Talking Points:
Asian Currency Crisis Refresher
What is a Currency Crisis?
Will This Be a Repeat of 1997?
Where Can We Look For Clarity?
In today's world, few but the most experienced remember the throes of the 1997 Asian Currency Crisis. In short, it was Hedge Funds against Central Banks of frontier Markets in the Asian Pacific Region who were holding strong in order to establish a strong currency and bolster their economy to a new era of prosperity.
However, the economic forces were not favorable such that the Central Banks refused to budge, the Hedge Funds pushed harder with their deep pockets until the Central Banks were forced to wave their white flag, and they did. We'll explain what happened in better detail in a moment but it's important to know that many are fearing the Asian Currency Crisis of 1997 duplicated in 2015, however, we're dealing with a different and potentially more aggressive tiger this time around. Let's unwind what's happening and what the effects may soon be.
What is a Currency Crisis?
A Currency Crisis in the FX market often boils down to one word, deficits. Deficits are another word for debt and in the FX world, they're often acquired from willing economic neighbors who will lend. Sometimes the lending is done out of joint interest and other times the lending is done for the benefit of the lender mainly. Either way, a crisis develops when payments are due to foreign creditors and present economic conditions prevent the debt from being paid.
Will This Be a Repeat of 1997?
In 16 years, there have been many positive developments of the global economy that limit the likelihood of a 1997 repeat. 1997 saw many currencies pegged to the USD, which presented a problem. In short, their economies were dropping such that there was a widening gap between the value of the dollar and the intrinsic and risk-adjusted value of their home currency. As deficits swelled and their already light reserves were being used to prop up the currency, hedge funds circled like vultures the vulnerable central banks like Thailand until they were forced to depeg from the USD causing a near free-fall in many Asian-Pacific currencies. The genesis of this was an ineffective peg policy and aggressively rising debt, the later of which is happening today.
If you'd like to see borrowing rates, it's helpful to assess what's the foundation for debt growth. The initial development is aggressive borrowing. To assess credit excess, one helpful measure that is a bit tricky to find in some economies is net-new credit creation relative to an economy’s GDP. One common occurrence we’ve seen before prior massive peaks in an economy or market is net new credit relative to GDP growth above 20% in a 1-yr span.
Here are a few examples: The US had 20% Net New Credit relative to GDP 1 year ahead of 2008, before the Great Financial Crisis Thailand had nearly 30% Net New Credit relative to GDP in 1 year ahead of 1996, before the Asian Financial Crisis. Recently, China’s economy has created net new credit at 35% of GDP for 5 consecutive years and the ratings company Fitch has adjusted numbers and they believes the number is closer to 40%. Given their GDP, that’s about $3 Trillion per year of new credit.
That's a lot of money borrowed. However, there is a lot more capital in these economies than there has been in the past. Make no mistake, Emerging Markets have been hurt as commodities have lost their bid but many central banks have much larger reserves than were present in 1997.
While the current situation may bear some resemblances to 1997, the differences are significant and it's best to see the differences and look for opportunity within them.
Where Can We Look For Clarity?
We can look for the carry trade as a sign that emerging markets are seeing capital inflows, which they depend on for growth. Put in question form, is there foreign investment coming into the growing economies in need of capital to grow or is money leaving in search of safer investments? Keep in mind these emerging or frontier markets are not considered safe investments relative to developed economies so capital tends to flow out in uncertain economic times..
In the month of August, the JPY, which is the cornerstone of the Carry Trade house, gained across all currencies and aggressively against emerging markets. As an example, the MXNJPY popular carry trade lost ~5.5% in August alone. The ZARJPY lost ~5.85% & the BRLJPY lost ~6.7% also in August. If this trend continues, a different albeit presently dire emerging market crisis could grow as these economies need money coming in, not money flooding out.
Stay safe out there.
Subject: Another Asian Currency Crisis? 
Wed Sep 09, 2015 2:47 pm
