Financial Crisis in East Asia: Bank Runs, Asset Bubbles and Antidotes

By Miller, Marcus; Luangaram, Pongsak | National Institute Economic Review, July 1998 | Go to article overview

Financial Crisis in East Asia: Bank Runs, Asset Bubbles and Antidotes


Miller, Marcus, Luangaram, Pongsak, National Institute Economic Review


"Theories without facts are empty: facts without theories are blind."

Immanuel Kant in the Critique of Pure Reason

1. Introduction

What is so special about the East Asian crisis? Radelet and Sachs (1998a, p.1) provide a graphic answer as follows: "The East Asian financial crisis is remarkable in several ways. The crisis has hit the most rapidly growing economies in the world. It has prompted the largest financial bailouts in history. It is the sharpest financial crisis to hit the developing world since the 1982 debt crisis. It is the least anticipated financial crisis in years."

After a brief account of the facts in section 2, we outline various types of financial crisis {section 3). Then in section 4, we ask which theory best fits the facts. Was the East Asian crisis essentially creditor panic where a mad scramble for liquidity brought an inherently sound financial and economic system to its knees as Radelet and Sachs (1998b) suggest?; or was the miracle indeed flawed by fundamental problems in asset prices and resource allocation? We conclude that both factors played a role: there was certainly a creditor panic, but it was in large part due to economic excesses in the domestic private sector and inadequate regulatory responses by the government, particularly in respect of banking. Section 5 discusses how contagion can occur in environments where investors are poorly informed and each looks to the others for guidance. Various approaches to crisis prevention and management are outlined in section 6. Then, after a brief look at prospects for recovery, the article concludes with immediate steps that might help resolve the current crises; and with proposed reforms to the international monetary system to prevent a recurrence.

2. Main features of East Asian crises

Calvo and Goldstein (1996, p.25) have noted that "in a sense, every financial crisis can be regarded as a failure of the early warning system". But the early warning macroeconomic indicators that were relevant for the 1994/5 Mexican crisis - too much consumption (too low saving), persistent budget deficits and a high rate of inflation - did not apply in the East Asian economies. So those seeking the mainsprings of the recent crisis need to look elsewhere - at the weakness of financial systems, for example, due to inefficient and inadequate regulation and (implicit or explicit) government guarantees.

This has led many critics to conclude that the problems these countries face today arise not because government did too much, but because they did too little. Put differently, the roots of the crisis lie in private sector activities.(1) The build-up of short-term foreign liabilities (on an unhedged basis) during economic boom, and the misallocation to unsound projects and non-productive sectors, exposed these economies to a sudden loss of confidence. When it came, the capital outflows, together with the depreciation of local currency and collapse of asset prices, exacerbated the financial position of the private sector and the crisis proved self-fulfilling.

In this section, we provide a summary of the four main elements that contributed to the onset of the crisis in East Asia;((2)) specifically a) external factors and macro-economic imbalances, b) private capital inflows, c) the role of financial intermediation, and d) the behaviour of asset prices.

a) External factors and macroeconomic imbalances

East Asian countries have enjoyed an impressive economic performance for several decades: in Korea, Indonesia and Thailand - the countries we focus on in this section - GDP grew at around 8-9 per cent per annum from the beginning of the 1990s till 1996. In Korea, the rapid growth in output - of chips, ships, and cars, for example - was backed by rapid capital accumulation financed by a high rate of domestic saving - about 35 per cent of GDP. Thai residents also saved about a third of their income - and invested even more: Indonesians saved and invested just over a quarter of their income. …

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