaebol.These conglomerates su�ered from very high debt/equity ratios. In addition, a large terms of trade de-cline during 1996±1997 hurt the pro®tability of theconglomerates and resulted in a string of bankrupt-cies in 1997 to the detriment of the ®nancial sector.The authorities had in some instances come to therescue of insolvent ®nancial institutions and pre-vented them from being liquidated.

In addition, trade restrictions, capital controls, closelinks between the government, banks, and the corpora-tions, and lack of transparency all contributed to thecrisis. Camdessus (1998b) has gone on to claim that theglobal ®nancial system needs to be reformed through aprocess orchestrated by the IMF, national governments,the World Bank, the OECD and the Bank for Interna-tional Settlements. The IMF's agenda includes: adop-tion of standards and codes of good practice at theglobal level; transparency in government policies, datadissemination, accounting and disclosure; liberalisationof capital ¯ows; and the promotion of strong ®nancialinstitutions, prudent regulation and e�ective supervisionwithin nations. See too Camdessus (1998c).

So a second long run explanation pays particularattention to changes in the nature of capital ¯ows todeveloping countries during the 1990s. Private ¯ows todeveloping countries increased sixfold during the 1990s,providing ®nance of a kind and magnitude that suchcountries had previously not learned to manage(McKibbin and Martin, 1998; see also Table 1).

Now a quarter of all equity trading on the world'sstock exchanges involves cross-border ¯ows of money(Howell, 1998). Such in¯ows of foreign money havebeen triggered by de-regulation: national currencymarkets are too small to cope with the magnitude ofinternational capital ¯ows14.

These very high in¯ows of capital have entered whatare more or less development states (Wade, 1998). Thetheory of the development state identi®es high rates of

12 Siamwalla (1998), for example, has argued that there has been a

decline in the quality of Thai macroeconomic policy. The Thai civil

service, he argues, has gradually lost autonomy and proved unable to

recruit competitively. Within the Bank of Thailand, severe factionalism

and competition for promotion became acute, leading to a loss of

teamwork, despite substantial investment in human capital. Parlia-

mentary government in Thailand has proved incapable of managing

the bureaucrats and bankers in a context where national economic

performance is less important to the electorate than local performance.13 Moral hazard seems rather unimportant: it is more likely that high

growth rates and the prospects of fast returns were what really drove

investment. Indeed, Korea allowed three of the biggest chaebol to fail

between 1990 and 1997 and another six in 1997 (Wade, 1998).

14 A conclusion also reached by the Hong Kong government in

August 1998, when it increased the size of the local capital market so

that speculators had to bet much larger sums of money in order to

threaten the peg of the $HK to the $US.


household savings within east Asia, that are deposited inbanks, which onlend them to ®rms. Firms thus havehigh debt-equity ratios, but can grow fast, even if theyare vulnerable to external shocks. This bank-based high-debt model became the development state in Japan(1955±1973), Korea (1961±1995) and Taiwan (1955-),which sought to steer market forces in line with nationalgoals. The model included mild interest rate repression,high-trust relations between banks and big ®rms, vari-ous kinds of credit and ®scal incentives, and means ofconsultation between banks, ®rms and governments. Italso included limits on the movement of ®nancial capitalacross borders.

As the economies of east Asia were successful,15 theyattracted high levels of foreign capital: in 1993±95Thailand was investing over 40% of GDP, China, Sin-gapore and Korea 35±40%, Hong Kong, Indonesia andJapan 30±35% (Howell, 1998). This capital, leveragedthrough the domestic banking systems, drove a veryrapid growth in supply. However, with ®nancial liber-alisation, with faster and easier ¯ows of short termcapital and, in some countries, with democratisation,®rm-bank-government collaboration became more ®x-ated on short term issues rather than long-term devel-opment objectives. Particularly, the management of highlevels of indebtedness proved problematic when capitalcould more easily ¯ow across borders and burst prop-erty bubbles.

A third long run explanation focuses on the regula-tion of economic growth models (Webber, 1995). Theestablished newly industrialised economies had by the1980s shifted from a model of growth in which exportswere growing faster than imports to a model in whichexports and imports were growing at approximately thesame rate: the NIEs' export success had elicited pro-tectionism and demands for currency appreciation asincreased competition within export markets was driv-ing prices down. Under this circumstance, the rate of

growth of output is constrained by the rate of growth ofdomestic demand, unless exogenous investment growsrapidly. Like Japan before them, the NIEs had beenforced to grow either through domestic demand or ex-ogenous investment (and their corporations had beenforced to rely on domestic demand or investment inlower wage economies). The ready availability of foreigncapital, from the north Atlantic but also from Japan,served to stimulate output faster than domestic demandwas growing. In the long run, with zero growth of netexports and output growing faster than domestic de-mand rates of pro®t must fall (Webber and Rigby,1999), a prediction consistent with falling capital: outputratios through the east Asian region. As rates of pro®tfall, unproductive investments become relatively moreattractive. So this interpretation relies on the exhaustionof the regime of export-led growth and the readyavailability of foreign capital, in the context of fallingpro®tability, to identify falling relative prices and risingunproductive investment as the underlying causes of thecrisis.

Apart from the ascribed ``naughtiness'' of the eastAsian people themselves, the underlying causes of thecrisis have been attributed to the growing availability ofunregulated foreign capital (and, in particular, short runcapital) and the exhaustion of a regime of export ledgrowth. These problems led in the end to a classicproperty and equity speculative bubble, which eventu-ally began to burst in Thailand in 1995. These ideas canbe gathered in the real explanation of the ®nancial crisisin Asia, as in Fig. 4.

3. Finance and the real economy

There is little dispute that the explanations do iden-tify characteristics of the east Asian economies; it ismore di�cult, however, to demonstrate that these un-derlying problems gave rise to particular triggers in theyear or two preceding the crisis. To demonstrate failuresof governance, the existence of huge in¯ows of capital orthe shift to a new model of growth is not to demonstratethat these conditions caused the crisis. As even someo�cial economists (such as the Reserve Bank of Aus-tralia) have observed, such structural conditions asforms of economic and ®nancial governance cannot be

15 Some of these economies may not have been performing as well as

the data suggest. Nasution (1998), for instance, has pointed out that

Indonesia's low rate of in¯ation owes a lot to government subsidies;

the rate of growth of GDP to the ``bubble'' industries (construction,

public utilities and non-traded services); and the growth of exports to

those sectors (shoes, textiles and clothing, and electronics) and ®rms

(from Japan, Korea and Taiwan) that used few domestic inputs.

Table 1

Capital ¯ows to developing countries, 1990±1997a

1990 1992 1994 1996 1997

Private ®nancial ¯ows 29.8 57.1 107.1 170.6 156.5

O�cial ®nancial ¯ows 56.3 55.5 45.7 40.8 100.0

Foreign direct investment 32.8 49.6 90.4 128.7 125.0

a Note: Units are billions of $US; Source: Howell (1998).


the cause of the recent currency crisis in Asia, be-cause these de®ciencies have been around for de-cades. They did not deter international capitalfrom ¯owing in year after year and, therefore, couldnot be the cause of the change of direction in 1997.They are important, not because they cause a cur-rency crisis, but because they provide an environ-ment where a currency crisis can lead to a severeeconomic crisis (Macfarlane, 1998a).

Of course, given the likelihood that the crisis was initself a panic attack, there does not have to have been atrigger of any real signi®cance.

3.1. Problems of real causes

Others dispute the existence of shocks that are iden-ti®ed by real explanations. McKibbin and Martin(1998), for example, demonstrate that Indonesia, Koreaand Thailand su�ered no major changes in terms oftrade, real e�ective exchange rates or price-earnings ra-tios in the stock market prior to the onset of the crisis inmid-1997.16 The risk premium only began to rise in mid-1997. Indonesia's exchange rate was overvalued, butonly to a moderate degree. It is also easy to overestimatethe strength of the currencies' peg to the $US:both theIndonesian and Korean currencies fell by about 20%against the $US between 1991 and mid-1997 (see Fig. 1).According to Kaminsky et al. (1998), historical evidenceindicates that prior crises were preceded by: low levels ofinternational reserves; severe currency appreciation;high domestic credit growth; high proportion of creditto the public sector; high domestic in¯ation; deteriora-tion in the trade balance; declining export performance;excessive money growth; low ratios of international re-serves to narrow money; deceleration in real GDPgrowth; and rising public de®cits. Of these eleven indi-cators, only two apply to Korea: reversals in the trade

balance and declining export performance; only thosetwo and currency appreciation apply to Indonesia; andonly those three and excessive money growth apply toThailand (Bustelo, 1998). That is, ®nancial crises seemto be largely unpredictable:

Of course, some individual investors may havesensed the dangers, but at an institutional levelthe facts show unequivocally that both the onsetand the extent of the crisis came as a complete sur-prise (Benzanson, 1998).

As Radelet and Sachs (1998) argue, if the crisis wasprimarily the result of deep-rooted problems, it shouldnot have taken the world by surprise. However, if thecrisis was essentially a ®nancial panic, it was inherentlyunpredictable. Radelet and Sachs demonstrate that untilthe third quarter of 1997 there was widespread optimismabout the region among international bankers (thespreads between Asian and comparable US interest ratesnarrowed during the 1990s to reach a low point in the®rst half of 1997, just as the crisis was about to unfold),credit rating agencies (ratings remained unchangedthroughout 1996 and the ®rst half of 1997), securities®rms (published forecasts), and the IMF itself (in itspublished country assessments and its October 1997World Economic Outlook). The same observation ismade by the Reserve Bank of Australia (Macfarlane,1998a). As Table 2 indicates, there was little warningabout the crisis from rating agencies.

That is, real analyses of the events leading up to thecrisis assume that events in the real economy drive the®nancial system. By so doing, they pay far too littlerespect to the relations between the ®nancial and the realeconomy that are revealed by this and other earlierbanking crisis. It is salutory to remember other similarevents: the attack on sterling and the lira in 1992, and onAustralia in 1985. Commonly Argentina, Brasil andMexico are cited as comparisons with east Asia, butthere have in fact been many banking crises within othercountries, even countries that most commentatorswould consider to be well regulated. Macfarlane

16 Price-earnings ratios in the Thai stock market started to decline in

1996.

Fig. 4. Real explanations for the ®nancial crisis in Asia.


(1998b), for example, provides data on systemic bank-ing crises in the north Atlantic region since the 1980s(Table 3).

This history raises, then, the issue of ®nancial liber-alisation. Neo-liberals point to the crisis and assign acause to the theory of homegrown vulnerabilities. Evenso, neo-liberals must recognise that ®nancial regulationfails in even the best-regulated systems ± as Macfarlane'sexamples of Table 3 indicate. And whose norms are tobe applied: those of capital market systems like the USand UK or those of bank-based systems? Finally, evenneo-liberals must recognise the need to control wildovershooting.

There are, then, three related considerations. Finan-cial crises appear to have only a couple of commondenominators ± and the number of common denomi-nators is diminishing as the number of crises increases.

This crisis was not predicted by any of the institutions ofglobal ®nancial governance. Similar crises occur in eventhe best regulated of ®nancial systems. Perhaps, then,the central theoretical implication of this crisis is that thereal cause is irrelevant. By this I mean that real expla-nations look for the cause of the ®nancial crisis in theconditions of the east Asian economies and argue thatthe real economy has ®nancial e�ects (which in theirown turn have other real e�ects). Perhaps, on the con-trary, we should recognise that the ®nancial system isnow driving itself, independent of conditions in the realeconomy, so that the chain of causation is: ®nancialsystem ! east Asia.

For money has a variety of roles and their relativeimportance is changing. Money is a standard of price,against which the values of other commodities can beassessed, as well as a medium of circulation and a meansof payment, circulated as money of account: these arethe functions of money that are signi®cant in real ex-planations of crisis. But money is a store of value tooand increasing proportions of the world's money arebeing held as stores of value rather than as a means oftransaction (Howell, 1998). So changing perceptions ofcurrency values can trigger rapid and volatile capitalmovements. Causation therefore shifts: whereas the realexplanations of Section 2 have tried to identify whathappened to the real economy so as to cause or totrigger such shifts in the ®nancial economy, it may bemore productive to ask how the changing ®nancial

Table 2

History of rating of sovereign, long-term debt in foreign currency, by Moody's and Standard and Poor'sa

Moody's Standard & Poor's

Rating Date Rating Date

Indonesia Baa3 14.3.1994 BBBÿ 20.7.1992

BBB 18.4.1995

BBBÿ 10.10.1997

Ba1 21.12.1997 BB+ 31.12.1997

B2 9.1.1998 BB 9.1.1998

B 27.1.1998

B3 20.3.1998 Bÿ 11.3.1998

S Korea A2 18.11.1988 A+ 1.10.1988

A1 4.4.1990 AAÿ 3.5.1997

A+ 24.10.1997

A3 27.11.1997 Aÿ 25.11.1997

Baa2 10.12.1997 BBBÿ 11.12.1997

Ba1 21.12.1997 B+ 22.12.1997

BB+ 18.2.1998

Thailand A2 1.8.1989 Aÿ 26.6.1989

A 29.12.1994

A3 8.4.1997 Aÿ 3.9.1997

Baa1 1.10.1997 BBB 24.10.1997

Baa3 27.11.1997

Ba1 21.12.1997 BBBÿ 8.1.1998

a Note: Ratings in italics are for non-investment grade ratings; Source: Bank for International Settlements, 1998 (BIS) 68th Annual Report (1 April

1997±31 March 1998) Basle: BIS.

Table 3

Costs of recapitalising the banking system in earlier crisesa

Country Period Cost (as % of GDP)

Finland 1991±1993 8.0

Norway 1987±1989 4.0

Spain 1977±1985 16.0

Sweden 1991 6.4

USA (S & L) 1984±1991 3.2

a Source: Macfarlane (1998b).


economy drove the real economy. This line of argumenttakes two di�erent forms.

3.2. The speculative ®nancial economy

To understand the speculative ®nancial economy,let's start by thinking about the way in which the valueof money is set in a model of real trade. Suppose thatthere are two countries, A and B, that trade. As B ex-ports to A, so people in A must use their $A buy $B withwhich to pay the producers of B for their exports. Thedemand for $B relative to $A therefore rises and therelative values of the currencies change accordingly. Acontrary motion occurs when A exports to B. If, then,the balance of trade is such that A exports more than itimports, the demand for $A is greater than the demandfor $B and so the value of $A rises relative to the valueof $B. Two features of this model are important: ®rstly,the real movement of commodities drives the contrarymovement of money and so the relative prices of cur-rencies; and secondly, the movements are compensating± a trade imbalance calls forth currency changes that inthemselves tend to remedy the trade imbalance.17

But the monetary ¯ows into east Asia were not of thiskind. Under conditions of global liquidity and easytransfer of money, the strength of east Asian economies(especially relative to Japan) attracted capital. As wehave seen, there were massive capital in¯ows to the re-gion in the 1990s. These in¯ows did not occur to com-pensate for the movement of commodities: the in¯ows ofmoney were themselves the independent variable.However, as money ¯ows from B to A three e�ects oc-cur. First, just as in the real example, a ¯ow of moneyfrom B to A implies an increase in the demand for $Aand so an increase in its price. Secondly, since much ofthis capital was used to buy ®xed assets rather thanproductive facilities, the in¯ow stimulated rising assetprices. Thirdly, the increased availability of money inrelation to local production within A (and the lack ofmoney in B relative to production) tended to increasethe trade de®cit of A. Notice that this system is not selfcompensating: the revaluation of the $A and the in¯a-tion of asset prices both tend to encourage increasedin¯ows of capital by raising their pro®tability.

The relationship between the ¯ows of commodities,the ¯ows of money and changes in the relative values ofmoney thus depends on which ¯ow is driving the system.If the values of currencies are set mainly by real tradeconsiderations, then a ¯ow of money from B to A im-plies that the $A is revalued, the trade imbalance fallsand money ¯ows diminish. If the values of currencies areset mainly by ®nancial considerations and asset prices,

then the revaluation encourages additional in¯ows ofmoney and increasing trade de®cits. Increasingly, it isthis latter consideration that has become dominant:capital in¯ows stimulate asset appreciation, trade de®-cits and currency revaluations (or at least relative cur-rency stability in the face of trade de®cits). Andconversely in the case of Japan: capital out¯ows havestimulated asset depreciation, trade surpluses and cur-rency devaluations (or at least currency stability in theface of trade surpluses). In other words, the exchangerates are shifting in non-orthodox directions, dancing tothe tune of capital ¯ows rather than to trade ¯ows.18

Under such a regime, capital in¯ows created the twinproblems of east Asia: an asset bubble and increasingcompetition within producers' export markets.

3.3. Manipulation

On the other hand, currency markets are also ma-nipulated. The real models (in whatever version) and themodel of capital ¯ows in Section 3.2 consider investorswho make decisions on the basis of information that ismore or less accurate. The investors are neutral in thesense of reacting, for better or worse, to circumstances.Such ®nancial players are guessing that there will be¯uctuation and guessing on its characteristics. However,it is clear that at least in some cases, ®nancial playershave manipulated markets in order to achieve ¯uctua-tions in currencies. That is, there has been manipulationrather than mere speculation.

One example of such a manipulation occurred inHong Kong in August 1998 (see daily reports in theFinancial Times, 15±31 August 1998). Speculators heldshort positions in the stock market: that is, they soldstocks that they did not own at the time of sale.19 Next,the speculators sold Hong Kong dollars, thus tending toforce down the value of the $HK. Under the mechanismthat maintains the peg of the $HK to the $US, thiscaused the Monetary Authority to raise the interest rateand that in turn, tended to drive the prices of stocksdown. At this point, the speculators bought the stocks(cheaply) that were needed to be delivered on the con-tract for sale made earlier (at the higher price). In orderto prevent this form of market manipulation, the Hong

17 A similar model of capital ¯ows can be constructed with

investment decisions driving the ¯ows of money.

18 To see the relative magnitudes involved, consider the situation of

1998. Suppose you borrow Y130M at 1%. This enables you to invest

$1M in US bonds at 5%. At the end of a year, the interest earned is

5±1%� 4%� $40 000. If the Y falls 10%, the gain from currency

changes is more than double the interest earned. The speculative

income (earned from changes in currency prices) dominates the real

income (earned from moving money between two places with di�erent

interest rates).19 Stock markets regulate the time that elapses between an agreement

to trade at a given price and the actual delivery of the paper certi®cates

(and money). Common practice in Hong Kong in late 1988 was for this

time to be a couple of days.


Kong government bought up to a billion (US) dollarsper day of stocks, increased the amount of moneyavailable to Hong Kong banks (so that larger sums hadto be spent in order to shift the currency) and tightenedthe rules on short selling in the stock market.

Another form of manipulation is thought to haveoccurred more generally. Suppose that a currency traderbelieves that the ringgit, say, is overvalued. The specu-lator borrows, say, 500M ringgit from a bank withinMalaysia. S/he then exchanges them for, say, $200M.Since the sale of ringgit tends to depress their price,repeated transactions of this kind will tend to assist theringgit downwards. Then when the ®rst loan becomesdue, the repayment might cost only $150M (plus inter-est). The Malaysian bank has its money back plus in-terest; the speculator has $50M less interest; the onlylosers are all the holders of ringgit (essentially Malay-sians and Malaysian corporations). Howell (1998)claims that foreigners borrowed heavily in Asian cur-rencies in the expectation that these currencies would beforced to devalue. In order for this manipulation towork, it is not necessary for the east Asian currency tobe `àctually'' overvalued; all that is important is thatsu�cient sums of ringgit are exchanged within Malaysiafor dollars ± that is, that currency speculators are largerelative to currency markets and that a clear majority ofthe speculation occurs in the one direction.

3.4. Price changes

Whether they are speculators or manipulators, oper-ators in ®nancial markets can play these games only ifprices change. A commodity can be the target of spec-ulation or manipulation only if its price is not largelydetermined by its value (that is by the social conditionsunder which it is produced). In practice, this means thatthe prices of target commodities have important non-produced components ± natural resource contributionsin the case of mineral and agricultural commodities;scarcity in the case of real estate and stocks; or use-valuedeterminants in the case of money. Their price not beingdetermined by the social conditions of production, suchcommodities can become targets for price speculation ormanipulation. The basis for the speculation or manip-ulation is not important: some among this set of com-modities will be the target for speculation ormanipulation, and as ®nancial ¯ows have become in-creasingly liberalised so money has increasingly becomethe target of choice.

So it was in east Asia. There may have been failuresof governance, degeneration of the development statemodel, falling rates of pro®t. But these conditionsmerely identi®ed the target for the speculation or ma-nipulation (and perhaps exacerbated the e�ects ofspeculation or manipulation). However, there wouldhave been a ®nancial crisis somewhere, just as there have

been currency and banking crises throughout the 1980sand 1990s in the developed as well as in the developingworld. In other words, explanations of the long run orunderlying causes of the crisis must focus not on con-ditions in east Asia but on the mode of operation ofglobal ®nancial markets.20 The existence of speculatorsor manipulators who can deploy more money than is inthe reserves of all except a handful of countries is theunderlying or long run cause of the crisis; conditions ineast Asia merely serve to specify that the crisis occurredhere now.

4. Conclusion

Of course, these are early days in the history of theeast Asian ®nancial crisis. The long-term impacts are notclear and the full range of a�ected countries may yet belarger than that listed here. Equally, analysis of the crisisis still in its infancy. These uncertainties notwithstand-ing, o�cial interpretations of the crisis have been re-markably de®nite about cause and therefore aboutappropriate policy responses. The most common o�cialanalyses identify failings of the east Asian governmentsand their forms of regulation; east Asians were the causeand therefore need to pay for the major prices and tomake the appropriate policy changes. There were,however, other characteristics of east Asian recent his-tory that also underlay the crisis and in which east Asiangovernments were less culpable. Furthermore, I haveargued that the key long run condition that underlay thedevelopment of the crisis is the existence of large spec-ulative funds roaming the globe in search of opportu-nities to exploit price ¯uctuations. This argument claimsthat the conditions of east Asian societies merely spec-i®ed which places would become the target of specula-tion or manipulation, but the fact of speculation ormanipulation is independent of these conditions. This isthe central theoretical implication of the crisis. Thecentral political implication of this argument is that itrefocuses debate on the operations of the global ®nan-cial system rather than on the actions of victims of thecrisis.

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Documents

Finance and the real economy: theoretical implications of the financial crisis in Asia