countries will face mounting pressure to achieve economic growth. Against this backdrop, these countries must increase domestic demand to offset the adverse effects from plummeting demand in foreign markets. In the long term, they need to consider changing their model of economic development.

Unlike emerging economies, South Korea and Japan have seen their financial systems badly hit by the U.S. financial crisis. With their deep involvement in the U.S. financial system, Japan's financial institutions have been severely affected. Japanese insurer Yamato Life Insurance Co. filed for bankruptcy with the Tokyo District Court on October 10, becoming the first Japanese financial institution to go under in the global financial crisis. The company's financial conditions have deteriorated in the wake of the U.S. subprime mortgage crisis, with liabilities totaling 269.5 billion yen ($2.7 billion). The Nikkei 225 stock market index dived 9.62 percent the day Yamato Life Insurance Co. declared bankruptcy, the biggest one-day loss since the stock market crash in 1987. Japan has a high savings rate and is the world's biggest creditor nation. Despite the financial turmoil, the exchange rate of the yen soared as capital poured into the country to avoid risks in the international financial market.

South Korea, with its excessive financial openness and relatively weak economic power, is the first Asian country to become mired in a systemic financial crisis. The South Korean won has depreciated nearly 30 percent since the end of last year, approaching the psychological benchmark of 1,500 won to the dollar at its lowest point. Many companies have collapsed due to the drastic fluctuations, forcing the South Korean Government to interfere with the exchange rate.

According to South Korea's central bank, the country's foreign exchange reserves have dropped for the last six consecutive months, from $264.24 billion at the end of March to $239.67 billion at the end of September, the first time since South Korea began reporting on its foreign exchange reserves in 1971. At the end of June, the country's external debts amounted to $268 billion. Some Western media have commented that South Korea might follow in Iceland's footsteps and experience a meltdown because of its foreign exchange shortage. Such comments may dampen confidence and further strain South Korea's foreign exchange market.

The future impact of the U.S. financial crisis on East Asia hinges on the following three factors: the depth and duration of the crisis, the economic transition of East Asian countries and their progress in establishing a regional cooperative mechanism.

Seeking a way out

Under heavy pressure from the U.S. financial crisis, South Korea is eager to step up East Asian financial cooperation to establish a foreign exchange fund with China and Japan.

The idea of the foreign exchange fund originated at the 10th ASEAN+3 Finance Ministers' Meeting, representing members of the Association of Southeast Asian Nations (ASEAN) plus China, Japan and South Korea, in Kyoto, Japan, in May 2007. At the meeting, the ministers suggested changing the Chiang Mai Initiative, which aims to create a network of bilateral swap arrangements to address short-term liquidity difficulties in the region, into a multilateral mechanism. They agreed on the size of the foreign exchange fund at their 11th annual meeting in Madrid, Spain, in May this year. The parties pledged at least $80 billion to the fund, with China, Japan and South Korea contributing 80 percent and ASEAN countries covering the remaining 20 percent. The fund is designed to help individual countries deal with their foreign exchange shortages and fend off the risks speculative capital poses to the region's financial system.

It seems that the fund, scheduled to be established next year, needs to materialize ahead of