Looking back in anger at inflated stock market and real estate bubbles

By Michael R, Kratke

[This article published in: Freitag 07, 2/15/2008 is translated from the German on the World Wide Web, Michael R. Kratke is a professor of economics at the University of Amsterdam.]

The current financial crisis has its predecessors – the malaise of the European monetary system of 1992-1993, the Mexican shock of 1995-1996 and the crash two years ago in Southeast Asia’s tiger states, a financial- and monetary crisis with global repercussions. Whoever analyzes causes and consequences discovers parallels to the restless finance markets these days.

Unlike Japan’s economic tuberculosis, countries like Thailand, Malaysia, Indonesia and Singapore experienced an unparalleled boom in the middle of the 1990s. The credit volume of these “tiger states” grew eight to ten percent faster than their gross domestic product (GDP). An expanding portion of these credits flowed into the purchase of stocks and real estate. Foreign capital was enticed with all means – excessive interests and excessive exchange rates.

Enormous capital streamed in short-term monetary investments that could dissolve at any time, not in lasting direct investments. Higher stock prices and home prices fueled the credit boom. The banks of Southeast Asian countries became massively indebted through dollar- and yen-loans with short running times and – believing the stock- and real estate boom would continue – financed long-term credits in the local currencies. By the middle of 1997, almost $390 billion flowed mostly from Japanese and European banks to Southeast Asia. Private German banks and regional German banks led the way.

The longer the boom lasted, the more unstable the countries became. At the end, the central banks of Asian countries had only trifling foreign currency reserves, much too little to repay the foreign credits in case of a fall. This was an ideal field for currency speculators who – unlike the central banks of the tiger states – did not trust the coupling of Southeast Asian currencies to the dollar.

Crisis came to Thailand in March 1997. The first signs of over-production in Southeast Asian export industries (computers and computer chips) could not be ignored any longer and export revenues fell. In this situation, international speculators launched their attack. On July 2, 1997 the Thai baht was officially uncoupled from the dollar – a climax of a series of vain attempts of the Bangkok government to defend its currency against speculative attacks.

Within the shortest time, the Thai currency plunged around 20 percent triggering a panic capital flight. Masses of short-term credits were withdrawn by foreign banks. Over $100 billion was withdrawn in less than six months. At the same time, the foreign debts of domestic businesses and banks soared through the devaluation of the baht. They could not pay their liabilities in foreign currencies and declared bankruptcy in droves. When the Thai central bank tried to avert its collapse through supportive credits, it was too late. The central bank had to appeal to the IMF for help.

In August 1997, the virus spread from Thailand to Malaysia, Singapore, Indonesia and the Philippines. In the five most intensely affected countries, stock market shares fell over 60 percent (!) within a few days. From 1997 to 1998, $600 billion in stock capital and joint stock was destroyed. Even Taiwan, South Korea and Hong Kong that had not suffered speculative attacks up to then fell in this whirlpool. That the price collapse in Asia led to a short-term worldwide economic slump could hardly be surprising. But while the stock trade quickly recovered in Europe and North America, Asia remained permanently stricken. For South Korea and the other tiger states, a serious recession could not be averted any more after the speculative bubble burst and caused firm bankruptcies and mass unemployment. The crash dispossessed millions of people in the grieved countries who had joined in with their modest resources and now lost everything.

Three states – Thailand, South Korea and Indonesia – received the lion’s share of financial aid raised by the International Monetary Fund in alliance with other financial backers – under strict conditions. The IMF prescribed higher interests, higher taxes, massive cuts in public spending and further currency devaluations. Under the existing conditions, these prescriptions could only be counter-productive. Without this drastic cure, many banks and businesses in Southeast Asian countries would have survived the crisis.

Millions lost their jobs and the population became impoverished, particularly the middle class. Up to today the memory persists of the women from good society who sold their jewelry, clothing and gloves to assure the survival of their families. Despite serious crises, Malaysia maintained itself relatively well since it refused the aid of the IMF. Altogether the gross domestic product shriveled 13.7 percent in 1998, 8 percent in Thailand and 5.5 percent in South Korea. Southeast Asia massively lost foreign investments that flowed to China and India.

Even today the tiger states have not completely recovered from the shock of the Asian crisis. The rise of China and India was considerably accelerated. Japan’s position was permanently shaken. The boom of “emerging markets” was over. European and American investors threw themselves on the next bonanza. In 1998-1999, Internet-technology stocks went into their overheated phase that ended a little later with the bursting of the speculative bubble of the New Economy.

Are there parallels to the current situation? At that time over-valued real estate played a main role. Banks gave credits worldwide without really worrying about their quality. At that time hedge-funds and credit derivatives were not very important. Since the Asian crisis, we know that deregulated finance markets are everything but “efficient.” On the contrary, the radical dismantling of all capital transaction controls zealously pursued by the governments of threshold countries makes them more vulnerable than ever to short-term capital movements driven by speculative desires. Since then, we know the risks of pure export-oriented development strategies undergirded with foreign credits.

Since 1997-1998, it is clear the conventional monetary perspective embodied by the IMF harms more than benefits. For OECD countries, the International Monetary Fund is secondary. Asian and Latin American countries – devastated by conditions of the IMF – have made themselves independent of the IMF. In 1998, thanks to a massive upgrading of their currency reserves, Singapore, Hong Kong and Taiwan were able to defend their exchange rates. Ten years later, China after profiting as an export-nation and capital importer has the greatest currency reserves in the world and suffers with the weakening dollar. Asian threshold countries seek to divest or uncouple from the US currency. This is a consequence of the shock of 1997-1998.

In today’s crisis, no one thinks of calling to the IMF or World Bank as rescuers in all distress because both are occupied with themselves and their own financial misery. This is a late consequence of the Asian crisis and of the lessons drawn by the afflicted states.


Wall Street in the Maelstrom
October 28, 1997 – Exchange rates collapse on the Asian stock exchanges. In the suction of the crash, Wall Street lost 13 percent. The German stock index (DAX) recorded a minus eight percent on this day.

Bankruptcies in Russia
August 21, 1998 – Several banks in Russia are insolvent. The DAX falls 5.4 percent within 24 hours.

Terror and Panic
September 11/12, 2001 – After the attacks in New York and Washington, panic spreads on the world financial markets. Wall Street completely stopped. The DAX lost 8.5 percent. Exchange rates collapsed more than eleven percent worldwide.

Military Response
September 14/15, 2001 – The exchange rates were adversely affected when the US announced it would give a military response to September 11. The DAX lost another six percent.

Stock-destroying Iraq War
March 24/25, 2003 – The US invasion of Iraq grievously affected the finance markets. Panic selling of stocks occurred. The DAX fell 6.1 percent.

Black Monday
January 21, 2008 – The crisis on the US mortgage market that erupted in July 2007 has finally infected the world finance market. Ignited by an approaching US recession, the stock exchanges collapse worldwide, the DAX around 7.2 percent.


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