1997 Asian Financial Crisis

The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown (financial contagion).

The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.^[1]

Though there has been general agreement on the existence of a crisis and its consequences, what is less clear is the causes of the crisis, as well as its scope and resolution. Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. The People's Republic of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.

Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993-96, then shot up beyond 180% during the worst of the crisis. In Korea, the ratios rose from 13-21% and then as high as 40%, while the other Northern NICs (Newly Industrialized Countries) fared much better. Only in Thailand and Korea did debt service-to-exports ratios rise. ^[2]

Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced to step down in May 1998 in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In the Philippines growth dropped to virtually zero in 1998. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover.^[3]

History

Until 1997, Asia attracted almost half of the total capital inflow from developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced high growth rates, 8-12% GDP, in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including the IMF and World Bank, and was known as part of the "Asian economic miracle".

In 1994, noted economist Paul Krugman published an article attacking the idea of an "Asian economic miracle".^[4] 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^{[neutrality disputed]}, though he himself stated that he had not predicted the crisis nor foreseen its depth.

The causes of the debacle are many and disputed. 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, and Indonesia, which had the added complication of what was called "crony capitalism".^[5] 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.^[6]

At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s, two factors began to change their economic environment. As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had attracted hot money flows through high short-term interest rates, and raised the value of the U.S. dollar, to which many Southeast Asian nations' currencies were pegged, thus making their exports less competitive. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

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.^[7] 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.^[8]

Many 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.^[9] 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.

Other economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of the real economy in the crisis compared to the financial markets due to the speed of the crisis. The rapidity with which the crisis happened has prompted Sachs and others to compare it to a classic bank run prompted by a sudden risk shock. Sachs pointed to strict monetary and contractory fiscal policies implemented by the governments on the advice of the IMF in the wake of the crisis, while Frederic Mishkin points to the role of asymmetric information in the financial markets that led to a "herd mentality" among investors that magnified a relatively small risk in the real economy. The crisis had thus attracted interest from behavioral economists interested in market psychology. Another possible cause of the sudden risk shock may also be attributable to the handover of Hong Kong sovereignty on 1 July 1997. During the 1990s, hot money flew into the Southeast Asia region but investors were often ignorant of the actual fundamentals or risk profiles of the respective economies. The uncertainty regarding the future of Hong Kong led investors to shrink even further away from Asia, exacerbating economic conditions in the area (subsequently leading to the devaluation of the Thai baht on 2 July 1997).^[10]

The foreign ministers of the 10 ASEAN countries believed that the well co-ordinated manipulation of currencies was a deliberate attempt to destabilize the ASEAN economies. Former Malaysian Prime Minister Mahathir Mohamad accused George Soros of ruining Malaysia's economy with "massive currency speculation." (Soros appeared to have had his bets in against the Asian currency devaluations, incurring a loss when the crisis hit.^{[citation needed]}) At the 30th ASEAN Ministerial Meeting held in Subang Jaya, Malaysia, they issued a joint declaration on 25 July 1997 expressing serious concern and called for further intensification of ASEAN's cooperation to safeguard and promote ASEAN's interest in this regard.^[11] Coincidentally, on that same day, the central bankers of most of the affected countries were at the EMEAP (Executive Meeting of East Asia Pacific) meeting in Shanghai, and they failed to make the 'New Arrangement to Borrow' operational. A year earlier, the finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto, Japan on 17 March 1996, and according to that joint declaration, they had been unable to double the amounts available under the 'General Agreement to Borrow' and the 'Emergency Finance Mechanism'. As such, the crisis could be seen as the failure to adequately build capacity in time to prevent Currency Manipulation. This hypothesis enjoyed little support among economists, however, who argue that no single investor could have had enough impact on the market to successfully manipulate the currencies' values. In addition, the level of organization necessary to coordinate a massive exodus of investors from Southeast Asian currencies in order to manipulate their values rendered this possibility remote.

Malaysia

Further information: Economy of Malaysia

Before the crisis, Malaysia had a large current account deficit of 5% of its GDP. At the time, Malaysia was a popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock exchange in the world (with turnover exceeding even markets with far higher capitalization like the NYSE). Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by 2020, a government policy articulated in Wawasan 2020. At the start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%.

In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets. By end of 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 3.80 to the dollar.

In 1998, the output of the real economy declined plunging the country into its first recession for many years. The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the KLSE fell below 270 points. In September that year, various defensive measures were announced in order to overcome the crisis. The principal measure taken were to move the ringgit from a free float to a fixed exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed while aid offered from the IMF was refused. Various task force agencies were formed. The Corporate Debt Restructuring Committee dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate orderly asset realization. Danamodal recapitalized banks.

Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly substantial surplus. Banks were better capitalized and NPLs were realised in an orderly way. Small banks were bought out by strong ones. A large number of PLCs were unable to regulate their financial affairs and were delisted. Compared to the 1997 current account, by 2005, Malaysia was estimated to have a US$14.06 billion surplus.^[21] Asset values however, have not returned to their pre-crisis highs. In 2005 the last of the crisis measures were removed as the ringgit was taken off the fixed exchange system. But unlike the pre-crisis days, it did not appear to be a free float, but a managed float, like the Singapore dollar.

US To Face Poor Economy for 10-15 Years: Robertson

Multi-millionaire investor Julian Robertson told CNBC that the United States is "just getting into the recession," and that the poor economy will last as long as 10 to 15 years.

Last year, Robertson had said that the U.S. economy was in for "a doozy of a recession." He said the reason was the credit situation was worse than anyone had thought.

"Doozy’s a tough one and long one, I think that’s what we’re headed for," said the chairman of Tiger Management.


"I don’t mean to imply that this is going to last quite as long as what’s been happening in Japan, but when they went into their decline in 1990, almost 20 years ago, their people were loaded with savings—but [Americans are] all broke," he said. "...If we leave out the home in the calculations, I’d say that 80-85 percent of Americans are broke. So they have to cut back on their spending."

Robertson said that his current favorite trade is the "curve steepener" trade.


"It’s a derivative which pays the movements in the difference between the two-year interest rate on government bonds and the 10-year and 30-year…I think the curve steepener is the best hedge against inflation and I think we’re going to have some inflation."

Robertson was optimistic about "some excellent buys" that investors should consider.


"I have a pretty good bet on copper. I think that copper, which is selling so far below its cost of production, is a terrific short," he added.

Turn Money Talk Into Money-Saving Action

There is nothing less romantic than financial problems.

If you’re among the many couples struggling during these tough economic times, instead of dropping a few hundred dollars this Valentine’s Day on candy, jewelry and fancy dinners, consider sitting down with your loved one to discuss your finances.

Ross Levin, a certified financial planner and president of Accredited Investors Inc. says in a difficult economic environment such as this, people in a relationship can react differently to their financial circumstance and communication can become very strained. In order to avoid tension, it is important to step back and ask each other about where your finances are now and what are your future objectives?

“For most people not much has actually changed.,” says Levin. “They didn’t know how much of their retirement would be ten years ago and they still don’t.”

Love-Hate Investment Debate

Despite that, however, people often panic, and make unnecessary changes that Levin says “act against their own self interest.”

One such mistake is becoming too conservative with their asset allocation too quickly.

Elisabeth Plax, a certified financial planner and president of Plax & Associates Financial Service, says it is often the case in volatile markets that one person may want to sell everything and go completely into cash, while the other partner may want to ride out the turmoil.

While moving to cash may seem like a flight to safety, it is not a good solution as it can make it difficult for you to generate the returns you need and will prevent you from taking advantage of a recovery once it comes.

The trick, she says, is to compromise by incorporating a middle-ground investment strategy that moves some money to more conservative investments such as fixed income while maintaining enough in equities so you can take advantage of a recovery.

Asset allocation and balanced funds are good options that offer a high level of diversification tailored to many different risk tolerances, she says, as are some long-short funds, which can offer more protection on the downside

Saul Simon, a certified financial planner and private wealth adviser with Simon Financial Group, says another major mistake people often make during these times is to stop investing in their 401(K) retirement plan.

In fact, he says, there is at least one good reason to keep investing.

“If you are adding money to these accounts, there is major dollar-cost averaging taking place,” he says, which entails investing in small, regular increments. With price of many securities so depressed, now is actually an opportune time to do this.

Plax agrees that halting these contributions is a big mistake that too many people make.

“Don’t stop contributions to your 401(k)s,” she says. ”Yes, they will go through a horrendously volatile cycle but in a few years from now you will be happy to have bought shares at such low prices,” adding it is important to keep you eye on the long term and don’t give up on stocks because you need the performance.

While not making unnecessary changes to your portfolio is half the battle, advisors say there are a few proactive steps that you can also take, which may be able to help your save a few dimes if money is getting tight.

Savings At Home

According to Levin, one option to consider is refinancing your home. However, you had better do your homework first as this isn’t for everyone.

Currently, homeowners can get some very attractive rates on conforming loans – which are those valued at $417,000 or less. Depending on your current rate, refinancing can save you a lot on your interest payments.

If you decide to refinance and you do not plan to be in your home a long time, you may want to do a zero cost refinance, which does not require you to pay closing costs. Instead those costs are wrapped into the interest rate. So you pay a little higher interest rate but no immediate costs associated with the refinance, which is good for the short term.

If you do plan on staying for awhile and you have the money to pay the upfront costs, that is a better option as you will have a lower interest rate over the long haul. You may find it attractive to go from a 30-year to a 15-year loan, which carries a lower rate bur raises the size of your monthly principal payment.

Levin says rates right now are attractive on both fixed rate and adjustable loans, though “we think in the fixed-rate the rates are attractive enough that it makes sense to go with that.”

He adds that when it comes to jumbo loans, refinancing options are slim as rates haven’t yet come down as much, though he says “if you know you won’t be in the house very long, there is a nicer spread on adjustable loans, which might make sense.

Also, he says, if you have strong credit another option to free some cash may be to do a home equity line, where you may be able to get some really low rates. There is a risk if interest rates move higher but in the meantime you can save a lot of money, he says.

Insurance And Retirement

Another area you may be able to find some cost savings is with deductibles—such as on your property insurance.

If you are able to raise your deductible—the sum that you must pay before your insurance company will pay out—it can save you a lot of money on your premium.

The question, Levin says, you have to discuss is “how high of a deductible are you willing to go.”

For couples that are not experiencing financial troubles but are looking to take advantage of the current environment, now may be a good time to think about transferring some of your wealth.

According to Simon, “interest rates are so low and assets have been depressed from a wealth transfer planning perspective.” As a result you can gift assets at a discounted value to their actual economic value.

In addition, Plax says that now is also the perfect time to consider rolling over your traditional IRA to a Roth IRA. One of the biggest differences between a traditional IRA and a Roth IRA is that with a traditional IRA your contributions are made on a pre-tax basis, and will continue to grow tax-free until withdrawn. Meanwhile with a Roth IRAs, contributions are not tax deductible, however when the money is withdrawn during retirement, they are tax-free.

Because the assets in the IRA are so low and you can transfer them in-kind to the Roth IRA so you are paying taxes on a smaller value and these assets will now start growing again in the Roth and come out tax free.

This can be a good idea for people who have sufficient disposable dollars to pay for the taxes, as you need to be able to pay the taxes from other kinds of savings. However, she says if you are considering doing this you need to determine whether this will put you into another tax bracket, which may not make it worthwhile. In this case, you may want to consider rolling over assets in increments. The IRA switchover is also subject to an income cap, so make sure you qualify.

While tough economic times can put a lot of strain on relationships, a little planning and a lot of communication can help ensure love is not lost.