The Crisis in a Nutshell

1. The Crisis in a Nutshell Too Much, Too Fast

2. 1960s – 1980s • Most FDI Rich to Rich • US investment in Europe • The American Challenge

3. Late 1980s – 1990s • FDI shifts to developing countries • Many in Africa & LA oppose FDI • Asia and former Soviet block countries favor & welcome FDI

4. Early 1990s • Liberalize FDI laws • Privatization • Market friendly policies • Deregulation

5. 1995 - 1997 East and Southeast Asia become favorite target for banks, investors and speculators from the world economy

6. 1995 - 1997 The countries drown in floods of money & credit. Eight Asian countries receive over 2/3 of world investment funds

7. TRANSITION FROM 1994(III,IV) to 1997(I,II) • THAILAND: Increased weight of $US in its basket of reserve currencies • HONG KONG & TAIWAN: Remained pegged to the $US • INDONESIA, KOREA, MALAYSIA, SINGAPORE & CHINA: Managed float toward tighter ties to $US

8. Currency Supply & Demand in 1995-97 Growing excess supply of dollars Growing excess demand for baht Baht per Dollar Dollars purchased by Bank of Thailand with baht. Baht flow into Thai commercial banks and their reserves R Pressure toward baht appreciation S1 S2 Growing dollar supply Dollars traded

9. Commercial Bank Reserves Bank reserves pay no interest Hence, massive loans Excessive investments Excess capacity

10. 1995 - 1997 • Dollar + BAHT, RUPIAH, PESO & RINGGIT appreciated 40% with respect to the yen • Strong purchasing power over foreign goods & services • Domestic goods not competitive • Domestic interest rates were high

11. 1995 - 1997 • Current account deficits; growing net interest payments to outland • Capital Account surpluses; strong growth rates & high interest rates => heavy capital inflows ($US) • Dollars accumulate as R; banks awash with liquidity => lending & building

12. THAILAND: EARLY 1997 • Banks lent heavily to finance construction • Financiers borrowed abroad at low interest rates & opened accounts in Thailand at high interest • Banks & financiers lent heavily to investors and industry

13. THAILAND 1997 • Correction! Foreign investors panic, try to repatriate profits • Reversal! Baht holders try to buy dollars from Thai banks and BOT • Exchange rate pressure! BOT tries to keep peg: buys baht with dollars • Speculation! Interest rates rise; BOT dollar reserves depleted

14. Thailand 1997: Sharp Reversal Baht per Dollar D2 D1 S2 NEW ER S1 Exchange Rate rises: baht depreciates. SUPPLY FALLING DEMAND RISING INITIAL ER Dollars Traded

15. THAILAND 1997 • Shorting a currency: Traders Albert & Bill bargain on 15 May • BOT pegged ER at B25/$1 • Albert offers to sell baht to Bill in two months at the rate of B30/$1. Bill agrees • BOT floats baht on 02 July; baht value falls to B40/$1 by 15 July • Albert can now buy 120 baht for $3 and sell them to Bill for $4.00

16. THAILAND 1997 • Short selling enormous due to falling stock of BOT reserve dollars, low risk and high expected profits • Liquidity drying up. Capital intensive projects failing • Bank loans unpaid • Debt to foreigners due in dollars • The stock market was cannibalized

17. MALAYSIA, PHILIPPINES, INDONESIA • similar policies and vulnerabilities • Speculators => expedited fall of currency values • Philippines were not hit so hard; currency was more flexible & some cronyism already been ousted with Marcos

18. SPECULATORS • Speculators, like the Paparazzi, exploit weakness or vulnerability • However, they make it incumbent upon us to avoid the kind of behavior or policies that create exploitable weaknesses