Money and finance in the global economy. The international monetary system is the body of rules and procedures by which different national currencies are exchanged for each other in world trade.
The dollar remains the key reserve currency, although the system is based on some cooperation among the FED, the European Central Bank (the Bundesbank before 1999) and the Bank of Japan.
Desirable objectives of IMS:
The large increase in prices and profits suddenly goes into reverse gear.
Banks stop extending credit, and in fact demand payment for the credits they earlier had granted, i.e. there is a credit squeeze. Foreign capital moves out. Currencies are forced to devalue.
1970s- early 1980s: Crisis in developing countries, especially Latin America.
Build-up of high debt levels with Western banks, which had used their lines of credit to recycle Petrodollars.
Starting in 1979, Paul Volcker, the Fed Chairman, raised interests drastically to fight US inflation.
International banks followed suit, raised interest rates and the unsustainable debt of many countries position was exposed.
Japan’s growth rate.
In December 1994 the Mexican peso devalues, following an abrupt crisis of confidence in the Mexican economy. President Clinton leads a recovery effort, sustained by US Treasury funds as well as by the IMF. In 1995 Mexico’s GDP fell by 6%.
Chronology of the Asian financial crisis
Thailand had benefited from dollar and yen loans, converted into baht to speculate in local real estate and other assets. International banks and hedge funds poured money into Thailand. By 1996 doubt began to creep in: were these loans secure? Selling of baht assets into dollars commenced. To counter the impending crisis and maintain the value of the baht, the Thai central bank raised interest rates. However higher interest rates reduced the demand for real estate and brought prices down. Selling of the baht increased and the Bank ran out of dollars to support the baht.
July 1997- Thailand dropped the baht-dollar peg, leaving the bath free to float
August 1997- The IMF grants a 17 billion dollar loan to Thailand. Indonesia prime minister blames foreign speculators for the crisis
October 1997. The Hong Kong stock market falls by 25% over just 4 days and a few days later falls by another 5%. Shares fall all over the world, including on Wall Street. The IMF approves a rescue package of 42 billion dollars for Indonesia.
November 1997: The crisis spreads to Brasil. The South Korean currency, the won, crashes. In Japan Yamaichi Securities collapse, revealing how the acute problems of the Japanese economy have not been solved.
December 1997 . Fears for the South Korean economy dramatize the crisis. The IMF grants a huge bailout loan of 58 billion $ to South Korea.
January 1998. The IMF and the Indonesian government agree on a package of economic reforms while Indonesia sinks deeper.
April 1998. Signs of crisis in Japan. New agreement between the IMF and Indonesia. The US Congress criticizes the IMF’s role in the Asian crisis.
May 1998. Student revolts in Indonesia. Amidst further economic trouble, the Indonesian president, Suharto, resigns.
January 1998. One of the most important investment banks in Hong Kong, Peregrine Investments Holding folds. However despite renewed heavy losses on the stock markets in the entire region, the Hong Kong dollar resists.
Monetary policy in H.K is managed through a Currency Board, which backs the money supply with of US dollars. Also China is prepared to support the Hong Kong dollar with its own vast monetary reserves. Speculators retreat.
May 1998: devaluation of the ruble. Bad news from Russia sparks a wave of panic on world markets, with a sharp fall in Wall Street. Brazil’s currency, the real, comes under attack
October 1998. The IMF, strongly backed by the US Treasury, grants Brazil a huge, 40 bn. $ loan, demanding a change in Brazil’s economic policy and further market reform.
January 1999: failure by Brazil to carry out economic reform leads to a 35% devaluation of the real and the flight of investors.
China and India escaped the crisis. Their capital markets had remained closed
Was the IMF prescription correct?
According to Stiglitz the Asian crisis was different from the financial crises in Latin America during the 1980s. Whereas in Latin America the problem had been inflation and debts in the public sector, in Asia public finances were in good shape, whereas the corporate sector was badly in debt.
The solution therefore should have been different, and should not have included budget cuts and austerity measures. It should have, instead, concentrated on macro-economic stability, and in corporate restructuring.
Rather than imposing austerity, the IMF should have let corporations pay the price of their profligacy, by allowing exchange rate devaluation. Interest rates should not have been raised.
Financial crisis in Asia: debate
Left wing critics: They blame the IMF for its arrogance and insensitivity and for its neo-liberal ideological approach. The IMF proved to be the tool of international finance, and its prescriptions followed the wishes of the US government and Wall Street.
Right wing, free market critics,the IMF should not have spent so much money bailing out speculators.
The IMF defence. Only a strong IMF package stopped the crisis from damaging the entire world economy.
According to Martin Wolf the IMF was made the scapegoat, while responsibility for bad economic management rests with governments.
It is reasonable and consistent that the IMF should follow to a certain degree the will of its paymasters, i.e. the lending nations. If it were to act otherwise creditors would stop funding it and would seek to manage their relations with debtor countries bilaterally.
Proposals and remedies.
Gilpin believes that short term capital flows should be regulated. A tax could be levied to discourage speculation. Other observers think this solution – called the Tobin tax -both impractical and unreasonable.
The Asian crisis highlighted the need for better international rules. Prescription on bank reserves were introduced through the Basel convention. Proposals were floated for an international bankruptcy procedure.
It remains true that the international financial system is the weakest link in the global economy and that its governance is very weak and contested.