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The Asian Financial Crisis



     

    Indice
    1.
    Introduction

    2. Bibliography

    1.
    Introduction

    For quite an extensive period Indonesia, Korea, Malaysia
    and Thailand had a stable growth and their economic data such as
    inflation, fiscal
    position, and increase in exports showed solid perspectives to
    the foreign investors. Consequently, it would be accurate to
    state that not many economic agents anticipated the financial
    Asian crisis to
    occur.
    Moreover, it is relevant to understand what the causes of the
    Asian economic currency and financial crises of 1997-1998 were?
    To address this question, we will have to acknowledge two main
    factors that were taking place prior the crises. These were a
    lack of transparency, which made the investors and economical
    agents assume an Asian financial stability, and mislead
    structural and economic policies, which did not attempt to solve
    deficits in the balance of payments and debt tribulations.
    The following will rely on four main proposals of what should
    have been done by the policy makers in each stage of the
    financial crisis. The four proposals are: tax for outflow of
    shot-term capital, a
    fixed spread for the financial institutions that will apply only
    in the short term, a dirty exchange rate that will apply only the
    short term as well and an improvement of financial
    transparency.
    The Asian financial crisis took place in 1997, which had an
    evolution that started mainly in the 90’s in countries such
    as South Korea, Thailand, Indonesia and Malaysia. These countries
    experienced a rapid international debt boost, due to shorter
    payments dead line. Thus, the international debt of North Korea,
    for instance, increased from 31.699 million dollars in 1990 to
    164.345 million at the end of 1996. Thailand increased from
    28.088 million dollar debt to 90.622 million in the same period.
    The short-debt represented 31% of the total debt in 1990 for
    South Korea, yet in 1996 it represented 67% (world bank report).
    Most parts of this debt was involved in the private sector.
    Without a doubt, this short-term debt represented one of the main
    reasons, which led to the financial crisis to occur. Furthermore
    it would be precise to say that Lawrence, Lincoln, Furman and
    Stiglitz agree that this factor was one of the main causes of the
    crises.
    This high short-term debt occurred because the Asian private
    entities offered a high short-term interest rate, which made the
    investor locate their capital in those institutions, due to the
    high return of investment. The second reason was that the
    exchange rate responded to a fixed system, meaning that the
    investors would not lose any funds in the conversion of one
    currency to another, as they withdraw their funds and take them
    back to their own country. This situation made the banks
    experience a deficit balance, which reflected high payouts to the
    investors and not enough assets to make the accounts balance. In
    addition the stabilization agencies were not aware of the
    financial condition of the banks, which enable them to decrease
    the magnitude of the crisis.
    Therefore, it seems clear that the financial system needed
    resources, which could provide them some oxygen until they could
    achieve to equalize their liabilities and assets. It also seems
    clear that the Asian banks needed a longer period to reimburse
    their liabilities. Yet, in order to achieve this task, the first
    approach that comes to mind is an increased in interest rates for
    long-term investments and a decrease in interest rates for
    short–term. Nevertheless, this strategy was already
    applied, but it did not bring the results that were expected. The
    explanation of this fact is that once the interest rates change,
    another factors such as exchange rate, money supply, and exports
    change as well. Additionally, several actors such as the Central
    Bank, the government and the market determine the interest rates,
    which makes the transition from a lower interest rates to a
    higher interest rates complicated because these entities would
    have to agree with each other.
    Moreover, if the interest rates go up the market will suspect a
    weakening in the financial system. According to Furman and
    Stiglitz an increase in the interest rates represents "a signal
    of lack of confidence". The consequences of this mechanism (an
    increase in interest rates) could be even more striking than
    staying with the same interest rates, because the investors would
    not be willing to deposit funds in an institution that might not
    be capable to make give them back. At the same time, some
    investors might be prepared to withdraw the deposits that are
    already in the Asians accounts. Once this situation occurs the
    Asian financial entities would not even have shot-term capital.
    Because of these reasons, the International Monetary Fund
    proposal to increase the interest rates violates the first rule
    of medicine: Do not harm the patient.
    A possible solution to this matter could have been a tax creation
    for short-term capital outflow. This way the investors could have
    been attracted to invest in long-term and the market would not
    been affected (the interest rates stayed the same).
    Another advantage of this approach is that, it could have been
    easy to apply, since the government has the complete faculty to
    create taxes.
    However this strategy would have been difficult to control, because
    money does not have to pass customs. Furthermore, the investor
    does not even have to see the money; he or she could change
    accounts electronically. That is one of the reasons, why the
    creation of a regulation entity is very important. It would
    analyze the accounting and financial situation of every Asian
    bank in each country and exposed that information constantly. Let
    us remember that one of the major reasons for the crisis was the
    lack of transparency. In addition, this regulation entity should
    have complete autonomy from the rest of the government; this way
    this entity would provide reports and analyses, which would not
    be influence by any political tendency and interest.
    On the other hand, we have to acknowledge the fact there are two
    interest rates, with which a bank does a business. It is not
    enough for a Bank to have solvency (from investment) it also
    needs creditors to give that solvency. Without creditors the
    banks would be in bankrupt sooner or later. In the Asian case,
    several Asians individuals were borrowing capital abroad, due to
    the higher interest rate. This situation represents another
    problem to the Asian financial system. In spite, of the fact
    (with new tax policy) that the capital will stay in Asia for a longer
    period. We can be positive about this argument, because the Banks
    will still have to respond to their lenders sooner or later.
    Additionally, the government could not impose taxes on borrows
    even if they are made in foreign countries (Asia needs to wake up
    the economy).
    Once again we find ourselves in the same dilemma, how could we
    promote the domestic investor to stay in the domestic financial
    system? We have seen that an increase in the interest rate would
    cause repercussions in other economical readings, which would
    lead to a vicious cycle. Applying a monetary policy through the
    interest rate, involves numerous actors and policy makers, which
    probably would not agree with each other in several aspects.
    A convenient mechanism could be that the government would set a
    mandatory low spread for the banks. In other words, the banks
    would be obligated to reduce their profits due to the difference
    between lending and borrowing interest rates. For instance, two
    or three percentage. This method would encourage local
    individuals to search for domestic funds, and at the same time
    the interest rates would fluctuate according to the market. We
    also have to admit that this mechanism goes against the golden
    rules of market economy, which is fixing the prices. However this
    mechanism would apply for a short period until the economy
    activates again.
    Another problem that the Asian countries faced was the
    consequence of the fixed exchange rate. As it was mentioned
    before, many investors found the Asian market attractive, because
    they did not have the risk of losing investment in the conversion
    of one currency to the other due to the fixed exchange rate
    system. But, once the crisis occurred the Asian central banks no
    longer had reserves to keep the currency fixed. The only option
    that these countries could use was to let the exchange rate
    float. However, if the currency stops being fixed the investors
    might decide to invest somewhere else. This is, because they are
    no longer gaining from the fixed exchange rate. This situation
    will imply other problems for the banks, because they would not
    have the funds that they desperately need.
    Additionally, the citizen will abandoned the local currency due
    to the lack of credibility in their governments, as a result the
    currency will depreciate. Thus, the debtors could no longer pay
    their creditors, because they borrowed foreign currency from
    offshore institutions (less interest rates) while their income in
    local currency was not rising at the same level. Additionally,
    this country will experience inflation. A logical solution to
    this problem could be to borrow capital from foreign institutions
    to maintain a fixed currency (the central banks did not have
    enough reserves to do so).
    However, Asian countries were facing another immense problem, a
    reduction in their exports, which made the crisis even worst.
    Exports are the engine of growth in many Asian countries, because
    they represent an important part of their economy. For instance,
    in South Korea and Thailand exports are 40% of the GDP. Needless
    to say, if the exports decrease the economies find themselves in
    serious budgets difficulties. Besides, the exporters are left
    without funds to pay their debts. Why did the exports decreased?
    The main reason is that the exchange rate was fixed to the value
    of the dollar, but once the dollar started to appreciate the
    Asian countries started to lose competitiveness.

    The trade theory tells us that a deficit in the current account
    could be solved with a depreciation of the currency. This
    technique would improve the countries competitiveness by making
    the exports products cheaper.
    In order to depreciate the currency, the Central Bank would have
    to let the exchange rate float (they run out of reserves), as an
    effect the citizens will abandon the local currency making the
    currency depreciate. However, this method in Asian countries
    would bring the negative consequences that we mentioned
    before.
    Consequently, we will have to measure if the benefits exceed the
    negative outcomes. But, according to other countries experience,
    such as the Latin Americans, the inflation was so brutal that the
    exports could not compensate it. It is also my belief that the
    Asian countries were on the same path.
    Because of this reason, the Asian countries should have
    depreciate the currency to increase the exports until the
    benefits would be more numerous than the disadvantages of
    inflation and debt payments difficulties. Sequentially the Asian
    countries will to maintain the exchange rate fixed until a limit,
    where the negative consequences will discourage the economy. At
    this point the role of the IMF has great relevance, because it
    could lend dollars to the Asian countries, which had a great
    reduction in their reserves, to sustain this dirty float. Of
    course this strategy would only apply in the short term until the
    Asian governments would gain its credibility back. This proposal
    would have applied for a period, in which the Asian governments
    would have gained the trust and credibility of the Asians
    citizens and international investors. Once these goals are
    achieved,
    the golden rules of the market would be established again.
    As it was mentioned before, the Asian financial market showed a
    lack of transparency, for example it has long been known that
    financial intermediaries whose liabilities are guaranteed by the
    government pose a serious problem of moral hazard.
    For instance, the U.S savings and loan debacle is the classic
    example: because depositors in thrifts were guaranteed by the
    FSLIC, they had no incentive to police the lending of
    institutions in which they placed their money; "since the owners
    of thrifts did need to put much of their own money at risk, they
    had every incentive to play a game of heads I win, tails the
    taxpayers loses" (Paul Krugman)
    The Asian situation was more complicated. In general, creditors
    of financial institutions did not receive explicit guarantees
    from the governments. However, it seems that the governments had
    some connections with they main financial institutions and the
    main companies. (The Asian model, the miracle, the crisis and the
    fund. Jeffrey A. Frankel.) Because of this reason, the companies
    did not care about the financial situation of the entities, in
    which they were investing. The financial institutions did not
    care about the financial conditions of their creditors either.
    There was no reason to bother, if the creditors are no longer in
    the capability of paying their debts, the government would
    compensate them. Nevertheless, the government never had the
    resources to "help" these institutions when the crisis occurred
    and this situation made the crisis even more dramatic.
    The Asian countries needed institutions, which could have been
    controlling the financial entities constantly. These
    regulations
    entities would not have let the financial institutions lend
    funds, without a previous study of the creditors. These entities
    would have also publicized the financial conditions of each
    entity constantly. This way the market would stabilized itself
    avoiding a crisis to occur.
    Finally, institutions such as the IMF and prestigious economists
    do not seem to coincide on several politics, which the Asian
    states should have applied. Yet, the only argument on which they
    agree is the fact that Asian countries needed transparency,
    truthful entities and credibility. Therefore, if nations do not
    want to go through a crisis of this magnitude they will be
    obligated to involve these concepts in every day
    transactions.

    2.
    Bibliography

    Furman and Stiglitz. Economic Papers
    IMF. Monthly reports
    Paul Krugman. "pop internalism"
    World Bank monthly reports.
    Lincoln. Article. The Economics. "Miracle or crisis"
    Lawrence. Article. Wall street Journal. "Causes and
    problems.

     

     

     

    Autor:

    Andrés Vergara

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