The Asian Currency Crisis

The Asian Currency Crisis started when Thai businesses began to default on the loans they took out in order to finance investments in commercial and residential. Excessive investment in property resulted in an oversupply of available real estate . Because the investors were unable to make any profit on the surplus real estate they could not pay the loans they took out from Thai financial institutions. It was feared that because the investors were unable to pay the Thai institutions that in turn the Thai lenders would default on their loans from international banks. As a result of this speculation, foreign investors fled the Thai stock market selling their positions and converting them to dollars This led to an increased demand for U.S. dollars and an increased supply of Thai Baht which pushed down the dollar/baht exchange rate and caused the Thai stock market to plunge The dollar to baht exchange rate dropped from $1 = Bt 25 to $1 = Bt 55 by January of 1998 as the Thailand stock market index declined from 787 in early 1997 all the way down to 337 by the end of the year. The wave of speculation spread to other currencies causing them to be marked lower as well which resulted in an explosion of debt throughout the region and hence an Asian Currency Crisis. The crisis was the result of a few factors which when combined ended up creating a deadly arrangement. The first of the major causes for the crises was the previous decade of unprecedented export driven grown experienced by the countries of Southeast Asia. Export grew so much and was so successful from 1990 to 1996 that investors even began to make the transition from exporting basic materials to exporting more technical. Specifically, the value of exports from Thailand had grown by 16 percent per year, Malaysia had grown by 18 percent annually, Singapores exports grew by 15 percent, Hong Kongs by 14 percent and South Korea and Indonesias exports grew by 12 percent annually . The high level of success in exports thus encouraged bolder investment and led to an investment boom in commercial and residential property, industrial assets and infrastructure. In particular gross domestic investment grew by 16.3 percent annually in Indonesia, 16 percent in Malaysia, 15.3 percent in Thailand and 7.2 percent in South Korea in the years 1990 to 1995. In certain Southeast Asian nations the governments encouraged investment in certain areas of the economy in order to reach national goals and as part of the industrialization strategy. For example, South Korea urged investment in new factories to boost growth but these diversified conglomerates borrowed heavily, some of them creating debts up to four

times their equity . In Indonesia crony capitalism prevailed in the economy limiting competition through the creation of monopolies. Banks in Indonesia as a result were forced to give loans for potentially risky investments such as auto production. The overarching theme here is that the mid 1990s investment boom was financed with borrowed money and gross domestic investment in the countries of Southeast Asia was higher during this time period than in any other. As the number of investments continued to increase, the quality of investments began to decline. To make matters worse, many of these long term investments were carried out using short term loans. Eventually these investments which were made based on unrealistic projections of future demand conditions resulted in significant excess capacity. Excess capacity resulted in plunging prices on everything from property to semiconductors. Another major factor behind the crisis was the fact that the countries of Southeast Asia had pegged their currency to the US dollar. Investors borrowed in US dollars because interest rates on dollar borrowings were less than rates on domestic currency. Unfortunately, as excess capacity began to drive prices down, the governments of the affected countries could not maintain the dollar peg and their currencies started to depreciate against the dollar. This was not helped by the fact that inflation was higher in Southeast Asia than the U.S. This drove up the debt burden when measured in local currency and resulted in companies defaulting on debt due to even higher borrowing costs. The expanding of imports was also a factor in the crisis especially since the expansion in imports came with a decline in the selling of exports in 1996 as China emerged as a major exporting nation in the region. Following a period of export led growth, the nations of Southeast Asia had been investing in foreign goods at unprecedented rates causing their current account deficits to increase which made it even more difficult for them to maintain their currencies against the U.S. dollar as they lacked the currency reserves to intervene to keep the market from raising or lowering the rates. Moreover, all of the borrowing in dollars and importing of goods created an extensive supply of Southeast Asian currencies in the hands of foreigners which was extremely problematic as the currencies began to fall against the dollar and demand for anything but Southeast Asian currency increased . The damage to the Asian economies caused by this financial tsunami was devastating. Property and goods were devalued and left unsold due to over supply , prices plunged, unemployment increased, debt grew and local currencies depreciated relative to the dollar while inflation increased. Some countries in an effort to maintain the dollar peg exhausted or nearly exhausted their foreign exchange reserves. Moreover, investors from other countries pulled out of deals and as a result the stock markets of the affected countries

crashed. This all led to a significant drop in economic growth measured by GDP in the years following the crisis. Specifically, by 1998 GDP fell 11 percent in Thailand, 8 percent in Malaysia and 13 percent in Indonesia. Moreover, the crises resulted in political turmoil in some countries such as Indonesia As for the rest of the world, the Asian Currency Crisis led to downward pressures hitting other foreign currencies such as the Brazilian real (World Bank, 1998). Asia's problems had an effect on markets in Russia, Latin America, Europe, and the United States (World Bank, 1998). In fact, the US economy was greatly affected by the crisis as was demonstrated by the roughly 7% drop in the Dow Jones industrial in October of 1997 and the fact that the New York Stock Exchange even suspended trading for a short time which in turn resulted in a decrease in consumer spending . Even Japan, the strongest economy in Asia at the time of the crisis, and the largest holder of currency reserves experienced a slow in economic growth following the crisis and Russia underwent a financial crisis in 1998 that likely would not have occurred had it not been for the Asian Crisis which reduced the price of oil and made international investors even more reluctant to lend to developing nations (World Bank, 1998). The only country that seemed to really benefit from the crisis was China which was able to make economic gains due to the losses of other Asian nations though it did temporarily experience a decrease in economic growth. Some Southeast Asian nations have still not fully recovered from the effects of the currency crisis though conditions have improved. The crisis was resolved for the most part through action taken on behalf of the IMF, which provided emergency loans to countries such as South Korea, Indonesia, Thailand and Malaysia so that they would not default on all of their international financial obligations . Specifically, the IMF put together a 37 billion dollar rescue package for Indonesia, a 17.2 billion dollar package for Thailand and a 55 billion dollar package of loans for South Korea. In return for the loans each of the nations had to adopt certain practices which the IMF believed would foster a return to economic growth. The IMF asked that the affected nations cut public spending, raise taxes, raise interest rates, deregulate certain sectors to allow competition, privatize state owned assets and improve financial reporting overall . Unfortunately , in several nations all these requirements did was worsen the economy by causing an increase in unemployment and further recession so really those nations that received aid from the IMF are the ones who continued to suffer in the aftermath of the crisis. The IMF as a result has come under much criticism for the effectiveness of its policies. The IMF and its supporters consider its efforts in the Asian Currency Crises a success because with out the intervention of the IMF, they believe the

crises would have continued to spread and the after effects would have been much worse. Nevertheless, the IMF is reviewing its policies should it need to step in to curb another economic crisis which is unfortunately a very real possibility. Even after the lessons of the Asian Currency Crisis there still remains the chance that another crisis could occur. This is due to the fact that despite the many warnings and past economic crisis, some nations continue to carry out reckless economic policies. What is even more frightening is the fact that such an economic crisis could happen to even to the worlds largest economic superpower, the United States. The pattern of economic growth the United States has experienced of late is eerily similar to that of the Southeast Asian nations. The U.S. had a period of export led growth through which it generated a high level of income that could be used for international investment. Resultantly, the United States began importing most of its goods as the spread of globalization or the increased opening of markets has increased market competition making it cheaper for the United States to import rather than to produce and export goods. Due to this increase in international investment which is sending U.S. dollars abroad, the U.S. currently has a current account deficit of nearly 800 billion dollars which is the largest current account deficit it has ever had. This means that there are more dollars in the hands of foreigners than ever before. As long as the US keeps buying foreign goods and those foreigners invest dollars in the United States everything will be fine, but should they stop investing the dollars back in the US, that is where the problems will arise. For instance, should someone speculate the downfall of the dollar or should one nation such as China suddenly want to sell all of their dollars, or stop investing in the United States the supply of the dollar would be so large that demand for the dollar will fall and the demand for other currencies will rise therefore resulting in a devaluation of the dollar in relation to another foreign currency or currencies. A devaluation of the dollar to due over supply could be devastating to the US economy and could throw the United States into a currency crisis or at least in to a recession. Ironically, nations such as Japan and China are now less vulnerable to a currency crisis because they both have a current account surplus and have taken steps to build up their foreign currency reserves following the lessons of the past. Other than the United States, any nation which holds a current account deficit, pegs its currency to another (making it susceptible to exchange rate risk), lacks foreign reserves, borrows too much money over the short term, or makes a large number of investments with an inaccurate forecast of future demand and supply logistics, is vulnerable to a currency

crisis. The United States and other nations with any of these characteristics would be wise to remedy them as soon as it is fiscally possible.