Asia Waiting to Exhale

Why do currencies still tumble, despite IMF help? Reforming banks is not easy.

As the world tries to figure out whether Asia's economic crisis will get worse, stay bad, or go away, experts are tense - especially with each other.

Chalmers Johnson, an expert on East Asia, disparages the recent work of a "particularly odious colleague" who writes a column for an American newspaper. Edward Lincoln, a Japan specialist at the Brookings Institution in Washington, brushes off a fellow economist whose comments have influenced the debate. "Frankly, my own opinion is that whatever [he] thinks, probably the opposite is true," Mr. Lincoln says.

Such cutting comments are more than academic banter, perhaps because the stakes are high: East Asia's crisis could bring worldwide deflation. In order to forestall potential doom in the United States and elsewhere, policymakers are struggling to understand why a region known for economic "miracles" has begun to implode.

There is at least one common thread that links a plunging currency in Indonesia to massive bankruptcies in South Korea to the prospect of financial instability in Japan: bad lending - lots of it.

At a basic level, economist Lincoln says, the Asian crisis is "a banking problem in which nobody was paying much attention to what banks were doing, including the banks themselves. And in the absence of that oversight, they ended up doing a lot of things they shouldn't have."

The reasons for the excessive debt vary from economy to economy. Thais continued to borrow, spend, and invest in recent years, ignoring the erosion of their ability to compete with China. Under South Korea's system, the government has long offered the tacit assurance of official help for overleveraged firms, encouraging them to borrow without limit. In Indonesia's nepotistic power structure, banks often chose borrowers on the basis of family connections, not creditworthiness.

Last summer, new skepticism about some Southeast Asian economies caused a crisis of confidence. Currency speculation is a game played in herds, and the herd decided that the Thai baht and Malaysian ringgit were overvalued because underlying economic conditions weren't as rosy as they had been in the past: There was too much capacity, too much investment, even too much confidence.

The resulting currency plunge quickly affected the Indonesian rupiah and the Philippine peso and brought companies - many of whom had borrowed heavily at home and abroad - to the verge of defaulting. All the countries but Malaysia turned to the International Monetary Fund, a lender of last resort funded by the world's rich nations. Later in the year, the Korean currency and stock markets caved in, forcing another IMF rescue.

The IMF is now demanding reforms in exchange for billions of dollars of financial assistance. These reforms are designed to make Southeast Asian and Korean companies leaner and encourage their governments to adopt more open, free-market economic policies. The crisis, and these remedies, have already begun to produce bankruptcies and rising unemployment.

All the crisis countries have achieved success through exports, and companies will now have to cut prices to stay afloat. Their devalued currencies also mean that their goods are much cheaper in the US and other developed economies. "There's going to be a lot of Asian stuff coming into the US, cheap," says Scott Foster, a securities analyst with ING Barings in Tokyo.

All of this presents an immediate concern for those who try to safeguard the US economy: the possibility of deflation. Falling prices are OK for those on fixed incomes or with large bundles of cash hidden in the garden shed, but perilous for just about everyone else. As Federal Reserve Chairman Alan Greenspan noted over the weekend, "[H]istorically, it has been very rapid asset price declines - in equity and real estate, especially - that have held the potential to be a virulently negative force in the economy."

Despite IMF interventions, the new year seems to have brought no relief. On Jan. 6 the Thai baht, Indonesian rupiah, Malaysian ringgit, and Philippine peso all hit new lows. Korea's currency and stock market have strengthened a bit lately, but only after two of the world's most financially influential people - the investors George Soros and Sir John Templeton - took actions to support what was the world's 11th-largest economy.

A second major danger is that Japan - the world's second-largest economy and a huge lender to the rest of the world - will be severely affected. This country has been struggling out of a recession for nearly a decade with little success, and its financial institutions are still carrying hundreds of billions of dollars of bad loans after the burst of a speculative bubble in the 1980s.

Last year, Japan's fourth-biggest securities house went bankrupt amid growing fears about governmental inaction. Mr. Johnson, who runs a small think tank called the Japan Policy Research Institute in Cardiff, Calif., calls this country's leader "Herbert Hoover Hashimoto."

Don't fix until it's very, very broke

How did East Asia get into such trouble with so few people noticing? The reason seems to be that no one wants to be told to fix something until it's really, really broken. In retrospect it seems obvious that Thailand's real estate boom was out of control, but until early last year lenders and borrowers were willing to believe they could still make money.

"Koreans are big gamblers to start with," says Mr. Foster, who spent three years in Seoul researching companies. "They built their country on a big gamble, and it worked. You're really just screaming into the wind trying to tell them to stop doing what has been so successful. It had to collapse of its own weight."

Privacy a problem

In all of the countries in crisis, it is difficult to figure out what's going on. "It was hard, let's say at a time like 1989 in Japan, to really get a grip on what the dangers were," Lincoln says. "Because nobody really knew what the banks were up to. The essence of the whole system is that information doesn't flow freely out to public markets. Banks operate on the basis of private transactions that nobody sees."

What economists call "imprudent" lending was not limited to domestic banks - the West's biggest financial institutions have been just as guilty, says James Abegglen, a Tokyo-based consultant. The Korean crisis is "a matter of the international banking community being totally irresponsible in the world's 11th-biggest economy." Many of their loans were short-term and rather than work with Korean borrowers to find solutions, most big institutions have wanted to flee, he says.

Banks with bad loans and companies with huge quantities of debt don't exist in a vacuum, of course; they are part of economic systems. The state-guided capitalism of Japan and Korea - and to a lesser extent Indonesia, Malaysia, and Thailand - is under unprecedented scrutiny.

With Korea and Japan, says Johnson, there is a little-noticed dimension. "What we're seeing is the collapse of the American structure of satellites from the cold war," a process comparable in some respects to what happened in Eastern Europe after the fall of the Berlin wall.

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