# Asian crisis

The Asian crisis is the name given to the financial , currency and economic crisis in East Asia in 1997 and 1998. It began in Thailand in March 1997 and spread to several Asian states, especially many of the so-called tiger and panther states .

The hardest hit countries were Indonesia , South Korea and Thailand . The crisis also made itself felt in Malaysia , the Philippines and Singapore , while the People's Republic of China and the Republic of China (Taiwan) remained largely untouched. The simultaneous economic crisis in Japan had its own causes; it was intensified by the Asian crisis.

Countries particularly affected by the Asian crisis

## Origin and causes of the crisis

In retrospect, some economic and political undesirable developments are suspected as causes or favorable factors for the Asian crisis, e. B. excessive investments and trade deficits , excessive borrowing - also in foreign currency - and institutional deficits in regional financial markets . Some explanations alleged a self-inflicted crisis combined with a failure of international financial markets; others put the International Monetary Fund (IMF) at the center of criticism.

### Credit bubble

As a result of the liberalization of the financial sectors of Asian countries, a credit boom arose in Asia in the 1990s . The growth of the loan volume during this period averaged 8 to 10 percent above the growth rates of GDP . Not only did industrial overcapacities arise, as in South Korea, but an increasing proportion of the loans were used to buy stocks and real estate . The consequences were a surge in the stock markets and a sharp rise in property prices by up to four times. With real estate and stock prices rising, Asian banks believed they had good collateral, which encouraged further lending. This capital flowed in turn into stocks and real estate. The resulting price increases created a speculative bubble in some areas. This “ vicious circle ” of lending and the increased value of the collateral resulted in a very one-sided orientation in lending. At the end of 1997, the proportion of loans secured by real estate in Thailand, Indonesia and Malaysia was between 25 and 40 percent. This made the banks vulnerable to price declines in the stock and real estate markets .

Exchange rates to the German mark of selected Asian currencies from 1995 to 1999

### Lack of foreign currency hedging

Other problems resulted from the different terms and foreign currencies of the loans taken out and granted. Since the banks wanted to benefit from the favorable interest rate situation on the international financial markets, the debt was often in US dollars or yen (Japan) with short terms. Lending to domestic borrowers was mostly long-term and in domestic currency. Banks financed parts of the long-term loans with the help of short-term borrowed money (" maturity transformation "). This led to serious differences in terms of maturity and currency between the loans taken out and those granted.

Back then, the banks trusted in the stability of their respective domestic currencies and their close pegs to the US dollar or the yen . Due to the government (supposedly) secured exchange rates, the exchange rate risk for borrowing from foreign funds seemed negligible and foreign exchange loans were comparatively cheap due to the low risk premiums . The lending banks either saw no need to hedge their yen or dollar liabilities against exchange rate fluctuations , or they did not use currency forwards to hedge their risks in order to achieve higher profits . By doing this they benefited from the weakness of the US dollar against the yen between 1985 and 1995. Until 1995 this strategy was very successful. The Southeast Asian countries were competitive and recorded strong export-driven growth. As the exchange rate of the US dollar rose against the yen, European currencies and the Chinese currency , local currencies suddenly rose in real terms, causing a serious deterioration in international competitiveness, lower exports and a serious current account deficit .

Percentage change in the exchange rates to the Deutsche Mark of selected Asian currencies from 1995 to 1999

### Foreign debt exceeded currency reserves

The main problem with this financial policy was that the short-term foreign currency loans that the Asian banks had taken out had only a relatively small amount of currency reserves . When the crisis occurred and the loans they had previously taken out became due, the crisis countries were unable to repay them on time with foreign currency . Some central banks (e.g. the Thai central bank ) tried to support the rates of their currencies by means of transactions on the currency futures market in order to avert a currency crisis .

### Weak regional financial market structures

In addition to the abuses outlined above, most countries had no or only insufficiently functioning supervisory authorities (" banking supervision "). The banks did not adequately assess the credit risk and creditworthiness of borrowers. Many of the banks also had an equity ratio that was far too low . The bank executives appeared to have trusted the government to support them should difficulties arise. The crisis may have been triggered or intensified by speculators who bet on a fall in the exchange rate of these countries and sold them forward.

### Misconduct of the international financial markets

The relatively low interest rate level in Japan at the time is considered to be a factor that led Asian banks to take out foreign currency loans in yen. Many investors wanted to be part of the future market of Southeast Asia and financed their commitments with a low equity ratio . There was also an opinion in the West that if problems arose, the governments in Asia would have the resources to deal with any solvency problems . But when the creditor banks no longer “stood still”, as Asian currencies and assets deteriorated and their claims became due, there was a massive withdrawal of capital from these countries. This in turn led to a downgrading of the creditworthiness of these Asian countries, which resulted in the further sale of investments held there by security-oriented institutional investors. This self-reinforcing flight of capital from the crisis countries is considered a failure of coordination . It was rational for a single creditor to collect debts as quickly as possible and thus limit losses. The fact that many creditors acted almost simultaneously ( herd behavior ) contributed to the depreciation of their investments.

## Chronological overview of important events

 1997 Indonesia Malaysia South Korea Philippines Thailand March 1997 First official announcement regarding problems with two unnamed financial intermediaries and start of recapitalization of these. April 1997 The National Bank of Malaysia , Bank Negara Malaysia, limits banks' lending to property and share purchases. Between March and June 1997, 66 financial intermediaries received non-public liquidity from the Thai central bank . Significant capital outflows. May 1997 June 1997 16 financial intermediaries are closed. The government gives a savings guarantee to all financial institutions. July 1997 The Indonesian rupiah is coming under pressure and depreciating against the US dollar. Bank Negara Malaysia intervenes massively to defend the exchange rate of the Malay ringgit . A little later the currency peg was abandoned. Several South Korean banks are rated "negative outlook" by rating agencies The Philippine peso is allowed to fluctuate around the US dollar within a wider range. The currency peg will be lifted and the Thai baht will lose between 15 and 20 percent of its value. August 1997 The peg to the US dollar is lifted and the Indonesian rupiah loses its value massively. The government issued a guarantee for all liabilities of the South Korean banks. Foreign investors put loans that were extended to the banks due. Measures to strengthen the financial market are being taken. 42 financial intermediaries temporarily closed. A 3-year emergency arrangement with the International Monetary Fund, the World Bank and other bilateral sources worth $17.1 billion is agreed September 1997 October 1997 16 banks are closed; A limited savings deposit guarantee is given. Further bank closings are announced. November 1997 A 3-year emergency arrangement with the International Monetary Fund is approved. The aid package from the IMF, the World Bank and other bilateral sources of 48.1 billion US dollars by March 1999 was approved. The South Korean won is coming under pressure and the permitted exchange rate fluctuation is expanding. The won loses massively in value. The Korea Asset Management Corporation (KAMCO) Investment company was founded to take over non-performing loans Change of government . Implementation of economic reforms. Emergency government decrees to relieve and restructure the financial sector. December 1997 A bank run begins. Half of all bank deposits are deducted. A 3-year emergency arrangement with the International Monetary Fund is approved. The shares of 14 universal banks are suspended from trading and 2 large banks are nationalized. Change of government. Reforms of the financial market, establishment of the financial market supervision and implementation of controls. 56 temporarily closed financial intermediaries will be finally closed and wound up. The Thai National Bank is nationalizing the universal banks. 1998 Indonesia Malaysia South Korea Philippines Thailand January 1998 A second IMF program is announced. The Indonesian Bank Restructuring Agency (IBRA) is founded and issues a general guarantee for the Indonesian banks. Measures to strengthen prudential rules are announced. Bank Negara Malaysia issues a general guarantee for all bank deposits. Agreement between South Korea and external private creditors regarding the rescheduling of short-term debt. 10 out of 14 banks suspended from on-exchange trading will be closed. The remaining 20 banks are required to present restructuring plans. The Thai central bank intervenes with two commercial banks; Shareholders are excluded. February 1998 Doubts about the future of the financial sector are growing amid political uncertainty. The Indonesian rupiah is further devalued and a currency board is discussed. President Suharto is re-elected. A commercial bank is bought by foreign strategic investors. Kim Dae-jung and a new government take office. March 1998 A program to consolidate finances and recapitalize businesses and commercial banks is announced. 3-year stand-by arrangement with the IMF is agreed New classification for threatened losses and their provisions is introduced. April 1998 IBRA closes 7 banks and takes over 7 more. Four of the 20 restructuring plans are rejected and the 4 banks are closed and wound up. May 1998 Riots in Indonesia. The rupiah is further devalued. Bank runs intensify. The central bank of Indonesia, Bank Indonesia, has to provide liquidity. IBRA takes over a large private bank. President Suharto resigns. The Bank of Thailand intervenes with 7 financial intermediaries; Shareholders are excluded. June 1998 International lenders and Indonesian companies agree on debt restructuring programs for Indonesian companies. Danaharta , a state-owned asset management company, is established. The South Korean government closes 7 smaller banks and two more banks are merged with larger commercial banks. New classification for threatened losses and their provisions is introduced. July 1998 August 1998 Danamodal , a bank restructuring and reorganization agency , is established. Financial sector restructuring plan announced. Providing public funds to support bank recapitalization. Intervention with two banks and five finance companies. Shareholder interests eliminated. September 1998 Indonesia's foreign debts with institutional investors are being refinanced. Bank Mandiri is created through the merger of the four largest state banks. Plans for a joint government announced. Recapitalization measures by private banks. Capital controls will be introduced, the exchange rate will be pegged, disclosure requirements relaxed, and measures to encourage bank lending to be adopted. October 1998 The Indonesian government adopts amendments to the banking law to strengthen the IBRA. November 1998 December 1998 1999 Indonesia Malaysia South Korea Philippines Thailand January 1999 February 1999 Capital controls are replaced by levies. March 1999 Indonesia's government closes 38 banks and IBRA takes over seven more. State restructuring plans have been announced for nine banks. April 1999 Closure of a joint venture bank. Indonesia's government announces a plan to recapitalize three nationalized bankrupt banks. May 1999 June 1999 Eight private banks are being recapitalized with public and private funds. July 1999 Indonesia's government announces a plan to liquidate the IBRA banks. The Thai government intervenes at a smaller private bank and is preparing the sale. August 1999 Merger of the banking units of Bank Mandiri. ## Economic impact ### Effects of the crisis on the Asian countries Percentage annual GDP growth of selected Asian countries (gross domestic product with constant prices and constant national currency divided by the population of the respective country) After years of strong growth, Asian countries faced a sudden fall into recession in 1997. Investors at the time and potential investors were skeptical about the region's prospects and reacted accordingly. Before the crisis began, the " tiger states " were still very successful in the global capital markets, with the US dollar market accounting for around 33 billion US dollars a year. In 1998, the value dropped to just$ 8 billion for Asian borrowers. In 1998 GDP contracted in Indonesia (−13.7%), Thailand (−8.0%), South Korea (−5.5%), Hong Kong (−5.1%) and the Philippines (−0.5% ) after these countries had recorded long-term growth up to 1996. In Japan, GDP fell by 2.8%. In South Korea the unemployment rate rose from 2% (1996) to 6.8% (1998), in Malaysia from 2.5% (1996) to 8% (1998) and in Indonesia to 22% (early 1999).

Unemployment rate in selected Asian countries from 1995 to 1998

As the Asian crisis continued to worsen, the International Monetary Fund endeavored to contain negative consequences. In 1997/98 he provided 39 billion US dollars for Thailand, Indonesia and South Korea. In addition, numerous governments and international organizations tried to provide assistance. At that time there was hope that the market would soon recover. The currencies most affected, the Thai baht , the Indonesian rupiah and the South Korean won , had caught up some of their depreciation by mid-1998 and had stabilized. The export figures also stabilized again. A reassuring fact was that not all countries were affected equally. The PRC was relatively immune to the direct effects of the crisis. The yuan retained its value, the gross domestic product continued to grow and exports continued to grow strongly. Although the capital outflows from foreign investors were also considerable in China, the external debt and budget deficit were lower than, for example, in Thailand and Malaysia. Furthermore, China's foreign exchange reserves were significantly larger than those of the countries most affected by the Asian crisis.

Japan was hit harder by the negative effects of the crisis than the US and Europe. The Japanese crisis, which had persisted since 1991, was exacerbated by the Asian crisis. Japan's GDP, which grew by 3.8 percent in 1996, contracted 0.7 percent in 1997, 2.1 percent in 1998 and 0.7 percent in 1999.

### Effects of the crisis on other countries

The market forecasts at the outbreak of the crisis were extremely poor and promised a serious negative effect on the entire world production. There were forecasts that assumed a reduction of up to a third. In fact, the direct effects turned out to be much smaller. The reason for this is the relatively small export share of the USA and Europe to the Asian countries, with the exception of Japan. For example, in 1996 only 2.5% of US exports went to Southeast Asia. In contrast, the Asian countries had an average high export quota of 36% to the USA and Europe and were thus closely dependent.

The USA was able to maintain its economic growth during the events and even increase it towards the end of 1998. At the same time, inflation was kept low, consumer spending was high and unemployment hit a 30-year low of 4.3%. But the climax of the positive developments for the US was the soaring of the Dow Jones Index , which topped the 10,000 mark and pulled the European stock markets to a record high.

The impact on the EU economy was limited, although European investment in Asia suffered a setback. The secondary and tertiary sectors had the greatest difficulty, as a number of European industrial products and services were destined for the Asian market. According to the government, the losses suffered by the Federal Republic of Germany were estimated at 10 billion DM . The growth rate of the German economy fell by 0.25% and the unemployment rate rose by 0.1–0.2%.

## Effects on the population

The social repercussions of the crisis were mainly expressed in the rise in unemployment figures and a sharp drop in real income. Not all income brackets were affected equally. The share of wages and salaries in total income fell, leading to changes in the distribution of income. Rural residents who grew or raised their own food had benefited from selling their produce at rising prices, while urban households who had to buy food at high market prices were negatively affected. As a result, urban poverty increased faster than rural poverty . As the state cuts social spending , it has reduced the availability of services and the quality of education, health and other public utilities. Household investments in education, health, nutrition and family planning also decreased. When it comes to health care, many households turned to self-help or took traditional healers rather than modern medical care. Private hospitals and clinics in Malaysia reported a drop of between 15 and 50 percent in the number of patients receiving treatment. Contraceptive costs rose and large numbers of women dropped out of family planning programs. In Indonesia to date, the participants in the national family planning programs had to bear the full costs. Accordingly, estimates assume that the number of illegal abortions and infanticide has increased significantly.

## The crisis subsides and recovery

The economic recovery from the crisis was quick in most of the affected countries. Good macroeconomic management in strengthening the stabilization of the financial markets played a special role. In most Asian countries, real and nominal interest rates in the money markets were lower two years later than before the 1997 crisis. As speculative pressures on currencies eased, interest rates fell in South Korea, Thailand (early 1998) and Indonesia (mid-1999) . Private-sector lending has been drastically reduced, negatively impacting private consumption, but stabilizing the banking system.

In the years 2005–2007 the gross national product rose by an average of 8% annually, as fast as before the crisis. However, this number also takes into account the growth of China and India.

Studies indicate that public infrastructure in 2007, especially in Thailand and Indonesia, was worse than a decade earlier during the crisis. Investment spending has fallen due to economic and political uncertainty and companies are still very cautious about borrowing. The Asian Development Bank is therefore calling for governments to do much more to change this: investing more in education and infrastructure, preventing corruption and improving the legal framework.

## The role of the International Monetary Fund

The International Monetary Fund implemented programs in Indonesia, South Korea and Thailand that included financial aid but were subject to structural reform and macroeconomic conditions.

### The aid program for South Korea

On December 4, 1997, the International Monetary Fund approved a letter of intent from the South Korean government for a three-year financial aid program of $58 billion, of which only$ 21 billion was paid out. At the time, it was the largest monetary grant from the International Monetary Fund to any country. The terms of this grant included a short-term increase in the South Korean key interest rate, reforms of the heavily indebted corporate sector and restructuring measures with regard to the terms of short-term loans.

### The aid program for Indonesia

In 1997-98, the International Monetary Fund provided \$ 14.9 billion in financial aid to Indonesia. Economic policy measures linked to this financial aid included restructuring and closing of financial institutions, combating corruption and mafia-like structures, releasing the rupiah rate and liberalizing trade.

### Criticism of the actions of the International Monetary Fund

The International Monetary Fund describes its measures as successful and necessary. Even so, the role of the IMF remains highly controversial to this day, and the IMF's actions during and after the Asian crisis met with a lot of criticism, particularly from those in the US. By 1997/98, the IMF had “enacted” structural programs for lending in more than 90 developing and emerging countries. Criticism of the requirements, the priorities of these requirements and the structural changes to be implemented ( liberalization of the markets) came predominantly from the political left . In the American Congress, however, the political right at the time of the Asian crisis also expressed criticism of the actions of the IMF. She accused the IMF of having saved US banks and bondholders from far-reaching losses at the expense of taxpayers. In some cases, the critics from both political camps demanded the abolition of the IMF for different political motives.

The criticism, regardless of the political motivation, of the International Monetary Fund can be summarized as follows:

Induction of “moral hazard” on the part of the IMF
The creditors of the Asian financial intermediaries were seduced into taking heightened risks, as they supposedly could expect that the IMF would step in if there were payment difficulties, as it had done in other crises before.
The measures imposed in the context of the Asian crisis were wrong
Raising interest rates and taxes along with cutting government spending during a recession are counterproductive.
Focus on economic policy measures neglecting social measures
The structural programs prescribed by the IMF were based on purely fiscal criteria, such as monetary stability, the priority of debt repayment and balanced current accounts. For example, countries were indirectly “forced” to stop investing in the education system or subsidizing staple foods. Social unrest such as in Indonesia are the result.
The IMF agenda abrogates the sovereignty and democratic control of the dependent states
With the liberalization of the financial markets, the states would have completely surrendered themselves to the world market. To prevent capital flight in the event of a crisis or to defend their currency against speculation, these states could not help themselves through legal regulations, but only through their own action on the market, for example through support purchases for their own currency.

## Theoretical explanatory models

The causes of currency and financial crises are the subject of numerous scientific studies and explanations in the economic literature. A distinction must be made between models of three different generations, which are based on several theoretical explanations.

### First generation models

First generation models for the theoretical explanation of financial crises are based predominantly on the model of Paul Krugman . In these models, such as the model presented by Robert Flood & Peter Garber in 1984 , it is explained that a financial crisis can be triggered if the government, whose budget has permanent monetary budget deficits , tries to transfer a reserve currency to a reserve currency if its foreign exchange reserves are limited to maintain a fixed exchange rate ( exchange rate parity ). In these models, financial crises are viewed as purely currency crises.

### Second generation models

The second generation models also view a financial crisis as merely a currency crisis. In these models, for example the model published by Maurice Obstfeld in 1994, it is explained that a currency crisis can be triggered even without an expansive monetary policy and without the associated high budget deficit. These models explain that international financial market participants launch speculative attacks on a currency if they expect a country to abandon a policy of stable exchange rates in favor of other goals, such as combating unemployment. These second generation models are predominantly based on the expectations of economic agents, which determine the triggering of a financial crisis.

### Current models

Current models, also called third generation models, try to take into account the fact that financial crises are not just currency crises, but also economic crises or financial market crises at the same time or immediately afterwards. These models are summarized in the English-language literature under the term "twin crises". In particular, the role of current account deficits, government guarantees for banks (also indirectly via the moral hazard problem) and weak financial market structures are linked to currency crises.

In 1999, Giancarlo Corsetti , Paolo Pesenti , Nouriel Roubini published a model which, based on the moral hazard problem, tries to represent the financial market and currency crisis in Asia in a macroeconomic way. The moral hazard problem is understood to mean that an indirect state guarantee system provides an incentive for weakly regulated and controlled private financial institutions to engage in excessive, risky investments.

#### Assumptions and explanations

##### The private sector

In the model, a small, open economy is assumed, which is specialized in the production of a tradable good . This market economy is represented by the Cobb-Douglas production function . ${\ displaystyle Y \,}$

${\ displaystyle Y_ {t} = A \ cdot K_ {t} ^ {\ alpha} L_ {t} ^ {1- \ alpha}}$ With ${\ displaystyle \ alpha \ in (0,1)}$
• ${\ displaystyle Y}$: Production amount
• ${\ displaystyle A}$: Stochastic process that depicts technical progress . As a factor before the production function, as in the above case, the Hicks -neutral technical progress is shown.${\ displaystyle A}$
• ${\ displaystyle K}$: Capital investment
• ${\ displaystyle L}$: Labor input
• ${\ displaystyle t}$: Time
• ${\ displaystyle \ alpha}$: Partial production elasticity of capital
• ${\ displaystyle (1- \ alpha)}$: Partial production elasticity of labor

In the event that the sum of the partial production elasticities , ergo the scale elasticity = 1, as in the above equation , this means: An increased / decreased use of these production factors and leads to an increased / decreased production in the same ratio. This property is also referred to as constant returns to scale . ${\ displaystyle \ alpha + (1- \ alpha) = 1}$${\ displaystyle K}$${\ displaystyle L}$

It is also assumed that the capital market is segmented and not perfect . This means that only a small part of the population has access to the capital market (for example banks, insurance companies and other institutional investors), hereinafter referred to as the "elite" (ELI), and the remaining inhabitants in the further "rest of the country" (ROC) do not have capital assets.

The expected utility function of the elite is defined as follows: ${\ displaystyle U \,}$

${\ displaystyle U ^ {ELI} = E_ {t} \ cdot \ \ sum _ {s = t} ^ {\ infty} {\ frac {1} {(1+ \ delta) ^ {st}}} \ cdot \ [C_ {s} ^ {ELI} + \ gamma \ ln (M_ {s} / P_ {s})] \,}$

• ${\ displaystyle M}$: Nominal amount of money
• ${\ displaystyle P}$: Price level
• ${\ displaystyle E}$: Yield
• ${\ displaystyle U}$: Benefit
• ${\ displaystyle C ^ {ELI}}$: Consumption of the "elite"
• ${\ displaystyle \ delta}$: Time parameters
• ${\ displaystyle \ gamma \ ln (M_ {s} / P_ {s})}$: Inflation or deflation

It is also assumed that for the budget constraint of the elite, the country's entire capital stock is consistently financed by foreign financial institutions. This assumption is a realistic oversimplification, given that Corsetti has empirical evidence on how inadequate the equity ratio of domestic companies was at the time the crisis arose.

${\ displaystyle K_ {t + 1} -K_ {t} - (D_ {t + 1} -D_ {t}) \ cdot \ {\ frac {\ xi _ {t}} {P_ {t}}} = \ beta \ cdot \ W_ {t} - \ pi _ {t} \ cdot \ {\ frac {\ xi _ {t}} {P_ {t}}} \ cdot \ D_ {t} -C ^ {ELI} -T ^ {ELI} - {\ frac {M_ {t} -M_ {t-1}} {P_ {t}}} \,}$

• ${\ displaystyle D}$: Debt with foreign institutional investors
• ${\ displaystyle K}$: Capital
• ${\ displaystyle \ pi}$: Borrowing costs
• ${\ displaystyle \ beta}$: Number of investors with international capital market access (ELI)
• ${\ displaystyle T}$: Taxes
• ${\ displaystyle \ xi}$: Nominal exchange rate
• ${\ displaystyle W}$: Earned income
• ${\ displaystyle P}$: domestic price level

For the “rest of the country”, earned income is the only source of income . The budget constraint for the rest of the country is defined by their consumption and the taxes to be paid.

${\ displaystyle (1- \ beta) \ cdot \ W_ {t} = C_ {t} ^ {ROC} + T_ {t} ^ {ROC} \,}$

• ${\ displaystyle (1- \ beta)}$: Number of domestic investors without international capital market access (ROC)

From these budget constraints, it can be seen that if the outstanding amount of debt with foreign institutional investors exceeds the country's capital stock, a crisis would be triggered if foreign creditors stopped lending. The elite would then be forced to file for bankruptcy unless the government or the central bank intervenes, for example on the money supply or exchange rate. ${\ displaystyle D}$

##### The public sector

The state levies taxes, has cash reserves and can borrow and lend money in the international money market at a market interest rate . The consolidated (government and central bank) budget equation would therefore be: ${\ displaystyle r}$

${\ displaystyle {\ frac {\ xi _ {t}} {P_ {t}}} \ cdot \ [(R_ {t + 1} -L_ {t + 1}) - (R_ {t} -L_ {t })] = T_ {t} ^ {ELI} + T_ {t} ^ {ROC} + {\ frac {M_ {t} -M_ {t-1}} {P_ {t}}} + r \ cdot \ {\ frac {\ epsilon _ {t}} {P_ {t}}} \ cdot \ (R_ {t} -L_ {t}) \,}$

• ${\ displaystyle \ xi}$: Nominal exchange rate
• ${\ displaystyle \ epsilon}$: real exchange rate
• ${\ displaystyle R}$: Cash reserves (in foreign currency)
• ${\ displaystyle L}$: Liabilities (in foreign currency)
• ${\ displaystyle r}$: Market rate

Assuming that the government pegs the domestic currency to a strong, non-volatile currency, the following pre-crisis public sector budget constraint arises.

${\ displaystyle R_ {t + 1} -R {t} = {\ frac {M_ {t} -M_ {t-1}} {\ xi _ {t}}} + r \ cdot \ R_ {t} \ ,}$

With ${\ displaystyle t_ {0} \ leq t \ leq t_ {c} \,}$

Before the crisis, the state had a reasonably balanced current account . This means that the initial level of cash reserves is positive and that debt could be offset through taxes on labor income and corporate taxes. The price level is constant and indexed with 1. When the crisis occurs , the debts of the public sector are increased by the financial expenditures of the state in order to rescue the insolvent elite. Accordingly, the budget constraint of the public sector, supplemented by the additional expenses, changes as follows: ${\ displaystyle t_ {c}}$

${\ displaystyle L_ {t_ {c}} = - \ delta \ cdot \ T_ {t_ {c}} ^ {ELI} = D_ {t_ {c}} \ cdot \ (1 + r) - (K_ {t_ { c}} + \ alpha \ cdot \ Y_ {t_ {c}}) \,}$

If this budget constraint is inserted into the aforementioned budget equation, one obtains the budget equation during the crisis:

${\ displaystyle L_ {t_ {c} +1} -R_ {t_ {c} +1} = E_ {t_ {c} +1} \ sum _ {s = t_ {c} +1} ^ {\ infty} \ left ({\ frac {1} {1 + r}} \ right) ^ {s-t_ {c}} \ cdot \ \ left (\ eta _ {s} \ cdot \ W_ {s} + {\ frac {M_ {s} -M_ {s-1}} {P_ {s}}} \ right) \,}$

• ${\ displaystyle \ eta _ {s} \ cdot \ W_ {s}}$= Total tax revenue ( )${\ displaystyle T ^ {Roc} + T ^ {ELI}}$

This equation corresponds to the accruing liabilities, i.e. debts minus the cash reserves (left side of the equation), and the discounted expected returns from taxing labor income and increasing the money supply .

#### Refinancing spiral

The following is a model of how the crisis situation worsens when the foreign institutional investors grant loans to the elite in addition to the capital stock backed by the state with reserves. The following equation shows by the first derivative of what the elite happens when they add another unit to the international financial market as a credit. ${\ displaystyle K}$

${\ displaystyle - {\ frac {\ partial \ left [\ sum _ {s = 0} ^ {\ infty} {\ frac {T_ {t + 1 + s} ^ {ELI}} {(1 + r) ^ {s}}} \ right]} {\ partial K_ {t + 1}}} = \ theta _ {t + 1}}$

Since the elite are certain of the guarantee of the government or the central bank and they can expect a positive capital transfer from it, they will not suffer any loss, regardless of whether there is a negative production shock ( Cobb-Douglas production function ) or not. And for this very reason, this is the crucial mistake , the elite will refinance all financial bottlenecks through further lending on the international financial market. It follows that the desired capital endowment of the elite is greater than the actually efficient one . ${\ displaystyle K_ {c}}$${\ displaystyle K ^ {*}}$

${\ displaystyle K_ {c} \ equiv \ left ({\ frac {\ alpha (A + \ delta)} {r}} \ right) ^ {\ frac {1} {1- \ alpha}}> K ^ {* } \ equiv \ left ({\ frac {\ alpha \ cdot \ A} {r}} \ right) ^ {\ frac {1} {1- \ alpha}}}$

Paul Krugman calls this phenomenon a specific "overinvestment". This is stimulated by an expected positive return on further borrowing. This additional borrowing to cover losses is also known as the “evergreening effect”.

The accumulated losses at the time due to bad debts of the domestic institutions are defined as follows: ${\ displaystyle F}$${\ displaystyle t}$

${\ displaystyle F_ {t} = \ sum _ {s = t_ {0}} ^ {t-1} \ left [\ alpha (A + \ delta -A) K ^ {* ^ {\ alpha}} \ right] (1 + r) ^ {ts}}$

At the time of the crisis, i.e. the bankruptcy of the elite, the accumulated losses of the elite are transferred to the budget of the public sector ${\ displaystyle L = D + F}$

#### The public sector in crisis

The budget constraint after the crisis was triggered therefore looks like this:

${\ displaystyle (1- \ gamma) \ cdot \ F _ {{t_ {c}} + 1} - \ left [{\ frac {\ eta ^ {*}} {r}} (1- \ alpha) AK ^ {\ alpha} \ right] = E _ {{t_ {c}} + 1} \ sum _ {s = t_ {c} +1} ^ {\ infty} \ left ({\ frac {1} {1 + r }} \ right) ^ {s} -t_ {c} \ cdot \ \ left ({\ frac {M_ {s} -M_ {s-1}} {P_ {s}}} \ right)}$

• ${\ displaystyle \ eta ^ {*}}$ Average interest rate after which the crisis was triggered

At this point in time, the financial market crisis can lead to a currency crisis if the tax revenue from labor income and corporate taxation is not sufficiently high. Because then the left side of the equation would be positive and an increase in the money supply would be necessary. One possibility to prevent this would have been a credible implementation of a repayment plan in installments, provided that it would have been compatible with the creditors. This possibility was not used, which is why the money supply had to be increased. This led to a further increase in the inflation rate , which had already increased rapidly due to the depletion of the money reserves. In addition to the financial crisis, this initiated the currency crisis.

#### The role of foreign institutional investors and speculators

The foreign institutional investors are ready to finance the domestic elite as long as there is a minimum of public sector cash reserves. At the moment when the liabilities added to the national debt by the anticipated accumulated losses exceed the cash reserve threshold, the foreign institutional investors will try to collect their claims. (“Show me the money constraint”). This means that the crisis is triggered as soon as the following condition occurs:

${\ displaystyle R_ {t_ {e} +1} \ leq \ gamma \ cdot \ F_ {t_ {e} +1}}$

With

• ${\ displaystyle \ gamma \ cdot \ F_ {t_ {e} +1}}$: Official cash reserves expressed as a fraction of the increasing government liabilities that may arise.

With the onset of the first bankrupt financial institution, speculators immediately began to speculate on the decline in the exchange rate. Because they anticipated a decline in exchange rates, firstly through the depletion of the money reserves, secondly through the triggering of the "Show me the money constraints" and thirdly through the underfunding of the outstanding receivables with tax revenues. This speculation against the Asian currencies made their situation even worse.

What was unusual about the Asian crisis was that the problems were not limited to a national level, but rather had regional or global effects. A wide variety of theories have been derived from this phenomenon, including the notion that crises in countries that are actually “healthy” and were praised by analysts just before the crisis could be contagious . This effect became known as the contagion or the contagion effect in the English-language literature .

### Criticism of the mathematical modeling

Paul Krugman criticized that the financial intermediaries depicted in the first generation models were not serving any useful purpose. Although the assumption is correct from the point of view of moral hazard , it neglects an important aspect of financial market crises: financial market crises have such severe effects on economic growth precisely because financial intermediaries are particularly affected.

Paul Krugman goes on to criticize that it is wrong to put the sole blame for overinvestment and overvaluation of assets on domestic financial intermediaries. He justifies this with the fact that private individuals and foreign institutional investors also invested in Asian stocks and real estate before and during the Asian crisis. This suggests that “ Herding ” in particular could have played a decisive role.

Lukas Menkhoff criticizes the third generation models “The unsatisfactory thing about the large number of plausible-sounding explanations is that they do not fit together into a harmonious whole. It is not clear to what extent the explanations compete with one another and in what weighting they play a role. "

## Preventive measures

Speculative attacks can take various forms, with a financial market crisis causing a currency crisis. Under certain circumstances, as shown in the Corsetti model, the “ moral hazard ” problem can lead to additional government liabilities through the bankruptcy of domestic credit institutions, which in turn limit the possibility of a policy of fixed exchange rates.

Precise and strict financial market supervision to safeguard against an inadequate assessment of the risk of the outstanding claims of domestic financial institutions is to be seen as the most important instrument for crisis prevention. In Europe, since speculative attacks cannot be controlled without the management of capital flows and are not only limited to developing countries, this is taken into account by a credit risk assessment that is being introduced across Europe by the Basel II regulations. As a result, any bankruptcies and mismanagement of credit institutions and companies that grant excessive loans abroad or take out loans in foreign currencies can be identified early on and the state or central bank can plan liabilities that do not appear in the current account at an early stage. An early assessment of government liabilities that may arise would reduce the extent of overinvestments. At the same time, at a new level of investment efficiency, the real income of the rest of the country would fall, partly due to lower real wages and partly due to a higher tax rate . During the subprime crisis in 2007, critics pointed out that the Basel II regulations would not suffice. The minimum capital requirements for credit risks are too low.

Paulo Corsetti, on the other hand, sees the simplest method of preventive government measures in controlling the flow of capital by taxing credit agreements or borrowings in foreign currency. The problem that arises here would be that developing countries in particular are dependent on foreign direct investment . Their lenders tried to hedge against the high exchange rate volatility in developing countries by taking out loans not in local currency, but on the basis of US dollars or yen. Nevertheless, from a theoretical point of view, when implementing a control of capital flows, the tax rate should be selected in such a way that a balanced relationship between non-completion and completion of the loan in foreign currency is possible.

## Cultural explanations of the Asian crisis, its effects and its criticism

In addition to the economic explanatory models, the social sciences discussed the cultural causes of the Asian crisis.

In the 1990s , American sociologists at Harvard University formulated the thesis that the cultural values ​​of a society can have a decisive influence on its economic development. The discussion of this connection had already been held in the 1950s and 1960s, in the context of the debate about the modernization theory . Authors such as Samuel P. Huntington , Lawrence E. Harrison , Francis Fukuyama, and others. v. a. However, (re-) updated the claim that cultural stubbornness could rebel against the ubiquitous westernization, prevail and nevertheless (or: precisely because of it) pave the way for the rise in the capitalist world economy. In the case of East Asia, Confucian values ​​were responsible for the institutional form of capitalism in the region, for certain forms of economic behavior by individuals and for differences in global economic development. This line of reasoning has been paraphrased as the Confucianism thesis.

The Confucianism thesis was able to gain some media and political response. In science, the argumentation was able to tie in with the sociological debate on a worldwide renewal of religion (→ thesis of desecularization ). The challenge of neoliberal and neoclassical arguments also contributed to the expansion of the culturalist declarations.

On the one hand, the explicit reference of culturalistic explanations to Max Weber must be viewed critically , as he had rejected the inference of the differences between modern capitalisms and religion - as the dominant cultural factor of the explanation - as a "foolish doctrinal thesis" . For modern forms of capitalism, its anethical quality (≈ beyond all ethics ) is, according to Weber, of constitutive importance. On the other hand, the various explanations contradict each other insofar as the reasons for the Asian financial crisis are seen either as " secularization " (here: Westernization) of Confucian values ​​in the course of forced globalization , or, conversely, as a strong aftermath of Confucian traditions. The problem lies in the fact that "the distinct, dominant character of religion as the determining force of individual lifestyle [...] is seldom sufficiently identifiable for the proponents of the [...] Confucianism thesis".

## literature

• G. Corsetti, P. Pesenti, N. Roubini: Paper Tigers? A model of the Asian crisis. In: European Economic Review. 43, 1999, pp. 1211-1236.
• G. Corsetti, P. Pesenti, N. Roubini: What Caused the Asian Currency and Financial Crises. In: A Macroeconomic Overview. Part I, 1998.
• Stephan K. Green: The Asian crisis and its significance for the world economy. In: Political Studies. Volume 50, No. 366, 07/08 1999.
• H. Joebges: Transmission mechanisms of currency crises. Using the example of the tequila crisis (1994/95) and the Asian crisis (1997). Herbert Utz Verlag, Munich 2006, ISBN 3-8316-0659-5 .
• P. Krugman: A model of balance of payments crises. In: Journal of Money, Credit, and Banking. 11, 1979, pp. 311-325.
• P. Nunnenkamp: The Asian crisis and what can be learned from it. Institute for the World Economy, contribution to the Third World yearbook, Kiel 1999.
• GL Kaminsky, CM Reinhart: The Twin Crises: The Causes of Banking and Balance-of-Payments Problems. In: The American Economic Review. June 1999, pp. 471-500.
• GG Kaufman, TH Krueger, WC Hunter: The Asian Financial Crisis: Origins, Implications and Solutions. Springer, 1999, ISBN 0-7923-8472-5 .
• Markus Pohlmann: The development of capitalism in East Asia and the lessons from the Asian financial crisis. In: Leviathan. Volume 32, No. 3, 2004, pp. 360-381. ub.uni-heidelberg.de (PDF)

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7. Ronald McKinnon, H. Pill: Credible Liberalizations and International Capital Flows: The “Overborrowing Syndrome”. In: Takatoshi Ito, Anne O. Krueger (Ed.): Financial Deregulation and Integration in East Asia. Chicago, London 1996, pp. 7-42.
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15. (...) first, the failure to dampen overheating pressures that had become increasingly evident in Thailand and many other countries in the region and were manifested in large external deficits and property and stock market bubbles; second, the maintenance of pegged exchange rate regimes for too long, which encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors: and third, lax prudential rules and financial oversight, which led to a sharp deterioration in the quality of banks' loan portfolios. In: Stanley Fischer: The Asian Crisis: A View from the IMF. Address at the Midwinter Conference of the Bankers' Association for Foreign Trade. IMF 1998
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 This version was added to the list of articles worth reading on March 13, 2008 .