The Crisis in a Nutshell Too Much, Too Fast

1960s – 1980s  Most FDI Rich to Rich  US investment in Europe  The American Challenge

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

Early 1990s  Liberalize FDI laws  Privatization  Market friendly policies  Deregulation

East and Southeast Asia become favorite target for banks, investors and speculators from the world economy

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

Currency Supply & Demand in BahtperDollar Dollars traded Growing dollar supply Growing excess supply of dollars Growing excess demand for baht S1 S2 Pressuretowardbahtappreciation Dollars purchased by Bank of Thailand with baht. Baht flow into Thai commercial banks and their reserves R

Commercial Bank Reserves

 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

 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

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

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

Thailand 1997: Sharp Reversal BahtperDollar Dollars Traded D1 D2 S1 S2 SUPPLYFALLING DEMAND RISING Exchange Rate rises: baht depreciates. INITIAL ER NEW ER

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

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

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

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