The Asain Finacial Crisis Essays - Foreign Exchange Market

The Asain Finacial Crisis The Asain Finacial Crisis The beginning of the Asian financial crisis can be traced back to 2 July 1997. That was the day the Thai Government announced a managed float of the Baht and called on the International Monetary Fund (IMF) for 'technical assistance'. That day the Baht fell around 20 per cent against the $US. This became the trigger for the Asian currency crisis. Within the week the Philippines and Malaysian Governments were heavily intervening to defend their currencies. While Indonesia intervened and also allowed the currency to move in a widened trading range a sort of a float but with a floor below which the monetary authority acts to defend the currency against further falls. By the end of the month there was a 'currency meltdown' during which the Malaysian Prime Minister Mahathir attacked 'rogue speculators' and named the notorious speculator and hedge fund manager, George Soros, as being personally responsible for the fall in value of the ringgit. Soon other East Asian economies became involved, Taiwan, Hong Kong, Singapore and others to varying degrees. Stock and property markets were also feeling the pressure though the declines in stock prices tended to show a less volatile but nevertheless downward trend over most of 1997. By 27 October the crisis had had a world wide impact, on that day provoking a massive response on Wall Street with the Dow Jones industrial average falling by 554.26 or 7.18 per cent, its biggest point fall in history, causing stock exchange officials to suspend trading. Countries such as Thailand, Indonesia, Malaysia and the Philippines have embraced an unusual policy combination of liberalisation of controls on flows of financial capital on the one hand, and quasi-fixed/ heavily managed exchange rate systems on the other. These exchange rate systems have been operated largely through linkages with the United States (US) dollar as their anchor. (1) Such external policy mixes are only sustainable in the longer term if there is close harmonisation of economic/ financial policies and conditions with those of the anchor country (in this case, the United States). Otherwise, establishing capital flows will inevitably undermine the exchange rate. Rather than harmonisation, there seems to have actually been increased economic and financial divergence with the US, especially in terms of current account deficits, inflation and interest rates. These increasing disparities have prompted global (and local) financial interests to speculate against the administered exchange rate linkages, i.e. speculative pressure mounted that the monetary authorities in these countries would not be able to hold their exchange rate links. In most cases, such financial speculation has been of sufficient magnitude to actually provoke the collapse of the administered exchange rate links, in the manner of 'self fulfilling' prophecies. Defence of the exchange rate through the use of foreign exchange reserves and higher interest rates proved to be insufficient. (2) The result has been large devaluation's of the exchange rates of these countries, especially against the US dollar. Large interest rate increases to support the exchange rates at their new lower levels (to prevent wholesale over reaction and collapse in foreign exchange markets and to help contain the strong inflationary forces set in motion); and extra restrictions in fiscal policy. Designed to rise national saving, contain domestic spending and reassure foreign investors and international institutions such as the International Monetary Fund (IMF). Figure 1 shows the magnitude of this devaluation's. The IMF had arranged conditional financial support packages for Thailand and Indonesia. (3) Financial support is provided in exchange for (on condition of) economic policy reforms which, it is argued, will encourage economic recovery and help prevent a recurrence of the turmoil these countries are now experiencing. In the case of Australia, help to Thailand has taken the form of a 'currency swap' where Australia's US dollar assets of up to $1 billion were exchanged for Thai Baht, with an agreement that the reverse exchange would occur at a future point in time. These financial crises have also provoked substantial falls in the stock markets of these countries and in other parts of Asia. (They also contributed to stock market falls around the world). Foreign investor funds would have been initially withdrawn as exchange rate speculation mounted, and this would have partly taken the form of a sell off of foreign-owned stock. As well, much higher interest rates (both before and after the currency devaluation's) encourage flows of funds out of shares and into loan/ debt-type assets. In turn, higher interest rates and lower exchange rates have substantially increased the rate of collapse/ bankruptcy of businesses operating in highly leveraged sectors (especially where loan contracts were written in foreign