The Asian Financial Crisis

THE ASIAN FINANCIAL CRISIS: CAUSES AND CONSEQUENCES FOR THE U.S. by Matthew J. Dillingham A SENIOR THESIS in GENERAL STUDIES Submitted to the General Studies Council in the College of Arts and Sciences at Texas Tech University in Partial Fulfillment of the Requirement for the Degree of BACHELOR OF GENERAL STUDIES Approved DR. DEB~ LAJ;JIE Department of Business Administration Co-Chair of Thesis Committee DR. JOHN P. TUMAN Department of Political Science Co-Chair of Thesis Committee DR. DALE DAVIS Director of General Studies MAY 1998 It)g,~ r' 3 ACKNOWLEDGEMENTS f1tj~ 10.4 This thesis would have not been possible without the support and assistance from a select group of Texas Tech faculty. I would first like to thank my thesis committee co-chairs, Dr. John Tuman, Department of Political Science, and Dr. Debra Laverie, College of Business Administration, for their patience and assistance in the development and research of my first thesis. Their knowledge and dedication were very much an asset in my completing this work. I would also like to thank the Director of General Studies, Dr. Dale Davis, for his dedication to his students and the development of the General Studies program. Without his guidance, I would not have been able to complete this thesis in the organized and timely manner in which I did. Finally, I would like to recognize the General Studies Advisor, Ms. Linda Gregston, and the General Studies Council for their help in the development of my project. Without any of these people, this thesis could not have been a success. I thank you all. 11 TABLE OF CONTENTS ACKNOWLEDGEMENTS ii CHAPTER I. THE RISE AND FALL OF ASIA'S MIRACLE ECONOMIES 1 Introduction 1 Causes of the Crisis 2 Problems to be Remedied 9 II. THE UNITED STATES INVESTED INTERESTS IN ASIA 12 Implications of the Crisis for the United States 12 The Costs to the U.S. Economy 16 Possible Solutions 20 III. INDONESIA: AN ILLUMINATING ASIAN CASE 22 Policy Purposes 22 Suharto Follows Own Agenda 27 IV. CONCLUSION 33 WORKS CITED 34 III CHAPTER I THE RISE AND FALL OF ASIA'S MIRACLE ECONOMIES Introduction Asia, the land of wealth, industries and the "miracle economies," is now (in the late 1990s) experiencing a time of crisis. The current crisis has brought economic turmoil, hunger, bankruptcies, bank failure and many other destructive events not to only the Asian economy but also to the world's economy. However, economic crises have already occurred in the early 1990s, especially in emerging markets. For example, there was a currency devaluation crisis in Mexico in 1994, and a run on the banks in Argentina in 1995; then there was the banking and exchange-rate collapse in Bulgaria in 1996. These were followed by the drastic 1997 crises in the Czech Republic and then in Asia (Sachs 69). Asia has been characterized as an economic powerhouse, known as the "Flying Geese," led by Japan, which showed the economies of East Asia the way to economic superiority. Asia seemed like it was indestructible. To many, Asian markets were immune to recession and produced strong growth rates that no other economy could replicate. For investors, there were almost too many opportunities to choose from. General Electric, AT&T, and Royal Dutch/Shell Group mapped multi-billion dollar strategies to tap a market that had an insatiable demand for everything. Foreign capital flowed into bull markets from Bangkok to Jakarta. "Anywhere you 2 dipped your oars," recalls George Baeder, President of Hong Kong-based Pacific Rim Consulting Ltd., which advises numerous multinationals, "you got growth of 30 percent" (Engardio 3). How could economies with so much growth fail? Two of the many reasons are the over-extension of their economies by making bad loan deals and over expanding their production, causing over-capacity and devalutions on the price of the products. Effects of the over-capacity caused companies to cut back on labor and take a hit on their profits. This thesis will focus on the problems that this crisis has generated for the Asian economies and also for the U.S. economy. Because of the scope of this crisis, an attempt will be made to analyze the general causes in Asia while focusing on Indonesia as an illustrative case. Causes of the Crisis What factors underlie the Asian economic crisis? Is it an exchange rate crash, devaluation and failure of currency, overproduction or all of these combined with a variety of other factors? After two decades of extreme economic expansion, the Asian region is getting a reality check. The problems and causes of Asia's economic demise were initiated by extreme growth and prosperity. Some analysts say Japan could be the major factor in the fall of the "miracle economies." The Southeast Asian economies had been so stable and 2 3 productive for such a long period that the economies were seen as economic miracles. The region had become an economic powerhouse in just three decades, rising from a poverty stricken region to a powerful financial force in the international economy. How could such an economically powerful and influential economy (Southeast Asia) fall and cause the emerging markets of Asia to plummet with it? According to the December 10, 1997, issue of the New York Times, nothing was ever actually physically done to cause the crisis. Japan had only thought about increasing its low interest rates to boost the yen. Nevertheless, the suggestion of higher rates led to capital movement: In early May, Japanese officials, concerned about the decline of the yen, hinted that they might raise interest rates. The threat never materialized. But it proved to be the first sign of an Asian flue that six months[now ten months] later is still spreading and has already prompted around $100 billion in international pledges for a cure. (Fuerbringer 1) Since the Japanese are so powerful and influential economically, this "hint" sent a shock wave not only throughout Asia and its emerging economies but also through the U.S. The words of the Japanese sent global investors into a Southeast Asian currency selling frenzy, "setting off a tumble not only in the currencies but in local stock markets as well"(Fuerbringer 2). A domino effect was thus in effect spreading from Indonesia to Thailand to Hong Kong, 3 4 eventually striking Wall Street and causing the market to crash with the Dow Jones Industrial Average plummeting 554 points on October 27,1997. The threat of the Japanese contemplating an interest rate increase made investors make a mad dash for the door. Investment bankers and commercial bankers became fearful of what would happen to the big investments that were "predicated" on currency stability. As the bankers began to liquidate their local currencies, so did large foreign corporations, who were also trying to convert local currency into the more stable dollar. Not only did the foreign companies and investment bankers want to remove their capital as well as other financial interests, local companies tried to convert their yen into dollars; this caused the local currencies to plunge, including the Thai baht and the Indonesian rupiah. Many economists have compared the Mexican peso crisis with the Asian crisis. The comparison deals with the philosophy of "moral hazard" and the International Monetary Fund, whereby economic actors accept high risks with their economic decisions, because of the protection from the International Monetary Fund for their losses. Economists Ron McKinnon of Standor and Paul Drugman of Massachusetts Institute of Technology have both said that the Asian banking standard was based on the idea of "moral hazard," which is described thus: "Depositors in, shareholders of and lenders to Asian banks all assumed that Asian governments would pick up the tab if the banks themselves faltered. The result: too much lending at too little profit." (Rohwer 86). 4 5 For years, in emerging markets all over the world, countries borrowed vast amounts of money from the banks with "rock bottom" interest rates in Japan and the similarly low rates of the U.S. The problem arises when the countries that borrow put the money into short-term notes in Southeast Asia that pay higher rates. Since currencies in Asia have been stable for so long, more money was being borrowed at massively low interest rates. When interest rates increase in the foreign market or local currencies start to increase, profits would turn to losses. The threat of the interest rate hike by Japanese was just enough to cause firms to sell off their notes, thus stimulating more local currency. With more currency in the economy, the value of the local currency spiraled downward. This downward spiral increased the money owed to the lending banks. Many believe this is because of the lack of faith in Asian domestic currencies. Camdessus of the IMF stated after the initial crisis, "The underlying cause of the rout. .. was the mistaken faith of millions of investors in the stability of the Asian currencies. Such misplaced faith makes the Asian decline similar in its origins and its unfolding to the European currency crisis of 1992 and 1993." The faith in a country's currency is close to the same events that happened in many other emerging markets during the past few decades. Many banks made risky loans, hoping to build a good relationship with these countries in hopes of higher profits in the future. A loan to an Asian emerging market may lead to investment banking fees or a bond offering in the future. This process allowed the issuing and borrowing of loans with no backing, and then expecting 5 6 the government or an international monetary institution to pick up the mess.

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