CAMBRIDGE: The Asian economic crisis is not going according to plan. Last Fall when the Western Governments and the IMF sponsored more than $100 billion in bailout loans to Asia, the hope was for a quick rebound. Those hopes are now dashed. Output is falling sharply everywhere. Japan is falling into deep recession. Some knowledgeable observers speak of an Asian Depression.
To understand these fast moving events, we have to understand Asia’s financial systems. Asia’s economies were built on debt finance more than equity finance. Asian households put money in the banks which was then lent to Asia’s enterprises. The banks made large loans to undercapitalized enterprises, which were thereby able to expand rapidly despite a shortage of equity capital. Debt financing allowed the Asian countries to grow at rates that were unprecedented in world history.
So far so good. The system worked well until the early 1990s, when Asia’s financial markets were opened to international capital markets. For the first time in many countries, Asia’s banks were allowed to borrow from abroad. Unfortunately, foreign bankers were not conservative like Asian households. Money that came in one day could come out the next.
This is what happened. Foreign bankers lent $55 billion to five Asian countries (Indonesia, Korea, Malaysia, the Philippines, and Thailand) in 1996. They withdrew at least $17 billion in 1997 when they got scared by the devaluation of the Thai Baht. Suddenly, the entire debt-financed system was broken. Asian banks had to demand the repayment of loans from industrial borrowers, so that the banks could pay off their own foreign creditors. Heavily indebted Asian enterprises didn’t have the cash to repay their loans, since the loans had been sunk into new factories, real estate, and other long-term ventures.