Page 292 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes In several Asian countries, close ties between business interests and government officials appear
to have helped foster considerable moral hazard in lending. In Thailand, so-called finance
companies, often run by relatives of government officials, lent money to highly speculative real
estate ventures; in Indonesia, lenders were far too eager to finance ventures by members of the
president’s family. These factors help to explain how, despite high saving rates, East Asian
countries were led to invest so much that their current accounts were in deficit prior to the
crisis.
Some analysts have suggested that excessive lending, driven by moral hazard, helped create an
unsustainable boom in Asian economies, especially in real estate, that temporarily concealed
the poor quality of many of the investments; and that the inevitable end of this boom caused a
downward spiral of declining prices and failing banks. However, while moral hazard was
certainly a factor in the runup to crisis, its importance remains a subject of considerable dispute.
3. Legal framework : One important weakness of Asian economies only became apparent after
they stumbled : the lack of a good legal framework for dealing with companies in trouble. In
the United States, there is a well-established procedure for bankruptcy—that is, for dealing
with a company that cannot pay its debts. In such a procedure, the courts take possession of the
firm on behalf of the creditors, then seek to find a way to satisfy their claims as well as possible.
Often this means keeping the company in existence and converting the debts it cannot pay into
ownership shares. In Asian economies, however, bankruptcy law was weak, in part because
the astonishing growth of the economies had made corporate failures a rare event. When times
did turn bad, a destructive impasse developed. Troubled companies would simply stop paying
their debts. They then could not operate effectively because nobody would lend to them until
the outstanding debts were repaid. Yet the creditors lacked any way to seize the limping
enterprises from their original owners.
Of course, every economy has weaknesses, but the performance of the East Asian economies
had been so spectacular that few paid much attention to theirs. Even those who were aware
that the “miracle” economies had problems could hardly have anticipated the catastrophe that
overtook them in 1997.
26.1 The Asian Financial Crisis

The Asian financial crisis is generally considered to have started on July 2, 1997, with the devaluation
of the Thai baht. Thailand had been showing signs of financial strain for more than a year. During
1996 it became apparent that far too many office towers had been built; first the nation’s real estate
market, then its stock market, went into decline. In the first half of 1997 speculation about a possible
devaluation of the baht led to an accelerating loss of foreign exchange reserves, and on July 2 the
country attempted a controlled 15 percent devaluation. As in the case of Mexico in 1994, however,
the attempted moderate devaluation spun out of control, sparking massive speculation and a far
deeper plunge.

Thailand itself is a small economy. However, the sharp drop in the Thai currency was
followed by speculation against the currencies first of its immediate neighbor Malaysia,
then of Indonesia, and eventually of the much larger and more developed economy of
South Korea.

All of these economies seemed to speculators to share with Thailand the weaknesses previously
listed; all were feeling the effects in 1997 of renewed economic slowdown in their largest industrial
neighbor, Japan. In each case, governments were faced with awkward dilemmas, stemming partly
from the dependence of their economies on trade, partly from the fact that domestic banks and

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