“A financial crisis is “a situation where the supply of money is outpaced for the demand of money” (buisnessdictionary.com). It is necessary to first distinguish the three principal types of crisis which can be experienced individually or as a result of each other. The first type of crisis could be a banking crisis wherein people lose confidence in their banking system and systematically withdraw all of their savings. The second is an exchange rate crisis where inhabitants become worried about the strength of their currency and exchange it – in the context of this essay, into dollars. Thirdly is an external debt crisis which commences from an increase in foreign debt and no more loans are provided to a country as there is some perceived doubt that they will not be able to guarantee investment.
The East Asian crisis is particularly astounding as it attacked some of the fastest growing economies. After such rapid growth in capital often described as the “Asian Miracle” how did a crisis in East Asia occur when the region had so much promise? The miracle that had occurred created a region rife with over investment and the success of the economies was taken for granted. Primarily, signs of the crisis started to emerge in Thailand with the collapse of their currency – the “baht” and it then became pegged to the US dollar. The crisis is now at an end but mainly due to the errors of the International Monetary Fund (IMF), it could take years for these countries to get back to their previous economic conditions. “… IMF policies not only exacerbated the downturn but were partially responsible for the onset…” (Stiglitz 2002, pp 89) East Asia didn’t actually need any additional capital that they were pressured into receiving. South Korea for example was a region that had experienced admirable growth but realised the necessity for some deregulation or liberalisation. The US treasury believed the system of liberalisation implemented by South Korea was too slow and the treasury made the decision to speed up liberalisation for maximum profit making opportunities.
The main cause of this crisis was extreme capital market and financial liberalisation pushed on East Asian regions by the IMF. South East Asian countries did not fully comprehend the policies in place so this also had a role in worsening the crisis. The IMF made the serious mistake of not researching the countries in which they were trying to help so policies implemented were generic and not specific. Eventually however, the World Bank was persuaded to do some research on the region of East Asia which was named “The East Asian Miracle” wherein East Asia saved and invested wisely and did not follow any advice of the Washington Consensus. “However, the IMFand Treasury made their most profound mistakes in their initial response to the crisis” (Stiglitz, 2002, pp 104). The IMF badly diagnosed the problems in East Asia and understood the issues as being far more severe than they actually were.
It can be debated that a further root of the East Asian Crisis was a weakness in the financial system and irresponsible lending. This risky lending is also known as “moral hazard” meaning loans were provided by banks knowing that little of their own money was being put at risk. Therefore, financial institutions had no incentive to reduce this risky lending as they did not have to face the consequences.
The value of the floating currency fell and was no longer pegged to the US dollar. To a large extent, financial institutions became weak through foreign exchange risks. Economies such as Korea started to reluctantly permit their companies to borrow money from abroad. Suddenly these institutions that had been so willing to lend money originally were demanding repayment but unfortunately these developing countries did not have the reserves available to pay such liabilities. Speculative...