Primary causes and implications of the 1997 Asian currency crisis

Asian Currency Crisis

The objective of this work is to determine the primary explanations for the 1997 Asian currency crisis and to discuss implications of that crisis for the Asian economic paradigm.

PLAZA ACCORD (APPRECIATION of YET AGAINST DOLLAR)

The work of Hughes (1999) entitled: "Japanese Policy and the East Asian Currency Crisis: Abject Defeat or Quiet Victory" states that while Japan cannot be held as responsible for the model of growth of the East Asian states, at the same time "Japanese government policy and transnational corporations (TNC) undoubtedly have played a decisive role in instigating the process which has propelled this growth strategy. The role in the transfer of the developmental model to East Asia as well as economic integration of the region is known to have been "enhanced substantially following the Plaza and Louvre Accords of 1985 and 1987, designed respectively to raise the values of the yen and NIES-4 currencies against the U.S. dollar. The objective of the Plaza Accord and appreciation of the yen was to reduce the U.S.'s burgeoning trade surplus with Japan and to begin to force the latter to move away from its own export-oriented growth strategy, depend on the U.S. overseas market, and switch to reliance on domestic demand." (Hughes, 1999) the unintended and greatest impact of the Plaza Accord and the appreciation of the yen is stated to have been provoking "...a massive upsurge in Japanese investment in East Asia, as well as in the U.S. And Europe. The primary impact of the Plaza Accord is stated to be the release of "...huge flows of Japanese production capital into East Asia, which were to then circumvent U.S. efforts to rein in Japan's ability to conduct an export-led growth strategy." (Hughes, 1999)

II. LIBERALIZATION (BANK of JAPAN, FOREIGN LOANS)

Following the Plaza Accord the Bank of Japan was characterized by liberalization and specifically in the area of foreign loans and as well the Bank of Thailand followed the same course in lending. Entrepreneurs in Asia are noted in the work of Wong entitled: "Lessons from the Asian Financial Crisis relates that Asians are known to place a general trust in their governments for enactment of economic policies which are sound and "their failure to sense the dangers of borrowing short in foreign currency and investing in long-term projects with earnings denominated in local currency was disastrous." (Wong, nd) in July 1997 Thailand "ran out of foreign reserves and devalued the baht which lost over 1/2 of its value. Having admitted the total loss of foreign reserves, there was a run on the bank of Thailand and this quickly spread to Malaysia, Indonesia, the Philippines, South Korea, Singapore and Taiwan. Attempts of the International Monetary Fund to assist these countries was not successful with too small a bailout package at too late of a date.

III. KIERETSU - EXPORT of CAPITAL

The work of Ouandlous and Philippatos entitled: "The Effect of Japanese Financial Liberalization on Keiretsu, the Main Bank System, and Japanese Corporate Financing: Evidence for 1972-1992" relates that: "Critics of the Japanese financial system have long held that Japanese keiretsu and the Main Bank system have helped Japanese corporations reduce their cost of capital and therefore gain a cost comparative advantage over their western counterparts. These institutional practices, claim critics, have limited the access of foreign firms to the Japanese product and financial markets. From the mid-1980s onwards, the evidence shows that Japanese financial liberalization has not only reduced the financial influence of these institutions, but has had a varied impact on Japanese corporate flow-of-funds patterns and on Japanese corporate size." (1999) Ouandlous and Philippatos state that the groups which comprise the keiretsu are the most influence and powerful firms "defined by either the size of their assets or by the size of their domestic market share..." And "...have reciprocal ownership interests and close financial ties with the largest city banks." (1999) at the core of each grouping of keiretsu is "a large and powerful bank..." with the role "in addition to being stockholders, is to participate in the financing of the keiretsu member firms." (Ouandlous and Philippatos, 1999) When financial liberalization began to take effect between 1975 and 1985 "...corporate financial deficits reversed their precarious course and dropped sharply to an annual low of 2.9%. Increasing government fiscal deficits, the impact of the oil crisis, the inflation that ensued, the slow economic growth, and the concomitant effect of the deregulation of financial markets initially caused this drastic drop. In the following three years this financial deficit declined further to reach an annual average historical low of 1.8%." (Ouandlous and Philippatos, 1999)

IV. END of BUBBLE ECONOMY

Ouandlous and Philippatos report that corporate financial deficits in the Japanese economy began to show an upward trend in the period between 1985 and 1990 and that "the full effect of liberalization of financial markets and recent Japanese economic recession - the cause of which includes the appreciation of the yen and the 'bubble' economy in which assets prices have soared to gargantuan proportions - explains to a large extent the decline in the corporate deficit on the early 1990s. " (1999)

V. FOREIGN BANKS LENDING EXPANDS

The 1987 Plaza Accord result in the dropping of the value of the U.S. dollar and "ushered in a new era of the appreciating Yen. This led to a six-year cycle of Japanese investment in Asia that transformed and expanded the industrial base for Malaysia, Indonesia, and Thailand." (Wong, nd) During this time the Bank of Japan was writing off bad debts in the banking system following the bursting of the asset bubble and pursued a low interest rate policy focused on bank solvency. Unusual risks were taken by the banks lending to the Asian economies in seeking high yields seeking a resolution to their own debt problems. According to Wong, "Foreign banks and other institutional investors from Europe and later the United States, all flush with funds, soon discovered Asia's emerging markets, where interest rates were high and risk was low because currencies were pegged to the U.S. dollar." (Wong, nd) This financial business environment "led to a five-year boom with Asian equities. As the Asian economies grew, infrastructure bottlenecks became apparent." (Wong, nd) Not only were these banks "effecting currency and maturity mismatches, these banks often extended loans without adequately assessing credit risks." (Wong, nd) Wong relates that by 1995 the.." era of the strong yen was being replaced by the era of the strong U.S. dollar and a number of Asian economies were slowing down and experiencing current account deficits." (Wong, nd)

VI. 1994 - CHINA: DEVALUATION of CURRENCY

In 1994, China devalued its currency by 35% and extended a 17% rebate to exporters in order to stimulate growth in exports. Resulting from the devaluation of China's currency was an exacerbation of problems throughout Asia.

VII. 1995-96 -MINI-RECESSION, DEBT PROBLEM, ACCUMULATION

In the summer of 1995, the reversal of the chronic weakness of the dollar resulted in the depreciation of the Japanese yen, which had been approaching an acute deflationary crisis with a steep fall in the stock market. (Makin, 2000; paraphrased)

VIII. 1996-97 - DEBT / FOREIGN EXCHANGE, RESERVE RATIONS DETERIORATE

The work of Williamson (1999) entitled: "Implications of the East Asian Crisis for Debt Management" relate that a countries debt can be viewed from four different external perspectives in terms of debt composition which include: (1) FDI; (2) Portfolio Equity; (3) Long-term loans; and (4) short-term loans. This is the ideal composition of a countries debts however the debt profile of countries in East Asia are known to profoundly differ from the foregoing profile in that they had too much short-term debt relative to long-term debt and as well too much debt as compared to equity.

IX. 1997 JULY 2ND - CURRENCY CRISIS EXPANDS FROM THAILAND INTO EAST ASIAN COUNTRIES

On July 2, 1997 the devaluation of the Thai baht shocked the already struggling economies in the East Asian countries. This devaluation was an attempt to "defend an overvalued almost-fixed exchange rate even though much foreign debt had accumulated, the current account was in substantial deficit, and export growth had turned negative. This invited a series of speculative raids, which eventually exhausted the reserve stock and led to devaluation..." (Williamson, 1999) with an effect on the solvency of the financial system and the corporate sector that was devastating and only intensified the crisis. The economies of the East Asian countries attempted to conceal the problems by borrowing from the banks. The International Monetary Fund issued an ultimatum to South Korea which included: (1) cuts in domestic government spending; (2) doubling of unemployment from 4% to 8% (3) closure of twelve government-owned banks; (4) restrictions on foreign ownership of Korean banks to be terminated; (5) foreign firms would be allowed full access to the Korean government bond market; (6) foreign firms would be allowed a 100% share in top Chaebol firms, a jump from 25% previously; (7) Foreign firms must be allowed full access to insurance; and (8) the government chaebol link would be more transparent.

X. EXPLANATION of the ASIAN CRISIS

The Asian currency crisis has been described from the mainstream view, or that of 'cronyism' to be in the nature of a moral hazard illustrated by the fact that the East Asian businesses attempted to hide the expansion of foreign debt and over-extension of credit. Additionally explanations have been given which state over-liquidity and under-regulation combined with speculation in the financial markets explain the Asian Crisis. The work of Wade (1998) relates that it is agreed among most that "the sharp pullout of funds by investors across the region was the trigger, and that the pullout was panicky." (Wade, 1998) Furthermore, liberalization "permitted domestic agents to raise finance on foreign markets and gave foreign agents access to the domestic financial market." (Wade, 1998) Furthermore, liberalization results in governments giving up their capacity to coordinate foreign private borrowing. Due to a surge in investment in the region productivity and profits suffered and marginal companies were putting more and more investment into speculative and non-tradable ventures such as property and land. Wade states that the "whipsaw movement of capital inflows and outflows is the main proximate cause of the crisis." (1998) Things were made worse by the International Monetary Fund who misdiagnosed the problem "as a macroeconomic balance-of-payments problem rather than as a microeconomic debt inflation problem, and as a crisis of excess consumption rather than excess investment..." And finally the IMF's insistent on a "domestic austerity package and on fundamental structural reforms in return for bailout funds." (Wade, 1998) This reinforced the image of 'cronyism'. Wade relates that avoidance of these types of crises in the future requires integration of national economies even more fully into world capital markets." (Wade, 1998) Chalmers Johnson states that the crisis was caused "much more by under-regulation than by corruption or any other side effects of an overly close relationship between businesses and the government." (1998) Greater transparency and openness is stated to be a requirement in avoiding Asian type crises. Furthermore it is necessary that shareholders get a better deal and that a return on equity be more closely attended to. It will be necessary to break the grip of cronyism in countries such as Japan. Wong states that the crisis can be attributed to specific factors which include: (1) Banks in Japan and Europe were glad to lend overseas due to economic recession and the high profits of Southeast Asia; (2) the long-standing economic boom and low interest rates in the U.S. markets released a torrent of funds seeking higher yield in emerging markets; (3) the emergence of China as a major exporting nations in the region contributed to the worsening current account balance of some Southeast Asian economies; (4) the confidence of many Asian leaders eager to push their development plans with no regard for economic fundamentals and to use the liberalized financial markets in growing instant international financial centers was undertaken too early with the urge of international agencies, bankers and investors; and (5) Corrupt practices, outdated banking rules and weak supervision left many of the Asians ill-prepared to handle the flooding of foreign funds in a global capital market. (nd) it is certain that the common interests of the government and banking sectors is likely the most prominent contributor to the currency crisis in the Asian countries.