Asian Crisis Still Resonates…

There haven’t been any official events to mark the 20th anniversary of the Asian crisis, which erupted when Thailand freely floated the THB on July 2nd 1997 (having struggled to fund an 8% current account deficit, twice the average across EM Asia at the time). Within a year that had caused a domino effect ‘margin call’ across emerging markets, culminating in the collapse of Russian markets and the devaluation of the ruble in August 1998. Russia only accounted for just over 4% of world GDP in 1997, but was a major borrower of short-term capital and the contagion effects were rapid.

What was until then a regional crisis spread across GEM and then global markets, causing spreads and volatility to surge with a cross correlated violence that blew up value-at-risk models. That contributed to the collapse of $126bn AUM hedge fund LTCM by year-end, which led to a Fed engineered bailout. That would have been a potential shock on a par with Lehman’s implosion, but the fallout was pre-empted unlike in 2008 – LTCM had successfully hedged most of the risk from the Asian currency crisis and delivered a 17% after fees return in 1997 (after over 40% in each of the previous two years by applying huge leverage on its ‘relative value’ strategy).

Global capital flows since then have been shaped by these events, as Asian (and wider EM) governments committed to never allow themselves to become vulnerable to speculative attack again, driving mercantilist policies and a huge build-up in official reserves as a bulwark. Asia’s currency reserves stand at almost $6.3trn over half the global total, versus less than $1trn in 1996 as a portfolio flow ‘margin call’ loomed.

Those reserves were largely recycled into Treasuries, funding persistent US current account deficits and the steady deterioration of the country’s net international position or ‘net worth’. Aggregate Asian CA surpluses are back at pre-crisis levels of over $600bn (and with China’s surplus looking understated because of very questionable growth of the estimated tourism deficit as covered in a recent Fed analysis, probably well over $700bn).

I’ve just been to Budapest, where the raddled face of hedge fund legend George Soros stares down from government sponsored billboards, labelling him  as a scheming currency manipulator (he has accused his native country under its right-wing, anti-immigrant leadership of becoming a ‘mafia state’). It seems unlikely that for all his pseudo intellectual ‘reflexivity’ theories Soros could have anticipated the longer-term fallout from his currency attacks across Asia in those tumultuous months. One of those is that he helped end the era of swashbuckling macro hedge funds bending intimidated governments to their will – no hedge fund balance sheet can fight an aggressively deployed central bank one.

As we highlighted back in 2014/15 as the consensus abandoned EM assets, the move to floating exchange rate systems and high reserves versus FX debt made another crisis, which was widely feared at the time, highly unlikely – tumbling currencies acted as an EM macro pressure relief valve and forcibly closed current account deficits from Indonesia to Brazil, underpinning the ‘surprise’ rally in EM assets over the past 18mths. However, the sustainability of the capital recycling model built up since the late 1990s looks very doubtful – the US economy simply can’t absorb huge surpluses from both Asian and Europe any longer as the ‘consumer of last resort’.

The Asian crisis led indirectly to the 2008 global one, as the ‘savings glut’ being forced upon (a very receptive and overly deregulated) US suppressed funding costs, as explained by Ben Bernanke back in 2015. In the interim, the Fed by rapidly cutting rates in an overreaction to the LTCM debacle fuelled the Dotcom bubble – unintended consequences have been the defining feature of central bank policymaking over the past two decades. Meantime, is there another LTCM combination of hubris and leverage lurking within the global financial system after another extended period of low volatility? We’ll find out as the first central banks take tentative steps toward policy and balance sheet normalization in the next 12-18mths, but it’s probably not in Asia…