Tuesday, August 21, 2007

The Lessons Learned from the Asian Financial Crisis

The events that led up to the financial crisis in Asian economies are far too similar to what has been happening in the world’s largest economy, the US. During the 90s, capital was flowing into the region as investors and speculators saw vast opportunity in countries like Thailand, Indonesia, South Korea and the Philippines. For the record, private capital flow amounted close to $100 billion in 1996, equivalent to almost one third of worldwide money, as portfolio equity investment quadrupled within a year. The resulting investment was so enormous that it was comparable to percentages in total gross domestic product.

At the time, the boost in foreign capital subsequently supported expansion in the Asian Tiger economies as the countries were able to attract massive amounts of direct investment, spurred by higher interest rates in order to curb corresponding inflationary pressures. Once again investors turned to credit markets and instruments in boosting up speculation for assets in the region. This helped to support elevated levels in respective stock markets and housing sectors as investors sought rates of return at a cost of a forming bubble. Incidentally, demand was so great speculation led the Philippine stock index to advance by 60 percent in 1995-96 while boosting the Jakarta benchmark higher by 58.5 percent during the same period.

Completely overleveraged and over invested, the region was ripe for disaster as the unthinkable occurred on July 2nd 1997. On that day, the Thai government, a central body who relentlessly promised not to revalue its currency, allowed the Thai baht to float. Now with speculation constituting a majority of the market, sellers were moving faster as buying demand dried up leaving some in the market holding massive losses. The tragedy didn’t stop there as the effects were far reaching. Beginning in Southeast Asia, the contagion effect spread throughout the global markets as regional and benchmark indexes went down like dominoes. Although the effect was reduced to a more mild “Asian flu” by the time it landed in America, the damage could also seen in the Dow Industrials, which was severely hit by a 554 point plunge on October 27th. The loss equated to 7.2 percent as the New York Stock Exchange briefly halted trading amidst the panic. In the currency markets, no currency pair can capture the visual display as perfectly as shown in the downturn in USDJPY. Shortly after the contagion effect and impending exodus of risky loving speculators, the pair was rocked lower on grounds of a carry trade exit. In a matter of a week and a half, the USDJPY fell almost 1500 pips to a hard landing at 114.00.

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