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| Asia's so-called miracle was shattered in truth by
thousands upon thousands of ill-conceived projects financed by a deluge of cheap
money.[...] Instead of the patient capital of the past that built railroads and
steel mills, the bulk of these billions were in short-term instruments that
could be jerked from one country to the next at the press of a button by jittery
twenty-something traders and fund managers. Mark Clifford and Pete Engardio in Meltdown: Asia's Boom, Bust, and Beyond (Prentice-Hall Press, 2000), pp. 9-10 |
The financial crisis that hit Thailand, Indonesia, South Korea and to a lesser extent Hong Kong and Taiwan in 1997 was not generally anticipated but it should have been. Although the macroeconomic variables such as budget balances, both fiscal and trade, were in good shape and they had vast holdings of foreign currency to use to maintain their exchange rates as pegged to the dollar the microeconomic situation was quite different. Firms in the affected countries had made large amounts of loans from Western banks and they were borrowing short term to finance long term projects. The firms were committing themselves to foreign currency payments and not hedging the exchange rate risk. This meant that if the value of the domestic currency fell with respect to the foreign currencies the amount of domestic currency required to make payment committments would increase and could increase to the point of bankrupting the firms. The notion of hedging and risk management never seemed to have occured to many of the firms in these countries. The decision makers had taken the East Asian prosperity as unassailable. This unrealistic attitude was in part due to the fact that many of the decision makers were not real business people. Many were people who had strong contacts with the government and made their money as a result of special priviledges. Others were heirs to family fortunes who did not appreciate the necessity of economizing and weighing risks. But many were legitimate business people who had developed false notions of what constitutes the proper basis for making decisions. Profitability was not given its rightful place in making decisions. This disdain for profits as opposed to sales and market share was often rationalized as a focus on long term profitability versus they saw as the misguided emphasis of short term profitability of Western business. But this was a coverup for a feudalistic, militaristic orientation versus an economic orientations. In military events resources are wasted prodigously to gain victory and the rewards come after the opponents have been vanquished. But in market economies the loss incurred in gaining market share generally can never be recouped. The industrial organizations in Japan and elsewhere that ignored the necessity of making a profit were houses of cards that ultimately had to collapse.
To sum up the East Asian Financial Crisis of 1997-98 had its roots in the lack of a proper criterion for deciding an investment project is worthwhile. Instead the decision to go ahead with a project was based upon whether financing could be obtained. That could have placed the burden of doing an analysis of the net present value of the project on the lender. But the lenders also did not exercise this option. Instead the lenders placed reliance on a belief that the sovereign governments would not permit a financial collapse. There is a distinct element of feudalism in the attitudes toward business in the countries affected by the crisis. There was an attempt to replace economic analysis with a militaristic mentality that appeared to work when times were prosperous but failed miserably when conditions soured.
Although most of the countries affected by the financial crisis had good macroeconomic indicators, some even perfect, Thailand, where the crisis started, had clear economic troubles in the time before the crisis hit. In the spring of 1997 a land developer in Thailand, Somprasong Land, defaulted on its $80 million Eurobond issue. Also in the spring of 1997 a Thai finance company Finance One collapsed. In 1996 the head of the central bank of Thailand, the Bank of Thailand, resigned as a result of a scandal concerning the Bangkok Bank of Commerce.
When a fiscal deficit developed the Government sought passage of a special tax on batteries and motorcycles to increase revenues but Parliament voted it down.
The political economic structure of Thailand was hampered by the extent that members of Parliament were heavily involved in business. And these politico-businessmen were not particularly astute businessmen; many relied more on the strength of their connections than their administrative ability or market acumen. One name for the system is "crony capitalism."
In the spring of the 1997 the Thai government took some steps to remedy the situation but declared it would never devalue the Thai baht. At that time the exchange rate was about 25 baht to the dollar and the Bank of Thai was committed to supporting that rate.
Although currency speculators are blamed for forcing devaluations the real cause lies in the elements of supply and demand. The speculators may instigate the devaluation at a particular time but they only prompt what had to occur sometime anyway. The way the speculators precipitate a devaluation is to borrow the currency and sell it. The cost to the speculators is the interest charges on their borrowings. But although the sales of the currency by speculators may seem large the real movement comes when they are able to convince the general public that a devaluation is inevitable and emminent. The speculators, in effect, attempt to trigger an avalanche of currency transfers by the individuals and businesses who do not want to see the value of their holdings drop virtually instantly. The central bank tries to fight this loss in confidence by increasing the domestic interest rates to discourage capital transfers, to attract new short term capital and to punish speculators by increase the cost of their borrowing.
The Thai conglomerate was founded in 1921 by two brothers, Chia Ek Chow and . During most of its existence it concentrated on animal feeds, poultry, and seeds. It imported seeds and fertilizer from Guangdong Province in South China, the ancestoral homeland of the founders, and it exported poultry products,initially eggs and later chickens and ducks. Later the CP Group developed a sea food branch.
The trade with China lapsed during the Mao years but was re-opened after Deng Xiaoping's Modernization Program encouraged trade of China with the outside world. CP set up an animal feed venture in Shenzhen (near Hong Kong), the first outside direct investment in China.
The son of Chia Ek Chow, Dhanin Chearavanont (The Thai government insisted the Thai Chinese adopt Thai names) set about diversifying CP in a very big way. The Group entered telecommunications, chemicals and vehicles. It entered the mass merchandising field with joint ventures with Wal-Mart of the U.S., Yaohan of Japan and Makro of the Netherlands. It set a chain of convenience stores in Thailand modeled on the 7-Eleven chain in the U.S. This was achieved through a joint venture operation with Southland, the owner of the 7-Eleven chain. CP entered the commercial development field through CP Land which built about one hundred urban complexes featuring shopping malls, office space and hotels. CP also began producing packaged foods for export.
CP used its contact and influence to get franchises for these new fields and then negotiated a joint venture with multinational enterprises with the technical expertise required. For example, the CP Group got permission to set up a new telephone system, a much needed operation for Thailand. CP Group secured Nynex of the U.S. to handled the operation of the system.
When opportunities in new fields arose in China CP took them. After setting up a poultry operation in the Shanghai area the government offered to let the CP Group resurect a failing motorcycle manufacturing operation in Shanghai. CP licensed the technology it wanted from Honda.
CP seemed to have the political skills necessary to gain the approval of government and the business acumen to bring in the technical skills it lacked. But the entry of CP into new fields and new markets looked dangerous but CP seems to have managed. Lesser companies did not have the skills of CP to do everything everywhere. Furthermore CP could operate successfully with the ambiguity of its relationships with government. Other enterprises trying to do similar things did not have the requisite skills and such overexpansion brought disaster. Even CP had trouble with its joint telephone company venture with Nynex.
What people in history have been subjected to so many wrenching, cataclysmic changes as the Malay peoples? The Malays make up the vast majorities of the populations of Malaysia, Indonesia and the Philippines. In classical times invaders from India established Hindu culture and religion in the area. The remnants of this cultural invasion survives in a few places such as Bali and in the monuments. Then came Islam displacing the Hindu culture. In the 16th century the Portuguese and Spanish came but the Portuguese were soon displaced by the Dutch and the English. After centuries of Dutch and English domination suddenly in the 1940's the Japanese expelled both. After a period of transition there was independence under regimes which were the successors to the Dutch and English. Sukarno ruled the former Dutch possessions and allied himself with leftist forces. Quite abruptly Sukarno was stripped of his power and a former general, Suharto, was the dominating figure after a civil blood bath. Then came decades of stability and corruption. But within the course of a singel year Suharto was out of power. Again after of period of political instability and transition with many of the most effective citizens leaving the country the daughter of Sukarno is in power. With such political turmoil it is surprising that any of the common people can continue to keep the economy operating.
It is important to distinguish between firms which owe there existence to efficiency and skill and are likely to survive a change of regime and firms which are dependent upon special privilege granted by a particular regime and which will eventually disappear with the end of that regime.
On July 2, 1997 the Bank of Thailand, after expending about $30 billion in foreign currency supporting the exchange rate, let the baht float. The value of the baht dropped about 15%. Economists generally view the attempt to peg exchange rates as risky, costly and ultimately futile.
There was a rationale for the Bank of Thailand continuing to support the baht. Many Thai firms had borrowed heavily and the debt service was denominated in foreign currency. A decrease in the value of the baht would increase the baht-cost of the debt service of these firms to the point of their insolvency. Thus the Bank of Thailand worried about a financial collapse in Thailand and a subsequent recession.
Of course this predicament for Thai businesses came as a result of their confidence that the exchange rate would not change, a notion perpetrated by the Bank of Thailand. Perhaps some of the problem lies in the misnomer "fixed exchange rates." Fixed exchange rates are not necessarily fixed, they eliminate the frequent, small adjustments of floating exchange rates and replace them with infrequent, big adjustments. The capital transfers in anticipation of one of these big adjustments may make the magnitude of the adjustment greater than it other wise would have been. In other words, the magnitude of the infrequent adjustments may be larger than the net sum of the small adjustments under a floating rate regime.
(To be continued)
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