Saturday, February 8, 2020

"How speculative attacks on currencies led to the East Asian Crisis of 1997"

From Winton's Longer View:

Riding the Asian Tigers
During the 1980s and the early to mid -1990s, the East Asian Tigers leapt ahead, fed on a rich diet of foreign capital. But in the wake of Mexico’s default (1994) and Japan’s banking crisis (1996), international investors began to regard Asia more warily and savagely attacked regional currencies one by one.
Massive and rapid growth is a wonderful buffer. Like a river in flood, it hides the rocks on the river bed.
Easy Tiger The rise of the Tiger Economies in the early 1990s was intimately tied to the after-effects of the Japanese asset bubble. Diminishing opportunities at home encouraged Japanese banks to ramp up their lending to other Asian countries – in particular to highly speculative real estate concerns – and by 1995 they were providing nearly half the credit of the region.

At the same time, falling Japanese interest rates led to the emergence of a carry trade in yen, where international speculators would borrow cheaply in yen and then invest in higher yielding regional currencies, such as the Thai baht, and earn the spread. Such arbitrage trades resulted in massive flows of hot money into countries such as Thailand, Malaysia and Indonesia.

This deluge of easy money led to construction booms throughout the region, climaxing in mid-1997 with the completion of Kuala Lumpur’s Petronas towers.

During the early and mid-1990s, almost everywhere in East Asia had become a building site. Entire cities were transformed. For example, by the end of the decade Hanoi, which in 1992 had been a sleepy town of French colonial villas, swishing bicycles, with restaurants known by their street numbers, had metamorphosed into a sprawling, dynamic city.
As had been the case in Japan a decade earlier, real estate prices skyrocketed. Although the growth was based on a splurge of speculative credits, many Asians attributed the boom to strong fundamentals and their superior ‘Asian values’: diligence, respect for authority, the elevating of collective rights over individual rights.

They also believed that these same values would offer protection against the social and political pressures which have frequently accompanied periods of rapid growth in the West, allowing their boom to continue forever. In this way they were able to rationalise the prevailing euphoria.

Baht Out of Hell
The first clouds upon the horizon appeared in the wake of the 1994 Mexican Peso Crisis, which gave investors pause for thought about investing in emerging markets. The region’s troubles then intensified in mid-1996 when Japanese banks began repatriating capital from Asian countries, due to a domestic banking crisis.

These developments were particularly unwelcome for Thailand, which had been the primary beneficiary of the carry trade, and by early 1997, the Thai baht – pegged at B25 to the US dollar – was looking highly vulnerable.

Events gathered pace in early May, when Goldman Sachs released a research note predicting that the baht would soon undergo a competitive devaluation. A few days later, there was a speculative attack on the baht to which the Bank of Thailand (BoT) responded by calling for the intervention of regional central banks and creating a liquidity squeeze in the offshore market.

It did this by forbidding local banks to supply baht to foreigners, pushing up overnight lending rates to 1000–1500%. Hedge funds reportedly lost $300m. Then, on 2 July, BoT floated the baht which by the end of the day had lost 14–19% of its value, prompting the BoT to request IMF assistance.

The shockwaves of Thailand’s currency crisis spread throughout the region in what the Thai foreign minister termed the ‘Tom Yum Koong Syndrome’, referring to the famous Thai hot shrimp soup, which is ‘very spicy and dangerous for those who come unprepared’.

Speculative attention then turned towards the Philippines, whose central bank was forced to spend $540m in a single day on defending the currency....
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