Financial Crisis in East Asia: Bank Runs, Asset Bubbles and Antidotes

Was the East Asian crisis just a creditor panic with a mad scramble for liquidity that brought the banking system to its knees and the region's much-vaunted 'economic miracle' to a standstill? Or was the miracle indeed flawed by fundamental problems in asset prices and resource allocation? After a summary of the facts and an outline of various types of financial crisis, we conclude that the truth involves both factors, interacting in a vicious downward spiral. There certainly was panic among the creditors but it was triggered by genuine problems of overinvestment and overvaluation in emerging East Asian economies. Before turning to outline various approaches of crisis prevention and management and a brief account of the future prospects, we discuss how contagion can occur in environments where investors are poorly informed and each looks to the others for guidance. The paper ends with immediate steps that might help resolve the current crises; and with proposed reforms to the international monetary system to prevent a recurrence.

Non-Technical Summary: 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 paper 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 discuss - 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.download