Money perspective on the Asian financial crisis
Timothy Chan Ying Jie and Lim Jia En |
04 Aug 2021 20:42:39
The Asian Financial Crisis (AFC) represents a turning point for East Asian economies which enjoyed the booming decades of the 1980s and 1990s. A combination of economic events, policies and business cycles created the right conditions. to a financial bubble which resulted in an implosion destabilizing the financial markets of the region. Most researchers agree that the crisis was precipitated by Thailand’s real estate bubble which caused a domino effect of financial panic in the region.
While the conditions that sow the seeds of the crisis remain questionable, Jomo and Lane both point to crony capitalism, financial liberalization and national monetary policies in their 1999 studies, here we analyze an event that precipitated the collapse. Thai baht – the Federal Reserve raising interest rates. Many East Asian currencies were pegged to the US dollar. Its subsequent appreciation made it expensive for their central banks to buy dollars to maintain the peg.
Our analysis focuses on the role of the US dollar in maintaining stability and increasing instability. Why is the appreciation of the dollar such a destabilizing force on the affected Asian currencies? One concept that we follow is the idea of the “money view”, invented by Perry Mehrling. The monetary perspective is concerned with the cash flows that follow economic activities. For example, a liability must be paid with assets, either now or credited for the future. When the promise is kept and the debt is paid, it is considered settled.
It is this “survival constraint” of the adequacy of cash flows that disciplines the credit of economic actors. To develop this, the money view uses a money hierarchy, where some forms of money are easier to “settle” a debt. For example, bank deposits in the form of currencies can be used to instantly settle debts, as they are universally accepted and come closest to central bank reserves (because who wouldn’t accept hard cash?). On the other hand, securities are a form of credit because they only promise to pay a currency in the future, since they delay settlement.
The hierarchy of money is the key theme here that informs our analysis of AFC at the macro level. In international money markets, Perry Mehrling’s monetary vision defines an exchange rate as the “price of money against another currency”. In contrast, the conventional economic point of view and the financial point of view would view the exchange rate through the prism of tradable goods and tradable financial assets respectively.
According to Perry Mehrling’s definition of relative price according to the Monetary View, the United States dollar is at the top of the hierarchy of world currencies. Table 1 illustrates this point, as dollar-linked currencies accounted for 65 percent of the world economy (GDP) in the year 2000 alone. This hierarchy is reinforced by a strong demand for the dollar and dollar-denominated assets which extend the survival constraint in the global financial system.
From a monetary perspective, the key to the functioning of the financial payment system is the daily expansion and contraction of the central bank’s balance sheet – for the express purpose of regulating liquidity. It further serves as a means of providing elasticity or discipline. To clarify, central banks conduct open market operations as a means of enforcing discipline by setting interest rates. Lower interest rates relax market discipline, making the availability of credit cheaper and a lower exchange rate; the reverse happens when interest rates are increased.
In the narrative of the monetary vision, the liberalization of capital in the 1990s by Asian countries caused capital inflows as elasticity relaxed the discipline. This caused credit booms in national economies, creating a Minskyan financial cycle of speculation and increasing debt levels as economic players took excessive risks. Short-term debt has financed inflation in the prices of long-term assets. Countries indexed to the dollar have used their exports to generate trade surpluses in order to cover their financial account deficit through capital flows and to keep their foreign exchange reserves in indexation. Demand for dollars poured in until it got too expensive because of the Fed’s interest rate hike. As a result, this sudden discipline reduced liquidity, as noted by Bosworth’s 1998 study of the Asian financial crisis, causing a liquidity crunch as investors rushed into the currency and, by extension, disrupting the currency. valuation of vulnerable Asian currencies like the Thai baht.
The appreciation of the dollar and the depreciation of the baht created a contagion effect as the region’s exports – with which to feed the deficits in the financial accounts due to capital inflows by maintaining the current account surplus – are made uncompetitive, creating a currency crisis. What happened next was the collapse of a domino, as Thailand’s tiger economies faced speculative attacks and similar cuts in their economies.
The AFC and the global financial crisis have shown how crises expose the hierarchy of money on a global scale, illustrating the hierarchy of the dollar. Aizenman documented the importance of the role of the US dollar in providing liquidity during a crisis, where the Fed then extended dollar swap lines against foreign currencies to central banks to address the liquidity problem in the GFC and during the Covid shock.
Timothy Chan Ying Jie and Lim Jia En are undergraduate economics students at the University of Nottingham in Malaysia. [email protected]]