Creditor Panic, Asset Bubbles and Sharks: Three Views of the Asian Crisis

How are we to understand the East Asian crisis? There are two popular explanations: first that it was just like a nineteenth century British bank panic, calling for prompt action by a 'lender of last resort', namely the IMF; second that it was much worse —nothing less than the bursting of a modern-day South Sea Bubble. Jeffrey Sachs of Harvard University is closely associated with the first view. He stresses the liquidity crisis facing the emerging East Asian economies as foreign short-term credit was withdrawn in panic. Such 'coordination failure' on the part of creditors can be handled by injecting liquidity, as Walter Bagehot pointed out in the nineteenth century — or by forcing creditors to roll over their loans. If the panic is triggered by flawed fundamentals, then structural change —not just liquidity — is needed. What if global capital markets, lured by tales of miraculous growth and official money-back guarantees, poured money into a spectacular but unsustainable East Asian bubble? When such a bubble ends — as in Japan in 1989-90 — financial institutions face more than a liquidity problem: they are bankrupt. This account, championed by Michael Dooley and Paul Krugman, helps to explain why the IMF was unwilling to throw money at the problem. Where do the sharks come in? Are they merely figments of Malaysian premier Mahatir's imagination? Or are there strategic short-term investors, with guarantees on their loans, who can place side bets on a coming crisis —and then pull their money out to see if their predictions come true? Such fears were effectively dismissed in the IMF report on hedge funds released in early 1998. But the subsequent waves of speculative attack on the Hong Kong dollar give credence to the view that big players could be taking an active role in triggering crises for economies with sound fundamentals.These three views are discussed in the paper —along with possible policy responses.