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Interactions between Macro- and Microeconomic Institutions under Crisis Conditions

Interactions between Macro- and Microeconomic Institutions under Crisis Conditions

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Published by Benjamin Daniels
The pre-WWI world economy was remarkably open even by today’s standards, speculators and unregulated financial instruments have always existed, and corruption speculators have long been the favorite target of commentators in foundering economies. By examining recent crises in South Korea, Argentina, California and Greece, it is possible to shed light on the evolving nature of modern financial crises, its causes and solutions, and the implications for both industrialized and developing economies around the world.
The pre-WWI world economy was remarkably open even by today’s standards, speculators and unregulated financial instruments have always existed, and corruption speculators have long been the favorite target of commentators in foundering economies. By examining recent crises in South Korea, Argentina, California and Greece, it is possible to shed light on the evolving nature of modern financial crises, its causes and solutions, and the implications for both industrialized and developing economies around the world.

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Published by: Benjamin Daniels on Jan 29, 2011
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Interactions between Macro- and Microeconomic Institutions under Crisis Conditions
 Benjamin Daniels
 Financial and economic crises are nothing new; indeed, they have recurred time andtime again since the beginning of economic record-keeping. Yet the increased frequency andseverity of crises since the fall of the Soviet Union, particularly of 
“twin crises” comprising
both a foreign-exchange element and a domestic-recession element,
1
suggests that a newforce is at work within the long-established framework of economic crisis. Commonscapegoats for the turmoil include the establishment of a liberal world financial regime underthe auspices of the WTO, the IMF and the World Bank; the deregulation of various parts of the banking sector; the growth in speculative actors, including hedge funds; and virulent
“crony capitalism” that undermines stability by way of deep
-rooted corruption. None of theseforces, however, is a recent development. The pre-WWI world economy was remarkably
open even by today‟s standards, sp
eculators and unregulated financial instruments havealways existed, and corruption speculators have long been the favorite target of commentators in foundering economies. By examining recent crises in South Korea,Argentina, California and Greece, it is possible to shed light on the evolving nature of modern financial crises, its causes and solutions, and the implications for both industrializedand developing economies around the world.
While Thailand‟s troubles kicked off the Asian financial storm in 199
7, South
Korea‟s extended experience provides perhaps more insight into the mechanics underlying
the crisis. South Korea was a booming economy; by 1997 it was the eleventh-largest in the
world and its “case for joining the OECD was undeniable.”
2
Its GDP per capita had morethan doubled in each of the two preceding decades, reaching $14,000 (PPP) in that year.
3
It
“represented the fastest ever transition from an underdeveloped rural nation ruled by dictatorsto an industrialized country ruled by democracy.”
4
 
Like many of the other Asian “tiger”
economies of the early- to mid-
1990s, South Korea‟s successes were driven in large part by
central coordination, including an aggressive industrial policy that directed low-cost loansinto favored industries, managed by massive conglomerates called
chaebol
. Korea‟s brands
became household names in the West
 – 
Samsung, Kia, Hyundai
 – 
and spread throughout low- 
1
Barry Eichengreen,
Financial Crises and What to Do About Them
(2002) 5.
2
Philippe Riès,
 Asian Storm: The Economic Crisis Examined 
, trans. Peter Starr (1998) 203.
3
 
IndexMundi, “
South Korea GDP - per capita (PPP)
” (2009).
 
4
Riès 195.
 
end markets in Asia.
5
 
Following South Korea‟s admission to the OECD in 1996, weaknesses
in the economy began to be identified, but by East Asian standards the quality of credit,government intervention, and financial liberalization were not in critical condition. South
Korea was a case for reform, but not an immediate concern; while it had “massively invested
in the b
est available technology,” it simply had not developed “best managerial policies.”
6
 There was little appetite for painful reforms in the country as well. As in most developingeconomies, the status quo remained legitimate and popular as long as it continued to produce
growth, and South Korea‟s model was remarkably efficient at doing just that. The financiershad “acted as development institutions,”
7
providing high levels of liquidity to
chaebol
conglomerates. Foreign lenders had followed suit after South Ko
rea‟s international
investment policies were liberalized, providing more capital to the rapidly-growing economy.And despite the economic busts in many surrounding countries beginning in July 1997, SouthKorea did not feel the heat until about December of that year.The extent of vulnerability in the South Korean economic structure was exposed onlyas a result of the external shock of regional recession. Throughout the early 1990s, SouthKorean producers had expanded dramatically into emerging markets, which purchased somesixty percent of exports.
8
When demand collapsed around Asia as a result of the spreadingcrisis, so too did the ability of the
chaebol
to service the high level of short-term debt theyhad accumulated as credit had begun tightening between 1994 and 1997, by which timealmost half of corporate debt had maturities shorter than twelve months.
9
The conglomerateswere caught in a classic crisis; after financing decades of growth with easy credit, both hadstalled. Debt-service payments, on the other hand, had not. In early 1998, the crisis came to ahead, and the resulting capital flight from South Korea devastated the value of its currency,
the won. With the collapse of the currency, rates of return in South Korea plummeted, “the
capital inflow
declined and a self fulfilling prophecy was born.”
10
 
At this point, “South Koreafaced „temporary illiquidity rather than fundamental insolvency,‟”
11
but the tumbling wonthreatened to drastically increase the real debt burden faced by South Korean companies andpush them over the line into actual insolvency. After intense negotiations with Seoul as thecrisis mounted, the IMF responded with a currency-
 based approach. It organized a “sharp rise
5
Riès 206.
6
Ibid.
7
Riès 205.
8
Riès 206.
9
Riès 204.
10
Charles P. Kindleberger and Robert Z. Aliber,
 Manias, Panics and Crashes: A History of FinancialCrises, 5
th
ed.
(2005) 92.
11
Riès 230.
 
in interest rates to stabilize the exchange rate and budget austerity to put the house back in
order.”
12
The IMF recommendation was exactly the opposite of what would be expectedunder Keynesian domestic economic policy, for which the Asian economies had been praisedby the World Bank only a few years before.
13
Domestic economy, which required lowerinterest rates and deficit spending to buoy through a contraction, came into full-scale clashwith international economy, which demanded the contractionary policies in order to restoreexchange-rate confidence. Under conditions of ongoing currency devaluation, the situationwas lose-lose: South Korea was suffering a twin crisis. By June 1998, however, the austeritymeasures led the won to stabilize and strengthen again, and South Korean GDP recovered bythe end of 2000. In spite of the failings of the South Korean economy, it seemed the distresshad been somewhat ephemeral, caused by a combination of short-term illiquidity and anensuing exchange-rate crash. By heading off the latter problem, South Korea was able toensure that
corporations‟ won
-denominated assets remained sufficient to service their debts,stabilizing the economy and promoting an effective recovery after a relatively shortrecession.Argentina, which faced an ostensibly similar crisis a few years later, had no such luck.Argentina had many of the same characteristics of South Korea. In terms of financialvulnerabilities, Argentina had amassed a disproportionately high ratio of short-term foreigndebt even while its export penetration in developed markets was falling.
14
After recoveringfrom its earlier economic difficulties, however, the country had instituted a currency board toguarantee monetary stability and, like South Korea, had implemented many of the
Washington Consensus reforms with gusto, earning it a “star”
15
label in the internationalcommunity. Argentina even fell victim to the same primary external shock 
 – 
a sharp declinein the value and volume of its exports.
16
As in South Korea, cash had dried up exactly when itwas needed most, but rather than face immediate pressure, Argentina was able to push back the maturities of many of its debts in the
blindaje
and
megacanje
debt exchanges in early2001.
17
But the situation remained unstable; the government was as insolvent as a sovereigncould be considered to be. With the currency peg in visible danger and the recessiondeepening, bank depositors began withdrawing dollars due to the fear that the peg would be
12
Riès 225.
13
Paul Krugman,
The Return of Depression Economics
(1999) 103.
14
 
José María Fanelli, “Growth, Instability and Convertibility Crisis,”
The Crisis That Was Not Prevented: Lessons for Argentina, the IMF, and Globalisation
(2003) 52.
15
 
Bernardo Lischinsky, “The Puzzle of Argentina‟s Debt Problem: Virtual Dollar Creation?”
TheCrisis That Was Not Prevented: Lessons for Argentina, the IMF, and Globalisation
(2003) 86.
16
Fanelli 58.
17
Lischinsky 95.

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