Transcript Yes “It” Did Happen Again—A Minsky Crisis Happened in Asia

Yes “It” Did Happen Again—A
Minsky Crisis Happened in Asia
Written by
J.A. Kregel
Introduction to Minsky’s ideas
The government should provide a floor
below the aggregate demand
A central bank is needed to lend at the
discount window to support asset prices
and thus bank solvency
In Southeast Asia banks are lending in
foreign currency therefore restricted by
foreign currency reserves
Financial fragility & development
Banks should lend only to those with good
credit, but the act of lending changes fair
collateral
Lending may strengthen a firm and thus
the bank that lent to them
Lending to countries will lower the value of
a country’s assets, and in turn lower the
bank’s credit standing
Minsky defines two types of financing
1. Speculative financing
2. Ponzi financing
The value of financing positions change with
variations in the macro economy
a rise in the domestic interest rate “i” to the firm
reduces present value of cash flows from
current projects
Increases cash flow commitments for
financing charges
A depreciation in the Exchange rate has the
same effect as an increase in “i”
The banks position if “i” increases or there is and ER
depreciation
1. reduces the present value of domestic cash
flows
2. Increases the interest cost of its foreign funding
3. Reduces the credit quality of its loans and
reduces its own credit rating
If these conditions occur a bank can find itself
transforming into a Ponzi unit
This creates a situation where banks are unwilling to
lend to each other, so the domestic interbank market
will contract
Firms and banks attempt to reduce foreign currency
exposure
Therefore Financially fragile systems is now unstable
Endogenous Financial Fragility
Possibly comes form an underestimation of risk
associated with certain investment plans
May happen when economic times are stable
Therefore there may be a reduction in the safety
cushion required
Therefore am endogenous change in margins
makes the passage from fragile to unstable
system in the event of an exogenous shock
A Normal Crisis
Domestic Firms borrow foreign currency at “i” which is
reset in a short rollover period
Short roll over-the maturity dates do not matter, here
rates change in reset periods which are short
Therefore a rise in foreign interest rates is quickly
transformed into an increased cash commitment for the
borrower, which in turn instantly reduces safety margins
i.e. diminishes the cushion
If there is a domestic currency depreciation relative to
borrowed currency , cushioned further eroded
And if Government raises domestic “i” to increase foreign
demand for their currency domestic demand may fall and
domestic cash flows will be reduced and domestic
financed will be decreased
The Asian Crisis
Most countries financed with the $ and the Yen
predominantly the Yen
Therefore an appreciation of the Yen relative the $
represents an increase in Asian domestic currency cash
flow commitment on borrowing form Japan
The changing point
Then a switch and the Yen depreciated against the $,
this and low Japanese “i” ,meant investors were placing
short-term funds in Asian benefited from interest rate
differential and possible exchange rate gain as the Yen
depreciated
Crisis because everyone in Japan was trying to do this
Flow increased b/c countries set-up special
“offshore financial centers to increase the role of
domestic Asian banks in their intermediation of
international capital flows into the region
This made it easier to borrow funds at a lower “i”
and invest them at higher Asian rates
These institutions did not retain a sharp division
from domestic markets and mediums for foreign
lending to domestic banks which created large
expansions in domestic lending
Next these countries restrictions on trading
creating greater speculative lending
Thus the shift from Yen strength and high Japanese “i” to
weakness and low, shifted capital flows form long-term to
short
Therefore exchange rates were supported by temporary
capital flows, while domestic production was losing
competitively to Japan and other non-$ markets
China enters Asian Market driving down prices of all
goods within Asia
Therefore the strength of the ER did not really reflect the
strength of the manufacturing market
Spring of 1997 the Bank of Thailand decides not to save
the countries largest financial firm: happened at a time of
uncertainty in international markets concerning the
evolution of international interest rate differentials
May 1997 people think Japanese
economy is turning around
Funds borrowed at low interest rates in
Japan and Hong Kong and invested in
Asia are withdrawn and returned to Japan,
appreciating the Yen, and increasing
pressure on Asian reserves and ERs
Asian funding falls; domestic banks
respond by calling their loans, but this is a
false alarm b/c Japan is not turning
around, the Yen reversed down again
Reasons for financial crisis in Asia
were endogenous and exogenous
Endogenous
Fact the ERs remained stable against the
$ for so long clearly reduced safety
cushions for lenders and borrowers
The capital inflows that kept currencies
stable thus implicitly increased fragility and
decreased the ability to finance the
commitments of these flows by reducing
the competitiveness of manufacturing
exogenous
The volatility of the Yen/$ ER and the associated
in relative interest rate spreads, and the flow of
arbitrage funds into and out of the region put
increased pressure on the already thin declining
margins of safety
Also international regulatory factors played a
role
Once there was a reversal of capital flows it
brought attention to factors that were already
there: prior bank failures, corporate
bankruptcies, warnings form the Bank for
International Settlements, rising real exchange
rates, and current account deficits
Central Banks Responses
When currencies reversed CB’s tried to defend
the exchange rates
They engaged in a series of rapid devaluations
to delink from the $
\In 3 weeks 6 countries gave up fixed ER’s that
had been stable against the $ for extended
periods
Tried to discourage speculation so they didn’t
have to raise “i” to protect the currency
In the 3 weeks movement in the ER wiped out
already insufficient margins of safety for
domestic and corporate banks
Therefore rims and banks transformed from Speculative
to Ponzi and the delinking of the $ encouraged
speculators when countries did not respond to with tight
monetary policy
AS currencies failed to stabilize “i” were raised barely
raised which reinforced the ER depreciation on the
balance sheets of firms and banks
Banks and firms then sought to limit damage from rising
$ rising interest rates by repaying foreign currency loans
as fast as possible
The result was a free fall in the ER and asset prices in
many countries as financing units tried to sell anything
possible to raise funds and reduce cash payment
commitment and foreign exposure
A Minsky debt deflation crisis was underway
What is to be done—What has
been done?
Cannot save Ponzi firms policy must try to save
the firms that are still in the speculative stage
To stop firms and banks from shifting from
speculative firms to Ponzi firms cash flows to
firms by supporting domestic demand and
reducing their lending costs
This leaves a productive capacity in place that
can increase exports earning to repay foreign
debt, and stops banking failure caused by
nonpayment and other things such as default
and credit downgrades
IMF Rescue
It was patterned after the Mexico crisis
IMF wanted to prevent erosion and devaluation
from increased import prices and increased
demand from the bailout of banks, to keep
imports down, and domestic demand was
constrained through a reduction in government
expenditures and tight monetary policy
To stop devaluation interest rates were raised
and financial institutions that could not meet
international capital standards were closed
IMF wanted to restore international confidence, return
short-term capital flows, increase experts and decrease
imports that will eventually make capital inflows
unnecessary
Because the collapse of the ER was due to financing
imports of capital goods therefore the banks and firms
need help the IMF only made their positions worst
Disappearance of foreign capital meant that banks had to
finance through domestic banks at higher “i”
With falling global demand firms relied on domestic
demand, but domestic demand fell due to IMF enforced
tight monetary policy
Firms had to repay lenders in Foreign currency but firms
could not purchase imports to meet payrolls therefore
they sold positions to make positions which equal a rapid
fall in export prices, while import prices rose in step with
devaluation of the currency
Tight monetary policy increases trading
financing costs, credit lines were reduced and
payment penalties increase
Therefore export capacity was reduced by the
inability of firms to get finance to continue
current operations
These Polices were exactly the opposite of what
is required to stop a Minsky debt deflation crisis
IMF considered problem as a flow but it was a
stock, firms and banks tried to liquidate their
stocks of goods and assets to liquidate their
stocks of FX debt
In Keynesian terms it was a problem of a shift in
liquidity preference not a problem of a shift in
spending propensities that had to be achieved
Is the Crisis Over?
If it is a Minsky debt deflation it is not over