We’ll talk about how Thailand could reach this highest growth rate shortly… Just to touch the cause: At the time Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. The drastically reduced import earnings that resulted from the forced devaluation then made a quick or even medium-term recovery impossible without strenuous international intervention. [Real GDP growth is GDP growth adjusted for price changes. Calculating real prices allows economists to determine if production increased or decreased, regardless of changes in the purchasing power of the currency.]

[Financial contagion refers to the phenomenon when one country’s economy is negatively affected because of changes in the asset prices of another country's financial market. A more recent crisis where disruptions quickly spread into other areas of financial markets is the Subprime mortgage financial crisis in August 2007.]

Automobile Industry: In 1998, Hyundai Motor took over Kia Motors. Samsung Motors' $5 billion dollar venture was dissolved due to the crisis, and eventually Daewoo Motors was sold to the American company General Motors (GM).

The "Asian flu" had also put pressure on the US and Japan. Their markets did not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial plunged 554 points or 7.2%, amid ongoing worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence (October 27, 1997 mini-crash). Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together as about 40% of Japan's exports go to Asia. The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back. GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from cheapened rivals. The Asian financial crisis also led to more bankruptcies in Japan. In addition, with South Korea's devalued currency, and China's steady gains, many companies complained outright that they could not compete. Another longer-term result was the changing relationship between the U.S. and Japan, with the U.S. no longer openly supporting the highly artificial trade environment and exchange rates that governed economic relations between the two countries for almost five decades after World War II

The "Asian flu" had also put pressure on the US and Japan. Their markets did not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial plunged 554 points or 7.2%, amid ongoing worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence (October 27, 1997 mini-crash). Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together as about 40% of Japan's exports go to Asia. The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back. GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from cheapened rivals. The Asian financial crisis also led to more bankruptcies in Japan. In addition, with South Korea's devalued currency, and China's steady gains, many companies complained outright that they could not compete. Another longer-term result was the changing relationship between the U.S. and Japan, with the U.S. no longer openly supporting the highly artificial trade environment and exchange rates that governed economic relations between the two countries for almost five decades after World War II

In 1994, noted economist Paul Krugman published an article attacking the idea of an "Asian economic miracle". He argued that East Asia's economic growth had historically been the result of capital investment, leading to growth in productivity. However, total factor productivity had increased only marginally or not at all. Krugman argued that only growth in total factor productivity, and not capital investment, could lead to long-term prosperity. Krugman's views would be seen by many as prescient after the financial crisis had become full-blown, though he himself stated that he had not predicted the crisis nor foreseen its depth.

Bubble Theory: 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, and Indonesia, which had the added complication of what was called "crony capitalism". 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.

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. 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.

any 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. 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.

any 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. 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.

In the middle of the 1990s, crony interests in Thailand, the Republic of Korea (Korea), Malaysia, and Indonesia, desiring to protect the dollar values of their assets, exerted pressure on Ministries of Finance and central banks to maintain exchange rates at overvalued levels. Short term loans were sought abroad to shore up the overvalued exchange rates. Current account deficits expanded. When acute foreign investors realized the weakness of the investments they had funded, they began to withdraw as much short-term capital as they could. Local investors fled to safe currencies.

1 East Asian Currency Crisis, 1997 Presented by Irene Saldanha Josh Brubaker Raj Debnath Troy Montgomery

2 Why is this relevant Why talk about a crisis that’s over now? Anything we should learn from this?

3 Summer of 1997 Bangkok, Thailand, East Asia Once upon a time….

4 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$ Before it started…

5 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…

6 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 What happened in Thailand…

7 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

8 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 What happened in Indonesia…

9 Drastic devaluation of the won: from 1,000 to 1,700 for 1 US$ Credit rating of the country (Moody’s): A1 to B2 National Debt-to-GDP ratio more than doubled Major setback in Automobile industry What happened in S.Korea…

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

11 40% of Japan’s 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 world’s largest currency holder, Japan could bounce back quickly What happened in Japan…

12 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 What happened in US...

13 Let’s 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 Why it happened… Part 1

14 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 Why it happened… Part 2

15 Real Estate Speculation Excessive real estate speculation Chinese effect Competition from China due to its export-oriented reforms in 90’s Western importers found cheaper manufacturers in China whose currency was depreciated relative to the US$ Why it happened… Part 3

16 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….. Why it happened… the Complete Story

17 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 (in domestic currency terms) More bankruptcies Further deepening of the crisis Why it happened… the complete story

18 Let’s 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 Can we explain this…

19 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 Why Relevant….

20 Let’s 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 Before we close…

21 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