Over the past decade, China’s state-owned economy has been easing capital controls and market liberalization. Will the 1997 Asian financial crisis repeat itself?
We wrote about “evaporating” government debt on how to use capital controls and spread spreads. However, as these two strategies become less and less effective and China’s role in the international market becomes more and more important, these tools will eventually die out.
But can China open its economy safely?
In the 1980s and 1990s, when Asian countries reduced their capital controls (essentially opening up their markets), they ended the biggest market collapse in history in the region.
In order to further understand why capital controls are crucial to the state economy, let us recall the history of several countries in Southeast Asia.
Northeast Asia know how to develop capital
As we have already discussed, Asia has a lot of natural and human capital.
After World War II, most Asian countries have between 30% and 50% savings and investment rates. This means that the government can allocate as much money as possible.
Japan, South Korea and other northeast Asian countries tend to invest in Asian Capital Development (ACD), the government protecting and controlling certain industries.
They have invested in less profitable sectors (short-term), such as agriculture and export-oriented manufacturing. The goal is to develop human capital slowly and positively. This process has given birth to globally competitive companies and increased foreign exchange reserves.
Taxation, reduction or elimination of a country’s capital inflows and outflows are all capital controls. This method is also used to transfer credit to key sectors.
Southeast Asian countries such as Thailand, Malaysia, Indonesia and the Philippines have the same economic line as Northeast Asian countries. However, they lost their grip on the financial system as stock markets rose, property prices rose and consumer loans increased.
Whenever the free market is confused in a closed, controlled financial system, problems arise.
If an ACD-compliant nation decides to open its financial markets, cancel its banking operations and capital inflows into its system, “crony capitalism” can integrate into the economy and economic progress may falter in the long run.
Once the market is relaxed, there will be plenty of speculative investment after high interest rates. But as a result, the economy came to an abrupt halt due to excessive external funding, plus hot and hot money.
When free markets “bother” the Philippines
The early victims of the Asian financial crisis were the Philippines.
During and after the colonial rule in the United States, the Philippines repeatedly tried to switch to an export-oriented economy reminiscent of the North’s economy. However, the government has always tried its best to reduce its efforts to reform and manage its economy. The whole process is gone.
In the 1950s oligarchs took over the banking system and privatized it.
In the early 1970s, however, capital controls ended in the Philippines following the “financial prescriptions” of the World Bank and the International Monetary Fund.
Because the Philippine government loses control of its financial system, the country can not become a globally competitive export economy because direct investment does not flow along long-term growth paths.
The money coming in eventually comes from a company run by the dictator’s family or friends rather than a high-end exporter.
However, the Philippine debt is in the form of U.S. dollars. Therefore, the interest rate of the United States in 1980 was the highest since World War II, and the Philippines still had difficulty in paying off its debts.
From 1965 to 1986, although the contribution of exports to the contribution of the Philippine GDP increased from 20% to 26%, the repayment of foreign loans increased more than tenfold.
In response to the financial crisis, the central bank increased the money supply to the economy.
But it also led to inflation (up to 50% in 1984). The relative value of one dollar rose from 7.5 pesos in 1980 to 20 pesos in 1986. During this time several banks have died.
Due to a lack of capital controls, the country experienced substantial capital outflows and the collapse of dictators.
The Philippines is an example where the free market is incompatible with the state economy. The two elements are rarely mixed. Free markets do not agree with Thailand’s economy
Thailand is also trying to become Asia’s financial center by losing financial control. But like the Philippines, China’s economy is also shaken. This is another example of how liberalization is not appropriate for some economies.
The Thai government authorized securities firms and non-bank finance in the 1970s.
From 1989 to 1991, Thailand lifted its capital controls, relaxed its control over the stock market and almost liberalized interest rates.
Not surprisingly, the government can no longer lock its goal of economic development in long-term economic development (albeit with a lower short-term rate of return).
In contrast, entrepreneurs, the IMF and other international financial institutions have gained short-term gains from the system.
Consumer finance, real estate and stocks soared.
From 1987 to 1996, Thailand’s economy became the fastest growing economy in the world.
While the asset bubble burst, Thailand’s economy became more import-oriented. Currency traders think the baht will lose its value and take advantage of this phenomenon.
The government has exhausted all foreign exchange reserves to ensure that the value of the Thai baht will not disappear. They failed and the Thai market crashed on board the second on July 2, 1997, which is how the Asian financial crisis started.
The financial system that prematurely liberalized in other Asian markets has also been damaged by the crisis.
Malaysia failed attempt
After Mahathir Mohamad became Malaysian Prime Minister in 1981, he implemented an “eastward” policy to catch up with the economic achievements of other East Asian countries.
But he also let go of interest rates.
Once opened, mortgages and real estate development projects have attracted most of the Malaysian high-interest loans as they are the most attractive investments. From the late 1970s to the 1980s, the share of bank credit in the real estate industry rose from about 20% to over 33%.
Therefore, Malaysia’s real estate market is booming, ignoring the long-term benefits of industrialization.
Credit was channeled to lucrative productive opportunities after easing the regulation of the Malaysian stock exchange and financial services in 1998.
In 1993, the Kuala Lumpur Stock Exchange (KLSE) soared. KLSE’s market value eventually ended up four times higher than Malaysia’s GDP, higher than the rest of the time. One day, the volume of transactions exceeded the New York Stock Exchange.
By 1994, the stock market soared and eventually broke out in 1997.
Despite the fact that some stock market speculators and landowners became billionaires overnight, the national economies that have long been easing financial markets have lost their economy.
What can China learn?
Although the World Bank and the International Monetary Fund have been pushing for deregulation in China, it will not be possible for China to do so until its manufacturing and service industries are fully developed. In the crises of 1997 and 2008, China’s economy was intact.
While China is trying to revive the Silk Road through the Belt and Road Initiative, the financial markets will also somehow deregulate.
However, as we have seen in Thailand, Malaysia and the Philippines, it is seldom possible to let go of the state economy.