East Asian Crisis

East Asian financial crisis are an evidence of fact that economies are prone to fianacial pressures in spite of a stable sustainable growth rate. The East Asian economic crisis is the most important economic event in the region of the past few decades. That much is agreed. Beyond this, there is yet no unanimity about its root causes nor about the solutions. The differences of views are being debated in academic and policy circles and reflected in the media. One thing though is certain: the earlier optimistic expectation that it would last only some months has proved wrong. Instead the financial crisis has been transformed into a full-blown recession or depression.

Moreover the threat of depreciation has spread from a few countries to many in the region, and is spreading to other areas such as Russia, South Africa, and possibly Eastern Europe and South America.

The objective f this term paper is to analyze the

* factors behind the east asian crisis

* Background

* Finacial liberalization

* Policy implication.

Back ground of Crisis.

The great debate on causes is whether the blame should be allocated to domestic policies and practices or to the intrinsic and volatile nature of the global financial system.

In the first phase of the crisis, as it spread from Thailand to Malaysia, Indonesia, the Philippines, then to South Korea, the international establishment (represented by the IMF) and the G7 countries placed the blame squarely on domestic ills in the East Asian countries.

They cited the ill judgment of the banks and financial institutions, the over-speculation in real estate and the share market, the collusion between governments and businesses, the bad policy of having fixed exchange rates (to the dollar) and the rather high current account deficits.

They studiously avoided blaming the financial markets, or currency speculation, and the behavior of huge institutional investors.

Although the cited weaknesses certainly existed, the view that these in themselves caused the crisis was difficult to sustain. For it implied that the "economic fundamentals" in East Asia were fatally flawed, yet only a few months or even weeks before the crisis erupted, the countries had been praised as models of sound fundamentals to be followed by others. And in 1993 the World Bank had coined the term the East Asian Miracle to describe the now vilified economies.

In an attempt to blame the crisis solely on the affected countries, intellectual "flip-flops" were made. Features that had been toasted as strengths were overnight concerted into evils. For example, the countries had been praised (indeed, over-praised) for having strong linkages between the public and private sectors. Today, that is totally condemned as the fatal flaw of crony capitalism. As an alternative to mainly blaming the countries, there rapidly developed another view of how the crisis emerged and spread. This view put the blame on the developments of the global financial system, with the combination of the following features:

* Financial deregulation and liberalisation across the world (as the legal basis);

* The increasing interconnection of markets and speed of transactions through computer technology (as the technological basis); and

* The development of large institutional financial players (such as the speculative hedge funds, the investment banks, and the huge mutual and pension funds).

This combination has led to the rapid shifting of large blocks of short-term capital flowing across borders in search of quick and high returns, to the tune of US$2 trillion a day.

Only one to two percent is accounted for by foreign exchange transactions relating to trade and foreign direct investment. The remainder is for speculation or short-term investments that can move very quickly when the speculators' or investors' perceptions change.

When a developing country carries out financial liberalisation before its institutions or knowledge base is prepared to deal with the consequences, the it opens itself to the possibility of tremendous shocks and instability associated with inflows and outflows of funds.

What happened in East Asia is not peculiar, but has already happened to many Latin American countries in the 1980s, to Mexico in 1994, to Sweden and Norway in the early 1990s. They faced sudden currency depreciations due to speculative attacks or large outflows of funds.

A total of US$184 billion entered developing Asian countries as net private capital flows is 1994-96, according to the Bank of International Settlements. In 1996, US$94 billion entered and in the first half of 1997 $70 billion poured in.

But with the onset of the crisis, the inflow suddenly shifted into reverse gear: $102 billion went out in the second half of 1997.

The massive outflow has continued since.

These figures help to show: (i) how huge the flows (in and out) can be; (ii) how volatile and sudden the shifts can be, when inflow turns to outflow; (iii) how the huge capital flows can be subjected to the tremendous effect of "herd instinct," in which a market opinion or operational leader starts to pull out, and triggers or catalyses a panic withdrawal by large institutional investors and players.

In the case of East Asia, although there were grounds to believe that some of the currencies were over-valued, there was an over- reaction of the market, and consequently an "over-shooting" downwards