Fundamental Macroeconomic Causes:
The East Asian Currency Crisis
Savings-investment imbalance--also reflected as current account imbalance
Dependence on short-term foreign capital (portfolio investment both equity and debt instruments--and loans) by private investors
Equity is better than debt
Direct investment is better than portfolio investment
Insolvency caused by the revaluation of foreign-currency denominated debts and the rise in the rate of interest
Domino effects of insolvency and bankruptcy
Problems magnified by high leverage (or high debt to equity ratio)
Inadequacy of foreign exchange reserves (working capital of a country) for supporting imports, debt service, and (potential) net short-term capital outflows\
Real exchange rate appreciation (loss of competitiveness) due to a domestic rate of inflation higher than the U.S. rate of inflation
Fundamental Microeconomic Causes:
Borrowing Too Much, Short-Term and in Wrong Currency
Maturity mismatch--borrowing short and investing (lending) long
Currency mismatch--revenue and cost (liability) in different currencies
Vulnerability magnified by high debt to equity ratio
Insolvency caused directly or indirectly by declines in the exchange rates
Oversold currencies create unnecessary bankruptcies and discourage recapitalization and re-structuring
Moral hazard on the parts of both lenders and borrowers
Past bailouts (Latin American loans, Mexican loans) of developed country lenders encourage moral hazard on the part of lenders
Implicit guarantee of banks and enterprises “too big to fail” by governments encourage moral hazard on the part of borrowers
“Herd mentality”--too much money chasing too few good projects leading to mis-pricing by developed country investors and lenders (it is better to make the same mistake as everyone else)
The East Asian Currency Crisis
Savings-investment imbalance--also reflected as current account imbalance
Dependence on short-term foreign capital (portfolio investment both equity and debt instruments--and loans) by private investors
Equity is better than debt
Direct investment is better than portfolio investment
Insolvency caused by the revaluation of foreign-currency denominated debts and the rise in the rate of interest
Domino effects of insolvency and bankruptcy
Problems magnified by high leverage (or high debt to equity ratio)
Inadequacy of foreign exchange reserves (working capital of a country) for supporting imports, debt service, and (potential) net short-term capital outflows\
Real exchange rate appreciation (loss of competitiveness) due to a domestic rate of inflation higher than the U.S. rate of inflation
Fundamental Microeconomic Causes:
Borrowing Too Much, Short-Term and in Wrong Currency
Maturity mismatch--borrowing short and investing (lending) long
Currency mismatch--revenue and cost (liability) in different currencies
Vulnerability magnified by high debt to equity ratio
Insolvency caused directly or indirectly by declines in the exchange rates
Oversold currencies create unnecessary bankruptcies and discourage recapitalization and re-structuring
Moral hazard on the parts of both lenders and borrowers
Past bailouts (Latin American loans, Mexican loans) of developed country lenders encourage moral hazard on the part of lenders
Implicit guarantee of banks and enterprises “too big to fail” by governments encourage moral hazard on the part of borrowers
“Herd mentality”--too much money chasing too few good projects leading to mis-pricing by developed country investors and lenders (it is better to make the same mistake as everyone else)