The Taming of the Tigers

In 1997, East Asian economies were in a dismal state. Malaysia, Indonesia and Thailand found themselves at the vortex of a swirling financial crisis that was gathering steam with every second and had the potential to obliterate the world economy because of financial contagion.

I have always been intrigued by economic crashes and busts because they show us the imperfection in the system.

They show us how the perfect economic principles that one reads in the textbooks or the models that one constructs are essentially driven by a “human factor”, which has its own set of imperfections.

And when we make impractical judgements, we start seeing the model melting, minute by minute.

With this chain of thought, I tried to understand what went wrong with economic judgements and decisions that led to such a calamitous outcome in East Asia.

Prior to the nineties, East Asian economies had primarily been following an economic plan of “export led growth”.

Delighted with the positive results which included profitable gains across the tables, investments were more sought after and saw a considerable increase as we entered the decade of the nineties.

For example, investment as a fraction of GDP rose from 29 percent in 1998 to a staggering 42 percent in 1996.

However, the inconvenient truth about investments is that you need a robust form of financing which was lacking in these economies. The task of credit allocation fundamentally fell on the shoulders of the domestic banks as the governments started shying away from this responsibility.

This led to ambiguous corporate practices because of extensive corporate pyramids and questionable relationships between the banks and a select few powerful corporations.

A wave of uncertainty was clouding over the sun in these countries and soon enough, because of a faster rate of investments compared to savings, the domestic banks just could not keep up with this game of extensive lending.

“Let’s go global now”.

This is the exact thought process behind these economies as they were determined to continue the fast growth rate of investments at all costs.

However, foreign investors did not really understand the political and economic environments of these countries and were not the most enthusiastic about future returns generated by investments.

Hence, instead of lending long term, they decided to go short term, lending out in the foreign currency to the domestic banks which offloaded the currency risk onto firms.

The domestic corporations lost sight of the value of their investments as money was in plentiful supply. They started to focus on quantity over quality. The conditions for an economic meltdown were now firmly in place.

There was now a glut of investments, financed by short term loans with an additional risk of foreign currency mismatch. All it needed was a trigger. And it came, principally in two ways.

First, the investments themselves flopped. High tech firms like Alphatec found themselves drowning in a pool of losses which petrified the foreign investors who immediately began the process of withdrawal.

Second, the Japanese Yen depreciated against the dollar in 1995. This made Japanese exports much more competitive compared to those of East Asia whose currencies had a closer link to the dollar.

East Asian exports fell at a rapid pace along with their corporate profits with extensive closures of their over ambitious investment projects. Many of the firms borrowing in foreign currency were bankrupted along with local banks who found themselves in analogous conditions.

The “dismal science” had shown its dismal side yet again.