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Asian Recovery?

June 7, 1999

Tags Booms and BustsBusiness CyclesCapital and Interest Theory

The Asian Wall Street Journal
June 15, 1999


The word recovery is on the lips of a lot of Asia experts these days. But if
Asia's economic policy makers are to witness a long-term recovery, they will
first need to reverse the interventionist policies that have distorted the
cost of capital in the region and depleted the wealth of Asian consumers and
investors. Contrary to popular thinking, it was the overly loose monetary
policies of Asia's central banks that led to the current crisis.

The damaging effects of these policies are nowhere more evident than in
where the results of unbridled monetary expansion have come home to roost.
Current economic wisdom holds that there is too much savings in Japan. This
keeps consumer spending weak, the thinking goes, thereby perpetuating the
economic slump. To combat this dire state of affairs, the Japanese
has done nearly everything in its power to stimulate demand--from bringing
down interest rates to nearly zero, to handing out spending vouchers.

While Japan's first quarter GDP figures for 1999 grew an impressive 1.9 percent,
lending remains at an all-time low. Despite the bank of Japan's efforts to
the money market with funds, lending by Japanese banks plunged 5.4 percent in
May--the sharpest drop ever recorded. That the BoJ's super-loose monetary
have so far been ineffective is not the result of negative investor
but is indicative of a much deeper malaise: the shrinking pool of funding.

Essentially, the "pool of funding" is the quantity of goods available in an
economy to support future production. The size of this pool determines
or not more sophisticated means of production can be introduced. For
if it requires one year of work to produce machinery that will increase a
company's productivity, but the company has only enough money saved to
it for one month, then the machinery will not be acquired--and the company will not be able to boost its productivity. In other words, the size of the
of funding sets a brake on the implementation of more productive--but
--stages of production.

Trouble erupts whenever the banking system makes it appear that the pool of
funding is larger than it actually is, encouraging producers to invest in
stages of production than are warranted by the real funds available. When
happens, the pool of funding begins to shrink.

One of the major factors that causes the pool of funding to shrink is a
prolonged loose monetary policy. Such a policy actually undermines wealth
production while encouraging its consumption and thereby the depletion of
pool of funding. When a central bank expands the money stock, it does not
enlarge the pool of funding--on the contrary, it gives rise to the
of goods that is not preceded by production. This does not lead to more, but
rather less means of sustenance for the production structure.

For a while, the central banks can get away with this, as the loose monetary
policies give the impression that they are boosting economic activity.
once the pool of funding begins to shrink, monetary policy becomes
That various counter-cyclical policies have failed to lift the Japanese
is indicative that the real pool of funding there is shrinking or
stagnating. So
much so that even a personal savings rate of 25 percent is not enough to replenish

In fact, central bank policies throughout crisis-stricken Asia have been
squandering savings at a much faster pace than people are saving. In Japan,
rate of growth of M2 money stood at over 9 percent, on average, between 1980 and
1990--i.e. for a period of 10 years. This monetary pumping was accompanied by a
fall in the discount rate from 9 percent in 1980 to near zero in 1998. Likewise, in
Thailand, the M2 money supply had been expanding at a rate of 30 percent by 1990,
in Indonesia M2 grew by 50 percent during that year.

In South Korea the rate of growth of M2 stood persistently above the 20 percent
throughout 1990. In Malaysia during that period M3 was expanding in excess
30 percent. Furthermore, in August 1993, the Indonesian inter-bank call rate was
lowered to 5.68 percent from 27 percent in March 1991. In December 1993, the Thai
inter-bank call rate was lowered to 6.75 percent from 11.5 percent in June 1992.

This massive monetary pumping generated an illusory prosperity in terms of
various popular economic indicators. For instance during the second half of
year-on-year Indonesian industrial production grew by 20 percent. South Korean
production jumped by February 1995 to 19 percent year-on-year, while Thailand's
industrial output climbed to a rate of growth of over 13 percent during that
period. In
Malaysia by May 1994 the yearly rate of growth of industrial output exceeded
20 percent mark.

What is deceptive about these seemingly healthy indicators is that they
represented a massive misdirection of savings, and hence, a depletion of
wealth. Asia's impressive pre-crisis GDP figures were not backed up by an
equally impressive pool of funding, and could not continue without

When the correction came, in the summer of 1997, indicators such as stock
began to move toward more realistic levels, in line with the state of the
wealth of the various economies. The fall in consumer outlays in response to
fall in the stock market, did not make things worse, as most economists

On the contrary, it halted the consumption of capital and began to lay the
foundation for rebuilding the pool of funding. To engage in monetary pumping
order to boost consumption and stock prices only defeats this corrective
mechanism. It conceals the true state of wealth in the economy, encouraging
excessive consumption and a decline in the sources of funding.

Instead of continuing with policies that actively promote the consumption of
wealth, the central banks should be more concerned with laying thefoundations
for growth. What is needed for real economic growth is an expanding pool of
funding. Until the economic leadership in Asia recognizes this, and puts a
to misguided efforts to "reflate" its way to recovery, the situation can
get worse.


Frank Shostak is chief economist at Ord Minnett Jardine Fleming Futures in Sydney. His website can be found here.

Copyright (c) 1999, Dow Jones & Company, Inc.

Also read Jeffrey Herbener on Japan's Boom and Bust and, from Investors Business Daily, an editorial that argues along the same lines.

Everything you need to know about the Asian crisis can be found on the Asian Crisis Home Page.

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