The financial crisis that hit Thailand, Indonesia, South Korea and to a lesser extent Hong Kong and Taiwan in 1997 was not generally anticipated but it should have been. Although the macroeconomic variables such as budget balances, both fiscal and trade, were in good shape and they had vast holdings of foreign currency to use to maintain their exchange rates as pegged to the dollar the microeconomic situation was quite different. Firms in the affected countries had made large amounts of loans from Western banks and they were borrowing short term to finance long term projects. The firms were committing themselves to foreign currency payments and not hedging the exchange rate risk. This meant that if the value of the domestic currency fell with respect to the foreign currencies the amount of domestic currency required to make payment committments would increase and could increase to the point of bankrupting the firms. The notion of hedging and risk management never seemed to have occured to many of the firms in these countries. The decision makers had taken the East Asian prosperity as unassailable. This unrealistic attitude was in part due to the fact that many of the decision makers were not real business people. Many were people who had strong contacts with the government and made their money as a result of special priviledges. Others were heirs to family fortunes who did not appreciate the necessity of economizing and weighing risks. But many were legitimate business people who had developed false notions of what constitutes the proper basis for making decisions. Profitability was not given its rightful place in making decisions. This disdain for profits as opposed to sales and market share was often rationalized as a focus on long term profitability versus they saw as the misguided emphasis of short term profitability of Western business. But this was a coverup for a feudalistic, militaristic orientation versus an economic orientations. In military events resources are wasted prodigously to gain victory and the rewards come after the opponents have been vanquished. But in market economies the loss incurred in gaining market share generally can never be recouped. The industrial organizations in Japan and elsewhere that ignored the necessity of making a profit were houses of cards that ultimately had to collapse.

To sum up the East Asian Financial Crisis of 1997-98 had its roots in the lack of a proper criterion for deciding an investment project is worthwhile. Instead the decision to go ahead with a project was based upon whether financing could be obtained. That could have placed the burden of doing an analysis of the net present value of the project on the lender. But the lenders also did not exercise this option. Instead the lenders placed reliance on a belief that the sovereign governments would not permit a financial collapse. There is a distinct element of feudalism in the attitudes toward business in the countries affected by the crisis. There was an attempt to replace economic analysis with a militaristic mentality that appeared to work when times were prosperous but failed miserably when conditions soured.

Indonesia