Asian and International Crisis - Literature review Example

Asian and International Crisis: Dissection by Asian and International Crisis: Dissection Asian and International Crisis Introduction to both crises The infamous Asian Financial Crisis happened at the start of 1997 and involved currency devaluations in many Asian countries. Thailand was the first country in which the currency failed first. This was due to the government’s decision to discontinue pegging it’s currency to the dollar. Currency declines, decline in stock markets, reduction in import revenues and government crises ensued. The Asian Financial Crisis prompted action from the IMF and the World Bank. The ripples of the crisis were felt in America, Europe, and Russia. Because of this crisis, many countries instituted measures to mitigate the effects on their economies. Some of this protectionist mechanisms adopted included intense purchase of US treasuries which many countries invest in. the crisis led countries like Japan, South Korea, Indonesia and Thailand to make some due reforms. The crisis is also referred to by many economists to be able to understand todays tangled markets particularly in currency markets and how to manage national accounts. The global financial crisis of 2007-2008 began with the collapse of the Northern Rock, a British bank. Singh (2009), states that the fall of Northern was just the start of what would be a sequence of falls. The fall of Northern Rock was followed closely by the fall of other major corporations. It is said that the crisis was just an egg hatching. The crisis’ can be said to have temporarily begun after the terrorist attack of 2001. The attack prompted the Federal Reserve to lower interests like never seen before because of the struggling economy. This created a housing boom. Mortgage markets were offering very attractive deals to people with poor credit. This made interest rates to shoot up again; as a result, mortgage prices were reset which led to sub-prime borrowers to default in payment. The mortgage companies were therefore left with properties that were not worth their original prices due to a shrinking market. There were a lot of more defaulters and several mortgage companies collapsed according to Singh (2009). Due to the selling of the mortgages to secondary investors as Collateralized Debt Obligations (CDOs) and Mortgage-Backed Securities (MBSs), the crisis also hurt investors and hedge funds. Causes of both crises Towards 1990, asset values appreciated greatly in Asia. This was because Asia had been enjoying high savings and therefore high investment rates owing to the economy operating in an atmosphere of fiscal restraint. This increase in asset values was particularly in land to some extent accompanied by growth in short-term borrowing from outside. There was a sequence of external tremors such as the devaluation of the Japanese yen and fall in prices of semiconductors which affected negatively the export earnings and led to dragging economic activity and depreciation of assets in several Asian countries. These happenings accompanied by upheaval in the foreign exchange market leading to collapse of the Thai baht (Moreno, 2014). What transpired in Thailand necessitated investors to re-evaluate the financial mechanisms and strength of currency pegs in the region. This resulted in a series of decline in currency markets and slump of stock markets. This was first experienced in South East Asia but spread afterwards to the remainder of the region. The year following the fall of the baht, the most affected currency declined in value against the US dollar 35-83% which represents a measure in dollars per unit Asian currency, and the most affected stock declines were to the tune of 40-60%. Moreno (2014) states that the economic turmoil in Asia was not followed by cyclical decline as it is normally the case, but by what most experts label as “runs” on financial and currency markets. It has been argued by some that these “runs” were not a reflection of inappropriate policies in handling the economy or poor institutions but were just typical panics. It is common knowledge that even banks or financial subsidiaries that are managed well are susceptible to shocks, since it is customary for them to do “maturity transformation”. This involves banks accepting deposits that mature fast like in three months to give out as loans that mature in a year or longer. This custom is profitable because it can avail more money to investors with long-term goals than they naturally would. According to Moreno (2014), banks do not find it difficult to manipulate their portfolios to meet surges in withdrawals. If however, depositors opted to make withdrawals from a given bank all at once due to maybe a panic, it would have deficiency in the amount of liquid assets it requires to manage its day to day activities which would be dangerous to the institution that is trying to maintain solvency. Radelet and Sachs (1998) stated financial institutions in East Asia had incurred considerable liquid debts whose potential threat was not minimizes by presence of liquid assets. This made them susceptible to shocks. This may have rendered some solvent banks insolvent because they could not be able to handle the abrupt disturbance in the funds pipeline. Moreno (2014) argues that this was not the whole narrative because the effects of the downturn were different in different economies. The crisis was most severely felt in those economies with the most susceptible financial markets namely Thailand, South Korea and Indonesia. It was however not the case with economies like that of Singapore that have relatively robust financial institutions. Moreno (2014) argues that the fall of the Thai baht and the Korean won in 1997 was preceded by indications of faults in the financial sector particularly by domestic borrowers’ failure to service their loans. It was clear in Indonesia that domestic lenders were unable to monitor their debtors which became even worse as the crisis progressed. Moreno (2014) notes that there were two major signs that are common in economies that have undergone a crisis that were vivid in the Asian economies; first financial subsidiaries had limited freedom to allocate credit using business mechanism. He says that in some cases, it was hard to refuse borrowers that had a lot of connections credit while sometimes firms that were not properly managed could get loans to meet a policy goal from the government. Second, owners of financial subsidiaries could not bear the complete burden of their failure. This demotivated the initiate to manage the risk properly. Financial intermediaries were especially protected by government guarantees. This is because the cost of huge shocks was too expensive for the government to carry or because the intermediaries were owned by relatives of government officials according to Krugman (1998).he further said that such guarantees can cause inflation in prices of assets and reduce economic health which eventually makes the financial system susceptible to total failure. There’s however an up-side to government guarantees; in Korea, the debt ratios of corporations say that they were expecting the government to support in the event of a crisis. The government encouraged banks to extend loans to corporations in 1997 confirming this. The weakened financial stand of banks as a result of this ignited the financial downturn in 1997. There had been faults in the financial sectors in Asia for long but why did the crisis happen at that time? Moreno (2014) argues that continued growth was not enough to expose the firms that had been shielded from consequences of their actions. It was only uncertainty that could do so. Another reason as argued by Moreno is that technological advancement had linked the banks to international world financial markets which had made them vulnerable to market changes. An open market is different from a closed economy in that in a closed economy, the government will always bail out domestic lenders who make mistakes to prevent depositors from making losses; if that kind of injection however happened in an open economy, it would make the exchange rates to become unstable. The global financial that begun in July 2007 was not any different. It is believed to have been caused by American investors’ lack of confidence in sub-prime mortgages caused by a crisis in liquidity. This prompted the Federal Reserve of the United States to pour in a lot of capital into the troubled markets. Markets around the globe had tumbled by September 2008 with the markets becoming very unstable. There was a slump in consumer confidence as everybody exercised caution due to uncertainty. Many people that had taken up sub-prime mortgage loans defaulted in repayments. This caused a crisis in the housing markets in the US. The borrowers were left with negative equity amidst the entire tumble in the value of homes. As is always the case in case of defaulting in payment, the banks had to repossess the properties that were of lower value than before. The banks were staring at a liquidity crisis. Giving and getting a loan became problematic in what is referred as a credit crunch. It is believed that the collapse of the US housing market ignited the global crisis; however, some pundits that have analysed the circumstances are of the opinion that the crisis was needed in order to necessitate institutional regulation to curtail lending unscrupulously. In September 2008, the crisis took a worse turn with the collapse of the Lehman Brothers. It proved difficult for governments around the globe to rescue financial institutions that were taking the heat from the collapse of housing and stock markets. A large number of financial institutions continued to experience desperate liquidity problems. The government of Australia announced the first of its bailout packages with the objective of reviving the slowing down economy. The United States came up with a stimulus package of its own of 700 billion dollars (Davies, 2014) but this did not pass as some in the Congress did not such a huge amount of taxpayers’ money needed to be spent on bailing out investment bankers in Wall Street who some believed started the crisis in the first place. People started to intensely invest in gold, bonds and the US dollar or the Euro because they believed it was a safer alternative to the struggling stock market. President Barrack Obama proposed that the government spend 1 trillion dollars in a bid to rescue the state of the financial markets (Davies, 2014). The government of Australia also came up with another package proposing to give cash to tax-payers and spend more on infrastructural projects. Comparing the two crises In comparison between the two crises, we see that the Asian crisis came from the unforeseen tremendous growth in the Asian economies such as those of Thailand, South Korea. What fuelled this growth was essentially a boom in export revenues. The boom was spurred by such factors as a relatively educated and cheap labour market coupled with export oriented markets (Halloran 1998, p. 24). The same can be said of the global crisis in which there was a housing market bubble that encouraged poor borrowers to acquire mortgage loans that they later failed to finance. In both case, there is uncontrolled expansion that culminated in a liquidity crisis. In the Asian crisis the lenders were out to look for yield, they were under protection from government policies at a time that there was not enough scrutiny or a reason to warrant such, but then the markets caved and there was need to bear responsibility (Halloran 1998, p. 35). The global crisis was not different; with the US as the epicentre of it, the origin of the mortgage crisis can be traced to the lack of sufficient caution by financial institutions; the economy was in a bubble and they needed to take advantage of the situation and make more money, but then came time for the bubble to deflate. Another similarity was an increase in prices of property. This was a sign of looming crisis. There was also moral risk, since lenders and borrowers did not face enough risk from their actions. There are however differences in how the governments responded to the two crises. Major central banks intervened intensely to avail liquidity to prevent interruptions and contagion effects in the markets. Also, the Federal Reserve of America cut interest rates considerably to lessen the intensity of the financial conditions and also approved stimulus packages. On the other hand in the Asian markets, because of low foreign reserves and huge capital outflow, the real economies tumbled. The governments only resorted to expansionary policies after exchange rates had become stable Difference is that during the Asian crisis, most governments took the non-performing loans and poured in fresh capital into the lenders; the IMF then filled the diminished foreign reserves of countries (Halloran 1998, p. 26). Injections of private capital in terms of foreign buy-out only happened later. In the global crisis on the other hand, new capital has come from direct injections and placements by federal reserves. Also, the Asian crisis had little effect on Western economies while the global crisis affected a lot of countries throughout the world and the recovery was not as fast as it was for the Asian crisis where the countries received a lot of assistance from international allies. China and the future Some countries like China were initially believed to be decoupled from crises happening in the west but have in the aftermath of the crisis invested heavily in the west. This has as a result removed the immunity they may have had or thought to have had. Economic crises are part of the world and have happened in the past, and will happen even in the future. The question should not be when but how an economy will cope with such a crisis so that the impact is mitigated. References Halloran, R. (January 1998) ‘Chinas Decisive Role in the Asian Financial Crisis’. Global Beat Issue Brief No. 24. 27 Investopedia. (n.d.) Subprime Meltdown Definition | Investopedia [online] Available at: http://www.investopedia.com/terms/s/subprime-meltdown.asp [Accessed: 15 Apr 2014]. Krugman, P. (1998) What happened to Asia Web.mit.edu. [online] Available at: http://web.mit.edu/krugman/www/DISINTER.html [Accessed: 15 Apr 2014]. Moreno, R. (2014) Federal Reserve Bank San Francisco | What Caused East Asia’s Financial Crisis? Frbsf.org. [online] Available at: http://www.frbsf.org/economic-research/publications/economic-letter/1998/august/what-caused-east-asia-financial-crisis/ [Accessed: 15 Apr 2014]. Singh, M. (2009) The 2007-08 Financial Crisis In Review Investopedia. [online] Available at: http://www.investopedia.com/articles/economics/09/financial-crisis-review.asp [Accessed: 15 Apr 2014]. Steven Radelet, Jeffrey Sachs. (1998). The Onset of the East Asian Financial Crisis. Available: http://www.nber.org/papers/w6680. Last accessed 14th April 2014. Yong Kwon, T. D. (2014) The IMF, Ukraine, and the Asian Financial Crisis Hangover The Diplomat. [online] Available at: http://thediplomat.com/2014/03/the-imf-ukraine-and-the-asian-financial-crisis-hangover/ [Accessed: 15 Apr 2014]. Read More