An Historical Perspective on the East Asian Crises
Michael D. Bordo
Rutgers University
Prepared for the Conference “Tigers in Distress: the Political Economy of the East Asian
Crisis.” Columbia University March 5, 1999
An Historical Perspective on the East Asian Crisis
As an economic historian of financial crises I think that the most obvious perspective that
comes to mind is that we have seen it all before. In many ways I believe that there is a lot
of truth to that statement but there are also some basic differences between the recent set
of crises and those of the past. In what follows I will make comparisons between the
crises of the previous golden age of globalization, the last quarter of the nineteenth
century ending with World War I and those in this decade. In many respects the crises of
the interwar like those of the 1960’s reflect systemic problems with the international
monetary system and need a slightly different perspective than the Asian crisis.
Background: Globalization in Historical Perspective
As background to our discussion of the crises of the past and of the present it is important
to note that the present era of massive capital flows to emerging countries, of integration
of financial markets and of greatly reduced barriers to international trade, has many
similarities to the five decades before 1914—the Victorian Golden Age. Some
authorities agree that international financial markets were even more integrated before
World War I than they are today. They were bound together by the corset of the gold
standard. Capital flowed across borders undeterred by currency risk or exchange
controls. Interest rates on government securities denominated in different currencies
converged strongly. International capital movements, scaled by the income of the
countries concerned, reached levels never matched subsequently. The integration of
capital markets was reinforced by and in turn reinforced the integration of labor and
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commodity markets. International migration reached high levels and the growth of trade
outstripped the growth of income.
Evidence for the golden age of capital market integration can be seen in the net
flows of capital from the core countries of Western Europe (Great Britain, France,
Germany, Netherlands, Belgium) to the overseas regions of recent settlement (the
Americas and Australasia). At its peak, the outflow from Britain reached 9 percent of
GNP and was almost as high in France, Germany, and the Netherlands (Bairoch and
Kozul-Wright 1996). Private capital moved essentially without restriction. Much of it
flowed into bonds financing railroads and other infrastructure investments and into longterm government debt. Figure 1 shows five-year moving averages of the mean absolute
value of the ratio of the current account balance to GDP for 12 countries. Figure 2 shows
current account balances for one large capital exporter, the United Kingdom, one large
capital importer, Canada, and the largest “emerging market,” the United States. A
striking feature of this data is the size and persistence of current account deficits in the
pre-1914 period, especially in Australia, Canada, Argentina, and the Nordic countries and
of the current account surpluses of the UK and France.
For comparison, Figure 3 shows the mean absolute value of the ratio of current
account to GDP for 23 of today’s emerging markets (countries whose GDP exceeded 30
billion dollars and were classified as indebted countries by the World Bank) using data
from the International Monetary Fund’s International Financial Statistics for the period
1949 to 1996. These countries were running current account imbalances under the recent
managed float averaging 4.1 percent of their GDPs, which is similar to the average for
the prewar sample of 3.9 percent which includes both capital importers and exporters.
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Net capital flows to emerging countries however are more variable now than they
were then. Also the capital flows then were considerably more persistent then than now.
This is based on evidence in Bordo, Eichengreen and Kim (1998) from Phillips Perron Z
tests and variance ratios. The greater persistence of current account deficits before 1914,
or to put it another way the lack of current account reversals, may provide some insights
into recent events. Factors which we argue that could explain both the greater size and
greater persistence of net capital flows before 1914 include the following:
1. The greater credibility of policymakers commitment to stable monetary and fiscal
policies as manifested in adherence to the gold standard, which I argue (Bordo and
Rockoff (1996)) acted as a ‘good housekeeping seal of approval’.
2. The fact that most British investment went to former colonies where the British
heritage was strong or commercial ties longstanding (eg. Argentina). A similar story
can be said for France. By comparison, today’s capital recipients tend to be very
different from the capital exporters.
3. Much of the capital flowing to the New World went to finance railroads and other
infrastructure. This investment required a long-term commitment because of its very
nature, the returns only accrued when the project was completed. Infrastructure
investment in today’s emerging countries does not dominate to the same extent.
4. Prewar investment went into export related and natural resource related projects that
generated a stream of foreign exchange revenues sufficient to pay the money back—it
did not give rise to balance of payment problems.
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5. Greater flexibility in nineteenth century economies so that a shift in capital flows
which implied the need to reallocate resources between sectors producing traded and
non-traded goods could be accommodated easily.
6. Thus today’s globalized capital market may be inherently less stable and prone to
reversals than in the golden age.
Lending Booms and Busts
Just as in the recent period, foreign capital flows to emerging markets were subject to
booms and busts. The classic case is that of foreign portfolio investment to Latin
America which went through 4 cycles before World War II. Carlos Marichal in A
Century of Latin American Debt Crises (1989) documents the fascinating record.
The first wave occurred in the 1820’s when British capital flowed into the newly
independent nations of Latin America to finance gold and silver mines and infrastructure.
The boom led to massive speculation in the London Stock Market in many stocks of
fictitious or dubious character culminating in a crash and a banking panic. All the new
states defaulted on their debt and did not regain access to foreign capital for decades until
they renegotiated their debts and paid into arrears. After being burned in South America,
British capital shifted to the U.S. into the securities of state’s financing canals and early
railroads. When many states defaulted on their debts in 1842 at the nadir of one of the
worst recessions of the nineteenth century, British capital pulled out of the U.S. for a
number of years.
The second Latin boom was in the 1850’s and 60’s to finance railroads. (See
Figure 4). It ended with the crisis of 1873 and massive defaults.
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The third wave was to Argentina and Uruguay in the 1880’s, again to finance
railroads and infrastructure. The boom ended with a crash in 1890 and a debt
moratorium. This triggered the Baring crisis in London. The famous investment house
of Barings which had underwritten many Argentine bonds was revealed to be insolvent.
A money market panic was prevented by the Bank of England’s organization of a lifeboat
operation in which other banks, backstopped by the Bank of England, in turn buttressed
by loans for the Bank of France, reflated Barings. Argentina was not rescued, it was cut
off from British capital for several years until it had renegotiated its debt and established
a stable financial regime. Lending resumed until 1914 when World War I permanently
shut off the British spigot.
The last historic wave of portfolio investment to Latin America was from the U.S.
in the 1920’s, largely into municipal infrastructure. That ended with the Great
Depression and the defaults by virtually every debtor country.
The lesson we learn from history is that there has always been optimism followed
by pessimism in a world with imperfect and asymmetric information. Lenders are not
fully informed about internal conditions in emerging countries, and borrowers may not
put the funds made available to their best use. Moreover, in the pre-1914 era, adherence
to the gold standard by reducing currency risk, made lending attractive just as did
pegging to the dollar in the recent period.
Contagion
What about contagion? Were the crises of the pre-1914 period characterized by the so
called contagious effects of the recent crises? The answer I believe is that contagion is a
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misnomer and the correct term is transmission. In the golden age financial crises were
transmitted across the world through the links of the fixed exchange rate gold standard.
Crises associated with banking panics in the U.S. spread to England and the continent in
1857 and in 1893 and 1907. They also went the other way. They were transmitted via
arbitrage in capital markets and via the current account. Virtually every crisis in Europe
led to a worse event in the peripheral world.
There is evidence that shocks to important financial institutions in London from
defaults in one country would lead to a restriction in lending to other borrowing
countries. The evidence also suggests that the British investors as a whole were able to
distinguish between solvent and insolvent borrowing countries. Thus Davis and
Huttenback (1988) show how British capital alternated between the U.S., Canada,
Australia, Argentina, and other countries reflecting the ebb and flow of their prospects.
The historical record suggests few instances of “pure” contagion where lending to
completely innocent parties was cut off.
The Difference Between Now and Then
What’s different in today’s boom-bust episodes from earlier ones is the belief that
domestic financial institutions are protected by an internal safety net and that foreign
lenders will not suffer losses on their loans in hard currencies because funds to
compensate them will be made available by the multiple international lending agencies
and the monetary authorities of the advanced countries. In earlier times losses were
actually sustained by lenders, and by borrowers who were then cut off from further loans.
Eventually, settlement of outstanding debts was reached, but at the cost of cessation of
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economic growth. Moral hazard weakens incentives for lenders to monitor the
performance of both the private and public sectors where they invest. By contrast, in
earlier times, presumably both borrowers and lenders learned the hard lesson that caution
paid. Thus although there were crises, although there were wealth losses and declines in
income, the record suggest that the wealth losses from today’s crises (seen in the size of
the fiscal transfers to restructure banking systems and the international rescue packages)
in which the market incentives of prudence in lending have been muted by moral hazard
and the knowledge that big bailouts are forthcoming, may be much larger.
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References
Bairoch, Paul, and Richard Kozul-Wright (1996). “Globalization Myths: Some
Reflections on Integration, Industrialization, and Growth in the World Economy.”
United Nations Conference on Trade and Development. Discussion Paper No.
113 (March).
Bordo, Michael D., Barry Eichengreen and Jongwoo Kim (1998) “Was There Really an
Earlier Period of international Financial Integration Comparable to Today?”
NBER Working Paper 6738. September.
Bordo, Michael D. and Hugh Rockoff (1996). “The Gold Standard as a Good
Housekeeping Seal of Approval.” Journal of Economic History. Vol 56 (June)
pp. 389-428.
Davis, Lance and Robert Huttenback (1988) “Mammon and the Pursuit of Empire”
Cambridge: Cambridge University Press.
Marichal, Carlos (1989) A Century of Latin American Debt Crisis. Princeton: Princeton
University Press.
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