by Merton Miller, University of Chicago
The popular account of the Asian Crisis puts the blame on currency speculators like George Soros and, more generally, on financial markets. By opening their economies to large inflows of foreign capital, the Asian tigers prospered for a time. But at the first sign of trouble, speculators began to drive down currency values, which in turn caused massive capital flight and general desolation.
This article assigns financial markets a different role in Asian case. Nobel laureate Merton Miller from University of Chicago, attributes the current problems in Asia – recent sharp reductions in the rapid economic growth – “not to too much reliance on financial markets but to too little”. He argues that a well fleshed out set of financial markets and associated institutions means a country can reduce its dependence on the banking system, which is normally far and away the dominant institutions forfinancing economic growth in the developing countries of the world today. Just as it was in the 19th century for the US, today’s emerging Asian economies do not have well-developed capital markets and so remain heavily dependent on their banking systems to finance growth.
Although banks play an important role in all economies by channeling funds from depositors to companies without access to capital markets, banking itself as Miller argues, “is not only basically 19th century technology, but disaster prone technology”. In Asian economies banking is a marvelous mechanism for channeling into productive investments the huge flow of household savings generated, since those countries including Mainland China, have savings-to-income ratios that are three, four, or even more times the countries in the West. For all its potential contributions to economic growth, banking remains fragile. The high leverage combined with their “extreme mismatch” of maturities (funding long-term assets with short-term and, in some cases, foreign currency-denominated liabilities) and reliance on demand deposits, makes them inherently vulnerable to massive runs – and their economies to severe and recurring credit crunches. And as Miller goes on to say, “in the summer of 1997 a banking-driven disaster struck in East Asia, just as it had struck so many times before in US history”
In the 20th century, Miller argues, the US economy has steadily reduced its dependence on banks by developing “dispersed and decentralized” financial markets and institutions. By so doing, it has reduced its susceptibility to credit crunches; for example, non-bank sources of capital were an important reason why the recession of 1990 was so mild and short-lived. At the same time financial markets have dramatically increased the efficiency of the U.S. capital allocation process. The U.S. is now diversified financially, as it were, in a way that East Asia in 1997 was not. As the developing countries of Asia do diversify and reduce their over-reliance on banking, they will reap major gains not only in stability, but in economic efficiency.
On the contrary to U.S., Japan has not reduced its economy’s dependence on banks, and “its efforts to deal with its banking problems have served only to destabilize itself as well as its neighbors”. In fact any indictment of banks and bank regulation for causing and prolonging the East Asia crisis must begin with Japan. Japan is far and away the biggest economy and the largest lender in the area. And Japan, of course, is the locus classicus of bank-driven economic growth and development. The keiretsu system was widely imitated throughout East Asia, notably in Korea. In the 1990’s, however, the Japanese banking system, for all its favorable aura in world publicity, had begun to have trouble meeting the international capital standards. The three main reasons can be cited for this failure. First was the dramatic fall of the Japanese stock market starting in early 1990. Closely parallel to this decline in stock was the collapse in real estate prices. The third and the most devastating one is the bad commercial loans to business which blew away the capital of banking system. Efforts by the Japanese to solve the banking problems – protecting the capital of their own banks by lowering interest rates, and by calling (or refusing to roll over) loans to Asian firms and banks – served to destabilize much of the rest of Asia, especially the banks in the rest of Asia.
Having a wide spectrum of financial markets available keeps a country from having to put all its development eggs in one basket. Commercial banking, at its best, can be an extremely efficient form of intermediation between saving and investment, particularly when a country is just starting out on its road to development. But relying on banking, like relying on atomic-energy electric power, is a disaster prone strategy requiring enormous amounts of direct government supervision to reduce the frequency of explosions. In fact regulatory apparatus designed to protect the banking system actually becomes counter-productive and leads to a credit freeze-up wherever any substantial number of banks go bad at the same time.
Miller, therefore, urges developing countries in Asia and elsewhere not to follow the Japanese example, but to take measures aimed at developing financial markets and institutions that will either substitute for or complement bank products and services. While lessening the vulnerability of the banking system it should also be recognized that for the long run, the only safe policy is to reduce the role of banks and banking in economic life and create market substitutes for functions now performed by banks.