International Policy

Federal Reserve Study: Asian Crisis Was Predictable

Asia's troubles actually began much earlier than last summer in the wealthy countries, contends economist Jane Little of the Federal Reserve Bank of Boston. In a new study, "Anatomy of a Currency Crisis," she argues that most economists and investors were looking at the wrong things early last year and did not foresee where events were heading.

Here are some of the key factors in her interpretation.

  • During the 1990s, the U.S., Europe and Japan successfully brought down their inflation rates and reduced their fiscal deficits through a mix of spending cuts and tax hikes.

  • These policies allowed them to keep interest rates down to 2 to 3 percent -- leaving international investors to start looking around the world for areas where they could achieve greater returns.

  • The result was that hundreds of billions of dollars in capital flowed into Indonesia, Malaysia, the Philippines, Thailand, Korea, Taiwan, Hong Kong and Singapore.

Those economies thrived -- but just when things seemed best, the biggest mistakes were made.

  • With exchange rates fixed, capital inflows to purchase Thai securities or to expand an Indonesian manufacturing plant required their central banks to buy dollars and supply the needed baht and rupiahs -- thus ballooning the money supply.

  • The central banks tried to offset the new money by boosting interest rates to head off domestic inflation -- which only encouraged more money to pour in.

  • With inflation creeping above U.S. levels and exchange rates fixed, Asian goods began to get more expensive on world markets.

  • When trade slowed and Asian trade deficits surged, the Asian nations had to borrow billions of dollars from overseas to pay their debts.

Dubious but massive building projects, coupled with financial and political corruption in some countries, led to the entire region not being able to pay its bills. Country after country was forced to devalue to attract new investment -- and to keep foreigners from liquidating their holdings. Thus was the crisis born, Little says, but a lesson might also be learned: fixed exchange rates don't fix anything if other policies are bad.

Source: Perspective, "Signs of Crisis," Investor's Business Daily, March 20, 1998.

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