::: Star Weekend Magazine :::

International

Been There, Done That
Lessons from the Burnt

Faruq Hasan

It's easy to be caught up by the huge financial maelstrom and be star struck. Headlines all around us seem intent to focus on the “newness” of the crisis and how governments across the world have to come up with new coping strategies that really don't have much historical precedence. Well, it's really not that simple. Meet and learn from the (jaded) residents of three regions around the world from three different time periods who have already dealt with their own crisis and have stories to tell.

The very recent financial crisis that affected mostly countries in East and South-East Asia should provide us with another opportunity to study, learn and combat the current crisis.

Japan in the 1990s: The early 90s saw the Japanese filled with euphoria. Inflation was an all time low, Japanese exporters were churning out automobiles and household electronics as if there was no tomorrow, and the stock market was finally steady and actually climbing. And then came November 1997, a D-Day for the Japanese economy. Japanese Banks, in a chilling reminder for today's policymakers and bankers, went in freefall while the government stood by, helplessly watching the carnage. There were three main reasons why this happened. Firstly, the stricter supervisory regime that came with the Japanese government handouts to banks meant the banks were both less able and less willing to lend. And faced with depleted capital and concerns over borrower credit quality, banks also aimed to shrink the amount of loans outstanding, and vastly cut down on the amount of loans, which decreased liquidity. Lastly, the weaker economy, which was still hurting after the recession of the early 90s, also caused loan demand to fall.

The lessons for today's policymakers are stark: the stricter rules that come with bail-outs, and the economic weakness that will ensue as banks stop lending so liberally, will feed on itself and reinforce the collapse of credit availability we're already seeing in economies around the world today. Japan may have made its own situation worse by hiking the sales tax from 3% to 5%, but Obama and Co, the default economic leaders of the world, would do well to continue on the path that they have already taken: stimulate consumers with a number of tax incentives while at the same time prop up the banking system and sending a strong disincentive against speculative borrowing and lending.

The Great Depression of the 30s: You've probably heard of comparisons of the current crisis with the Great Depression in one way or the other: the stock market crash, rapid jumps in unemployment and of course banks falling like a house of cards. Like the Depression, the tentacles of the current economic crisis have crept throughout the world. The causes too are strikingly similar: a housing bubble that no one anticipated bursting, weak government regulations and a weak Washington leadership (at least at the beginning) that paralyzed the financial and legislative system. Fortunately, with the help of hindsight, the solutions look pretty clear as well.

For one, governments all across the world have to be more pro-active now. The Great Depression was caused by a lethargic US Government that allowed both money supply to fall drastically, causing a mass shortage of credit, while at the same time allowing banks to die leading to a general sense of gloom that permeated very quickly. This time around, governments have already got a head start and have started using both fiscal and monetary policy to combat the problem. Governments also haven't made the same mistake of raising taxes to fund public spending. It's true that the debt to finance government spending has to be paid off eventually; taxing the poor while they're down is simply not an alternative. Leaders should also take note that although the Great Depression was ameliorated by the Second World War, this was not a sustainable solution. The wars in Iraq and Afghanistan, and the larger self-declared War on Terror has greatly bogged down the US economy and its partners' finances. Simple arithmetic means that every single penny going into the war efforts mean a penny diverted from mending the financial catastrophe.

The Asian Financial Crisis of the late 90s: The very recent financial crisis that affected mostly countries in East and South-East Asia should provide us with another opportunity to study, learn and combat the current crisis. Once again, the parallels between today's crisis and that of just a decade ago couldn't be more similar: the Asian crisis was based on bursting of asset price bubbles, which led to insolvencies of financial intermediaries and further asset price deflation, akin to (although much simpler than) what occurred in the US housing market today. There are some key differences to note though. One is the fact that the Asian crisis emanated from a cluster of several East Asian countries, and was more or less restricted to that region. This is in stark contrast to today's crisis which started from the US housing market which exported poisonous derivatives which ultimately afflicted all developed and some developing countries. The centrality of the source of the problem makes today's crisis trickier: it's tougher to battle your way out of a crisis when the world's largest economy is struggling with its own macroeconomic, financial, and exchange rate problems whereas the regional hub is in good overall shape (Canada and Mexico haven't tasted the same degree of panic). But the lessons that the Asian crisis provide can be utilised perfectly in this era as well: rapid expansion of bank and nonbank credit (far in excess of the growth of the real economy), cum high concentration of credit to the real estate and equity markets, is almost always a harbinger of trouble, in developing and industrial countries alike. This lesson was perfectly applicable a decade ago, in a region far, far away. It's just that sometimes economists (and more importantly, politicians) are just very poor historians.