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Introduction
The Asian Financial Crisis caught the world by surprise. Indeed, right up to the summer of 1997 many observers were still
singing praises of the Asian Tigers. Volumes had been written about the Asian Economic Miracle.
Asia's financial trouble began when the Thai baht came under speculative attack in May 1997. On the 2nd July, the baht
was devalued 15 to 20 percent and the Thai government requested technical assistance from the International Monetary Fund.
The speculative attacks spread to the Philippine peso, Malaysia ringgit, Singaporean dollar, Indonesian rupiah, Taiwan dollar,
Hong Kong dollar and South Korean won. By end of 1997, all Asian currencies with the exception of the Hong Kong dollar has
been devalued.
The direct effect of the currencies devaluation is a liquidity crisis within the Asian economies. Thailand, Indonesia
and South Korea requested IMF's help in reviving their economies. Philippines, which was already on IMF's programme, delay
its graduation. Malaysia rejected IMF's assistance and embarked on its own controversial measures.
The aim of this essay is to discuss some common arguments on the cause of the Asian Financial Crisis.
Market Manipulation by Big Players
The crisis started when hedge funds launched a concerted attack on the currencies of Asia's tiger economies. Soon after most
of the regions currencies succumb to devaluation. A vicious circle of competitive devaluation continued to push each currency
further downward.
Unable to contain his rage, Dr. Mahathir, Prime Minister of Malaysia, named George Soros as the man responsible for leading
the speculative attack. Soros, credited to be the most successful hedge fund investor ever, gained international notoriety
by successfully attacking the British pound in 1992. Using billions of dollars of his funds, he shorted, betting that the
British pound would not be able to hold its value. When the pound fell, Soros had made US$1 billion and a name for himself.
Through his three hedge funds, Soros has over US$14 billion at his disposal. Additionally, his every move is closely watched
and emulated by other hedge funds.
Mahathir (2000) denounced the currency traders as greedy, selfish and inhumane crooks. These speculators make their money
without regards to the destructive effects of their actions. Mahathir pointed out to destroy about 250 billion dollars of
national wealth and cause the suffering and hardship of millions of people; just to make two or three billion dollars is immoral.
He has repeatedly called for reforms and stricter regulations on currency trading.
Miller and Zhang (1998) identified a "double play" mechanism used by the hedge funds to maximise their gain
from the crisis. Not only do the hedge funds short sell the siege currency, but they also take short positions in the equity
market. Once the attack on the currency is launched, the central bank will raise the interest rate in defence. The rising
interest rate and the crisis of confidence will cause the stock market to fall. Foreign investors are inclined to liquidate
their stocks and repatriate their money home which will result in more pressure on the local currency. A vicious circle is
formed. Further falls in the foreign exchange market will affect the stock market, and vice versa.
For the speculators, as a whole, the cost of unsuccessful attack is more than covered by the gain from short selling in
the declining stock market. If they are successful in forcing the siege currency to devalue, they earn huge profits at the
expense of the victim country. Miller and Zhang (1998) warn that even countries with sound economies (such as Hong Kong or
Singapore), can be vulnerable to the market manipulation of big players.
Predictably, most western analysts are silent about the excesses of "rogue" currency speculators, preferring
to ridicule Dr. Mahathir instead. Current ideology dictates that market players (including hedge funds) always react only
to the country's economic fundamentals. Krugman (1997) contends that as a country's economic fundamentals worsen, the cost
of maintaining a fixed exchange rate becomes increasingly high. Therefore, inevitably the country will abandon the fixed exchange
rate and devaluate its currency. Speculation simply means that some smart big "investors" launch out an early attack
on the currency and earn profits before the abandonment of the fixed exchange rate. He claims that even without speculative
attacks, the currency will inevitably free floated at a later date. Hence, currency speculators only make the crisis earlier
rather than create the crisis.
In reality, we find that currency speculators do not always act to correct market distortions, rather they act to maximise
their profits within the shortest period of time. The concerted attack on both Singaporean and Hong Kong dollars showed that
even countries with a good track record and strong fundamentals are vulnerable. As a result of the attack, Singapore was forced
to devalue. Meanwhile Hong Kong managed to defend its dollar peg by drastically raising its domestic interest rate. This resulted
in financial hardship and contraction in the local economy.
Contagion and Competitive Devaluation
Miller and Luangaram (1998) contend that the financial crisis spread to other Asian countries through spill-over externalities
and herding behaviours of the international investors. Additionally, Asian countries are economically tied through cross-border
direct investment and have the same exporting markets. The collapse of one country's currency will seriously affect the competitiveness
of the others. During the Asian Financial Crisis "competitive devaluation" resulted in a vicious circle where an
Asian currency is pressed lower when its neighbour devalues.
According to Sachs (1997), much of the panic is a self-feeding frenzy, even if the economies were fundamentally healthy
at the start of the panic, nobody wants to be the last one out when currencies that are weakening and banks are tottering
because of the rapid drain of foreign loans.
Rapid Liberalization of the Finance Market
Southeast Asian tiger economies are highly dependant on foreign capital inflows for their economic growth. The first wave
of Japanese foreign direct investments came between 1986 and 1990. These foreign investments lifted the region out of recession
and ushering in an era of high growth. With the tapering off of Japanese investments in the 1990s, the investment funds from
the developed economies began to take interest in the region.
However, as a pre-requisite to attracting these western funds, the International Monetary Fund and World Bank recommended
a change in financial policies. Firstly, the country's financial system must be liberalised to allow unfettered inflow and
outflow of capital. Additionally, stock exchanges are to be fully open for participation of foreign investors. Secondly, the
domestic interest rates must be kept high relative to the interest rates in United States and other financial centres. Lastly,
the local currency is to be pegged to the US dollar in order to reduce risks for foreign investors. The recommended policies
were implemented and proved highly successful in attracting foreign capital inflows. (Bello, 1998)
According to Wade (1998a), both Japanese and European central banks pursued monetary expansion in order to boot domestic
consumption in the 1990s. However, the consumers had been slow to react. Hence, there was excess liquidity, which spilled
over into financial asset markets worldwide. Since the interest rates in the core countries were low, lenders rushed to East
and Southeast Asia for higher rate of return. For both domestic and foreign investors, the huge capital inflows created a
self-reinforcing effect on confidence, investment and economic growth of the Asian countries.
With the massive devaluations of the local currency, financial intermediaries found that their dollar-denominated debt
has increased in terms of local currency. To make the matter worse, due to an illogical crisis of confidence, many foreign
creditors refuse to roll over the short term loans. Surely, foreign creditors are not affected by the devaluation as the loans
are denominated in dollars.
In order to pay back foreign creditors, financial intermediaries are forced to recall their loans. This created a liquidity
crisis which threatens many corporations with bankruptcies. Financial panic ensues as corporations began to collect from their
debtors all at the same time.
Bullard et. al. (1998) comment that in many ways the Asian crisis is not an Asian crisis at all, but a global crisis which
has shown the inadequacies of markets, governments and international institutions in coping with rapid financial liberalisation.
Many Asian leaders tend to agree that the rapid financial liberalisation in the 1990s was a mistake.
Structural Weaknesses Theory
Corsetti et. al. (1998) proposed that the crisis reflected structural and policy distortions in the countries of the region.
Fundamental imbalances triggered the currency and financial crisis in 1997. Local financial institutions were plagued with
lax supervision, weak regulation, low capital adequacy ratios, lack of incentive-compatible deposit insurance schemes, insufficient
expertise in the regulatory institutions, distorted incentives for project selection and monitoring, outright corrupt lending
practices, non-market criteria of credit allocation, undercapitalised financial system and a growing share of non-performing
loans.
However, right up to the eve of the crisis market commentators, analysts, trade publications and financial regulatory
bodies had been overwhelmingly optimistic about the region's economic prospect. If there were any major structural flaw dooming
the Asian economies, it must have been the best kept secret among the neo-liberals. Can the logic of the market be hidden
from the very investors that make up the market? Financial investments, guaranteed or otherwise, were pouring unabated into
the region, not because of moral hazard of guaranteed loans, but because of the higher gains compared to investments in the
developed economies.
Sachs (1997) argues that although there were some weaknesses in the Asian economies just right before the crisis, it was
far from fatal. On the contrary, there were strengths such as high savings, budget surpluses, flexible labour markets, low
taxation and long-term growth prospects.
Moral Hazard, Crony Capitalism and Industrial Targeting
Many Western analysts identify crony capitalism and the resultant moral hazard as the cause of the Asian Financial Crisis.
Crony capitalism can best be described as the close relationship between the government and some domestic capitalists. The
advantages accorded to the favoured included the award of public contracts, advantageous treatment in economic regulation
as well as protection from competition.
The South Korean government identify large corporations in selected industries and groom them for competition in the international
market. According to Western analysts, this practice, known as "industrial targeting", creates over investment and
inefficiencies. (Corsetti et. al., 1998)
Western analysts believe that crony capitalism and industrial targeting create an impression to foreign investors that
the government will guarantee the loans to the "cronies". Corruption and nepotism behind this kind of crony capitalism
give rise to irresponsible high-risk investment and lending decisions. As a result, the international lenders had an incentive
to lend money to these financial intermediaries, without seriously assessing their long-run financial healthiness.
In reality, the so-called crony capitalism predates the financial troubles. Indeed, it brought the countries tremendous
economic accomplishment before the crisis. Crony capitalism seemed to coexist with healthy growth rates for quite a long while.
State sponsored enterprises will definitely do better against the larger foreign enterprises. Hence, it is wrong to assert
that crony capitalism and GDP growth rates must have a negative relationship.
Chang (1999) attacks the moral hazard argument by stating that moral hazard has been an essential element in the development
of capitalism. Moral hazard comes in the forms of limited liability, lender of last resort facility, and industrial policy.
The main benefit of moral hazard is to socialize risks.
Crony capitalism was hardly Asia's dark secret as most foreign investors were fully aware of its practices. Some investors
actually seek out "cronies" as the rate of returns from these investments clearly exceeds industry norms and the
risks of failure lower.
Stiglitz (1998) questions whether moral hazard factors can explain the scope, timing, and severity of the crisis. Notably
there were numerous other countries with worse financial sectors and less transparency that did not experience a crisis. Even
within the Asian region, some crony capitalist countries, like China and Vietnam, seem to be immune from the crisis, but other
"clean" countries, like Singapore and HK, are seriously hit by the crisis.
International Monetary Fund (IMF)
Radelet and Sachs (1998) criticised the International Monetary Fund for its handling of the Asian crisis. They pointed out
the panic might have not developed into a regional one, if IMF had not worsen international investors' confidence by their
mistakes. According to Sachs (1998), one of IMF's mistakes was to abruptly close many financial institutions throughout Asia.
This send a dangerous signal that you had better take your money out or you might lose it.
Radelet and Sachs (1998) reported IMF prescription for Thailand, Indonesia and South Korea was to maintain fiscal balance,
high interest rates, and tight credit, rather than to get the borrowers and creditors together to negotiate short-term debt
payment rescheduling. Consequently, high interest rates, tightened financial regulation, and failure in stemming capital outflows
pushed the Asian economies into a deep recession. IMF spread the economic pain from the insolvent banks, investment funds
and real estate companies that had gotten the countries into trouble, to thousands of small businesses, making them bankrupt.
Bullard et. al. (1998) charge that IMF treatment of domestic and foreign interests revealed its double standards. Domestic
firms were left to the mercy of the market (for example, the IMF insisted that numerous financial institutions in Indonesia
and Thailand could not be bailed out). Foreign investors, on the other hand, were given enhanced rights to ownership, the
possibility to convert debt to equity in struggling Asian enterprises and the chance of picking up others at bargain basement
prices, thanks to changes in foreign ownership rules included in the IMF packages.
Rejecting IMF's advice, Dr. Mahathir decided to take on the crisis by himself. The measures taken were highly controversial
and severely criticized by most Western analysts. Malaysia implemented capital control and fixed the exchange rate at ringgit
3.80 to the dollar to stem further currency speculation. Domestic interest rate was kept low to improve liquidity. The public
sector took over from the private sector to promote growth which resulted in a budget deficit. The outflow of capital was
regulated to stem panic withdrawal of funds from the country. Steps were taken to save large corporates in dire straits. Non-performing
loans were consolidated and removed from the financial institutions so that lending can continue. Malaysia's strategies were
almost directly opposite to IMF's prescriptions.
Comparing the recovery of Thailand, Indonesia and South Korea to that of Malaysia showed that the downturn had not been
as severe in Malaysia. Although there were a recession, Malaysians did not endure widespread corporate failures, mass unemployment,
political upheaval or increase poverty, which was experienced by its Asian neighbours.
During the Fourth Langkawi International Dialogue, an annual conference among developing countries, Seneviratne (1999)
reported strong endorsement of Dr. Mahathir's policies and criticism of the IMF's strategies from Asia's prominent leaders
and economic analysts.
Consequences of the Financial Crisis
Bullard et. al. (1998) commented that the Asian crisis was not simply a financial crisis but above all a human crisis. Millions
of people have been thrown out of work, and poverty and hunger are on the increase, as decades of social progress have been
thrown into reverse. Six years after the event, affected countries have yet to recover.
Due to harsh measures implemented, there were widespread corporate failures in the region. Additionally, ownership of
major financial institutions and major corporations were transferred to foreign investors due to forced financial and corporate
liberalisation. The economy continues to be revived, however the wealth created now flows to the rich economies of the West.
There is massive unemployment and increasing poverty due the wide-spread bankruptcies. The rising inflation increases
the hardship of the poor. As jobs in the city evaporated, many migrants are returning to the villages. There is a revival
of agriculture as the rural economy thrives.
In the city there has been an increase in prostitution, drug trafficking and crime, as the unemployed seek alternative
income. Worker unrests are on the rise as employers cut salaries to stay afloat.
Most government has repatriated foreign labour to ensure sufficient jobs for its citizens. This move may cause the recession
to spread to less developed countries of the region.
Wide spread poverty has caused irreparable damage on the environment. The unemployed and hungry depend on "slash
and burn" farming to survive. This wasteful form of agriculture has decimated large tracts of tropical rainforests with
no sign of abating. The forest fires result in a perpetual haze that envelops the South-East Asian region. The long term implication
of the haze on the health of millions of people remains unknown. The immediate effect of the haze is to hurt the region's
tourism industry.
The financial crisis has disrupted political stability in the region. A significant impact is the destabilisation of Indonesia.
President Suharto and his influential family have since been removed and chastise. The central government under President
Megawati remains weak and unable to control the social unrests in the provinces. With the increase in separatist movements,
the break-up of Indonesia cannot be ruled out.
Conclusion
The Asian Financial Crisis started with the hedge funds attacking the currencies of Asia. The resulting devaluations and crisis
of confidence created many corporate failures when foreign investors recall back short term loans. Post mortem of the crisis
by western analysts tend to put the blame on structural and policy distortions within the Asian economies. However, many Asian
analysts have the opinion that malicious attacks of the hedge funds in unregulated foreign exchange markets triggered the
Asian Financial Crisis. Additionally, the severity of the crisis was compounded by the large current account deficits and
refusal of foreign investors to roll-over short term debts. The mistake of Asian policy makers were to agree to financial
liberalisation before reforming weak and unregulated financial systems. Implementing the International Monetary Fund's prescriptions
actually worsen the economic downturn. The IMF has forced further financial and corporate liberalisation of the afflicted
economies. This resulted in foreign ownership and domination in many key industries. In contrast, Malaysia's controversial
and widely criticised strategies have yield better results. The consequences of the financial crisis include mass unemployment,
increasing poverty, inflation, political instability, destruction of the environment, increased prostitution and rising crime
rate.
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