Asian Crash 97--model for U.S. Crash

Overview:

The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.^[1]

Though there has been general agreement on the existence of a crisis and its consequences, what is less clear were the causes of the crisis, as well as its scope and resolution. Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. The People's Republic of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.

Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993-96, then shot up beyond 180% during the worst of the crisis. In Korea, the ratios rose from 13-21% and then as high as 40%, while the other Northern NICs (Newly Industrialized Countries) fared much better. Only in Thailand and Korea did debt service-to-exports ratios rise.

Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced to step down in May 1998 in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In the Philippines growth dropped to virtually zero in 1998. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover.^[3]

^History

Until 1997, Asia attracted almost half of the total capital inflow from developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced high growth rates, 8-12% GDP, in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including the IMF and World Bank, and was known as part of the "Asian economic miracle".

The causes of the debacle are many and disputed. Thailand's economy developed into a bubble fueled by "hot money". More and more was required as the size of the bubble grew. The same type of situation happened in Malaysia, although Malaysia had better political leadership^{[citation needed]}, and Indonesia, which had the added complication of what was called "crony capitalism".^[5] The short-term capital flow was expensive and often highly conditioned for quick profit. Development money went in a largely uncontrolled manner to certain people only, not particularly the best suited or most efficient, but those closest to the centers of power.^[6]

At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s, two factors began to change their economic environment. As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had attracted hot money flows through high short-term interest rates, and raised the value of the U.S. dollar, to which many Southeast Asian nations' currencies were pegged, thus making their exports less competitive. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

Some economists have advanced the impact of China on the real economy as a contributing factor to ASEAN nations' export growth slowdown, though these economists maintain the main cause of the crises was excessive real estate speculation.^[7] China had begun to compete effectively with other Asian exporters particularly in the 1990s after the implementation of a number of export-oriented reforms. Most importantly, the Thai and Indonesian currencies were closely tied to the dollar, which was appreciating in the 1990s. Western importers sought cheaper manufacturers and found them, indeed, in China whose currency was depreciated relative to the dollar. Other economists dispute this claim noting that both ASEAN and China experienced simultaneous rapid export growth in the early 1990s.^[8]

Many economists believe that the Asian crisis was created not by market psychology or technology, but by policies that distorted incentives within the lender-borrower relationship. The resulting large quantities of credit that became available generated a highly-leveraged economic climate, and pushed up asset prices to an unsustainable level.^[9] These asset prices eventually began to collapse, causing individuals and companies to default on debt obligations. The resulting panic among lenders led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies. In addition, as investors attempted to withdraw their money, the exchange market was flooded with the currencies of the crisis countries, putting depreciative pressure on their exchange rates. In order to prevent a collapse of the currency values, these countries' governments were forced to raise domestic interest rates to exceedingly high levels (to help diminish the flight of capital by making lending to that country relatively more attractive to investors) and to intervene in the exchange market, buying up any excess domestic currency at the fixed exchange rate with foreign reserves. Neither of these policy responses could be sustained for long. Very high interest rates, which can be extremely damaging to an economy that is relatively healthy, wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis.

JK’s condensation in larger print

Other factors contributing were the herd behavior of investors fleeing a falling market, and the handing over of Hong Kong sovereignty on July 1, 1997, which provide new investment opportunities thus exacerbating economic conditions—the Thai baht was devaluated on July 2, 1997.

The IMF stepped in with financing to stay avoid defaults; however, the series of bailout packages had conditions attached to them that implemented the neoliberal agenda. (In other words, the IMF's support was conditional on a series of drastic economic reforms influenced by neoliberal economic principles called a "structural adjustment package" (SAP). The SAPs called on crisis-struck nations to cut back on government spending to reduce deficits, allow insolvent banks and financial institutions to fail, and aggressively raise interest rates. nsolvent institutions had to be closed, and insolvency itself had to be clearly defined. In short, exactly the same kinds of financial institutions found in the United States and Europe had to be created in Asia, as a condition for IMF support. In addition, financial systems had to become "transparent", that is, provide the kind of reliable financial information used in the West to make sound financial decisions.^[13]) [By letting the institutions fail and removing restrictions on foreign institutions, this permitted the taking over of much of the financial markets by the globalizers—jk comment.]

However, the greatest criticism of the IMF's role in the crisis was targeted towards its response.^[14] As country after country fell into crisis, many local businesses and governments that had taken out loans in US dollars, which suddenly became much more expensive relative to the local currency which formed their earned income, found themselves unable to pay their creditors. The dynamics of the situation were closely similar to that of the Latin American debt crisis. The effects of the SAPs were mixed and their impact controversial. Critics, however, noted the contractionary nature of these policies, arguing that in a recession, the traditional Keynesian response was to increase government spending, prop up major companies, and lower interest rates. The reasoning was that by stimulating the economy and staving off recession, governments could restore confidence while preventing economic pain. They pointed out that the U.S. government had pursued expansionary policies, such as lowering interest rates, increasing government spending, and cutting taxes, when the United States itself entered a recession in 2001.

Although such reforms were, in most cases, long needed, the countries most involved had ended up undergoing an almost complete political and financial restructuring. They suffered permanent currency devaluations, massive numbers of bankruptcies, collapses of whole sectors of once-booming economies, real estate busts, high unemployment, and social unrest. For most of the countries involved, IMF intervention had been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis, that many locals called the financial crisis the "IMF crisis".^[15] To begin with, many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of the financial sector (elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.^[14] In other words, that the IMF itself was the cause.

Thailand:

On 14 May and 15 May 1997, the Thai baht was On 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the U.S. dollar, against international speculators. Thailand's booming economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge numbers of workers returning to their villages in the countryside and 600'000 foreign workers being sent back to their home countries.^[16] The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the largest Thai finance company until then, collapsed.^[17]hit by massive speculative attacks. On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the U.S. dollar, against international speculators. Thailand's booming economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge numbers of workers returning to their villages in the countryside and 600'000 foreign workers being sent back to their home countries.^[16] The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the largest Thai finance company until then, collapsed.^[17]

ISSUE:

The U.S. given the size of its economy is beyond being bailed out. The Thai government received from the IMF $20.9 billion; the U.S. needs trillions. Unlike that of Thailand, the principle developed nations are already heavily exposed in the U.S., and are unlikely to assume further risk (such as buy U.S. treasury notes, for which there are over $10 trillion currently out. Further drop in the U.S. dollar will permit the rolling over of those notes as they mature. The alternative of raising interest rates would while attracting foreign currency would further slow the economy. The falling dollar makes the repayment of debt more expensive. To repay a 1 million Euros borrowed 2 years when both currencies were at par would not require 1.4 million dollars.

The consequences included a reduction of the GDP of the 3 hardest hit nations by 31.7%, many businesses collapsed, and millions of people fell below the poverty line. Long term between 1997 and 2005, as reported by the CIA Factbook, there was a decline of per capita income: Indonesia from $4,600 to $3,700; Mayaysia from $11,100 to $10,400. Over the same period world per capita income rose from $6,500 to $9,300 in that period (assuming we can trust the CIA). The economy in 2005 in Indonesia is smaller in 2005 than it was in 1997, and there population has grown.

Similar shocks occurred in Russia in 1998, Brazil and Argentina in the late 1990s. There was a property bubble in Japan in the 1980s for which their economy has not recovered. Many Latin American countries have defaulted on their debts in the early 1980s.

The results of deregulation are to turn the forces for short-term profits and market manipulation loose. The U.S. experienced panics in 1819, 1825, 1837, 1857, 1873, 1893, 1901, 1897, 1929, and 2008--those of 1837, 1873, and 1927 were the worse.

Counter to common belief the depression of 1929 did not start with the stock market crash. Economic contractions broke the speculative bubble for which the Dow did not return to the 1929 high until 1954. The Dow went from a high of 381 on September 3^rd 1929 to a low of 198.6 on November 13^th, then to rebound to 294 in April, but thereafter to steadily decline to 41 on July 8^th 1932, a decline of 89% from its peak. In 1929 there was $8.5 in loans, more than the entire amount of currency circulating in the U.S. Stocks were leveraged at more than 70%. The price earnings ratio peaked at 32.6,

As a result of investigation into the crash Congress passed the Glass-Steagall Act of 1933, which mandated separation of banking from financing. The Glass Stegall Act established the Federal Deposit Insurance Corporation (FDIC). Senator Gramm of Texas McCain’s financial advsor) in the Gramm-Leach-Bliley Act (November 1999) over rode a clause in that act which prohibited bank holding company from owning other financial companies. Banks did not begin until January of 1933, which occurred under the lame duck Hoover administration. The Glass Stegall act was designed to separate commercial and investment banking. Congressional hearings revealed conflicts of interests and fraud in banking institutions with securities activities.

The first mistake occurred under Reagan with two acts that deregulated the Savings and Loan industry.

The repeal of the clause in November of 1999, enabled commercial lenders such as Citigroup, the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. ^[11] Citigroup played a major part in the repeal. Then called Citicorp, the company merged with Travelers Insurance company the year before using loopholes in Glass-Steagall that allowed for temporary exemptions. With lobbying led by Roger Levy, the "finance, insurance and real estate industries together are regularly the largest campaign contributors and biggest spenders on lobbying of all business sectors [in 1999]. They laid out more than $200 million for lobbying in 1998, according to the Center for Responsive Politics..." These industries succeeded in their two decades long effort to repeal the act.^[12]

The argument for preserving Glass-Steagall (as written in 1987):

1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The Crash of 2008 proves the wisdom, again of the act which separated banking and security speculating, or at least of having regulatory oversight. (Mortgages were sold in bundles as a commodity.)

Influx of foreign capital fueled speculative bubble.

Lack of regulation of the markets and banking.

High debt to GDP ratio

Undercutting of the manufacturing foundation by China

Instability fueled and attractive other market fueled the funds leaving