eBook
Related collections and offers
Overview
This book provides a sweeping, up-to-date, and boldly critical account of the financial crises that rocked East Asia and other parts of the world beginning with the collapse of the Thai baht in 1997. Retracing the story of Asia's "Crisis Five"--Indonesia, Malaysia, South Korea, the Philippines, and Thailand--Padma Desai argues that the region's imprudently fast-paced opening to the free flow of capital was pushed by determined advocates, official and private, in the global economy's U.S.-led developed center. Turmoil ensued in these peripheral economies, the Russian ruble faltered, and Brazil was eventually hit. The inequitable center-periphery relationship also extended to the policy measures that the crisis-swept economies implemented under International Monetary Fund bailouts, which intensified the downturns induced by the panic-driven outflows of short-term capital.
Financial Crisis, Contagion, and Containment examines crisis origin and resolution in a comparative perspective by combing empirical evidence from the most robust economies to the least. Why is the U.S. relatively successful at weathering economic ups and downs? Why is Japan stuck in policy paralysis? Why is the European Central Bank unable to achieve both inflation control and stable growth? How can emerging markets avoid turbulence amid free-flowing speculative capital from private lenders of the developed center? Engaging and nontechnical yet deeply insightful, this book appears at a time when the continuing turmoil in Argentina has revived policy debates for avoiding and addressing financial crises in emerging market economies.
Product Details
| ISBN-13: | 9781400865376 |
|---|---|
| Publisher: | Princeton University Press |
| Publication date: | 11/23/2014 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 320 |
| File size: | 5 MB |
About the Author
Read an Excerpt
Financial Crisis, Contagion, and Containment
From Asia to Argentina
By Padma Desai
PRINCETON UNIVERSITY PRESS
Copyright © 2003 Princeton University PressAll rights reserved.
ISBN: 978-1-4008-6537-6
CHAPTER 1
Introduction
The global economy experienced extraordinary changes in the nineties that affected the economic prospects of both developed and less developed countries when the decade ended.
One of its alarming features was the widespread and massive borrowing in both groups. In the U.S., the government budget deficit was being energetically brought down during the Clinton administration, but American households and businesses borrowed freely during the unprecedented economic boom of the second half of the decade. Japanese corporate and financial sectors borrowed heavily and invested unwisely in land and real estate, burdening Japanese banks with a mountain of nonperforming loans when the unsustainable expansion of the eighties ended. In that regard, investors in the European Monetary Union (EMU), latecomers on the scene with its formation in 1998, were an exception. They took advantage of the expanded bond market defined in the single currency euro and invested in U.S. industry and financial activities.
Countries of the less developed group did not lag behind as borrowers. In the East Asian cluster of Indonesia, Malaysia, Philippines, South Korea, and Thailand analyzed in this book, government finances were in balance but businesses and banks borrowed on short term in foreign currency and invested long term in dubious domestic assets. Governments in Russia, Brazil, Argentina, and Turkey accumulated a significant foreign debt burden without concern or ability to meet their repayment obligations via export earnings.
A major difference in the borrowing activities of the two groups arose from the decision-making process. Borrowers, public and private, in the three dominating zones—the U.S., the eurozone, and Japan included in this book—were free agents unencumbered by external pressures in their decisions to borrow and pay up their debts. By contrast, the economies in the second group analyzed here invited financial and currency crises from the borrowing binge facilitated by a premature opening up of their capital markets to free entry of short-term, speculative funds. Preferences of developed country lenders, private and institutional, played a role in the hasty liberalization of their economies' financial and capital account transactions involving foreign exchange.
A difference in the policy responses between the two sets of countries was also apparent when the debt-led expansion came to a halt. It ended in Japan in 1990 and in the U.S. in mid-2000. The East Asian economies were swept in a capital-outflow led financial and currency crisis that began in Thailand in mid-1997. Currencies tumbled at varying rates in Russia in August 1998, Brazil in January 1999, Turkey in early 2001, and Argentina in December 2001. Policy decisions to promote stable growth in Japan (marked by failure) and the U.S. (significantly on track despite the negative impact of the terrorist attacks of September 11, 2001) were domestically driven. By contrast, the crisis-ridden economies lost their decision-making initiatives under International Monetary Fund (IMF) bailouts, which consisted of extreme monetary and fiscal discipline and unrealistic triple-policy arrangements of floating exchange rates, free capital mobility, and a presumed monetary policy autonomy. The IMF sought to resolve an externally imposed crisis by subjecting these recession-prone economies to severe contractionary regimens, which would have been unthinkable in a developed economy in the midst of an economic downturn. None of these countries were adequately prepared for achieving post-crisis stable growth by implementing independent monetary policy in the midst of unrestricted capital flows and freely floating exchange rates. These triple-policy arrangements, preferred by the IMF, were more suited to the developed economies with flexible markets, robust institutions, and adequate supervision of their banking and financial sectors.
In this chapter, I introduce the book's theme of the contrasting interaction between the economic challenges and the policy responses of recent years in the developed center of the world economy and the less developed periphery. I begin with the former group.
The Developed Countries: Events and Outcomes
At the start of the new millennium, policy makers in the three dominant economies—the U.S., the eurozone, and Japan—were engaged in maintaining inflation-free, stable growth. The unprecedented expansion of the U.S. economy, marked by the stock market boom, ended in mid-2000, raising policy debates about a stimulus package aimed at arresting the economic slowdown that turned into a recession after the events of 9/11. Twelve of the fifteen European Union countries formed a monetary and economic union in May 1998, and surrendered their monetary policy autonomy to the European Central Bank by discarding their individual currencies and adopting the euro. The end of the Japanese investment boom of the eighties left a massive burden of bad loans with banks that posed formidable policy challenges for Japanese authorities in steering the economy to stable growth.
In 2002, the outcomes of the policy initiatives in each area varied significantly. The U.S. emerged in the first quarter out of a post-9/11 recession, which turned out to be short and shallow. The swift U.S. recovery was aided by the Federal Reserve's aggressive monetary easing and the government's budgetary stimulus. Continuing productivity growth added to the prospects of sustained growth in 2002. The eurozone's economic recovery lagged behind that of the U.S. as the European Central Bank fitfully implemented its mandate of achieving inflation-free growth for the zone in the midst of halting labor market liberalization and corporate sector deregulation reforms in member countries. The worst performer was Japan: a prolonged, on-again, off-again policy mix of monetary easing, tax reform, and clearing of bank debts failed to pull the economy out of the eventual malaise of declining prices. As a result, consumers postponed their spending and companies battled the impact of price deflation on their profitability and delayed capital spending. Japan's economic stagnation continued into 2002.
As I noted, the early years of the nineties were also marked by capital inflows into developing countries that abolished their capital account controls and liberalized their domestic credit and financial markets.
The Developing Countries: Premature Capital Mobility and Its Consequences
These inflows, pushed by determined Washington policy makers and supported by avid Wall Street financiers, were massively short term, speculative, and destabilizing. The banks and financial institutions of the borrowing countries were poorly supervised and their capital/asset ratios were inadequate Their lenders and borrowers were linked via special ties and traditional norms of financial practices. Risk management of portfolios was rudimentary. Short- term loans in hard currency were lent long term to domestic borrowers who invested the funds in real estate and businesses of questionable worth. As the highly leveraged borrowers missed debt payments and declared bankruptcies, foreign creditors withdrew funds aggravating the finances of these borrowers and dragging with them the values of the currencies they dumped. The 1997–98 financial crisis that spread from Bangkok to Brazil via Moscow became a currency crisis.
The nineties were thus marked by economic growth followed by severe downturn in several less developed countries of Asia as well. The East Asian economies of Indonesia, Malaysia, South Korea, and Thailand recorded high growth and low inflation rates and balanced government budgets in the decade leading to 1997. During this same period, the Philippine economy also steadily improved in terms of these norms. These five economies were hit by the financial and currency crisis that began with the collapse of the Thai currency in mid-1997 and spread to Russia and Brazil in 1998; they experienced severe recession from the IMF-imposed monetary and fiscal austerity measures calculated to restore currency stability and foreign investor confidence in their systems.
In contrast to the robust macroeconomic indicators in these East Asian economies in the pre-crisis decade, Russia's economic performance was shaky. The control of inflation from quadruple-digit levels of 1992 to low double-digit numbers thereafter was uncertain, budget deficit at 7 percent of gross domestic product (GDP) remained high, and economic growth in 1997 following a severe contraction of the economy (by half in domestic prices since 1991) was barely visible. In Brazil, the record of successful inflation control and positive economic growth following the adoption of the Real Plan in July 1994 was also handicapped by high budget deficits that spilled into current account deficits. As a latecomer attempting the painful transformation from a command to a market economy, the Russian economy in 1997 was far more deficient in its macroeconomic health than the Brazilian economy. It was also more vulnerable to the crisis contagion that spread from East Asia as foreign investors withdrew their ruble- and real-denominated assets. On August 17, 1998, the Russian authorities declared a unilateral default on the government's ruble debt, prohibited commercial banks from clearing their foreign liabilities, and devalued the ruble from 6 rubles to a dollar to 26 rubles. In response to a similar withdrawal of assets by nervous foreign investors in the final weeks of 1997, the Brazilian government cut back budget outlays by 2.5 percent of GDP, the central bank pushed up the basic lending rate to 43 ½ percent, and finally allowed the real to float in January 1999.
The East Asian "Crisis Five" and Brazil revived at rates varying from 2 to 3 percent in 2000. More remarkable was the turnaround of the Russian economy at 8 percent, driven by a booming oil sector and the relative price advantage of a substantially devalued ruble in favor of domestic industry. While these economies put the symptoms of a recession behind them, fears arose in late 2000, in unrelated developments, about financial and currency turmoil in debt-ridden Argentina and Turkey. In Argentina, the peso's link to the strong dollar backed by a currency board type arrangement helped squeeze inflation and promote growth until 1998. Following the devaluation of the Brazilian real in January 1999, however, the link slowed export growth and set in motion a recession that affected tax revenue inflows resulting in persistent budget deficits. These escalating uncertainties raised foreign investor's fears about a debt default and a peso devaluation, both of which occurred in December 2001. The Turkish lira too came under pressure toward the end of 2000 as a result of endemic budget deficits and extreme inflation that remained at 60 percent in 2001. In 2002, Argentina's economic uncertainties, defying an early solution, threatened to spill into political chaos as well. Turkey's prospects for a steady, low inflation growth depended on its policy makers' ability to bring its budget deficits under control in the midst of contentious politics which worsened with the dissolution of the parliament in August 2002 and announcement of new elections. In Brazil, too, voters' preference in the public opinion polls in favor of a left-of-center presidential candidate in the October 2002 election raised fears of a reversal of pro-market reforms. The IMF sought to relieve the pressure on the real induced by capital flows with the announcement of a rescue package of $30 billion on August 7.
The performance and policy record of both groups of countries, in bouncing back from economic slowdown or recession following a boom (as in the U.S., Japan, and the East Asian "Crisis Five") or maintaining steady growth following quadruple-digit inflation (as in Russia, Brazil, and Argentina) or simply achieving stable growth with low inflation without having to overcome the consequences of an economic boom or extreme inflation (as in the eurozone and Turkey), had major differences.
The Differences: Center versus Periphery, and Endogenous versus Exogenous Disturbances
First, among the developed economies of the U.S., the eurozone, and Japan, the U.S. arrangements, despite recent corporate governance scandals, meet the demands of an open market economy. They are least handicapped by structural bottlenecks such as fragmented labor markets, an overly regulated corporate sector, or extravagant welfare benefits. They are endowed with a sophisticated network of financial institutions including commercial banks that are regulated by supervisory agencies. The rapid and extensive adoption of information technology has also kept the U.S. economy ahead in productivity performance. In practice and philosophy, it is relentlessly engaged in the process of Schumpeterian creative destruction, which is encouraged by the resilient responses of households and businesses to policy signals. Despite frequent differences on economic policy issues, the two-party system is committed to the advancement of the free enterprise system. Benefiting from the combined impact of these attributes, the U.S. is better equipped than the eurozone and Japan in overcoming economic fluctuations and maintaining inflation-free, stable growth. It can also readily function under the policy trinity of a floating dollar, free capital mobility, and pursuit of monetary easing or tightening by the independent Federal Reserve.
Second, from a historical perspective, the developed group as a whole (including other member countries of the Organisation for Economic Cooperation & Development) is more advanced than the developing group (and others in that category excluded from this book's focus) in institutional capabilities, appropriate policy formulation, cohesive political decision making, and technological and managerial adaptability. It also has the maneuverability to battle the competitive pressures of an open global economy. The developed group belongs to the center of the world economic system not only because it has a dominant share of global income but also because it is better equipped to prevent the less developed group in the periphery from enlarging its share of the pie. This uneven playing field raises the issue of the speed with which the peripheral group can adopt the institutions and economic practices of the developed center and integrate with it in order for both to profit from capital flows from the developed center to the developing periphery. Ready or not for such integration, the less developed economies, which have opened their borders to capital flows, are called emerging market economies, a label I adopt for my analysis.
Third, the center-periphery inequitable relationship was brought into sharp focus in the nineties as the fast-paced and premature opening up of several emerging market economies to the free flow of capital threw them into economic turmoil in 1997, beginning with the East Asian crisis. Emerging market policy makers with few exceptions (in China and India) operated in a highly pressured environment in favor of such flows pushed from the advocates, official and private, of the U.S.-led center. The resulting economic and political destabilization in these economies in the nineties was thus imposed from outside, whereas the economic problems and acute challenges in the U.S., the eurozone, and Japan were endogenous.
Fourth, the exogenous-endogenous difference also extended to the policy measures that the crisis-swept economies were inevitably driven to implement under IMF rescue, which they sought. By contrast, the success (in the U.S.), the paralysis (in Japan), and the slowness (in the eurozone) resulted from policies that were domestically formulated and implemented. The countries that sought IMF bailout (with the sole exception of Malaysia which instead imposed capital account controls to moderate capital outflows) did not "own" their programs. The IMF fiscal and monetary austerity measures aimed at restoring investor confidence and arresting currency declines were severe because the financial support was inadequate to fill the liquidity crunch that resulted from the sudden and massive outflows of speculative funds. The IMF was also ideologically opposed to the adoption of market-based capital account controls in crisis-swept economies that sought its support, although such measures could have reduced the necessary funding. Again, the IMF failed to initiate timely and comprehensive debt restructuring for highly indebted recipients, such as Argentina, without which its budget deficit targets became irrelevant and its monetary tightening recipe ceased to be credible. Occasionally the size, timing, and frequency of support were influenced by the non-economic considerations signaled by the U.S.-led center. Far from being an objective and adequate lender of the last resort for emerging markets in financial crisis, the IMF in effect operated as a G-7–led institution, aggressively extending a mandate of irreversible capital mobility in inadequately prepared and therefore financially vulnerable emerging markets.
(Continues...)
Excerpted from Financial Crisis, Contagion, and Containment by Padma Desai. Copyright © 2003 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
- Frontmatter, pg. i
- Contents, pg. vii
- Preface, pg. ix
- 1. Introduction, pg. 1
- 2. The U.S. Economy in Transition, pg. 13
- 3. The Euro: Teething Troubles and Faltering Responses, pg. 46
- 4. Japan: The Lost Decade of the Nineties amidst Policy Paralysis, pg. 70
- 5. The Asian Financial Crisis, pg. 86
- 6. The Asian Crisis Chronology, pg. 119
- 7. The Ruble Collapses in August 1998, pg. 136
- 8. Contagion from the Ruble to the Real, pg. 162
- 9. Beyond Bangkok: Crisis Erupts in Buenos Aires and in the Bosphorus, pg. 172
- 10. The Contagion, pg. 197
- 11. International Monetary Fund to the Rescue: How Did It Fare? Badly, pg. 212
- 12. Crisis Prevention and Containment: The Next Steps in Financial Reform, pg. 263
- References, pg. 285
- Index, pg. 293
What People are Saying About This
The best book yet about the financial crises that have swept the world in recent years. Desai offers a comprehensive, critical survey that will unsettle ideologues right and left. This book is essential reading for anyone interested in the global economy.
— Paul Krugman, Princeton University
Padma Desai's thorough and insightful analysis of the financial crises that have devastated many emerging market economies over the past several years is essential reading for anyone seeking to understand the downside of the global financial system. Her forceful policy recommendations deserve to be considered at the highest level.
Professor Padma Desai has long stood as a voice for caution, pragmatism, and common sense against those who would impose untested economic models on economies in transition. In this book, she turns her attention to the central asymmetry of the world financial system: rich countries retain the privilege of managing their economies, while poor countries, having liberalized their financial markets prematurely, remain hostage to volatile capital flows, and when the inevitable crisis strikes, have to succumb to ill-fitting arrangements designed for them by the International Monetary Fund. This is a book that should be read widely.
— Dani Rodrik, Harvard University
Padma Desai attacks head-on fundamental questions about the compatibility of small emerging country economies with inherently volatile global financial markets—questions that have too often been ignored or glossed over in the policy debate.
— Paul Volcker, Former Chairman of the Federal Reserve
"The best book yet about the financial crises that have swept the world in recent years. Desai offers a comprehensive, critical survey that will unsettle ideologues right and left. This book is essential reading for anyone interested in the global economy."—Paul Krugman, Princeton University"Padma Desai attacks head-on fundamental questions about the compatibility of small emerging country economies with inherently volatile global financial markets—questions that have too often been ignored or glossed over in the policy debate."—Paul Volcker, Former Chairman of the Federal Reserve"Padma Desai's thorough and insightful analysis of the financial crises that have devastated many emerging market economies over the past several years is essential reading for anyone seeking to understand the downside of the global financial system. Her forceful policy recommendations deserve to be considered at the highest level."—George Soros"Padma Desai's stimulating and path-breaking comparative analysis of the pace and sequencing of financial liberalization processes has profound implications for the planning of national policies and the structure of international financial cooperation. The book makes an outstanding contribution to our understanding of these complex issues, and to the designing of sensible proposals for rebuilding the international financial architecture."—Manmohan Singh, Former Finance Minister of India"Professor Padma Desai has long stood as a voice for caution, pragmatism, and common sense against those who would impose untested economic models on economies in transition. In this book, she turns her attention to the central asymmetry of the world financial system: rich countries retain the privilege of managing their economies, while poor countries, having liberalized their financial markets prematurely, remain hostage to volatile capital flows, and when the inevitable crisis strikes, have to succumb to ill-fitting arrangements designed for them by the International Monetary Fund. This is a book that should be read widely."—Dani Rodrik, Harvard University"This fascinating book presents an impressive epic on the financial crises that have afflicted a large portion of the world. While comparing alternative views for the remedy, it presents truly provocative criticisms on the IMF's former policy of trying to sustain free capital mobility for countries facing crisis. Based on the most informed knowledge of this subject but presented in a nontechnical form, with lucid descriptions of familiar crises, it will be appreciated by students and scholars as well as a broader intellectual audience."—Koichi Hamada, President, Economic and Social Research Institute, Cabinet Office of the Japanese Government
Padma Desai's stimulating and path-breaking comparative analysis of the pace and sequencing of financial liberalization processes has profound implications for the planning of national policies and the structure of international financial cooperation. The book makes an outstanding contribution to our understanding of these complex issues, and to the designing of sensible proposals for rebuilding the international financial architecture.
— Manmohan Singh, Former Finance Minister of India
This fascinating book presents an impressive epic on the financial crises that have afflicted a large portion of the world. While comparing alternative views for the remedy, it presents truly provocative criticisms on the IMF's former policy of trying to sustain free capital mobility for countries facing crisis. Based on the most informed knowledge of this subject but presented in a nontechnical form, with lucid descriptions of familiar crises, it will be appreciated by students and scholars as well as a broader intellectual audience.
— Koichi Hamada, President, Economic and Social Research Institute, Cabinet Office of the Japanese Government
Recipe
"The best book yet about the financial crises that have swept the world in recent years. Desai offers a comprehensive, critical survey that will unsettle ideologues right and left. This book is essential reading for anyone interested in the global economy."—Paul Krugman, Princeton University
"Padma Desai attacks head-on fundamental questions about the compatibility of small emerging country economies with inherently volatile global financial markets—questions that have too often been ignored or glossed over in the policy debate."—Paul Volcker, Former Chairman of the Federal Reserve
"Padma Desai's thorough and insightful analysis of the financial crises that have devastated many emerging market economies over the past several years is essential reading for anyone seeking to understand the downside of the global financial system. Her forceful policy recommendations deserve to be considered at the highest level."—George Soros
"Padma Desai's stimulating and path-breaking comparative analysis of the pace and sequencing of financial liberalization processes has profound implications for the planning of national policies and the structure of international financial cooperation. The book makes an outstanding contribution to our understanding of these complex issues, and to the designing of sensible proposals for rebuilding the international financial architecture."—Manmohan Singh, Former Finance Minister of India
"Professor Padma Desai has long stood as a voice for caution, pragmatism, and common sense against those who would impose untested economic models on economies in transition. In this book, she turns her attention to the centralasymmetry of the world financial system: rich countries retain the privilege of managing their economies, while poor countries, having liberalized their financial markets prematurely, remain hostage to volatile capital flows, and when the inevitable crisis strikes, have to succumb to ill-fitting arrangements designed for them by the International Monetary Fund. This is a book that should be read widely."—Dani Rodrik, Harvard University
"This fascinating book presents an impressive epic on the financial crises that have afflicted a large portion of the world. While comparing alternative views for the remedy, it presents truly provocative criticisms on the IMF's former policy of trying to sustain free capital mobility for countries facing crisis. Based on the most informed knowledge of this subject but presented in a nontechnical form, with lucid descriptions of familiar crises, it will be appreciated by students and scholars as well as a broader intellectual audience."—Koichi Hamada, President, Economic and Social Research Institute, Cabinet Office of the Japanese Government