Another Economic Crisis Is Not Likely

Home > Opinion > Columns

print dictionary print

Another Economic Crisis Is Not Likely

Asian currencies have been declining recently. The currencies in the Philippines, Thailand and Indonesia are suffering from instability. The currencies in Taiwan and South Korea, which have been stable, have also shown signs of sliding.

Concerns are being raised that the currency instability in Asia may be a precursor to a second foreign exchange crisis. A close look at the causes of the instability, however, will help allay such fears.

The causes of the instability of Asian currencies are the lack of liquidity in the foreign exchange market and changes in the foreign exchange system. Ironically, the decreased liquidity in the Asian foreign exchange markets has something to do with the collapse of hedge funds which had served as a market maker. Hedge funds also served to increase the liquidity in Asian foreign exchange markets by providing them with dollar-denominated funds as recently as 1997, before the foreign exchange crisis in the southeast Asian region. But the funds faced bankruptcy en masse after the demise of Long-term Capital Management in November 1998. The failures of the hedge funds caused a short supply of dollar funds in Asia''s emerging financial markets and, as a consequence, reduced the liquidity in foreign exchange markets. In general, the market can be pushed by a small negative factor into wide fluctuations when suffering a liquidity crunch.

Changes in the foreign exchange system, including the introduction of a flexible exchange system in Asian countries, are also to blame. After the latest foreign exchange crisis, most Asian nations have changed their foreign exchange systems to reflect market signals, abandoning their previous fixed exchange systems.

As market perceptions of a currency''s value or a country''s economy change, the currency moves up or down, These natural movements as a result of the changed system are responsible for the currency value changes we see now.

Under a fixed exchange system, downward pressure does not immediate influence currency rates. When foreign exchange reserves runs out, this pent-up downward pressure bursts out to force massive changes of exchange rates. It is what happens when a fixed exchange rate system falls apart.

The ongoing changes in Asian currencies are nothing more than a process of reflecting such negative factors as political uncertainty amid a liquidity crunch.

Despite these negative factors, it appears unlikely that the latest currency instability will result in another Asian economic crisis.

This optimism comes from the relatively narrow range of exchange rate fluctuation so far. Asian currencies declined 6 - 7 percent on average from the start of this year. This is not a particular concern if it is compared to the euro''s fall of about 15 percent against the U.S. dollar during the same period. The optimism is even more convincing when compared to the foreign exchange crisis of 1997. The Korean currency, which was in the 900 won range against the U.S. dollar in October, 1997, crashed to 2,000 won per dollar at one point during December of that year.

The current state of macroeconomic fundamentals provides another basis for optimism. Most Asian countries are generating surpluses in their external trade and have enough foreign exchange reserve to brace themselves for a possible crisis. With the adoption of flexible exchange systems, they are capable of adjusting foreign exchange rates flexibly, which will help steer them clear of future crisis.

The latest movement of currencies in Asia is simply a short-term, technical response, occurring to varying degrees in each country in the process of their adopting the flexible foreign exchange system amid healthy economic fundamentals. Another foreign exchange crisis is therefore unlikely.

The writer Im Joon-hwan is a professor of international finance at Sogang University.
Log in to Twitter or Facebook account to connect
with the Korea JoongAng Daily
help-image Social comment?
lock icon

To write comments, please log in to one of the accounts.

Standards Board Policy (0/250자)