Henry for Asian Crisis

Henry C.K. Liu hliu at SPAMmindspring.com
Fri Feb 16 14:10:52 MST 2001

Xxxx Xxxxxx wrote:

>   Henry, since you have followed the Asian crisis very closely, I need
> to ask some basic questions to you (which I will have to incorporate
> in my proposal immediately. Hopefully today!!) Although I know the
> excess capacity problem of Asian economies, I have some problems with
> what had exactly happened on the *surface*  of financial
> markets--politics of money etc.. 1) Was the cause of the crisis
> inflation or deflation?  ( I need this to compare it with the 1970s
> recession, which was driven by the inflationary pressures of  the US
> dollar and postwar economic growth. The prices were rising in the 1971
> crisis more than the volume of material production. Nixon's devalued
> dollar to set off the inflationary devaluation of the dollar.. So the
> measures taken to cope with the crisis were anti-inflationary in
> character. Deflation was not expected because prices continued to rise
> even after Nixon's  attempt to control money supply   What about the
> Asian crisis? were the prices rising or falling? )
> The Asian Crises were primarily a financial collapse of the foreign
> exchange regime and its globalized unregulated markets.  One way to
> look at it is foreign exchange induced deflation which failed to
> service dollar denominated debts.  See the below.
> >Henry Liu has argued convincingly that the Tobin tax would be
> > totally ineffective in accomplishing its intended goal.  Beyond
> > that his article presents an exceptionally fine discussion of the
> > problems and threats inherent in the international system of
> > money and finance as it exists today.
> >
> > Because of the importance of this subject, I copied his PKT
> > message to a page on my website to make it available to a wider
> > audience.  With the intent of helping readability, I've taken the
> > liberty of correcting typos and breaking up some of the long
> > sentences and paragraphs.  Otherwise the article is verbatim.  It
> > can be accessed at
> > http://wfhummel.cnchost.com/financialsystem.html.
> >http://wfhummel.cnchost.com/globalfinancereform.html
> > William F Hummel
> >
>   2) Asian currencies were pegged to dollar by several US agreements
> (Plaza). When the dollad gained value in the 1990s,  the pegged local
> currencies were automatically overvalued-- increase in the face value
> of currency more than its worth-- and made Asian exports less
> competitive in international markets.  Asian economies responded to
> the crisis with some combination of currency devaluation (to cheapen
> their exports) and cuts in imports. Isn't this similar to Nixon's
> strategy above?
> No, the basic difference is that The Fed can print money without
> penalty, while Asian governments cannot.
> In his book The World Trading System at Risk, Bhagwati warns of the
> dangers of flouting the GATT's provisions.  He asserts that its
> underlying conception of trading by rules will be undermined if
> accusations of "unfair trade" practices are extended to areas as
> diverse
> as retail distribution systems, infrastructure spending, saving rates,
> and workers' rights. He challenges the economic and cultural
> stereotypes
> of Japan that fuel the sentiments supporting managed trade and
> aggressive
> unilateralism. He proposes rebuilding the GATT and with it the world
> trading system itself.
> The follwing is from a post I wrote for SR.
> Bhagwati  is a card carrying member of the fraternity of pro-trade
> economists, like Krugman, Summers and Mundel, who all participated in
> his
> Trading Blocs: Alternative Approaches to Analyzing Preferential Trade
> Agreements.
> These economists produced a lot of material, all of which skirts the
> fundamental problem of US financial hegmony.  They accept it not only
> as
> given, but as the blessing for the world.
> Bhagwati's paper that Doug mentioned predictiable also failed to
> identify
> the one single most import cause of the Asian financial crises: the
> hegemony of the US dollar.
> Unlike Doug and Rakesh my experience with the Asian Financial Crises
> did
> not come from books, but from direct personal experience.  I was part
> of
> a team of advisors assisting two major central banks in the region all
> through the 1997-1998 period.  The crises can be traced to one single
> cause, albeit with all sorts of peripheral factors, and that cause was
> the existence of unregulated globalized financial markets that allows
> speculative manipulation taking advantage of low cost funds
> denominated
> in currencies of selected countries, namely Japan, Germany and the
> United
> States, to make loans at higher interest rates denominated in local
> Asian
> currencies.  These institutions sought to strategically profit from
> recurring technical imbalances in global finance by assuming currency
> risks, rather than from traditional direct investment returns.
> Economists call this activity international arbitrage on the principle
> of
> open interest parity.  In  banking parlance, this type of activity is
> known as "carry trade".
> A good part of the responsibility of the Asian financial crises is
> attributable to international banks not facing up to their lender
> liability, a common legal concept holding lenders liable for damages
> if
> they knowingly lend beyond any borrower's capacity to handle the loan.
> It is convenient for Western creditors to point fingers at Asian crony
> capitalism and lack of transparency, but such practices, albeit
> undesirable, are not unique to Asia and were certainly not unknown to
> lenders when the bad loans were made.  Having been permanent cultural
> features in many part of the world, including Asia, such practices
> cannot
> be the direct cause of the region's sudden financial collapse, any
> more
> than its economic success of recent past.
> Many have argued during the crises tath to avoid political backlash in
> the region, IMF rescue packages should focus on correcting the
> structural
> defects of the unregulated globalization of financial markets and not
> be
> devious vehicles for wholesale foreign control of wounded Asian
> economies.  Some economists,
> including Jeffery Sachs of Harvard's Institute of International
> Development, have been critical of IMF's "off the shelf" rescue
> approaches for having exacerbated the financial crises in Asia.
> Moreover, the austerity measures demanded by IMF economists who are
> insensitive to local political realities, turned the economic turmoil
> into detonators of political instability throughout the region.
>  A fundamental problem in world trade finance is the excessive weight
> foreign exchange markets assign to the size of a country's foreign
> exchange reserves as indicator of  economic health and credit
> worthiness,
> despite general recognition by economists that the validity of this
> yardstick ended with the age of mercantilism a century ago.
> Yet, despite claims of scientific determinism, financial markets are
> not
> free of political bias.  And this residual focus on foreign exchange
> reserves is not applied evenly to all economies.  Curiously, the
> United
> States, the world?s largest debtor nation (carrying US$20,000 of
> national
> debt per capita), with two-thirds of all US currency being held
> overseas,
> with chronic budget deficits until this year and a history of
> volatile fluctuations in the floating exchange rates of its currency,
> is
> considered the safest haven from economic turmoil because of its
> perceived political stability and the size of its domestic economy.
> But
> the reality is the dollar's status as the world reserve currency is a
> historical relic.   On the opposite end, Hong Kong, with its huge
> foreign
> exchange reserves, perennial budgetary surpluses and zero sovereign
> debt,
> has repeatedly seen its solidly-backed currency under relentless
> attack
> in a market artificially fixed by a peg to the US dollar.  The U.S.
> dollar, despite unjustified perceptions of its soundness, is only as
> solid as the true state of the U.S. economy at any given time.  The
> U.S.
> economy looked good due to a decade of ruthless
> restructuring that improved corporate competitiveness, particularly in
> the service sector.  The globalization of the U.S. finance sector also
> contributed to the growth of the U.S. economy through the export of
> capital and inflation to the developing countries. Cross border sales
> and
> purchases of equity and bonds by American investors have risen from 9%
> of
> GDP in 1980 to 164% in 1996. But uncertainties loom large as the
> injurious impacts from the Asian crises, which are mere symptoms of a
> structurally flawed global
> financial architecture, begin to hit the U.S. economy.  While the US
> dollar is currently strong, a downward correction of 20% is a high
> possibility within the next three years.  While short-term
> fundamentals
> may still favor the US dollar, long term fundamentals are increasingly
> negative.   Net debtor position of the U.S. will exceed US$2 trillion
> soon. Whenever foreign-held dollar reserves are sold, an equivalent of
> U.S. owned assets are liquidated immediately at market price.  If the
> amount
> sold is large enough, it will add to the recession already in process
> in
> the U.S., as in 1929-32, which the post-war Bretton Woods system of
> fixed
> exchange rates was designed to prevent from occurring again. In
> 1995, after the Federal Reserve started to hike interest rates in 1994
> and sharply curtailed its own purchase of Treasury bills, triggering
> the
> first  Mexico peso crisis and a subsequent U.S. slowdown, the Bank of
> Japan initiated a program to buy $100 billion of US treasuries.  China
> bought $80 billion. Hong Kong and Singapore bought $22 billion each.
> Korea, Malaysia, Thailand, Indonesia and the Philippines bought $30
> billion. The Asian purchase totaled $260 billion from 1994 to 1997,
> the
> entire increase in foreign-held U.S. dollar reserves.  These recycled
> dollars pushed up stock prices in America.  A sharp correction of the
> stock market accompanied by an abrupt slowdown of the US economy is a
> matter
> of when and not if.  Also, the euro will continue to pose a direct
> challenge to the US dollar as the sole  preferred currency for
> international trade. The financial world is in the process of shifting
> from a dollar-centered system to a bipolar dollar-euro system,
> eventually
> to four currency regime that will include the yen and the RMB.  Just
> like
> the post-war corrections in U.S. markets in 1971-73, 1978-79, 1985-87,
> which critically stalled the U.S. economy because the contributing
> currency overvaluations were permitted to go too far and for too long,
> the next correction, which is in process by Greenspan's repeat of the
> same interest rate policy, will have equally severe economic
> consequences.
> This means that just when the Asian economies are working themselves
> out
> from the damages of the current crises, the U.S. economy may stall and
> the US dollar may fall in value.
> The US has pursue a strong dollar policy for a decade as  a matter of
> national interest.  An overvalued currency is suicidal even for a rich
> country in times of economic contraction.  Five years after the 1929
> crash, Franklin D. Roosevelt was forced in 1934 to eased monetary
> policy
> through a 59% devaluation of the US dollar against gold.  Conversely,
> an
> undervalued currency is injurious to the economy
> in times of recovery or expansion.
> Taiwan and Singapore both devalued their currencies early in the
> currency
> turmoil in 1997, by approximately 18%.  Timely devaluation gave both
> these governments more flexibility in dealing with the impact from the
> crises in the region. As a result, the economies of Taiwan and
> Singapore
> had ben less adversely impacted by contagion. China was impacted less
> directly and immediately because its economy is not open, but Chinese
> export was adversely affected until China provided the export sector
> with
> tax subsidy.  Hong Kong, being open and liquid with a fixed currency
> peg,
> experienced an inevitable meltdown that would continue until the peg
> is
> abandoned.
> The Asian financial crises are not mere passing storms or cyclical
> phases.  They are the opening acts of a historic restructuring of the
> global economic system in which the stakes are very high.  Economic
> globalization requires enlightened nationalism to keep it fair and
> just.
> As Lenin insightfully hypothesized, Western imperialism provided the
> escape valve that postponed the deterministic evolution of capitalism
> into socialism as predicted by Marx.  The collapse of Western
> imperialism, brought about by the rise of nationalism, heralded the
> advent of a wave of socialist economies after World War II in newly
> independent former colonies and semi-colonial territories, without the
> historical prerequisite of having first gone through capitalism. The
> historical relationship between capitalism and socialism is that
> capitalism is efficient in creating wealth for the few and socialism
> is
> necessary for sharing the wealth that capitalism creates in order for
> society to be more just and stable.  As such, the ripe candidates for
> socialist
> systems are the industrialized nations that have already benefited
> from
> the productive efficiency of capitalism, not the poor countries that
> have
> been ravaged by a century of Western imperialism.  There is no
> economic
> benefit in socializing poverty.  Most reasonable thinkers now accept
> that
> capitalism and socialism are not concepts adverse to each other, but
> are
> complimentary approaches to keep society prosperous and just.   Each
> nation, according to its historical conditions, must seek the proper
> mix
> of these approaches to fit its own developmental needs. Indiscriminate
> global imposition of Western market criteria is not workable or
> desirable.
> After the demise of political imperialism, capitalism manages to gain
> another new lease on life through the transformation of the newly
> setup
> socialist planned economies into capitalist market economies via the
> expansion of world trade.  Some political economists view unbalanced
> and
> unregulated world trade as a new form of economic imperialism, benign
> in
> appearance, rationalized under the laws of modern economics that hold
> sacred the principle of maximizing return on capital and the
> operational
> dynamics of free markets that favors the strong and perpetually
> condemns
> the weak. These concepts give the West an inherently unfair advantage
> against the capital-starved and ill-equipped third world. The
> international division of labor as currently constituted in
> globalization
> has been driven by wage competition between countries with a race to
> the
> bottom effect.  Countries also compete to reduce taxes, welfare
> benefits,
> environmental protection and trade regulations in the name of
> efficiency
> in a global market economy. Technology, lowering the cost of
> communication and managing complexity, now allows central control of
> highly decentralized operations worldwide.  Trade and foreign
> investment
> have preempted economic development and aid as the main paths for
> undeveloped nations to modernize and to prosper.
> Yet globalization of trade and finance has its critics in both
> developed
> and developing countries, but for different reasons.  In theory, free
> international movement of capital through integrated financial markets
> in a global economy allows efficient allocation of funds towards
> investments of  highest productivity.  This is only true if there is
> global full employment.  Free movement of capital without free
> movement
> of labor is an imperialist sham. But truly free markets do not exist
> in
> the real world, and even if they do, they operate under narrowly
> single-dimensional rules and historical biases, all of which aim
> toward
> maximizing return on capital without due regard for local social,
> political or environmental consequences or individual national
> aspirations.  Moreover, global financial market pressures tend to
> supplant the traditional roles local political leaders and government
> institutions play in formulating macroeconomic policies that safeguard
> individual national interests.
> Despite all the noise the United State makes about the benefits of
> world
> trade, US export of  $564.7 billion (FOB) constitutes only 7.6% of its
> GDP of $7.6 trillion (1996) and US import of $771 billion (CIF)
> constitutes 10.1% of GDP.  Export to all of Asia amounts to only 2.4%
> of
> its GDP of which Japan constitutes 1%.  Thus the U.S. can sustain a
> strong bargaining position in setting the terms of trade on a take it
> or
> leave it basis.
> Excessive reliance on world trade may not be in a country's best
> national
> interest, simply because national governments are forced to surrender
> their power to manage their economy to world market forces, or
> international trade institutions and agreements.  It is an argument
> put
> forward not only by the developing nations, but also by isolationists
> in
> America, with sufficient public support to  deprive President Clinton
> of
> his "fast track" authority to settle trade disputes.
> In contrast, Hong Kong export of $197.2 billion constitutes 121% of
> its
> GDP of $163.6 billion (1996), and HK import of $217 billion
> constitutes
> 130% of its GDP.  It is obvious that a rupture in world trade will
> impact
> Hong Kong differently than the U.S.
> When capital is mobile, governments are able to enjoy the benefits of
> fixed exchange rate stability only if they are willing to forego the
> empowerment of managing the economy through the setting of domestic
> interest rates and the supply and liquidity of money.   This means
> when
> global capital flow into a country, local interest rate will fall,
> sometimes to negative rates, distorting the orderly development of the
> affected economy.  For example, beginning in the mid-1980's, Hong
> Kong's
> currency board mechanism created persistent negative local interest
> rates, causing abnormal investment flows into the property sector,
> resulting in unrealistic price inflation that became a major problem
> in
> the current downturn. Conversely, when investors begin to pull out of
> a
> country or sell its currency, local interest will have to rise to
> counter the flow in order to maintain the exchange rate peg.  This
> invariably weakens the banking and financial system, eventually
> causing
> bank failures and institutional bankruptcies. This happened to Hong
> Kong
> in October 1997, with disastrous long-term consequences that are yet
> to
> unfold fully. Hong Kong will be plagued by excessively high interest
> rates until the currency board mechanism is abandoned or until the US
> dollar falls.  There will be no sustainable long-term economic
> recovery
> for Hong Kong until the HK Monetary Authority regains its power to set
> monetary policies.
> Pegging a currency's exchange rate to another currency does not
> automatically make an economy more stable.  If domestic economic
> policies
> are inconsistent with the chosen exchange rate, a fixed rate
> can itself lead to instability.  Small economies with less
> sophisticated
> financial markets face greater risk from opening to international
> capital.  Sudden capital flight can create economic havoc, as in the
> European currencies crises of 1992-93, in Mexico in 1994 and in
> Thailand
> in July 1997.  In the last quarter of 1997, institutional panic caused
> an
> abrupt drop of private capital flow, in excess of US$100 billion, to
> the
> five most affected countries: South Korea, Indonesia, Thailand,
> Malaysia
> and the Philippines.  South Korea alone saw its capital flow drop by
> US$50 billion as compared to 1996. It is projected that the region
> will
> experience a net outflow of US$9.4 billion in 1998, after a net
> outflow
> of capital of US$12.1 billion in 1997. And contagion effects can hit
> countries in an economic region and eventually the entire global
> system.
> As the economies of the lending nations contract, banks will withdraw
> urgently needed funds from other healthy economies where liquid
> markets
> still operate, thus forcing the healthy economies to collapse. This
> happened to the Hong Kong market in October 1997.  It will happen
> again
> and again before recovery is in sight.  The threat of Japanese banks
> retrieving capital from other countries, including the U.S., is very
> real.  Japan is in a prolonged phase of serious deflation.  When that
> happens, U.S. interest rates will skyrocket, sending Hong Kong rates
> beyond reach, foreclosing all hopes of a steady recovery.
> One way for a country to deal with currency risks is through sensible
> macroeconomic management by adopting sound monetary and fiscal
> policies.
> By maintaining the fixed peg of its currency to the US dollar through
> a
> currency board mechanism, a gaovern closes itself on this option of
> monetary autonomy.
> Another way is to restrict the opening to international capital flow.
> Henry C.K. Liu

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