Is the Asian Flu Fatal?

Why Asia's economies got sick--and what can be done to cure them.

James K. Glassman from the May 1998 issue

(Page 3 of 11)

In the late 1980s and the early 1990s, it was the semiconductor industry. Now part of that was a response to the U.S.-Japanese semiconductor agreement, which set a minimum price on semiconductors in the U.S. market for Japan. The Koreans decided to come in underneath that. The semiconductor market collapsed. They ended up owning a lot of paper from the semiconductor industry.

That is why Korea was in trouble a year before the stock market there was going down, down, down. Korean companies had really made a lot of investments which proved to be bad. Those investment decisions were made by the government.

Glassman: So do you think governments have learned that they shouldn't pick the chemical industry or the semiconductor industry or tell the chaebol how much they should invest or the banks how much they should lend?

Meltzer: I will light a candle and hope for the best. But I don't believe it.

Mallaby: I will look at Japan and observe that it has taken them an awful long time to get anywhere toward liberalization. They have been trying for a long time.

Glassman: Why did everyone miss what was going on? It seems to me a stunning misjudgment by almost everyone in the world.

Robert Litan: That's a $64 billion question. There were a few people who were predicting a collapse or a major financial panic, although no one stuck their neck out saying when it would occur. The IMF at least is claiming that it was warning these countries privately but not publicly at least several months before the crisis. But this is a case where we have lots of irrational exuberance to go around. Alan Greenspan [who complained about "irrational exuberance" among investors in the U.S. stock market, analogizing to the Japanese bubble] probably had the term right but the region wrong. I think Brink and Sebastian are right, that there was irrational exuberance by banks, by investors, by governments--they thought 7 percent or 8 percent growth would continue and trees would grow to the sky uninterrupted.

Lindsey: I don't think that there was a wholesale failure to see these problems. Anybody who is familiar with these economies knew they had rotten financial sectors, knew that there was endemic corruption, knew that there was a lot of crony capitalism, knew that the exchange rate pegs and macroeconomic fundamentals were in conflict. Yet you get lulled into 8 percent growth year after year after year. You start thinking, "Well, these problems exist but the virtues of these places seem to outweigh the problems." I think the moral hazard element tends to increase that lulling effect.

Litan: I was going to add one more thing that I think everyone missed: the suddenness and the severity of the problem once it became manifested. We had a classic case of contagion here, where even countries with strong fundamentals like Singapore and Taiwan, both countries with lots of reserves in the bank, got hit by the flu.

Meltzer: But that didn't last more than a few hours or days. Right?

Litan: Their currencies still are lower than where they were before the crisis.

Meltzer: Ten percent, something of that order?

Litan: Ten percent is not chicken feed.

Meltzer: No, no. But the market quickly did discriminate between those who were in trouble and those who were not. One of the things that has been left out here is the revaluation of the dollar. These countries peg [their currencies] to the dollar. They got the benefit of lower prices in Japan as a result of being pegged to the dollar. Then when the dollar revalued and the Chinese had devalued, they were in a less competitive position.

So I don't think that their problems were unforeseen. As a matter of fact, lenders began to demand guarantees from the state long before the crisis actually broke out in the form in which we know it in the fall.

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