The New York Times

April 30, 2010
I.H.T. Op-Ed Contributor

The Asian Financial Crisis Goes West


HONG KONG — The Greek-led debt crisis in Europe is looking ominously similar to the East Asian crisis of 1997-1998, but the comparison also points to how it may eventually be resolved.

Sure, there are differences: The European crisis concerns developed countries while the Asian one devastated nations at varying levels of development — Thailand, South Korea and Indonesia in particular. In the Asian case, the debts were largely in the private sector. In Europe, public debts are the focus.

But key similarities remain. First, afflicted Asian countries were borrowing in foreign currency. Europeans argue that their case is different because most of the debt is in their own currency, the euro. But in practice, the euro is the currency of the rich, northern core of Europe led by Germany. Countries on the periphery joined for prestige and the benefits of low interest rates. Similarly in Asia, countries effectively pegged their currencies to the dollar, with the result that foreign banks came to see little risk in lending dollars to finance local assets.

The second similarity follows from the first. In Asia, so long as it was easy to borrow, no one bothered about whether the exchange rate was appropriate. Many Asian countries’ external deficits ballooned and local inflation rose, but countries like Japan, with surplus savings, kept lending.

In Europe, the influx of capital into fringe countries following the adoption of the euro raised growth rates, but also pushed up wages faster than productivity. These countries thus now find themselves in a crisis that, as in Asia, has two parts: debt and inappropriate exchange rates.

In Asia, exchange rates collapsed under the pressure of the market. That may not happen in Europe — but only if the core countries pay the price.

That price is rising because of the third similarity: contagion. The Asian collapses did not happen simultaneously. Six months separated the first — Thailand — from the Korean and Indonesian crises. Following Greece, conditions have tightened sharply for Portugal; Ireland’s austerity efforts may prove insufficient; and question marks are hovering over Spain.

In Asia, debts were mostly short-term bank loans, so the crisis hit fast. In Europe, the central issue is the rollover of medium-term bonds. so there is more time to address the problem — but also more time for the disease to spread.

When the Asian crisis was eventually resolved, foreign banks had to absorb huge losses. That was relatively easy for Asia because the debts were mostly owed by bankrupt private-sector companies. Europe has a bigger problem because the debt is mostly public.

But debt write-offs will eventually be part of the solution, given that the politics in democratic Europe make it unlikely that austerity can be sustained for long. The Asian crisis induced radical political change that Europe will avoid.

Then the issue will become whether debt reduction is achieved by a moratorium on the debt, or by afflicted countries leaving the euro. In the Asian case, devaluation, produced deep but short recession. Currencies stabilized at lower levels and restored competitiveness, enabling them to run trade surpluses.

Europe’s problems are bigger. The write-offs that Japanese and Western banks had to make on their Asian loans did not imperil them; European banks are still convalescing from the global financial crisis and are in a poor position to write off more billions. Europe’s trade is mostly with itself, while Asia’s was with a wider world, so export-led recovery will be more difficult.

Nonetheless, Europe and the I.M.F. would do well to remember from the Asian crisis that years of fundamental imbalances cannot be massaged out of existence. Knots must be cut.