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Strategies & Market Trends : Asia Forum -- Ignore unavailable to you. Want to Upgrade?

To: Thomas Haegin who wrote (1266)	1/20/1998 9:54:00 AM
From: Mohan Marette	Read Replies (3) \| Respond to of 9980

Morgan Stanley on Asia. (for personal use only). Thomas and thread: Want to know what Morgan Stanley thinks of Asia? Of particular interest is the argument as to why a 'currency board' wouldn't work, I think it is point #2. ------------------------------------------------------------------ Non-Japan Asia: What Happened to Asia? Tim Condon (Hong Kong) Key Points: Bad banks impart instability to the currency because a means of resolving a bad bank problem is to inflate it away. Lack of confidence in monetary stability is the reason the Asian crisis countries' -- Indonesia, Malaysia, Thailand and South Korea -- currencies are under pressure. Neither capital controls nor a change of exchange rate regime will stabilize the currency unless measures are taken to resolve the bad bank problem. A "good" solution to the bad bank problem must resolve stock and flow problems. By far the most important is the flow problem, improving credit allocation. The stock problem involves allocating financial losses on the stock of bad loans. Details: "...those of us trying to make sense of that [Asian] crisis in terms of conventional currency-crisis models have been on the wrong track: the Asian crisis may have been only incidentally about currencies. Instead, it was mainly about bad banking and its consequences." Paul Krugman, "What Happened to Asia" January 8, 1998 (from the Paul Krugman website). I have been arguing that the main problem in Asia is bad banks and I take comfort from the quote from Paul Krugman, the father of the canonical "speculative attack" model of a balance of payments crisis. Where Krugman goes, others will follow and models of credit booms and asset price collapses with large devaluations soon will be commonplace in the professional economics literature. Bad banks impart instability to the currency because a means of resolving a bad bank problem is to inflate it away. Lack of confidence in monetary stability is the reason the currencies are under pressure in the four Asian crisis economies -- Indonesia, Malaysia, Thailand and South Korea. Focusing on the bad bank problem clarifies some things. First, capital controls will not help. I have argued that a temporary moratorium on private external debt could help consolidate expectations that the solution to the external debt crisis will involve a debt reduction, which could help accelerate that process. But a moratorium or capital controls would not stabilize the currency. Second, a currency board would not help. A currency board would set the exchange rate at a level at which all cash and currency are backed by US dollars. But it would do nothing to resolve the bad bank problem. Local residents would continue to hedge their exposure to an asset they expect to depreciate, and domestic interest rates would rise. It is wishful thinking, in my view, to believe that the political will to bear high interest rates would be greater simply by altering the exchange rate mechanism. Third, the economic downturn is magnified by the bad bank problem. Banks facing capital shortages and inadequate reserves to cover nonperforming loans call other loans or sell assets and collateral in declining markets, exacerbating the decline. Political pressure to ease the crisis by lowering interest rates becomes intense. Already we have seen the central banks in Malaysia, Thailand and Indonesia provide credit to troubled banks. I expect this to lead to rising inflation in these countries. A "good" solution to the bad bank problem must resolve stock and flow problems. By far the most important is the flow problem, improving credit allocation. The solution to the flow problem is to stop the bad banks from intermediating. Closure is one solution, but not the only one. Stopping the bad banks from intermediating could be accomplished through a 100% marginal reserve requirement on bad banks. The funds mobilized by the bad banks then could be reallocated to the good banks (for example, by auctioning them). Short of this, liberalizing access to foreign banks would be a step in the right direction. The stock problem involves allocating financial losses on the stock of bad loans. While less important for economic efficiency, the stock problem generally consumes a disproportionate share of policymakers' attention. This is because the solution often involves competition for government favors. As a rule, forcing bad banks' shareholders to absorb the maximum losses, as in the South Korean proposal to force bad bank' capital to be written down, is better than socializing all the losses, for example through inflation.