How did large trade deficits hurt the East Asian countries in the mid 1980s? (Recall that trade deficits are equivalent to inflows of financial capital from abroad.)

The first step is to understand the concepts of trade deficits and financial capital inflows. A trade deficit occurs when a country imports more goods and services than it exports. It has to cover the excess spending on imports by obtaining financial resources from other countries, which results in inflows of financial capital (such as loans, foreign investment, and remittances) from abroad.

East Asian countries typically include China, Japan, South Korea, Taiwan, Hong Kong, and some Southeast Asian countries like Singapore, Malaysia, Indonesia, and the Philippines. In the mid-1980s, many of these East Asian countries experienced large trade deficits, implying that they were spending more on imports than they were earning from exports.

The large trade deficits in the mid-1980s led to an increased reliance on foreign financial resources to cover the gap between imports and exports. As a result, East Asian countries had to borrow more from abroad (in the form of loans or government bonds), accept more foreign investment, or repatriate funds from their citizens living and working in other countries. This increased indebtedness and dependence on foreign financial resources made East Asian countries more vulnerable to external shocks, such as sudden changes in interest rates or exchange rates, and fluctuations in the global economy.

Large inflows of financial capital into East Asian countries led to several risks and vulnerabilities. First, they led to a surge in credit growth, which fueled asset price bubbles and overinvestment in certain sectors. When these bubbles burst, they resulted in severe financial crises. Second, large inflows of financial capital resulted in the appreciation of local currencies, which made exports more expensive and imports cheaper. This further widened the trade deficits and weakened the competitiveness of East Asian countries in global markets. Finally, the heavy reliance on foreign financial resources made these countries more vulnerable to sudden reversals in capital flows. When foreign investors pulled their funds out of these economies (as they did during the 1997 Asian Financial Crisis), it led to a sharp depreciation in local currencies and a wave of corporate and financial sector bankruptcies.

In conclusion, large trade deficits in the mid-1980s hurt East Asian countries by increasing their reliance on foreign financial resources, which made them more vulnerable to external shocks, currency fluctuations, and sudden reversals in capital flows. Furthermore, these large financial capital inflows fueled credit growth, asset price bubbles, and overinvestment, which eventually resulted in financial crises when the bubbles burst.