The Asian economic flu

"Inflationary concerns", "have to move ahead of the curve", says the Fed chief in 1997, just as Thailand plunges into financial chaos and seeks refuge in an emergency International Monetary Fund (IMF) package of $17 billion.

At the G7 Naples summit in 1994, leading nations resolved to have a look at and update if necessary, the post World War II international financial institutions (IMF, World Bank) to enable them to better address the present huge – and growing – private capital flows. The Mexican peso crisis brought the resolve into focus at the next year's G7 meeting (June 1995) in Halifax, Nova Scotia. Here, leaders decided that prevention of a future crisis would be helped by increasing the IMF's surveillance of countries policies and at the same time demand better and more timely numbers from their central banks and respective governments. (Australian Financial Review, June 19, 1995) An effort was also started to ensure the IMF and other relevant international institutions had enough capital on hand to provide liquidity to member nations should it be required.

The Asian crisis of July 1997 caught both plans by surprise. Did the global community of economists see the crisis coming ? Nope, not a single one. Just prior to the Thai economic collapse, both the World Bank and IMF had issued glowing economic reports for its 'Asian Tiger' economies, including that of Thailand. Thailand's savings rate was high, the government budget in surplus, the foreign debt low, its growth rate between 7 and 8 percent. Notably, Thailand had done everything asked of it by the IMF; acceptable inflation policies, improved growth policies and better reporting of its numbers. For Korea, in a report released that summer (winter in Australia) the IMF "welcomed Korea's continued impressive macro-economic performance and praised the authorities for their enviable fiscal record." Only months later that same IMF was putting together a $56 billion dollar relief package to bail out South Korean banks from their disasterous property loans and poor business lending.

At the Pacific Economic Co-operation Council (PECC) meeting several months before the Thai crisis hit the headlines, the meeting had taken the opportunity to congratulate themselves on their forecasting accuracy, and current forecast of "slightly better growth and stability" for Thailand. (Australian Financial Review, Sept 21, 1997) "Nor were there grounds," continued the PECC at the meeting, "for expecting immediate financial collapse."

Alas, the IMF and others do not measure land price, as per the figures contained in the attached graphs and highlighted by Fred Harrison in his 1997 beginning chapter to Frederic J Jones, The Chaos Makers. (Tables 4 and 5, pages 31and 32.) Both residential and commercial South East Asian real estate prices escalated sharply in the several years just prior to the 1997 economic collapse.

Asia residential land prices 1994 - PDF
Asia comm land prices - PDF

1997, the countdown to a crisis:
March. The Thai central bank reports that 10 lending institutions are "cash strapped".

Mid May. The Thai Baht remains fixed to currencies led by the US dollar. The Thai economy has been slowing for twelve months, as measured by its GDP. The banks, it has been noticed are suffering from an excess of property loans and the current account deficit is rising. Currency speculators take an interest in events as they begin to see the Baht might be ripe for a devaluation. Hedge funds see the opening and also take positions. They borrow massive quantities of Baht, with the intention of buying it back later at the cheaper - devalued - price. (Hedge funds have the ability to borrow many times their capital base.)

End May. Central Banks unite to bailout Thailand and defend the Baht's fixed rate to the US dollar. They respond to the currency speculators by imposing currency controls, to prevent the free flow of Baht overseas, and by lifting interest rates, to make the borrowing of Baht prohibitively expensive.

Early June. The Thai property slump worsens. The raising of interest rates does further damage. Even more empty buildings are now visible on the streets of Bangkok. The Thai government bans all media from printing negative reports about the economy.

June 11. The Central Bank defence of the Baht backfires. Selling on the Thai stock exchange begins in earnest as foreign controlled funds take advantage of the government defended currency value to sell out of local stocks and redeem their Baht for dollars. (i.e. taking advantage of the artificially high currency rate.)

June 25. It is reported that Thailand's current account deficit has worsened. The high interest rates needed to attract overseas investment has slowed the economy even further. Thai officials continue to oppose any devaluation, suggesting this would push up inflation and hurt companies with US$ denominated debts, many of which companies are well connected to, or owned by Thai politicians.

June 30. The Bank of Thailand intervenes in the economy to protect the integrity of the Thai financial system by forcing 16 of the worst affected banks to close or merge. The six finance companies and ten security firms, with combined assets of A $20 billion, "have for some time been struggling under bad loans to the chronically over-supplied property sector," says the Bank.

July 1. Thailand's Prime Minister states firmly: "The Baht will never be devalued" as "we would then all become poor." He blames over-consumption for the crisis. "This can be seen from the fact that each family has many cars. This has led to a trade deficit and to speculative attacks on the currency." (The Baht was last devalued in 1984.)

July 3. Two days later, the Baht is floated, effectively a devaluation. The Central Bank abandons its previous defence of the currency through past use of high interest rates which were crippling local companies, and through the use of its own reserves, which was proving expensive. The currency float is done to try and breathe life back into the economy by reducing interest rates and boosting exports. The risk is inflation and hurting companies with US dollar denominated debts.

Mid July. It is realised that international aid may be required to help Thailand stabilise its economy, as per the Mexican crisis. The difference here though is that most of the debt in Thailand is held by private companies, not the Government, as was the case in Mexico. The international aid will be required to avert a liquidity crisis, as banks stop lending, hurt by the bad property loans, and as the cost of financing previously incurred debt soars for all borrowing done in non-Thai currency. (These borrowings would have been originally undertaken because, at the time, overseas interest rates were much lower than Thai rates, especially in the preceding twelve months and since the currency was pegged, effectively government guaranteed, why hedge the risk ?)

July / August. The Australian Financial Review reports that speculators begin exploiting export weaknesses, structural imbalances (read bad property loans by banks) and political uncertainty generated by the Cambodia conflict, in other Asian currencies. These nations respond by pushing local interest rates sharply higher.

Welcome to monopoly capitalism. Towards the mid 1990's, the heightened speculation was fed even further by European, American and Japanese banks seeking to aggressively expand their balance sheets. As the process reversed these same banks began pulling out, worsening the credit contraction.

Thailand's troubles cascaded to other South East Asian nations in late 1997 including Malaysia, Indonesia, the Philippines, Hong Kong and South Korea. By Early 1998, both the Fed chairman and Treasury Secretary Robert Rubin were telling congress the US was yet to feel the worst flow-on effects of the Asian downturn, asking Congress to increase the borrowing authority of the IMF so it had the resources to stem the collapse. If not, a global panic was possible they reasoned. (Australian Financial Review, May 23, 1998)

What these two gentlemen were pointing out, but did not say, was related to what is called a bank's 'credit risk': a bank's exposure to a counter party's inability or unwillingness to repay its debt. And plenty of US banks had quite a bit of credit risk exposure to these Asian countries now in economic meltdown. Author Frank Partnoy (F.I.A.S.C.O., page 276) put it this way: Asian banks had been feasting, like the fat Mexican banks of the early 1990's, making leveraged bets on their own markets and currencies using equity swaps, total return swaps, options, futures, forwards and more complex derivatives. Now, they faced annihilation. Within months, the foreign currency value of investments in East Asia dropped by 50 percent or more...Most of the derivatives causing the pain were 'over-the-counter' rather than traded on any exchange. That means, for example, that Asian banks engaging in swaps had a counter-party, typically a US or European bank, who expected repayment in this swap...In other words, the Asian banks and companies hadn't lost money to any centralized exchange; they had lost money to other companies, primarily western banks."

Therefore, if the Asian banks defaulted, the counter-party stood to lose what they were owed. (An exposure of more than $20 billion to South Korea alone, said banking regulators.) So the IMF bailed out the Asian economies, so that western banks and Wall Street could be repaid.

The US could now expect slower growth as exports to the region slowed. (16 percent of all US farm products goes to Asia, reported the Secretary.) "A likely slower economy, no need to lift interest rates," admitted the Fed Chairman, suggesting further that "economic policy makers still did not fully understand today's global financial system."

In an enlightening review of the area published by the Queensland University of Technology, the authors documented over 300 pages of commentary from various market players, bank directors and heads of legal and accounting firms in the region. The authors were staggered by the admission of interviewees, reporting that: "We had very senior bankers – I mean heads of banks, local and foreign – saying to us unhesitatingly that more than half the banks in Indonesia were technically insolvent, but that the then President Suharto wouldn't let them go down. The banks had finished non-viable projects and were not calling up loans from borrowers connected to the right families."

Notably, the world's tallest building went up in Malaysia, (Petronas Towers) completed just prior to the crisis, overshadowing Thailand's attempt at the same world height record, the Baiyoke Sky Tower, still then under construction. (The tower eventually opened in early 1998, much of it still an incomplete shell.) In August of 1997, just prior to the unfolding of the crisis in Indonesia, its government announced plans to build the world's longest bridge, linking itself to Malaysia across the Malacca Straits. (42 kilometres, to be built by a construction consortium headed by President Soeharto's second daughter.) Also, plans were announced by a private group to build a 558 metre tower - the Jakarta Tower – the world's tallest, to be built on the site of the old airport near the centre of the capital, this time by the President's brother-in-law.

In Hong Kong, the property investor Wong Kwan paid $70 million (US) in March of 1997 for the Hong Kong mansion 'Genesis', overlooking the city, the most money ever paid, anywhere, for a house. By 2001, Kwan was having trouble paying the household bills. (Australian Financial Review, June 26, 2001)

The wash up:
Eventually, once the Thai government stopped fudging the figures, it was revealed by the Bank of Thailand that its country's non-performing real estate loans for 1998 stood at almost half of total lending by the financial sector for that year. Nearly $US30 billion will be required for the banks to subsequently recapitalise. ( Australian Financial Review, March 5, 1999.) It was later discovered that the Bank of Thailand had squandered hundreds of millions of dollars from its Financial Institution Development Fund, using the fund 'as an ATM to dole out cash' in an effort to support ailing property development companies throughout 1996 and '97. Some 430 billion Baht ($US10 billion) was lent – unauthorised – to 56 now failed finance companies. In what soon became the national scandal, dozens of politicians and senior bank staff were implicated. Taxpayers eventually wore the cost of the gigantic losses.

In Singapore, Lee Kwan Yew is quoted as saying his nation was now facing its worst crisis since the withdrawal of British Armed Forces in 1968, 30 year prior.

In Indonesia, the severity of the downturn brought leadership change to the nation, May 19th, 1998, when under substantial pressure from the crisis, the corrupt regime of Soeharto collapsed. This was the same day prices for bread, oil and other essentials peaked, from policies widely viewed as deliberately instigated by the regime in response to the tough economic times. (Petrol prices were lifted 71 percent for example, electricity price rises of 60 percent were foreshadowed, amidst growing fears of an impending rice shortage and rumours that International Monetary fund relief packages were helping bail out the President's family connections first, before anyone else.) Exactly 180 days later, the new regime brought out the troops to quell rioting and looting in the capital Jakarta. The recapitalisation of Indonesian banks will eventually top $US 35 billion.

Notably, the previous South East Asian downturn had occurred in 1985 / 86, ten years prior to this latest one and about the upper range limit for how long the decade business cycle will usually run. The value of their respective currencies fell then as well, but the devaluations back to economic fundamentals soon improved the region's export competitiveness against other nations, allowing eventual re-growth within the group of nations affected.

What happened in S. E. Asia is worth studying because similar (but not exact) events are now unfolding in New Zealand (2004 onwards) and could also find a replay in the United States towards the end of this decade. But note the order of events: declining real estate prices came first, which placed increased pressure on the banks over-exposed to this area of lending. Only after that was there a crisis of the currency.

Further reading:

Australian Financial Review
- New Strategies Devised to Prop up Economies in Crisis, June 19, 1995, page 4.
- Experts Missed Signals of Economic collapse in Thailand, September 20 – 21, 1997, page 11.
- Fraud or Flawed: Culprits Sought in Thai Bank Fiasco, March 5, 1998.
- Warning of Food Crisis in Indonesia, April 2, 1998, page 12.
- Asian Crisis Could Derail US, May 23, 1998.
- Black Picture of Bad Loans Emerges, March 5, 1999
- Thailand's Tallest Hotel Stays Aloof from Slump, October 29, 1999, page 62
- Wong Kwan Seeks His New Genesis, June 26, 2001, page 56.

Harrison, Fred. The Losses of Nations,

Insolvency Law and Practice in Asia, Queensland University of Technology, 1998. Quoted also in Business Review Weekly, Don't Talk Gloom, it Might be a Prophecy, August 10, 1998.

Asian Currency Crisis, report, Economic Indicator Services, October 31, 1997.

Jones, Frederic J. The Chaos Makers: The Butterfly and the Cusp. A Study of Economic Catastrophes, Othila Press Ltd, 1997. (Incorporates a beginning chapter by Fred Harrison, The Dreamers and the Deceived.)

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