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How Did the Financial Crisis in Southeast Asia Happen?

By Ju-chang He
14 October 1998

Recently, a financial turmoil, or financial crisis, is taking place in Southeast Asian countries. All the countries lay the blames on George Soros, an American speculator, for this crisis. However, I hold a different opinion. A Chinese saying goes: "It takes more than one cold day for the river to freeze three feet deep." How is it possible for a speculator to ruin several Asian countries in a few days? There must be reasons behind. Here, I would like to dig out the reasons behind, allowing the countries, especially the developing countries, to get a good lesson from it.

As is known to everyone, Southeast Asian countries exercise a fixed exchange rate system connected to US Dollars. What we should understand is that, to adopt a fixed exchange rate, the first thing is to determine an exchange rate level. For instance, 14 years ago, the Thai government fixed the exchange rate of Thai Baht to US Dollars at a level of 24.70 Baht to one Dollar. And this rate got fixed, not allowed to float. Is this rate reasonable? 14 years ago, nobody knew. Now, with my deduction, I've found this rate is not reasonable. It was too high 14 years ago, but it was too low today.

Here goes my deduction:

1. 14 years ago, if the rate of US Dollars was too low vs. the Thai Baht, people in other countries possessing US Dollars would not be happy. They would feel it a great loss to sell their Dollars to Thailand. Thus it would be difficult for Thailand to obtain US Dollars from the international market, and it would be impossible for the fixed exchange rate system to operate even at that time. According to this reasoning, I believe that 24.70 defined as the rate of Dollars to Baht was too high 14 years ago. That is to say, if one sold out his Baht for Dollars, he would lose. As a result, the wealth of Thailand flowed out cheaply for purchasing US Dollars. The reflection was a considerable increase of export volume. As the wealth was flowing out, the devaluation of Baht was aggravated, which caused the price to go up.
2. For the last 14 years, the price level of Thailand has kept going up. Last year, the price level was no longer acceptable to foreigners. They felt it a loss to sell their Dollars for Baht. Therefore, foreigners felt the fixed exchange rate of one Dollar to 24.70 Baht was too low for them last year. The international community thus had the common wish to increase the exchange rate of US Dollars to Baht. As Thailand exercises fixed exchange rate, their desire was hard to be satisfied and, therefore, became very covert.
3. At this time, George Soros became aware of this common desire to increase the exchange rate of Dollars to Baht. He believed, according to the price level in Thailand, that the fixed exchange rate of one Dollar to 24.70 Baht was really too low, and to sell Baht out for buying in Dollars would make the seller of Dollars lose. Therefore, he borrowed a great number of Baht from the banks worldwide. The amount was so huge that I estimate it might be over 100 billion Baht. Then, he changed all these Baht to Dollars according to the fixed exchange rate of 24.70. After all the Baht were sold out, he began to scatter the rumors all over the world that the Baht would devaluate, which made the Thai people begin to sell their Baht in big quantities. But whom the Baht were sold to? The foreigners had long since had the wish to increase the exchange rate of US Dollars to Baht. Therefore, they would not sell their Dollars to the Thai people at the fixed exchange rate of one Dollar to 24.70 Thai Baht. The Thai people had to sell their Baht to the Thai Government. The foreign exchange reserve of Thai government was soon run out. Even after the foreign exchange reserve of Thai government was empty, the demands for selling the Baht were not yet satisfied, so as to force the Thai Government to give up the fixed exchange rate. The exchange rate of US Dollars was soon increased to one Dollar for 29.45 Baht. At this time, Mr. Soros changed one portion of his Dollars back to Baht at the new rate of 29.45 and paid back the principal and interest to the banks. When he borrowed the Baht, he changed them to Dollars at the rate of 24.70. After the Thai Government gave up the fixed exchange rate, he changed back one portion of his Dollars at the rate of 29.45. In such a deal, he made a very considerable profit.

Conclusion

1. The devaluation of Thai Bath was not caused by this crisis, as the devaluation had happened before the occurrence of the crisis. With the fixed exchange rate carried out for 14 years, the prices in Thailand increased to an unacceptable level for foreigners. The fixed exchange rate did not allow the devaluation to be reflected apparently by the exchange rate. This does not mean that Baht had not devaluated before the Thai Government gave up its fixed exchange rate.
2. This financial crisis is just like an active volcano, and the common wishes of the international communities for increasing the exchange rate of US Dollars to Thai Baht are like the lava boiling beneath. Mr. Soros is like the man who stirred the crater of the volcano with an iron bar. It was because Mr. Soros gave the crater a stir that the active volcano sprayed out in advance. Obviously, it was not Mr. Soros, but the lava beneath that caused the burst of the volcano. That is to say, it was the common wish of the international communities to increase the exchange rate of Dollars to Baht that caused the financial crisis. The volcano would have burst sooner or later even if Mr. Soros hadn't stirred the crater.
3. China was not affected by this crisis, because it adopted strict control over its currency. Mr. Soros had got no way to borrow Renminbi yuan from the international banks. Without Renminbi yuan in hand, he is not able to speculate in Renminbi yuan. But the Chinese people should not be satisfied with the present situation. There are over 60% of the population in China still living in poverty. The living standards of the low-income families haven't got a rise in the past years. In China, there are still a lot of people who haven't got enough food and clothing and can't afford to send their children to school. Many children at the school age are deprived of education. Judging from my economic theory and economic growth model, China is still one of the most underdeveloped countries.
4. In order to prevent the occurrence of similar financial crisis in Southeast Asia, countries the world over should give up fixed exchange rate as soon as possible and continue carrying out free market economic policy.

Sincerely,
Ju-chang He