We may well be on the verge of a world slump.footnote1 The Thai crisis of July 1997 soon became the Southeast Asian crisis, then became the Asian crisis in October, and now has become the Great Asian Depression, The sudden intensification of insecurity and poverty that confronts hundreds of millions of people in Asia makes this one of the worst economic calamities of the twentieth century. Spending on education, health, and social assistance is shrinking rapidly, creating gaping ‘social deficits’.footnote2 The abrupt shift to negative growth in what had been the world’s fastest growing region has sent a contractionary wave coursing through the world economy, setting off a cycle of events elsewhere.

Commodity prices have fallen to their lowest levels in more than twenty years.footnote3 From Venezuela to Chile to Canada to New Zealand to Nigeria to South Africa to Russia—and places in between—commodity-based economies are finding it hard to sustain economic growth and public spending.

The Asian crisis has also triggered a ‘gestalt shift’ in the minds of the owners and managers of banks, hedge funds, pension funds, and other forms of mobile capital. They now see danger everywhere. Their pullout from one market causes pullout from others. The Morgan Stanley Capital International Index of emerging market stocks plummeted 33 per cent between mid-July and late August. In Europe the knockon effects of Asia have been strong enough to force the Italian central bank to intervene to support the lira. Figure 1 shows the path of an index of financial market performance covering the industrial and emerging markets from the start of 1997 to the start of September 1998. Since April it has been mostly in free-fall.

On the face of it, the dynamics are odd. In normal times, short-term capital has an incentive to move to countries with current account surpluses and flee from those with deficits. Asia is building up huge current account surpluses. Korea’s is running at an annualized rate of about 10 per cent of gdp, which is enormous. Thailand’s is nearly as big. Malaysia’s surplus is likely to be about 2 per cent of gdp. But foreign bankers and portfolio investors have been fleeing these economies. China has the second biggest foreign exchange reserves in the world after Japan and an enormous current account surplus, yet there are fears of a renmimbi devaluation. Hong Kong has a current account surplus and $96 billion of reserves—about the biggest reserves per person in the world—and the Chinese government has pledged it will use its $140 billion of reserves to support the Hong Kong dollar. Yet the Hong Kong dollar and stock market are under intense speculative attack. So is the Taiwan dollar, despite Taiwan’s towering exchange reserves and current account surpluses. The Japanese current account surplus is a large 3 per cent of gdp and Japan has the biggest net creditor position in the world by far. Yet foreign capital is not racing to take positions in the expectation of yen appreciation.

The answer to the puzzle lies partly in the fact that the current account surpluses result from import compression more than export expansion. The four most badly affected economies—Korea, Thailand, Malaysia, Indonesia—have undergone import falls of 30–40 per cent in the past year. The falls reflect deep recessions, which spell debt default, bankruptcies, still lower domestic interest rates and possible further ‘beggar thy neighbour’ currency devaluations.