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J. Bradford DeLong
Professor of Economics
January 12, 1998
approx 1060 words
What is East Asia's economic future? We can see ahead, albeit only dimly, for the next few years. In 1996 international investors poured perhaps $100 billion into East Asia. East Asian economies were the darlings of the world capital market: it seemed as if everyone who wanted to lay claim to any financial sophistication was diversifying into these fast-growing economies. In 1998 we will be lucky if the balance of capital flows is zero: if money flowing into East Asia from the world economy's industrial core matches money flowing out of it.
This sudden shift--a shift impelled much more by the trend-chasing and herding instincts of Wall Streeters who talk to each other too much than by any change in the fundamentals of East Asian economic development-- means that $100 billion a year that had financed investment in East Asia will no longer be there. That $100 billion had financed the employment of 20 million people working in investment industries, who dug sewer lines, built roads, erected buildings, and installed machines as both domestic and foreign investors bet that there was lots of money to be made in East Asia's industrial revolution. Now that $100 billion a year is gone. And with it the jobs of those 20 million people will go too. They will have to find new jobs. As their jobs vanish, while they search for new jobs, and even after they find new jobs they will be very annoyed: we will see just how stable and "harmonious" East Asian political systems truly are.
But Wall Street's sudden shift and panic has even more important consequences than the forthcoming economic migration of 20 million East Asian workers out of investment industries. In order to pay for the investments they had undertaken, international investors traded dollars for local currencies: baht, ringgit, rupiah, pesos, and won. This gave importers in East Asia $100 billion a year more to spend on imports than their economies earned in exports.
This $100 billion a year has also disappeared, leaving demand for dollars by East Asians to finance imports some $100 billion a year higher than the supply of dollars to them earned from exports. Whenever demand is greater than supply prices rise: a rise in the price of dollars is a fall in the value of other currencies, which have fallen--are falling--will fall until the supply and the demand for foreign exchange are brought back into balance.
In the long run (by, say, the year 2000, we hope) the fall in the value of East Asian currencies will bring the supply of and demand for foreign exchange back into balance. Falling exchange rates make East Asian goods more attractive to European and American purchasers, and so exports rise. Falling exchange rates make American and European goods expensive, and so East Asian imports fall.
In the short run, however, falling exchange rates do not directly bring the supply and demand for foreign exchange into balance. A falling exchange rate means (i) that foreigners buy more East Asian goods, yes, but also (ii) that they pay fewer dollars for each good they buy. In the short run of the next year or two the two effects will roughly balance: Europeans and Americans will not have had enough time to change their spending patterns to make (i) outweigh (ii). Falling exchange rates do, however, bankrupt firms and financial institutions with home-currency assets and dollar liabilities. And as these firms and institutions go bankrupt and their workers lose their jobs, demand for imports falls. In the short run of a year or two falling exchange rates will bring demand and supply of foreign exchange back into balance by creating an East Asian depression.
Can't governments stop exchange rates from falling? Yes--East Asian governments could stop their exchange rates from falling by raising interest rates to and perhaps beyond sky-high levels. But high interest rates make it unprofitable to invest or build, and so cause an East Asian depression as well. In the short run of the nexst year or two East Asian governments are damned if they let exchange rates fall, and damned if they try to keep exchange rates higher by raising interest rates. In the long run letting exchange rates fall promises relief as exports expand, while keeping exchange rates high by raising interest rates promises only depression without end.
So can anything be done? Yes--and the IMF is now doing it by lending to East Asia. Lending dollars to East Asian countries now will keep their exchange rates from falling as far and their interest rates from rising as high as if the countries were left on their own. With less of a decline in exchange rates, fewer firms and financial institutions with dollar liabilities will go bankrupt. With less of a rise in interest rates, fewer investment and construction projects will be cancelled. The East Asian depression will be smaller than it would be otherwise.
And in two years, if East Asian countries control domestic inflation, avoid exploding budget deficits, allow exchange rates to fall, and help workers move from investment to export industries, their economies will have substantial export surpluses, the crisis will be long past, and they will be able to repay the IMF so that it will have the resources to try to cushion the damage from the next international financial crisis.
There will be future financial crises, and so the IMF's first priority is to make sure that the countries it lends to pay it back, and in order to do that they must have export surpluses in a couple of years. The IMF's survival as an institution to help handle future financial crises depends on its getting its money back. Thus the policies that the IMF requires in return for its assistance are different from the policies that would minimize East Asia's depression because the IMF is fearing the consequences for future financial crises should it not survive as an institution.
It would probably be a better world if the IMF did not believe that its survival as an institution was at risk every time it intervened in a major financial crisis, and if the IMF could adjust policies to minimize the depressons that follow financial crises. We should work to build such an IMF. But given the IMF that we have--one that is supposed to make loans, not grants, and that is supposed to make, not lose money in its interventions--it would be a shame if we let our politicians destroy its ability to do the good it can do by demanding that it accomplish missions outside its powers.
J. Bradford DeLong is Professor of Economics at the University of California at Berkeley, a Research Associate of the National Bureau of Economic Research, and Co-Editor of the Journal of Economic Perspectives. From 1993 to 1995 he served the Clinton Administration's Treasury Department as Deputy Assistant Secretary for Economic Policy. He is the author of, among other things, "The Case for Mexico's Rescue" (Foreign Affairs, 1996) and The Marshall Plan: History's Most Successful Structural Adjustment Programme (1993).
Professor of Economics J. Bradford
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