austin-murphy-the-triumph-of-evil

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THE TRIUMPH OF EVIL
of over 35% during the 1997 currency crisis, its real GOP fell by only
0.5% thereafter. The developments in the Philippines provide particu­
larly strong evidence that the banking problems were not the cause of
the Asian crisis but merely a catalyst (and were perhaps also a symptom
that magnified the negative effect on real GOP, which was naturally
reduced as the currency crisis intensified the lending problems of the
banks with foreign currency debts). Moreover, although the banking
and debt problems of many of the devaluing Asian countries have still
not been solved, and in some cases have intensified (Orr, 1999), the cur
rencies have stabilized (and even reversed their declines) as the very
Large devaluations have enabled the current account deficits to disap
pear (or even turn into surpluses).
The Asian crisis also affected countries without extremely large cur­
rent account deficits but proportionally less. For instance, even India
with a minor current account deficit of only 1.5% suffered a mild cur­
rency devaluation of about 15%. Although capital controls in India may
have aided that country in avoiding an artificial currency decline related
to speculative capital flows, the fairly small current account deficit did
require some exchange rate adjustment. On the other hand, an Asian
competitor like communist China with a current account surplus did not
suffer any devaluation at all, even though it had very serious banking
problems and even though the widely touted currency controls in China
were not strict enough to prevent a capital outflow of over S 10 billion
there (Lachica, 2000).
In some of the crisis countries (such as in Asia in 1997), the cur­
rency depreciated more than enough to balance the current account
White these countries also raised interest rates significantly and thereby
caused a deep economic downturn in their countries, the governments
of these nations did not feel it politically feasible to raise interest rates
to the level needed to maintain an exchange rate that would just balance
the current account. In particular, capital outflows and the probability of
the initial devaluation causing a very rapid increase in domestic infla­
tion (and forcing further devaluations) rose so much after the devalu·
ation that the interest rate required to maintain an exchange rate bigb
enough to just balance the current account became prohibitively bigb.
For instance, in Indonesia, a political crisis (caused by the ioftatiOO
and real income losses that were brought on by the devaluation itself)
CHAPTER 6 23 1
made it socially impossible to raise interest rates sufficiently to stop the
devaluation-inflation-devaluation spiral, as the political crisis itselflow­
ered investor expectations that the cycle could be avoided (although the
cycle was eventually stopped, and hyperinflation avoided, by a demo­
cratic solution to the political crisis and a credible monetary tighten­
ing).
The currency crisis in Malaysia deviated slightly from the rest because
of a particular policy option it selected. In particular, Malaysia imposed
capital controls after the onset of its currency crisis in 1997 that allowed
interest rates to fall more rapidly than otherwise (at the same time that
the currency depreciation was minimized to the approximate point nec­
essary to just eliminate the current account deficit), and the country
thereby minimized the short-term negative effects of the crisis on real
income (Phillips, 1999).
The Russian crisis of 1998 developed characteristics similar to those
ofboth Indonesia and Malaysia. The 1998 Russian crisis was partially
related to the earlier devaluation/hyperinflation crisis there that occurred
when the capitalist Yeltsin government transformed the inconvertible
Russian ruble into a convertible currency in 1991. Although inflation
and currency stability were eventually contained by Russia's tight monetary
policy in the mid- l990s, the current account went into deficit in
1998 after the Asian currency crises (and devaluations) slowed world
CCOOomic growth and demand (and made Russian products less com­
�e). Because of the prior hyperinflation and because the continu­
� - �ion in Russia had caused a very serious political/social
tnsJs, mvestors perceived the probability of an immediate devaluation
lo resolve the BOP problem in Russia to be so high that the country was
tillable to stabilize the situation, even with real interest rates over 1 000/e
�even with substantial funding from institutions like the IMF. In par­
�e � signs or fears of �aluation and inflation (Oloudbry, 1 998).
�· the prior problems in Russia had made investors especiaUy sen­
• addrtJOO. the continuing economic depression and social chaos made
estors increasingJy skeptical of the ability of the country to pay its
�the enormous amount of overdue unpaid wages and therefore
� the risk of the government using currency depreciation to solve
� Pl'Oblems and printing money to pay the back wages due (F..a:m-
OIIilt
, 1998). Continued inelasticity of demand relative to exchange rate