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Asian Currency Crisis

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FIN 190

Asian Currency Crisis

The Asian currency crisis of 1996-97 brought to light the dangers of financing massive amounts of debt in a foreign currency which the domestic currency is pegged to. It also illustrated how developing countries are ill prepared to cope with such large scale financial issues. The projected continued growth in the Asian markets was built heavily on exaggerated predictions. Between 1990 and 1996 the area witnessed an exponential development period. Prior to the 90’s southern Asia countries exported predominantly textile based products at cheap prices. As the technology wave began to flourish demand for the components required began to rise and Asian countries took full advantage of the situation. They began exporting high amounts of electronics and tech components which brought in much higher revenue than the textiles of the past. The increases in export revenue sparked a building boom. This growth fueled commercial and residential property development, purchases of industrial assets and enhancements to infrastructure. All of this was built with borrowed money. Since the economic environment was expected to continue to get better borrowing was easy and the financial institutions were eager to lend money as fast as possible. Bold investments were made mainly to increase plant capacities. The idea was that if they could produce more they continue to derive the same levels of pricing. Indonesia, Malaysia, Thailand and South Korea were the countries that fueled this movement. These countries witnessed domestic investment growth rates increase by 16.3%, 16%, 15.3% and 7.2% respectively. Nearly all of these investments were financed. Indonesia, Malaysia, Thailand and South Korea, in their determination to increase production capabilities, did not account for the basics of supply and demand. Production capacities soared, flooding the market with goods. With such a level availability they caused the value of the products that were once very high to drop dramatically. The semi-conductor market for example, which fueled much of the technological market, saw its prices drop by as much as 90%. With prices falling below what was needed to support the cost of the financed production facilities companies began to default on their loans. As growth came to halt commercial and residential properties sat empty. Builders had ultimately created a five year supply of housing. With the buildings sitting empty and now no plans for further development, construction companies began to collapse one after another. This situation accelerated at such a rate that it could not be stopped primarily due to the over-extension of credit and the monetary policy of the aforementioned countries. All four countries had pegged their currencies to the dollar, and lent all the money in dollars. As the market disintegrated the governments could no longer support the pegged currency and each country went to a floating rate. Once on the open market the value of the currencies plummeted. Since all the lending was originally dispersed in dollars, consequently, it had to be repaid in dollars. The amounts that the companies had to repay increased as the currency values decreased. With massive amounts of now default debt the financial markets collapsed. Since many of the financiers invested between counties, and the countries operated they same monetarily, the problem spread throughout the region. The main four countries all followed the same economic policy as well, in which the governments steered private investment. Japan, although removed from the same governmental and fiscal mistakes saw their financial markets erode since some of their largest banks invested in the countries experiencing the financial devastation. As a result of the crisis, the economic development of these countries was halted. Prior to the boom, the countries were underdeveloped and very poor. The short lived expansion brought much wealth and a promise to the area. Foreign companies viewed the area as a place to invest in which created jobs and strengthened the economy. Asia was thought to be a great place to invest in. The collapse scared potential foreign investment away and set back the countries economically a decade or more. It reinforced the risk involved in investing in developing markets. Without foreign investment, the countries were forced to dig themselves out of a recession solely through their export industry. The area also lost many domestic companies due foreign acquisition when their values dropped. Most importantly the crisis affected the countries’ exchange rates. Once Indonesia, Malaysia, Thailand and South Korea released their currencies to the market they reached real market value. Exchange rates dropped by 50% or more for the four countries. Internal wealth was wiped away and the countries were once again quite poor. Some foreign trading partners were able to capitalize on the situation. The tech industry for example was able to purchase components for their products at substantially reduced rates. Assets of bankrupt companies were also able to be purchased at pennies on the dollar by those still willing to invest in the area. The crisis, and resulting exchange rate conditions, did negatively affect some U.S. markets. Since there was such an effort to increase infrastructure and industrial capacity, much of the heavy equipment was purchased from U.S. companies and financed through Asian banks. When the banks fell the U.S. companies were unable to collect on what they had sold resulting in less revenue than projected. The U.S. market is based off of projected earnings, and as earnings dropped due to the Asian collapse, the U.S. market did see a decline. To pull themselves out of the economic crisis the countries sought help from the IMF. It was the largest economic crisis the IMF had ever had to try and correct. The IMF issued $110B in short term loans the affected countries. With the loans came stern restrictions. In order to receive the loans the countries had to agree to the terms set forth by the IMF. The goal of the sanctions was to institute macro-economic policies to correct the issues. Some of the restrictions included reduced public spending, increasing interest rates and deregulation of government backed industries. The goal was to dissuade borrowing and create real growth with asset backed securities. This policy also helped to control inflation with rapidly declining currency values. One area of the globe which is likely to experience this same sort of economic disaster is Europe. If something is to happen it will begin with those involved in the European Union and subsequently spread throughout the rest of the region. When someone joins the European Union they give up their own currency, and ultimately the ability to control their currency. The monetary policy has to work across all nations. Greece is experiencing this problem now. Since they are involved in the union they cannot adjust monetary policy to help control the financial issues facing the country. As Greece struggles it holds back the value of the Euro. If the Euro continues to weaken the economy will as well. If the value of the Euro begins to spiral downward and interest rates are increased to slow the decline it will steer foreign investment away from the area. Since all of the countries in and out of the union are close to one another trade across borders is an important aspect of all the European countries. If the Euro declines those in the union will be unable to afford to purchase goods from non-union countries slowing the growth and overall economic health of the non-union countries. A collapse of the European Union economically could have severe global implications. The Asian crisis exemplifies the result of over-borrowing and excess capacity. A country cannot produce more than can be consumed and expect to remain in a growth status. Over extension of credit is what caused the U.S. financial crisis of 2008. The difference between Asia and the U.S. though is that Asian countries were still in the developmental stages, whereas the U.S. has a firmer base to rely on, and a stronger currency.

Works Cited
Hill, Charles. “The Asian Financial Crisis.” University of Washington.

Nanto, Dick. “The 1997-98 Asian Financial Crisis.” CRS Report for Congress.

Chowdhury, Abdur. “The Asian Currency Crisis.” The United Nations University. 1999

Bello, Walden. “IMF’s Role in the Asian Financial Crisis.” IFG News. 2003.

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