The 1997-98 Financial Crisis: Why in Asia? Why Not in Latin America?

Why there and not here?

The Asian crisis continues to confound experts: a region whose countries had long been considered paragons of successful economic development is mired in financial collapse and a deep recession. By contrast, the crisis has largely passed by Latin America, in spite of that region's checkered financial past It is tempting to blame the severity of the Asian crisis on the idiosyncrasies of the situation there. Recently there has been no shortage of attempts to identify an unprecedented syndrome and develop a new theory to go with it. Authoritarian politics, cronyism and corruption, government guarantees to banks and moral hazard, overinvestment and inefficiency, inflated asset prices, and a number of other factors have been variously singled out as peculiar causes of Asian economic distress. However, many these factors were also present in other countries that did not erupt into crisis recently. The new theories also fail to explain why such factors were not been identified as essential in the genesis of previous crises. Of course, one may try to argue that policies were crazier and governments more corrupt in Asian countries than everywhere else, and that analyses of previous crises in fact missed the role of such factors. But this reaction would be misguided. The recent Asian crash is not an unprecedented event. Instead, it can and should be understood as a conventional financial crisis made possible by the illiquidity of the financial sector, the likes of which we have seen before in so-called emerging markets. Chile in 1982 and Mexico in 1994 provide the clearest, but by no means the only, precedents. These crises have five distinguishing elements:1. International illiquidity , which sometimes results in outright collapse of the financial system (often but not always the commercial banks), is at the center of the problem. The key issue is a mismatch of assets and liabilitites: a country's financial system is internationally illiquid if its potential short term obligations in foreign currency exceed the amount of foreign currency it can have access to on short notice. As we shall discuss later (and we have argued at length in Chang and Velasco 1998a,b), the concept of international illiquidity is crucial for it involves a fragile situation: it is a key condition for financial crashes and/or balance of payments crises. 2. The illiquidity of the financial system is almost always rooted in a previous bout of financial liberalization , which accentuates the maturity mismatch between international assets and liabilities. In addition, capital flows from abroad , caused by an opening of the capital account and/or falls in world interest rates, magnify the problem by making available huge amounts of resources that can be intermediated by domestic banks. If short in maturity, as they were in the latter stages of the Mexican 1994 and Asian episodes, additional foreign loans can sharply increase the vulnerability of domestic banks: a creditors' panic, that is, a creditors' refusal to roll over these short term loans, may render a self-fulfilling bank run possible.download