The Little Crisis That Couldn't Two years ago doom-and-gloomsters warned that the financial crisis in East Asia would spread inevitably and mysteriously to the U.S. Here's why they were wrong.
(FORTUNE Magazine) – Remember the great Asian economic crisis? Back in late 1997 and in 1998, it seemed to be the perfect doom-and-gloom story for fin de siecle eschatologists: The monetary crisis that had first erupted in Thailand in July 1997 was rippling throughout East Asia, to Russia, to Latin America, and then--watch out! It was only a matter of time before it would be coming to America. A new word, "contagion," crept into the financial press to describe the mysterious way the crisis would spread.
Looking backward, it's hard to see what the fuss was about. Most economists foresaw little damage to the U.S. from Asia's problems.
But the time was ripe for pessimism. America's economic expansion was in record-breaking territory (this year it became the longest expansion in U.S. history), and forecasters were nervously scanning the horizon for signs of the next recession. The stock market, already at unheard-of levels (Dow 8000!), seemed like nothing if not a bubble about to burst. All the bad news from Asia had to affect the U.S. somehow, didn't it?
A well-publicized band of pessimists thought so. David Jones, chief economist at Aubrey G. Lanston, cut his estimate for 1998 real GDP growth to 1.6% in November 1997 (it turned out to be 4.3%). The Asian contagion, he told the Wall Street Journal, would produce "shock waves of pessimism emanating every three or four weeks in the stock market."
The prognoses got drearier, and by October 1998 a no less august figure than former Fed Chairman Paul Volcker intoned at a speech in Washington, "Suddenly, it all seems in jeopardy. All that real growth--all the trillions in paper wealth creation--is at risk. What started as a blip on the radar screen in Thailand--about as far away from Washington or New York as you can get--has somehow turned into something of a financial contagion."
Well today, less than a year and a half after that speech and just over 2 1/2 years since the first whiff of crisis, the final grades are in, and the pessimists flunked. Not only did the U.S. survive the Asian crisis--it roared through it with barely a gear shift. Neither the big drop in exports that was forecast nor the mysterious contagion effect ever hit the U.S.
A recent postmortem by the Federal Reserve Bank of St. Louis found that merchandise exports to Asia fell 12% in 1998 and notes that--other things being equal--this might have cut GDP growth by 0.4%. But as is often the case, other things were not equal, and even that modest decline never materialized. One reason is that manufacturers found other markets for their goods. In California, for example, exports to East Asia accounted for 47% of all manufactured goods in 1997. In 1998 exports to the region dropped 18.5%, but exports to all countries fell by only 1.6%. For the U.S. as a whole, merchandise exports in 1998 grew 3%.
What about "contagion"? It was always a slippery term, used when there was no apparent chain of events that could produce serious damage to the U.S. economy. The implication was that the banking system would be the point of infection.
But overall, U.S. banks weren't that heavily exposed to the Asian economy. A recent study by the Federal Reserve Board found that total U.S. bank exposure to developing countries was $195 billion on June 30, 1997, with exposure to the five "troubled" economies--Indonesia, South Korea, Malaysia, the Philippines, and Thailand--at $55 billion. While that's a lot of money, it was just 1.9% of total bank assets. A banking system as well capitalized and profitable as America's can easily handle bad loans in that range. "For the most part," the study says, "U.S. banks did not suffer large losses stemming directly from emerging market crises in recent years. When [individual] banks did suffer losses, they were generally able to offset them with earnings from other business segments."
So the next time you read some gloomy prediction of economic meltdown, make sure that whoever is selling it has a reason explaining both why--and how--it will happen.
REPORTER ASSOCIATE Lenore Schiff