without their own knowledge base simply followed the herd. in such a world, it is rational for any individual player to shift with the herd when new perceptions arrive. whatever the fundamentals, when the herd is running, you run with it. in its usual understated way, the bis observed that : “ highly correlated strategies across different players may have contributed to an aggravation of asset price movements ” ( bis ( june ) 1998, p. 95 ). the informational problems were compounded by the biased and ill - founded nature of much of the information and commentary. looking back on it, it might seem surprising that there were not more pundits, highlighting the excessive nature of the flows and the domestic policymaking deficiencies of the recipient countries. but who would these pundits be? among the policy officials in the recipient countries, the flows ( and the development of sophisticated financial sectors ) were a sign of progress and modernity : who would want to express doubts about that? in academic circles, the dominant paradigm was “ efficient markets ” – who would be bold enough to question the outcome of the market? any unexplained differential was passed off as a “ risk premium ” – the academic “ fifth ace ” that could square any circle and explain any regression result, no matter how different from the “ priors ”. in the financial markets themselves, who was going to bite the hand that fed them? 16 some of the subsequent commentary suggests naivety on the part of the investors ( they “ received repeated assurances that the financial sector was well supervised … and that there would be no changes in exchange rate policy ” ( imf 1998, p. 41 ) ). in hindsight, the degree of ignorance is so great as to border on the comic. business week ( 22 september 1998 ) reports a fund manager ’ s response to the russians ’ halting of trade in their domestic debt market in this way : “ nobody in the history of the world has ever done anything this foolish ”. some sense of history! at the same time, it should be noted that information that was available was not used. the bis banking data provided a comprehensive view on what turned out to be the most volatile element of the flows, but the existence of these data was either unknown or ignored. 17 as far as the outcome is concerned, however, unused information was as irrelevant as unavailable information. ( c ) the behaviour of risk premia the process of assessing and reassessing

singapore taiwan south korea thailand hong kong malaysia indonesia philippines 86 88 94 96 9886 88 94 96 it may be useful to recall, also, the old distinction between risk and uncertainty – it was the latter ( whose characteristic is unpredictability ) rather than the former that was relevant, and perhaps we should not be surprised that uncertainty premia can shift dramatically. ( d ) a disequilibrium process these capital - receiving emerging countries were being transformed at such a pace that it is not sensible or realistic to see the process in terms of the usual textbook notions of returns equilibrated at the margin and smooth allocation of resources, particularly capital. systems were in flux, and production functions were changing continuously. this general notion manifested itself in various ways, but three examples will illustrate the issue. the first example of apparent disequilibrium in capital flows was identified nearly two decades ago – the feldstein / horioka paradox ( 1980 ) – there seemed to be too much correlation between domestic saving and investment rates in individual countries, with the implication that capital flows between countries were smaller than would occur in a well integrated world. so here, perhaps, is another clue to the puzzle. it is not so much that capital flows rose suddenly to achieve abnormally high levels, but that they were – for some reason – less than optimal earlier, and so the big increase was a move towards a more normal or equilibrium situation. 18 these are asset or stock equilibria. when these ill - defined and easily changeable temporary equilibria are displaced by a shift of confidence, the flow requirements to shift from the old to the new stock equilibrium may be very large ( and very disruptive ). second, profits ( or even expected profits ) were not equilibrated across countries. for a sustained period ( through the 1980s ), excess profits had been earned, illustrated by equity returns and high domestic real interest rates in indonesia, korea and thailand. indeed, the constant revisiting of the feldstein / horioka result has found less correlation between domestic saving and investment rates over time, implying increasing international capital integration ( fujiki and kitamura 1995 ; ghosh 1995 ). - 12 - graph 7 asian share markets december 1987 = 100 index index indonesia thailand malaysia philippines south korea 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 source : datastream. table 4 : average real interest rates * south korea thailand indonesia # malaysia philippines 1980 – 89 1990 –