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The Wrong Medicine for Asia By JEFFREY D. SACHS CAMBRIDGE, Mass. -- In a
matter of just a few months, the Asian economies went from being the darlings of
the investment community to being virtual pariahs. There was a touch of the
absurd in the unfolding drama, as international money managers harshly
castigated the very same Asian governments they were praising just months
before. The International Monetary Fund has just announced a second bailout
package for the region, about $20 billion for Indonesia.
That should, in
principal, boost confidence. But if it is tied to orthodox financial conditions,
including budget cuts and sharply higher interest rates, the package could do
more harm than good, transforming a currency crisis into a rip-roaring economic
downturn. In the Great Depression, panicked investors fled from weak banks in
the United States and abroad. Since banks borrow short term in order to lend
long term, they can be thrown into crisis when a large number of depositors
suddenly line up to withdraw money. In the days before deposit insurance,
individual depositors would all try to be first in line for withdrawals. In
1933, the Federal Reserve played it disastrously wrong. Rather than lending
money to the banks to calm the panic and to show the depositors that they could
indeed still get their money out, the Fed tightened credit, as financial
orthodoxy prescribed. Confidence sank, and the banking system crumbled.
The
Asian crisis is akin to a bank run. Investors are lining up to be the first out
of the region. Much of the panic is a self-feeding frenzy: even if the economies
were fundamentally healthy at the start of the panic, nobody wants to be the
last one out when currencies are weakening and banks are tottering because of
the rapid drain of foreign loans. I t is somehow comforting, as in a good
morality tale, to blame corruption and mismanagement in Asia for the crisis.
Yes, these exist, and they weaken economic life. But the crisis itself is more
pedestrian: no economy can easily weather a panicked withdrawal of confidence,
especially if the money was flooding in just months before. The I.M.F. has
arrived quickly on the scene, but the East Asian financial crisis is very
different from the set of problems that the I.M.F. typically aims to solve.
The I.M.F.'s usual target is a government living beyond its means, financing budget
deficits by printing money at the central bank. The result is inflation,
together with a weakening currency and a drain of foreign exchange reserves. In
these circumstances, financial orthodoxy makes sense: cut the budget deficit and
restrict central bank credits to the government. The result will be to cut
inflation and end the weakening of the currency and loss of foreign exchange
reserves. In Southeast Asia, this story simply doesn't apply. Indonesia,
Malaysia, the Philippines and Thailand have all been running budget surpluses,
not deficits. Inflation has been low in all of the countries. Foreign exchange
reserves, until this past year, were stable or rising, not falling. The problems
emerged in the private sector. In all of the countries, international money
market managers and investment banks went on a lending binge from 1993 to 1996.
To a varying extent in all of the countries, the short-term borrowing from
abroad was used, unwisely, to support long-term investments in real estate and
other non-exporting sectors.
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