1997 Hong Kong Financial Crisis

FNCE 101 001

04/24/14
Group 2
Tianyu Guan, Tianran Hang, Tianni Lin, Yiran Zhang
Roadmap
Macroeconomic Overview
Analysis on Macroeconomic Issues & Policies Implemented
Exchange rate
Interest rate
Outcome of the Crisis
Macroeconomic Overview
Started in other Southeast Asia countries contagion
Thailand, Philippine, Malaysia, Indonesia, Taiwan, Hong Kong, South Korea
Hit Hong Kong on 23 Oct 1997
2 rounds of speculative attacks
Lasted until end of 1998
Pegged Exchange Rate
Since 1983
USD:HKD=1:7.8
Macroeconomic Overview
GDP growth rate decreased
Macroeconomic Overview
High inflation
Macroeconomic Overview
Consumer spending decreased
Macroeconomic Overview
Investment declined
Macroeconomic Overview
Housing bubble burst
Macroeconomic Overview
Interest rate skyrocketed
Macroeconomic Overview
Unemployment rate rose from 2% to 6%
Macroeconomic Overview
HKD Pegged to USD
HKD had been pegged at 7.8 to the U.S. dollar since 1983
Benefits
Eliminates exchange rate risks
Attracts foreign investors
Reasons of Overvalue of HKD
High Inflation compared to the US
Significantly higher inflation than US for a few years
HKD devaluation



Reasons of Overvalue of HKD (Contd)
Depreciation of Southeast Asian currencies
Southeast Asian currency (e.g. Thai baht) depreciation
Pegged floating
USD appreciation
HKD (pegged) appreciation
Underlying economic conditions unchanged
Overvalue of Hong Kong Dollar
Speculative Run on HKD
In October 1997, speculators, such as George Soros, initiated speculative attack
on HKD
Borrowed HKD
Converted HKD to USD at the overvalued exchange rate
Increased supply of HKD
HKMA had to spend reserves to maintain the demand of HKD
Speculative Run on HKD
Speculators idea:
Everyone wanted sell HKD.
HKMA needed to buy HKD, and
its reserves ran out quickly
Fundamental exchange rate
further decreased
Even more loss of reserves
occurred HKD devalues
profit from speculation
Speculative Run on HKD
Speculators assumptions
HKMA would run out of foreign exchange reserves
Declining export
Decreasing reserves
Speculative Run on HKD
Speculators assumptions
HKMA would run out of foreign exchange reserves
Little government intervention on its economy prior to the crisis
Chinese government was not likely to help out Hong Kong
Policy to combat the speculative attack
Pegged floating exchange rate
Thailand, Philippine, Taiwan
Foreign exchange reserve shortage
Policy to combat the speculative attack
Increase demand for local currency
Hong Kong Monetary Authority
More than US $80 billion in foreign reserve
Spent more than US$1 billion to defend the local currency
Chinese government guaranteed to maintain Hong Kongs economic stability
Interest rate skyrocketed
Interest Rate
Reasons of Increased Interest Rate
Increase of US interest rate
(1+i
HK
)=(1+i
US
)e
nom,t
/e
e
nom,t+1
Reasons of Increased Interest Rate
Currency board system

Second Round of Speculative Attacks
Short selling HK stocks
Double-play
Interest rate
15 Aug 1998
Overnight interests rate:
8% 23%
Briefly touching 280%
Second Round of Speculative Attacks
Heng Seng Index
1997 peak: 16,673 23 Oct 1997: 9,060 Oct 1998: 6,660
Policy to save the stock market
Government purchased US $15 billion of stocks
Owned 7% of stock market
Sell off in 1999
Tracker Fund of Hong Kong
US $4 billion profit
HKD still pegged to USD
All other Asian countries floating exchange rate
Outcome of the Crisis
Took 10 years to return to GDP level before the crisis
Outcome of the Crisis
Outcome of the Crisis
Deflation and then moderate inflation (~4%)
Risks of future currency crisis?
Lower inflation
No contagion risk
Successful defense of currency fended off speculative attacks
Outcome of the Crisis
Questions?