Financial crisis in East Asia: bank runs, asset bubbles and antidotes

The Review is pleased to give hospitality to CLARE Group articles, but is not necessarily in agreement with the views ex pressed ; responsibility for these rests with the authors. Members of the CLARE Group are M.J. Artis, T. Besley, A.J.C. Britton, W.A. Brown, W.J. Carlin, J.S. Flemming, C.A.E. Goodhart, J.A. Kay, R.C.O. Matthews, D.K. Miles, M.H. Miller, P.M. Oppenheimer, M.V. Posner, W.B. Reddaway, J.R. Sargent, M.Fg. Scott, Z.A. Silberston, S. Wadwhani and M. Weale. No one can deny the outstanding success of the East Asian economies in the last two decades of rapid economic growth backed by surging capital inflows. Key questions posed by the current crisis are: what went wrong, and why? how to fix it? and, how to prevent a recurrence? To answer them, the article begins with a brief overview of recent developments in the miracle economies of East Asia, focusing mainly on Korea, Indonesia and Thailand. We focus too on some of the shadows that came to darken the glittering success story-on declining competitiveness and growing financial vulnerability; and on regulatory failures in banking. Then we take a leaf from Charles Kindleberger's book (1996) on Panics, Manias and Crashes and dis cuss-with historical precedents-various types of financial crisis: speculative attacks on pegged exchange rates, asset bubbles, stock market crashes and bank runs. Based on the distinction between illiquidity, due to a shortage of cash, and insolvency arising from a failure of economic prospects, we go on to outline three main views of the current crisis. First that it was simply due to reversal of capital flows, to a failure of collective action on the part of creditors which could and should have been solved by supplying extra liquidity-or by forcing creditors to roll over their loans. Second the view that the miracle had grown into a bubble that had finally had to burst: so the problem was essentially one of insolvency. Finally the view that we prefer, that the panic was not wholly groundless (and rescue efforts were bound to be difficult) mainly because weak regulation combined with implicit deposit guarantees had left local bankers free to gamble with the money that global capital markets had poured into their parlours. Panic set in when foreign depositors realised that there were not enough dollar reserves left for the guarantee to be credible. This account (championed most notably by Paul Krugman of MIT) involves both illiquidity and insolvency and helps to explain why the IMF was unwilling simply to throw money at the problem. Why did the crisis spread like wildfire around the region? Was it because a bank run due to shaky fundamentals in one country was imitated elsewhere, as investors joined the herd heading for the exit? This and other accounts of contagion are discussed before turning to ideas for crisis prevention and management, and a brief account of future prospects for the region. The article concludes by outlining immediate steps to resolve the current financial crisis and by proposing international mon etary reforms to prevent a recurrence.