Rich pickings in this week’s Economist with a special report on the future of finance, and a nice briefing on ‘global economic imbalances’ that ties together the East Asian crisis of the late 90s with the current mess. The story runs like this, (allowing for my non-Economist spin)
The East Asian financial crisis of the late 90s was caused by a toxic mix of domestic financial deregulation and capital account liberalization that allowed Asian banks and other firms to go on a mid-90s foreign borrowing spree. Result? Asset bubbles, (e.g. Thai real estate), and then a crash as foreign (and domestic) capital launched speculative attacks on the region’s currencies or simply fled.
Asian governments swore they would not stay this dependent on the whims of capital markets and 
started to amass reserves, led by China (see bar chart) in order to defend their currencies from possible attack. These reserves don’t sit in vaults; they get invested in safe havens like US Treasuries. The interest rates aren’t that good, so Asian governments lose on the deal, but see it as an insurance premium worth paying.
What impact did this have on the US? Between 2000 and 2008, it received $5.7 trillion from abroad, 40% of its 2007 GDP. Over the same period the UK and Ireland got about 20% of GDP, Spain some 50%. As Asia exported capital, the US became a credit junkie, and its current account balance went negative (see graph). The avalanche of cheap capital brought out the worst excesses of greed in the US system. ‘Asian savings may have provided the rope, but America hanged itself’, explains the Economist. We know the rest.
The insurance scheme worked for individual Asian countries – the ones with big reserves suffered less in last year’s turmoil, but destabilised the system. The trouble is that ‘the anxieties that prompt emerging markets have not been assuaged. Indeed the crisis may have spurred some countries to seek even more self-insurance.’
From a systemic point of view, surpluses are just as destabilising as deficits, though they get a better press. The answer, argues the Economist, is coordinated action by both surplus and deficit countries – something that Keynes failed to achieve at the Bretton Woods conference, and which has dogged the system ever since. It would also help if the IMF hadn’t made such a mess of the Asia crisis – a Fund that doesn’t insist on all sorts of irrelevant or harmful policy conditions (e.g. cutting public spending in a recession) in return for its loans would offer governments more of an alternative to self insurance. As would regional alternatives such as the Asian Monetary Fund – mooted by Japan after the Asia crash and then watered down after US opposition.
So the roots of the crisis lie in the developing country crises of the late 90s, which in turn stemmed from a combination of financial liberalization, partly forced on them by the rich world, and the international financial institutions’ attempts to force bad policies on countries in return for bailouts. Poetic justice, chickens coming home to roost etc, but the wrong people are getting punished.