Wall Street History

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Wall Street History

07/16/1999

The Asian Crisis

Two weeks ago I listed a timeline for the 2nd half of 1997 when
the Asian Crisis hit financial markets worldwide. This week we
are going to take a look at the genesis of the crisis.

Jeffrey Sachs, a Harvard professor and economic advisor to
governments in Latin America, Eastern Europe and Russia, was
interviewed a few months ago for the PBS "Frontline" program.
Here are some excerpts from that interview.

Sachs was asked to comment on "globalization" and the Asian
emerging markets.

"Globalization was a deep trend pushed by technology and right
ideas, as much as anything else, (as well as) the failure of dozens
of attempts throughout the rest of the world to try to develop in a
closed way. So the deep push came from deep forces, but the
way that the deep forces were translated into the day-to-day
practice came from the U.S. Treasury, the International Monetary
Fund, the World Bank. Of course, investment bankers were part
of that milieu, as well."

Q: All of this made these emerging market countries quite
vulnerable...

"When countries open up to trade, they generally benefit,
because they can sell more, then they can buy more. And trade
has two-way gain. When countries open up to financial flows,
they can get themselves into a lot of hot water. If our banks are
willing to lend to their banks a lot of money at short term, you
get into a very vulnerable situation where, for whatever reason,
our banks decide to yank their money, that can bring down the
whole economy that''s borrowed from the international banks.

So, in the early 1990s, when a lot of the developing world
opened up to international capital flows, without the right kind of
regulatory environment, and not understanding how vulnerable
they would become to panics and euphoric waves of sentiment,
coming from London, New York or other money centers, they
ended up with a tremendous amount of short-term debt, often
invested in very good long0-term projects, but projects that
weren''t going to pay of for five or 10 or 20 years."

Q: If they have short-term debt, that means.

"If you have a lot of short-term debt, it means that all of that
money can be demanded in a very short period of time.
Technically, short-term debt means money that''s coming due
within a year. Typically, it means money that''s coming due
within 30 to 90 days.

Now, if you have billions and billions of dollars coming due in a
country in a short period of time, and if a sense of panic develops
among your creditors, so that everybody demands the money out
all at once, it''s almost inevitable that the debtor economy will
collapse, because it won''t be able to come up with that amount of
money in a short period."

Q: That''s what happened in Asia, to start this.most recent
rolling crisis, in 1997.

"In Asia, a lot of successful economies, that had been living on
their own saving, decided to open up their financial markets to
international capital in the early 1990s. So here were countries
doing quite well, but they decided they''d borrow a bit more and
do even better. They started borrowing several percentage points
of their national income, every year. It added up to about $175
billion of short-term debt, owed by five developing countries in
Asia: Indonesia, Korea, Malaysia, the Philippines, and Thailand.
That $175 billion could all be yanked quite quickly.

When the creditors, which were mainly international banks,
started to have anxieties about Asia in the middle of 1997, and
then they started to have anxieties about what the other banks
were going to do, because each one thought that the other one
was going to get his money out first. Then they realized that the
amount of short-term debt that was due was probably about 75%
more than the short-term dollar assets that those countries held, a
panic developed, in which every bank said, ''We don''t know and
we don''t care about the long term of this country. We just want
our money out right now.''

So, all of a sudden, there was a massive run on Asia, meaning
that all the creditors wanted to yank their money out as fast as
possible. And Asia didn''t have the dollars to pay, so the dollars
went into default. The currencies plummeted. Interest rates
soared. Working capital disappeared. Production seized up.
The whole region went into economic collapse."

Market Reaction

Of course, the Dow Jones took awhile to react to the Asian
Crisis, which officially started when the government of Thailand
devalued their currency on July 2, 1997. Setting the stage, one
month before the Dow Jones stood at 7289. By July 2nd the Dow
was in the midst of another leg in the great bull market and the
average stood at 7795. The Dow actually rose 1% the day
Thailand announced their move.

During the month of July, as the IMF scrambled to help
Thailand, and while Malaysia, the Philippines and Indonesia
were announcing various measures to combat a rapidly
escalating crisis of confidence in the Asian "tigers," the Dow
Jones continued to rally, hitting a high of 8259 on August 6th.

The U.S. financial markets focused on the domestic economy
which was growing at a solid rate with little inflation and low
interest rates. It was also quickly decided by the experts that
U.S. corporate earnings would not be severely impacted by
lessening demand in Asia.

Confidence began to wane, however, and then in October Hong
Kong''s market trembled. By October 27th, the U.S. markets
finally took notice. After Hong Kong had suffered through
another plunge the night before, the Dow Jones plummeted 554
points, (7.2%), for its largest single point loss in history. After
the close of action that day the Dow stood at 7161 (for a
correction from the 8/6 high of 13.3%).

The Dow recovery began the next day and the average quickly
settled into a nervous trading range of 7400-7700. By November
15th the average was at 7572. It finished 1997 at the 7908 level.

Next week, Russia.

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