Why we failed to read the signs of frailty and warn of East Asia's crisis
ON consequences that could have been foreseen
Tuesday 13 January 1998
I find this unforgivable. Once it was clear there was a problem everyone leapt in. The credit rating agencies downgraded the debt to near-junk status, which is a fat lot of use since, by then, the debt was yielding junk returns. The investment banks warned their clients that they should expect more turbulence after those self-same clients had lost half their money. The official world you would expect to be useless, for officials are too frightened for their careers to be prepared to give what are inevitably disagreeable warnings. Local financial institutions, particular local banks, I would expect to be pretty cowed and bullied, so it is unrealistic to expect warnings to come from that quarter. But the foreign financial community ought to have seen something coming and it did not.
The only previous shock that came in such a completely unexpected manner was the first oil crisis in 1973/4. Though the Shell scenario planners had noted that a sharp rise in prices was possible they did not expect a quadrupling; nor did the Treasury VSOP committee (vast surpluses of oil producers) also formed a few months earlier to consider the financial consequences of an oil price rise.
By contrast, the third world bank lending crisis of the early 1980s might have come as a surprise to the lending banks but banking crisis always come as surprises to the banks; quite a lot of other financial organisations were profoundly concerned by the growth of very low spread loans to Latin America.
So why was this one such a shock? The answer I think comes in three parts.
First, there is a structural weakness in the sources of information. Not many people follow the economies of East Asia, aside from Japan, and most of those that do work for financial institutions whose job it is to persuade investors to put their money there. The result was, at best, a lack of independence in the analysis and, at worst, actual corruption in that analysts were leant upon by their bosses to see the sector through rose-tinted spectacles.
Second, because the underlying economic performance of the region has been so strong, and in many cases for very good reasons, there was an assumption that even if some things went wrong, the general growth of the region would ensure that mistakes could be overcome. The fact that some of the big investment projects in the region were clearly overblown (Malaysia building the tallest building in the world should have been a good "sell" signal) did not seem to matter because with 7 per cent growth the losses on a few bad investments would be more than offset by the profits of the good ones.
Third, there is a certain, shall we say, "tough-minded" attitude in the financial community towards little matters like democracy, free speech, social costs and political rights. Some people even argued that the region's success was the result of its focus on economic progress rather than political freedom, as though the two were incompatible. People with money to invest, rather like authoritarian regimes and the region, provided plenty of examples. The fact that authoritarian regimes are better at covering things up and therefore are ultimately more fragile than democratic ones was quietly ignored.
Was it, then, really possible to foresee the crisis? I think I can demonstrate that it should have been. Have a look at the graphs. On the right you see Thai car sales - an interesting little picture dug out by the economists at Tokai Bank here in London. As you can see they fell off a cliff during 1997. But if you look closely you can spot that the fall started at the beginning of the year and was well in evidence by March. The currency and interest rates showed no real movement until well into the summer, though that spike in interest rates in the spring should have been a warning. Ideally the expert analysts should have been looking at bank indebtedness and saying three years ago that there was a problem; but simply by looking at one indicator of consumer confidence anyone ought to have been able to spot that something was up. Three years' notice would have been wonderful but even three months would have been helpful, for it would have given more time for a rescue to be put together.
Having fun kicking the experts is a good sport but there are some really disturbing conclusions. Forget about the actual problems of East Asia, for they are at least now in the open and the collateral damage to the rest of the world economy has been limited. There have even been some benefits in the decline in pressure on commodity markets, especially oil. Focus instead on the weakness of our early warning mechanism.
Question one: Are there structural weaknesses in the quality of information about other economic matters? For example is there the same conspiracy of silence about the level of US equities or the possibility of a collapse of EMU? There is a bit of talk about both, though I am astounded at the way in which the dangers of EMU are not fully acknowledged on the Continent. Other people could doubtless name their favourite "no talk zones" - dangers which are not properly discussed because to do so would be bad for business.
Question two: To what extent are values elsewhere dependent on a good general economic performance? For example, to what extent do public finances in the G7 countries allow for the next recession? The D-word, deflation, has moved into common currency, but the R-word, recession, is still hardly mentioned.
Question three: Are financial markets, in their self-confident view that their ideology is now the global standard, giving sufficient weight to the costs of establishing the market system in places with little experience of running it? If we were too tough-minded about the lack of democracy in East Asia, are we being too tough-minded about the costs of applying the market throughout Europe and North America?
I'm not really worried about East Asia. There will be a difficult three years and growth will resume. I'm more worried that we won't learn the lessons of the East Asian crisis: that we need honest, independent-minded people looking at every aspect of the world economy and being prepared to speak their mind without getting sacked when what they have to say does not fit the overly rosy house-view.
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