Lessons

As F. S. Mishkin mentioned in ‘Lessons from theAsian crisis (1999)’, there are several lessons learnt from this Asian crisis.   The first lesson from the crisis is a reasonable government intervention can make the financial system to restore stability: for emerging market countries, which requires the international lender of last resort. The second lesson is that the international lender of last resort must develop an appropriate loan condition to avoid formation of excessive moral hazard caused by financial instability.  In industrialized countries, the central bank can be through an expansionary monetary or the lender of last resort can restart whole financial system to recovery. Because the institution features of the financial system in emerging market make the central banks lack of this ability in these countries.  In this case, an international lender of last resort highly recommended to involve in coping with the financial crisis in these countries. 

International Monetary Fund (IMF), the financial fire-fighter of the world, played the part of international lender of last resort in this crisis. Austerity policy that IMF used only protected the safety of repaying loans, but the recession has aggravated in these countries. The natural of IMF is essentially just an organization of credit union. It cannot create unlimited number of international reserves. Therefore it cannot provide adequate loans to illiquid countries internationally.  Y.C.R.Wong (1999)presented in his paper, IMF was too inefficient to help those countries under that urgent situation, and the bailout IMF offered was “too little, too late”. But he also stated there was no evident shows IMF could have done more and quickly, and that given its own limitations to perform the role of international lender of last resort.

This crisis also exposed the financial sector was the weakest part in whole Asian economy structure, a steady financial system is very important to every country! The manufacturing industry in Japan and South Korea were very good, but they still had to suffer from the crisis. The reason was they had common characteristics as lack of capital market efficiency, improper credit decision-making and overspent the capital on real estate market. Furthermore, their internal risk control was seriously short and the external regulations were useless. In contrast, Hong Kong had a relatively stable banking system. This is why they could survive from this crisis.

The fourth lesson is that pegged exchange rate system for emerging market countries is very dangerous, it makes the financial crisis are more likely. Countries with sound political and legal framework are more capable to sustain pegged exchange rate system. As the international cash flow become more and more important, the currency in America and Europe are completely fluctuated. Under this circumstance, the emerging market is more appropriate to adopt a more flexible exchange rate regime. When a country lack of foreign exchange reserves, it is pointless to retain pegged exchange rate. That results a rapid increase in foreign exchange market after Asian financial crisis.

This Asian financial crisis is not only a disaster in Asia area, but also affected the globe economy. It disclosed a lot of weakness of Asian economic system, and hopefully we can learn from this crisis to avoid make same mistakes in the future.

How Hong Kong acted in the crisis

When the crisis swept the entire Southeast Asia, Chan and So etc (2002) stated in their book “Crisis and transformation in China’s Hong Kong” about the Hong Kong government original attitude, “The initial reaction of the Hong Kong Special Administration Region (SAR) government was one of indifference and misguided self-confidence.” However there was a reason for government’s optimism, Hong Kong was the one of the ‘Dragons’ in the Asian area and it was also the most successful economic development model in the world. Furthermore, Hong Kong was hold worth over US $80 billion foreign reserves which were the third largest in the world (Lui 2002). Even better, Hong Kong also had a successful experienced on defending currency attack in early 1995.

Nevertheless, this confident didn’t last for long. International speculators’ ambitions for Hong Kong were not only to aim at the Hong Kong dollar profit, but also to gain benefit in the stock market and futures market. Their approach was to accumulate of a large amount of short positions in the futures market firstly, and then buy dollars forward, put forward the Hong Kong dollar. Hong Kong Monetary Authority (HKMA) used the interest rate arbitrage, also known as the automatic adjustment mechanism as a tool to defend currency attack. It means when the Hong Kong dollar came under attack, government would increase interest rate to deal with it. People would start to worry about the interest rates soared to push down the stock and property market, while the speculators could be taking advantage of that, to selling massive futures. As a result, the stock market panic, everyone would sell stock, speculators could close out short position and earn huge profits from it. 

The above graph shows the daily K line in Hang Seng Index from August 1997 to August 1998. It clearly indicated that there was a sharp decrease in October 1997. Like a Curse, ‘Black Monday’ landed in Hong Kong just one day after the 10^th anniversary of the most famous ‘Black Monday’ occurred in 19^th October 1987. On 20^th October, the Hong Kong stock market started to decline. One day after it, the Hang Seng Index fell 765.33 points, and continued the momentum, it fell 1200 points in 22^nd.

In order to deal with the dilemma, Hong Kong Monetary Authority carried out several measures. One was to use a huge amount of foreign reserve to absorb Hong Kong dollar. Second was to raise the interest rate and tighten the money supply. After that, Hong Kong stock stopped falling and started to grow quickly. Chinese government also helped Hong Kong by cutting interest rate. All these factors made Hang Seng Index rebounded rapidly, also made Hong Kong dollar restore stability.

In 2007, Rodney Jones, an asset manager represented George Soros, said in an interview, "Government intervention raised public confidence in the market when it was near total collapse. It prevented a bigger crisis and saved the market." "We used to doubt if the HKSAR government's intervention would be effective or not, as timing and choice of strategies were of crucial importance. From what we see now, the HKSAR government chose the right time to intervene. We made a mistake at the time."

more about this interview just  click here

What caused the crisis?

As I said in the previous blog George is the person who pulled the trigger, but he is not all the reason for the Crisis.

-"Like other financial crises of years past, the Asian crisis can be traced to a set of interrelated problems" - M. Goldstein (1998)

According to Goldstein (1998), there are three factors should be mention here:            1)Financial-sector weakness; 2) External-sector problems; 3) Contagion.

     1)  Financial-sector weakness - from Mishkin (1998) asymmetric information acted an important role in this crisis. “In most financial crises, and particular in the East Asian crises, the key factor that causes asymmetric information problem to worsen and launch a financial crisis is a deterioration in balance sheets, particularly those in the financial sector.”

All the developing countries have a same target, which is to maintain economy to last high-speed develops. When the conditions of the rapid development of economy are insufficient, these countries turned to rely on external borrowing to maintain the economic growth. In the middle of 1990s, some Asian countries no longer have the ability to repay debt. In East Asian countries, real estate blown bubble for just bank loans and occurring of bad debts. The market institutional in Asia is not mature, especially the inadequate regulatory system.

     2)  External-sector problems – as Asian Financial Market is a young market in 1990s, the foreign exchange policies in some Asian countries are improper. To attracting more foreign investments they have to retain a fixed exchange rate and expansion of financial liberalization. All these provide a perfect opportunity for international speculators (like George Soros) to speculating currencies. To maintain a fixed exchange rate system, these countries use foreign exchange reserves to make up for the deficit that leads to increase of external debt.

     3)  Contagion – the following video shows the 97 Asian Crisis contagion.

Who starts the crisis?

The 1997 Asian financial crisis that was triggered in 2^nd of July and start from Thailand and the storm spread into other Asian countries very quickly. The contagion expanded to Malaysia, Singapore, South Korea, Hong Kong and so on sooner. This crisis breaks the Asian rapid economic development system. As country’s economy goes depression, their political situation also began to chaos.

 

Speak of that Asian financial crisis, George Soros is one person has to carry out. In another word, we can say Soros is the person who starts this crisis. In the early 1997, Soros and other arbitrage fund manager began to selling the Thai baht, the foreign exchange market in Thailand breakdown immediately. By way of the Thai baht went down, ‘Soros Storm’ sweep to Indonesia, the Philippines, Myanmar and other countries. All the currency has a substantial depreciation, leading to factory closure, bank failures and raising prices. - Click here to know more about George Soros.