Edition: U.S. / Global

How U.S. Wooed Asia To Let Cash Flow In

Published: February 16, 1999
(Page 6 of 8)

''The simple fact,'' said James Wolfensohn, president of the World Bank, ''is that very sophisticated banks loaned to Indonesian companies, without any real knowledge of their financial condition, based on name, based on competition. So you have to say to yourself, would it have made any difference if they had known? Well, maybe, but they did go nuts.''

Turning Point in '95

In 1995 governments did two things that would set up the emerging markets for trouble. What appeared to be a brilliant bailout of Mexico, led by Mr. Rubin and Mr. Summers, convinced investors that some countries were too strategically important to be allowed to fail. And then, when finance ministers from the Group of Seven industrialized countries gathered in Washington on April 24, 1995, they agreed to try to push up the value of the dollar against the Japanese yen.

The accord worked. The dollar rose smartly against the yen, easing the risk of a global crisis at that time.

But the pact also caused the rise of currencies like the Thai baht and the South Korean won, which were informally pegged to the dollar. Thailand and South Korea had already lost some competitiveness when China devalued its currency in 1994, and now they were tugged upward along with the dollar so that their exports became more expensive and even less competitive.

The upshot was that goods made there had more trouble competing abroad. Thai exports were stagnant in 1996 after having soared 23 percent in 1995, and the Thai current account deficit (a broad measure of the balance of trade) rose to 8 percent of gross national product in 1996, up from 2 percent in the late 1980's. Foreign currency reserves began to drain away to pay for the deficits, and the seeds of the crisis were sown.

As the money poured out, Thailand's deep structural problems became suddenly apparent to investors. Indeed, the countries with far stronger financial institutions weathered the storm much better -- the capital flight that devastated Thailand left Taiwan and Singapore with only mild damage. As a result, economists are still arguing about what combination of free capital flows and structural flaws truly spelled disaster.

One common vulnerability in many of the hardest-hit countries was that like Japan in the late 1980's, they had enjoyed speculative bubbles fueled by cheap credit.

The giddiness ended up creating havoc with the banking systems, for it resulted in what might be called the three excesses: excess borrowing, excess investment and excess capacity (meaning factories and equipment that are kept idle because of lower-than-expected demand).

These excesses were so widespread that their effects can be seen not just in the capital cities, but even in remote places like the Indonesian town of Mojokerto.

Salamet, a rickshaw driver who lives with his wife and three children on the edge of Mojokerto, always used to pay cash for purchases. But about five years ago, banks and finance companies began to pioneer a credit system even for the poorest people.

So Mr. Salamet and his wife, Yuti, bought furniture on installments. They paid for their son Dwi's school uniform on installments as well.

Mr. Salamet used to rent his rickshaw, a dilapidated contraption that looks like a love seat being pushed by a bicycle. But as the neighborhood prospered, Mr. Salamet dreamed of moving up in the world. He borrowed from the bank and bought a banged-up secondhand rickshaw with a red seat, promising to pay the equivalent of $4 a month for 14 months. He thought he would be able to earn the monthly payment in just a few days on his rickshaw, and so it seemed the perfect investment.

As it turned out, he bought in at the peak of the rickshaw bubble.

A decade ago, the area had about 100 rickshaws, and each of the drivers could earn about twice as much as a farm worker. But the advent of rickshaw financing, coupled with the general enthusiasm for moving up in the world, led to an explosion of rickshaws. Now there are 300.

''These days there are more rickshaws than the area can support,'' grumbled Rutiati, a 37-year-old woman who is a rickshaw agent, arranging financing for Mr. Salamet and others in the neighborhood. ''There are more rickshaws than passengers.''

Mr. Salamet and Mrs. Yuti (who like many Indonesians use only one name) have a plan to overcome the family's difficulties.

''I figure I'll start a little shop in front of our house here,'' Mrs. Yuti explained, beaming. ''It seems it's a good way to make money on the side. And if we're hungry, we can always eat the shop's food.''

The problem is that the neighborhood is also suffering from a shop boom. Banks in Mojokerto began lending to households wanting to open stores in their living rooms, and all the cheap credit and optimism in Mojokerto led to the same problem locally as around the world.

The number of shops in the neighborhood soared to 20, from 3. The banks in Mojokerto are scrambling to recover the loans they made to stores, but it seems the banks miscalculated when they assumed that the groceries would remain as collateral. Borrowers have taken the collateral and eaten it.

Asia Follows Japan