Friday, December 21, 2007

The Asian economic crisis: Ten years later (II)

It might be helpful for current uncertainty about the lasting effect of subprime market crisis, to keep in mind how important expectations are, and how relevant speculative forces are, to set the pace of adjustment path. Once there was well supported doubt, about the real value of each Asian economy exchange rate ,speculative forces were in charge of market behaviour. Any analysis on exchange rate fluctuations at that time, illustrate the magnitude of this speculative effect. R Dornbusch called overshooting , J Keynes called the speculative nature of business behaviour. Indonesia currency felt dramatically from 2,909 (1997)up to 10,014 ruppies per dollar(1998) , Korea currency moved from 950 won/dollar, (January 1997) up to 1600 won /dollar,(January 1998) , and Thailand baths from 31 (January 1997 ) up to 50 (January 1998). With all information available, speculators made quick decisions to move away from an increasing risky scenario. Somehow, speculators care very much about the real conditions of the economy, round the clock gathering information such that they are able to move quickly in case their expectations are not consistent with the fundamental .
It follows that speculative forces (suden changes on capital flows)are like a warning light ,about what is going wrong in the economy .Of course speculative forces by itself ,are not enough if they are not complemented by institutional weakness and misplaced focus of monetary policy.
a.- Institutional weakness. Reckless loan policies by private banks in Asian Economies, led to a sudden increase of loans which were not capable of matching its payment schedule .Bad loans, exacerbated negative expectations which reinforced the depreciation round, because everyone wanted to get out of that market to avoid further losses.The process of large gross intermediation of capital inflows and outflows through the banking system, implied that the domestic Asian bank increased their foreign short term liabilities faster than their foreign assets.. In the South Korean economy case, liabilities increased by U$$ 56 b between 1993 and 1997,while the gross assets increased only by U$$ 19.8 b. As a result, the net liability position of Korean banking system went up from U$$20,8 b in 1993,to U$$ 57 b by 1997,(U$$90b liability against U$$ 33b assets)(Roubini 1998).It is obviously a moral hazard case, which arise because of expectations of Government promises of bailout. Very much of domestic loan , were driven to finance speculative demand of existing fixed supply asset.
Another lesson from the Asian crisis, was that monetary policy must be rightly targeted to keep expectations under control. In most of Asian economies at that time ,it was focused on the wrong target .Instead of reacting to the speculative forces ,it underestimated the magnitude of such forces .It was more concerned with keeping stable the exchange rate throughout foreign currency markets operation, than constrained the aggregate expenditures level throughout higher interest rate which would have also allowed to slow down capital outflow and further currency depreciation . When it realized that such a correction was on top of the list, it was too late to stop the speculative waves.
Quality of information for a proper allocation of resources and economic decisions, was not good enough to guarantee stable economy growth and to avoid the recession in Asian economy by the end of 1997. The investment boom took place in the wrong sectors ,and speculative forces reacted faster than authorities attempt to control the damage. As a result, the whole event were driven by speculative behaviour adjustment , with no chance for macroeconomic policy , forces , to mitigate its negative impact.