East Asian Currency Crisis, 1997

Presented by

Irene Saldanha Josh Brubaker Raj Debnath Troy Montgomery

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Why is this relevant

Why talk about a crisis thats over now? Anything we should learn from this?

Once upon a time.

Summer of 1997 Bangkok, Thailand, East Asia

Before it started
From 1985 to 1996, growth rate averaging almost 9% annually - increased pressure on Thailand's currency, the baht From 1985 until July 1997, Baht was pegged at 25 US$

What happened in Thailand

Mid-May 97: Thai Baht was hit by massive speculative attack Spark: End-June 97, Thai Prime Minister declared that he would not devaluate the Baht Thai Government failed to defend the Baht against International speculators

Financial Crisis hits.

What happened in Thailand

Booming Thai Economy ground to a halt, contracted by 1.9%

Massive lay-offs in Finance, Real Estate & Construction: unemployment rate all-time high
Huge numbers of workers returning to their villages in the countryside and 600,000 foreign workers sent back Stock market dropped 75%, Finance One collapsed Baht reached 56 US$ in Jan 98
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Who were hit

Primary Casualty: Thailand, Indonesia, South Korea Fairly hurt: Hong Kong, Malaysia, Laos and Philippines Most Asian countries currencies fall significantly relative to the US$ Fear of Financial Contagion, Globally

What happened in Indonesia

Drastic devaluation of the rupiah: from 2,000 to 18,000 for 1 US$ Sharp price increase

Wake of widespread rioting: 500 deaths in Jakarta alone

Governor, Bank Indonesia was sacked President Suharto was forced to step down in May 1998 after 30 years in power
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What happened in S.Korea

Drastic devaluation of the won: from 1,000 to 1,700 for 1 US$ Credit rating of the country (Moodys): A1 to B2 National Debt-to-GDP ratio more than doubled Major setback in Automobile industry

What happened in Philippines..

Growth dropped to virtually zero in 1998 Peso fell significantly, from 26/US$ to even 55/US$ President Joseph Estrada was forced to resign

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What happened in Japan

40% of Japans export go to Asia, so it was affected even if the economy was strong
Japanese Yen fall to 147 as mass selling began GDP real growth rate slowed from 5% to 1.6% Some companies went Bankrupt Being worlds largest currency holder, Japan could bounce back quickly
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What happened in US...

Markets did not collapse, but were severely hit NYSE briefly suspended trading, for the first time Dow Jones Industrial Average suffered as 3rd biggest point losses ever Relationship with Japan changed forever: US stopped supporting the highly artificial Trade environment and Exchange Rate

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Why it happened Part 1

Lets hear to what Paul Krugman was trying to say since 1994 "Asian economic miracle.. Result of capital investment (high interest rate to attract foreign investment) Growth in productivity, without much improvement in Total Factor productivity needed for long-term prosperity
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Why it happened Part 2

Bubble Theory
bubble fueled by "hot money More and more was required as the size of the bubble grew short-term capital flow was expensive and often highly conditioned for quick profit Development money went in a largely uncontrolled manner to people closest to the political power
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Why it happened Part 3

Real Estate Speculation
Excessive real estate speculation

Chinese effect
Competition from China due to its export-oriented reforms in 90s

Western importers found cheaper manufacturers in China whose currency was depreciated relative to the US$
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Why it happened the Complete Story

Policy that distorts the incentives within the lender-borrower relationship
Artificially high Interest rate to attract investors Large quantities of available credit Highly-Leveraged economic climate Asset prices pushed up to unsustainable level, and eventually collapse Default on Debt obligation Panic among Lenders Large withdrawal of credit Credit crunch and further bankruptcies Depreciative pressure on credit rates Potential Collapse of the market

Government enters..
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Why it happened the complete story

Policy that distorts the incentives within the lender-borrower relationship (continued)
Government is forced to raise Domestic interest rate to exceedingly high Economy becomes more fragile
Government buys excess domestic currency at fixed exchange rate Hemorrhaging foreign reserves of central banks Tide of fleeing capital does not stop Authority ceases to defend fixed exchange rate Currency floats and depreciates Foreign currency-denominated liabilities grew substantially domestic currency terms) More bankruptcies Further deepening of the crisis

(in

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Can we explain this

Lets assume that foreign investors buy Thai Bond when they invest Exceedingly high interest rate attracts more such investment So Bond Demand > Bond Supply and Money demand < Money Supply Equilibrium is disturbed when Interest rate is pushed to artificially high, higher than the optimum rate r* With higher rate r, M/p (Money/price) decreases Asset price falls Govt increases Interest rate
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Why Relevant.
Mistakes:

Goals of raising interest rates, ideally:

economic growth to combat unemployment and inflation to cool an otherwise overheated economy Contractionary Policy

Incorrect Monetary Policy, artificially raising the Rate of Interest to exceedingly high Fiscal Policy related problem: incorrect distribution of wealth
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Before we close
Lets see what happened to our Thai friends
IMF unveiled a $17 billion rescue package, and another bailout package of $3.9 billion
subject to conditionality for reorganizing and restructuring, establishing strong regulatory frameworks

Tax revenue balanced the budget in 2004, 4 years ahead of schedule Baht reached 33/US$ by 2007
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Questions?
References:
Miles, Scott, Understanding the Wealth of Nations Krugman, Paul: The Myth of Asia's Miracle: A Cautionary Fable Palma, Gabriel: The Three Routes to Financial Crises

Hughes , Helen: Crony Capitalism & East Asian Currency Financial Crises
Bello, Walden: IMF's Role in the Asian Financial Crisis Yellen, Janet: The Asian Financial Crisis Ten Years Later Wikipedia.com newschool.edu

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