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Monday, 13 October 2008

Credit Crunch vs Asian Financial Crisis

It is not difficult to notice that majority of the news nowadays centred on the ensuing credit crisis and the potential knock on effects on the economy. Though Singapore had technically entered a 'recession' after 2 consecutive quarterly contraction, the 'real' one have yet be felt... there are still queues at restaurants and the ERP rates had not gone down.

I happen to watch some evening news on Channel 8 a few days ago. An analyst (I think he is) commented that the comparing the current credit crisis with the Asian Financial crisis in 1997, the proposed solution by the US and European nations then for Asian nations stand in stark contrast to that for their current problems. I decided to verify his comment and pen my thoughts.

Similar problem, different solutions

Both crisis are the consequence of severe economic excesses gone wild (the almost inevitable product at the tail end of a boom-bust cycle). And coincidentally, both have similar roots with a property bubble that burst. The prescription by IMF included cutting back government spending to reduce fiscal deficit, allowing insolvent financial institutions to fail as punishment. This was aim to restore confidence.

Fast forward 11 years to 2008. To treat the current problem where many financial institutions have over leveraged, the prescription now was to bail them out if they had grown too big to fail in order to restore confidence. The consequence of such action could result in deep fiscal deficit for these European nations and United States.

Proposed solutions

From US to Europe, government and central banks inject tremendous amount of money into the financial market. Approving, pledging trillions of dollars to bail out or provide loans to banks and other financial institutions almost dying from the current credit freeze. The concerted effort seem to look like a last minute massive blood transfusion to revive a patient strugging to survive from a huge gapping, bleeding wound.

Health status

Looking at the current health status of the 'rescuing' countries who are trying to donate blood when they had none or little, I am quite surprised how they can realise the amount they pledge. The following two links shows the current account surplus or deficit of major countries and their foreign reserves:
Current account surplus or deficit measures the trade balance while the foreign reserve measures the foreign (liquid) assets of the country. Both are indicative how financial sound the country are in terms of crisis survivability.

From the list, it is easy to see how deep in the 'red' are the major countries hard hit by this credit crunch, i.e. US, United Kingdom, France etc.

Potential consequences

There are a huge number of financial institutions that had over leveraged. The painful de-leveraging process and the asset write downs that could easily terminate them if not because of the massive bailouts by central banks and government.

The worst case scenario I could foresee is a series of bailouts and nationalization of financial institutions until the central banks and government ran out of resources and implode on themselves, i.e. government default like Russia in 1998. That would then spark of a global recession and Asia will just have to survive on growing but sustainable inter country trade, waiting for these industrialized western nations to crawl out of financial nuclear winter.

The 'best' case scenario, or rather a moderate one, would be an eventual devaluation of their currencies, British pound, US dollar and Euro. They could supply, pump in, guarantee all deposits, debts etc. But the eventual flood in money supply would be met with a severe erosion in value, to be felt in months or years to come.


There is no fast solution to this credit problem. Any such thoughts are too native and simplistic. The rally today could just a few sparkles in an otherwise dying heap of fire. Australia and New Zealand dollars had devalued as expected when they had to cut their unsustainable interest rate, soon or later, more frequent trips to European or American tour would be possible.



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