Vorläufige Fassung / Preliminary version

The common-sense explanation of the East-Asian currency crisis runs as follows: A speculative bubble on stock and property markets in the Tiger states had finally burst. The bubble was a result of banks lending recklessly, largely because their liquidity was effectively guaranteed by the state. This gave them cheap access to funds that they lent out at high interest rates for speculative investment - a classic case of moral hazard: massive winnings beckoned if the speculations paid off; if not, the taxpayer would meet the loss.

But this plausible reconstruction of the crisis has one weakness: the claimed asset price bubbles never existed - at least, not on the stock markets. In fact, East Asian stocks had performed unusually badly. From 1993 to mid 1997 - just before the financial crisis - share prices fell by 68.7% in Thailand, 13.9% in South Korea, 18.1% in Singapore and 5.6% in Malaysia. In Indonesia and Hong Kong they rose by 23.2% and 27.8% respectively.

So rapid adoption of the 'speculative boom' theory must be partly explained in terms of perceived interests, as it places much of the blame for the debacle on profit-hungry banks, other speculators and their respective governments. Also, the common-sense theory belies much 'projection' to avoid 'cognitive dissonance', because the true share price bubbles arose in the industrialized nations themselves: from late 1993 to September 1997, share prices rose by 116.4% in the US, by 53.4% in the UK and by 84.2% in Germany, while real productive capital grew far more slowly in these countries than in the East.

Dollar Appreciation as the Origin of the Crisis

What, then, are the real reasons why such different countries as South Korea, Thailand and Indonesia became insolvent over a short period of months? Two developments are common to (almost) all the Tiger states: First, their current account deficits have worsened markedly since 1993/94 and, second, they have funded these deficits chiefly with dollar loans from Western banks, notably in Germany and Japan. The main cause of current account deficits in the East-Asian developing countries have been growth gaps between them, Europe and Japan: since the early 90s, sustained high interest rates, the collapse of stable exchange rates within the EMS, the ensuing monetary division of Europe, and concerted belt-tightening policies in the wake of Maastricht have slowed economic growth in Europe. Over the same period, real investment and production in East Asia continued their rapid expansion. As a result, East Asian demand for EU (and Japanese) imports grew far faster than the other way round. That is, demand from the Tiger states fueled export-driven growth and mitigated the 'home-made' crisis in the EU.

Faced with budgetary discipline, restrictive fiscal policy and a low propensity to borrow in industry, Western banks were only too pleased to lend surplus liquidity to banks and firms in the dynamic countries of East Asia. Considering the sustained, rapid economic growth in East Asia (which remained around 6% into 1997), the great majority of foreign loans may be assumed to have funded real investment projects rather than short-term stock market or property speculation.

What triggered the financial crisis was neither the level of foreign debt nor the rate of its growth, but the fact that it was valued in dollars and that from early 1995 onwards, the dollar began appreciating faster than it ever had since the early 80s. By mid 1997, the dollar exchange rate had risen from DM 1.40 to DM 1.80 and from ¥ 85 to ¥ 115 (i.e., by 30% and 35% respectively). This cut the dollar export revenues needed to service foreign debt: for example, a car exported to Germany and sold at DM 20,000 earned Hyundai about $14,400 in mid-1995. Two years later, this was down to around $11,100 - solely because the dollar had risen against the D-mark (in the short term at least, a country's ability to service dollar-denominated foreign debt depends not on the exchange rate between the dollar and its own currency, but on that between the dollar and other currencies in which it earns export revenues).

We can state the general rule as follows: If the dollar goes up, the dollar price of exports falls and the real interest rate on dollar-denominated debt rises. Here is another example: Assume that South Korea exports half to the USA and half to Germany, and the dollar and D-mark prices of exports in the two countries remain constant. If the dollar rises 30% against the D-mark, the total dollar value of South Korean exports (and revenue from them) falls and the real interest rate on dollar-denominated debt rises, in both cases by 15%.

As the dollar is the world currency and most international debt is denominated in it, the real cost (i.e., the real interest rate) of such debt can only be found by calculating nominal interest rates and price changes in dollars. A glance at the IMF World Economic Outlook shows that in dollar terms, the world economy has undergone deflation for the last two years. In 1995, world market prices for industrial goods were still rising, by 10.3% over the year. In 1996 they fell by 3.1% and in 1997 by 7.3% (the dollar was still falling in 1995; since then the world currency became rapidly dearer). Thus, at near-constant nominal interest (LIBOR) rates, real interest on international dollar-denominated debt rose by 17% between 1995 and 1997. This is the main cause of the debt crisis among the Tiger states.

Creditors see the process as follows: Assume that in mid 1995, a German bank granted South Korea a $1 billion (DM 1.4 billion) loan for which interest but no capital was payable in the ensuing period. By mid 1997 the amount owed to the German bank would be worth DM 1.8 billion: the creditor had made an extra profit, the debtor an extra loss (of DM 400 million each). Were the debtor unable (or unwilling) to pay for this appreciation of the debt, the bank would have to make suitable provision and, eventually, write it off. On the bottom line, everyone loses out, the hardest hit being industrial firms and their employees.

In other words, in an economic system where the exchange rate of the world currency fluctuates (particularly) strongly, international lending and borrowing is speculative in character (unless loans are fully hedged).

The debt crisis in Latin America developed by the same logic as the current crisis in East Asia. From 1980 to 1982, the recession in the industrialized countries had been softened by dynamic import demand from the Tiger states of the time, such as Argentina and Brazil, whose current account deficits grew rapidly. At the same time, a high interest rate policy pursued by the USA triggered a dramatic appreciation of the dollar and a consequent deflation in world trade: from 1980 to 1982, the real interest rate for Latin American dollar-denominated debt rose by 30% (from 10% to 20%). In 1982, the debt crisis broke.

But Latin America had far more foreign debt in the early 80s than East Asian developing countries have now, so the effects of the current debt crisis will be correspondingly less severe than the last one. Whereas the Tiger states' current account deficits and hence their foreign debt increased markedly but in the last few years, the developing countries of Latin America had maintained high current account deficits from the early 70s onwards. The differing lengths of the debt accumulation periods are reflected in the amount of foreign debt and the funds needed to service it. In 1983, Latin America's foreign debt reached 290.7% and its debt service ratio 43.2% of total exports. In 1997, the foreign debt of the Asian developing nations was 107.3% and their debt service ratio 15.7% of total exports.

The Dual Role of the Dollar

All events that have shaped the world economy since 1945 have been directly linked to the dollar's dual role as the US national currency and as standard tender for all raw materials (flows) and most international debts and financial assets (stocks): the 'dollar shortage' in the immediate postwar period and its relief through dollar loans (under the Marshall Plan); US exploitation of its world banker status during the Vietnam War (dollar exports); the resultant loss in credibility of the dollar´s gold parity and hence of the fixed exchange rate system; this system's collapse in 1971, the ensuing dollar devaluations, the oil price shocks and the recessions they triggered; the 1980/81 US monetary policy of high interest rates and the 1982 dollar appreciation and debt crisis; dollar interest rate cuts beginning in the mid-80s and the dollar devaluation till 1995, the growth of US export´s world market share by one third since 1985 and the corresponding loss by European hard-currency countries and Japan; the dollar's recent appreciation since 1995, and finally the 1997 debt crisis in the Tiger states.

The wild swings of exchange rates - and particularly dollar rates - between overvaluation and undervaluation result from the prevalence of short-term speculation based on chart techniques. If a price rises past a set limit, these computer models generate 'buy' signals that, once heeded, drive the price up yet further, causing other models with a longer 'fuse' to generate buying orders in turn, and so on. This produces upward or downward bubbles systematically. With the expansion of derivatives markets, these 'games' are increasingly destabilizing not only exchange rates, but also interest rates, raw material prices (particularly oil) and share prices. At the same time, market prices are increasingly deviating from their fundamental equilibria: according to the Federal Reserve Bank, the nominal value of real capital has risen by 130% since 1980, while its market value, expressed in share prices, has increased by about 700%.

Effects of the Financial Crisis

The growth-slowing effects of the current financial crisis on the affected region and the world economy as a whole will be less severe than the one of the 1980s debt crisis, not only because the foreign debt of the countries concerned is far lower than in 1982/83, but for three additional reasons:

- The economies of the industrialized nations are far healthier than they were in 1982/83 (though we cannot expect a single country or group of countries to switch to expansionary fiscal policy to the same extent as the USA did in 1983).

- If at all, the dollar exchange rate will probably not continue to rise as strongly as between 1982 and 1985.

- Not least in consideration of the 80s debt crisis, the currently negligible rate of inflation and the attendant danger of 'toppling' into a (slight) deflation, the US appears willing to cut dollar interest rates should the crisis worsen appreciably.

While such a slackening of the monetary policy reins by the reserve currency nation may somewhat relieve the effects of the crisis on the world economy, it may also slow economic growth in the EU if the ECB is unwilling to deliver a matching cut in euro interest rates and the euro consequently appreciates against the dollar.

This eventuality points to a trilemma: First, as the US national currency, the dollar has been heavily undervalued relative to the ecu and the yen since the mid-80s - the main reason for the continuous growth in US market share. Second, as a world currency, it has already appreciated too far since 1995 because, as we have seen, a rising dollar inflates dollar-denominated debt. Third, the dollar's dual role enables the US to take out unlimited foreign debt. It has exploited this ability to an exorbitant degree for the last 15 years: US foreign debt has almost reached $1,500 billion, and is growing by some $150 billion a year (about the same amount as the US current account deficit). Thus, the world's richest economy is simultaneously its biggest debtor and the greatest net consumer of goods and services from the rest of the world. As the annual uptake of new foreign debt by the US far exceeds its interest payments on existing debt, the creditor countries (primarily the EU and Japan) are effectively paying the interest themselves. In return for this and the real transfer of resources, they merely receive credit notes from the USA in ever-increasing value.

The main reason why the US balance of payments remains in deficit despite the undervalued dollar is not just that the reserve currency country (and only this country) can borrow entirely in a single currency, but that many US imports (particularly those from Europe) are luxury goods, from Porsches to noble French wines: demand for such goods mostly stems from the best-placed US households and so is barely sensitive to price and exchange rates.

For these reasons, the dollar would have to be undervalued even more if the amounts owed to creditors, especially the EU and Japan, are ever to be at least partly repaid in US-made goods (this presupposes a US current account surplus). Note, though, that this would drive European unemployment even higher.

Towards a Systemic Therapy

The main systemic reason for international financial crises, and also of 'excessive' US indebtedness, is that a global economy needs a true world currency. Failing this, the dollar plays a dual role: as the US national currency and as (substitute) tender for all raw materials and most international debt. The dollar exchange rate fluctuates the most (as luck would have it), not only because of the conflict between US national interests and the global need for a stable world currency, but also because the dollar serves as a standard 'token' on currency markets, all transactions being done vis à vis the dollar. It is everyday speculation on these markets that accumulates to the bubble-like upward and downward sprints by the world currency, redistributing income and purchasing power on a global scale - between raw materials and industrial goods, and between creditor and debtor countries.

Because of this, the coming of the euro should also be taken as an opportunity to stabilize exchange rates between the three main currencies - the dollar, the euro and the yen - analogously to EMU's forerunner, the EMS. This would be a first step towards a new world monetary system under which, instead of the national currency of one industrialized nation - the leading one at that - serving simultaneously as the world currency, the numeraire for stocks and flows in the global economy would be a basket of the main national currencies (like the ecu in the EMS).

The coming of the euro would make exchange rates much easier to stabilize in the transitional period, because there would only be two exchange rates left to fix - between the dollar, the euro and the yen. Standard commodities such as raw materials, and also international financial stocks, should also be denominated not in dollars, but in a basket of the three main currencies. This would greatly reduce the incentive to realign exchange rates, and if it did come to a realignment, at least its price and redistribution effects on the global economy would be mitigated.

The provision of low-interest funds, to be repaid only slowly, to improve infrastructure and environmental conditions in developing and transition countries would speed their development and, via imports, also stimulate production and employment growth in the industrialized world (the historical precedent for such a global cooperative strategy being the Marshall Plan).

A systemic therapy of this kind may appear utopian today, but financial crises like that in East Asia together with their consequences will make it increasingly clear that the global economic framework needs radical restructuring. After all, we came very close to creating a stable world monetary system once before: In negotiations on the new world monetary order, Keynes proposed the following in 1943/44 based on the experiences of the Great Depression:

- No national currency serves as a world currency any more. Instead, a genuine world currency is created as a basket of the main national currencies (he called the basket currency 'Bancor').

- International settlements are handled at fixed exchange rates by a 'Clearing Union'.

- Temporary disequilibria in the global economic goods and financing cycle are corrected by expansionary policies in the surplus country and not by belt-tightening measures in the deficit country, so that equilibrium is restored at a higher rather than a lower level of activity (the IMF still fails to grasp this logic today).

Keynes was unable to push through these proposals at Bretton Woods in 1944. The new world power, the US, wanted its own currency to take on the role of the world currency (as sterling had before). In view of the experience of the dollar standard and urged on by further financial crises, we may yet succeed, at a second attempt, in creating a world monetary system that complements the globalization of markets with a globalization of (economic) policy. In this respect, we need not less globalization, but more.