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Crisis lessons


The other day, Yanis Varoufakis, whose blog and contributions on Twitter (@yanisvaroufakis) I generally enjoy very much, sent the following slightly impatient and desperate sounding response to my plea to take into account the cost of the euro and abolish it instantaneously:

“@rszbt You ain’t seen nothing yet, I am very much afraid: A Germany with 6m unemployed and a S. Eur. with 20% inflation and 30% unemployment.”

I see the point. However, the question is whether Europe really has a choice. As became apparent in my last article, in my view the answer depends less on macroeconomic developments than on financial market expectations.

Beside the most recent events in the US and Europe, there were two big financial crises which left a lasting impression on me and instilling a sense of crisis dynamics influenced my thinking.

One was the Asian crisis of 1997/98. In a research paper I presented a chronology of events in the region focusing on the first year of the crisis, which I add here at the end. I wrote:

The interplay of actions and reactions in the markets results in three phenomena that any attempt to prevent or dampen down a crisis will have to take into account.

The first is herd behavior. Traders searching to go with the market tend to observe and imitate one another. In particular in times of turbulence, they are less attentive to economic scenarios or political attempts to influence markets than to their direct environment.

The second is contagion: Traders are testing one market and, after a while, when they have been successful, turn to other markets or regions. In this, they strongly look for similarities neglecting circumstances that call for a more differentiated approach.

The third phenomenon is a kind of “quasiperiodicity” in market dynamics. Crises are coming in waves with windows of tranquility in between. Traders jump on a bandwagon, then stop realizing profits, pausing, and, when observers and policy makers got the impression that all is over, sometimes start anew.

The Asian crisis may serve as an example for all three.

And, I would like to add, for most financial crises before and after.

One example is the EMS crisis in 1992/93 which, as I wrote elsewhere,  shows many parallels to the current situation as its “timeline” demonstrates, which I insert here once again.

There are two lessons I learned from these events:

1)      Once financial markets gain momentum there is no official coffer big enough to stem the flood of speculation. The only way out of the crisis then is to abolish the system or structure which has come under attack.

2)      A system breakdown is not the end of the world. Some crisis countries in these and other cases recovered surprisingly well afterwards. Others took a longer time.  In general, the cost of crisis and recovery are the lower, the faster policy is throwing in the towel and accepting the inevitable.

In the eurozone valuable time has been lost in confusion, bickering and political power games. Uncertainty about the nature of the crisis and the effectiveness of policy measures and instruments blurred the picture. Experts were rarely a help.  But now, the luxury of ever new rounds of interventions, bailouts and crisis management appears no longer tolerable or affordable. Time to quit.


Timeline of the first year of the Asian crisis 

Early 1997 Pressure on the Thai baht
May 15 Thailand introduces controls aimed at segmenting the onshore and offshore markets but strong pressure continues.
July 2 Floating of the Thai baht. Pressure spreads to the Philippine peso, Malaysian ringgit and Indonesian rupiah.
July 11 Band of the Philippine peso widened. Band of the Indonesian rupiah widened from 8% to 12%.
end-July Malaysian ringgit falls by 4.8%.
August 11 The IMF unveils a rescue package for Thailand includings loans totaling $16 billion from the IMF and Asian nations.
August 14 Floating of the Indonesian rupiah.
August 15 Speculative attack on the Hong Kong dollar.
August 20 IMF standby credit for Thailand of $3.9 billion approved.
October 17 Authorities stop supporting the New Taiwan dollar, which falls by 6%. Pressure on Hong Kong dollar and equity markets intensifies.
October 14 The band of the Vietnamese dong is widened to +10%.
October 20–23 Financial turbulence in Hong Kong. Hang Seng index falls by 23% in three days. Pressure on Korean won mounts.
October 27 7% decline in US equity prices. Sharp declines in Latin American equity markets.
October 28 3% decline in Russian equity prices.
October 31 After intense pressure on the real the Central Bank of Brazil strengthens its interventions.
November 5 IMF standby credit for Indonesia of $10.1 billion approved;     $3 billion made available immediately.
November 10 Interest rates raised by 7 percentage points in Russia and authorities announce that the intervention band for the rouble will be widened from ±5% to ±15%.
November 20 Daily fluctuation band for the Korean won widened from    ±2¼% to ±10%.
21 November Korea applies for IMF standby credit.
December 4 IMF standby credit for Korea of a record $21 billion over three years approved; $5.6 billion disbursed immediately.
December 16
Floating of the Korean won.


Timeline EMS Crisis*

March 13 1979 Start of EMS with two fluctuations bands of + 2.25% (Belgium, Denmark, France, Germany, Ireland, Luxembourg, the Netherlands)  and + 6% (Italy)
October 4 1981 French franc devalued 8.5% against D-mark
June 14 1982 French franc devalued 10% against D-mark
March 21 1983 French franc devalued 8% against D-mark
April 7 1986 French franc devalued 6% against D-mark
June 19 1989 Spanish peseta joins ERM (wide band + 6%)
January 8 1990 Italian lira moves to narrow band
October 8 1990 Sterling joins ERM
December 20 1991 “German interest rate raised”, “Marching to the German drum”
April 5 1992 Portuguese escudo joins ERM (wide band + 6%)
July 17 1992 “Germany lifts discount rate”, “Europeans impeded by policies ‘made in Frankfurt'”
July 18/19 1992 “World financial markets tumble”
July 21 1992 “Huge operation to save dollar”, “Lira falls to record low against D-Mark”
July 22 1992 “Italian lira: the sick currency of Europe – If Rome opts for devaluation others may follow and the EMS could fall apart”
August 12 1992 “Central banks step in to prop up dollar”
September 14 1992 Lira devalued 7%
September 16 1992 Lira and Sterling leave ERM, peseta devalued 5%
September 18 1992 “Speculators find new ERM targets after lira and peseta”
September 29 1992 United interventions of the Bundesbank and the Bank of France to stop franc devaluation, “Pound  hits new low against D-Mark as franc rallies”,  “French franc pays price for partnership with D-Mark”
October 2 1992 “Bank of France spent FFr80bn supporting franc through crisis”
October 16 1992 “Danes seek opt-outs from Maastricht”
November 3 1992 “French weaponry secured win in battle for franc”
November 20 1992 “Speculators force Sweden to drop link with ERM”
November 23 1992 Spanish peseta and Portuguese escudo devalued 6%, “Irish punt, Danish krone seen as targets for selling”, “Bundesbank under new rates pressure”
November 24 1992 “EC governments raise interest rates in effort to protect ERM”
December 2 1992 “Schlesinger calls ERM an incentive to speculators – Bank of France forced to intervene to support franc in tense trading”
December 3 1992 “French franc struggles in spite of intervention”
January 5 1993 “French franc under pressure”
January 6 1993 “Germany joins France to support embattled franc”
January 9/10 1993 “Costly siege of the franc fort – The defense of the French currency is putting a severe strain on the economy”
January 21 1993 “Counting the cost of weathering ERM storm – Battle for punt leaves long list of casualties – ‘Franc fort’ squeezes jobs, growth and prices”
February 1 1993 Irish punt devalued 10%, “Dealers warn of new ERM pressures”
February 4 1993 “Speculators push Danish krone to floor in ERM – European crisis deepens as currencies weaken and slow growth threatens EMU”, “Pound hits record low in heavy trading”
February 12 1993 Hard-core currencies under pressure in the markets, “Dealers scare the D-Mark’s Belgium shadow”, “France urges faster move towards EMU”
February 25 1993 “Spain warns of tax on currency speculators”
May 14 1993 Peseta devalued 8%, escudo devalued 6.5%
May 27 1993 “Peseta in sharp fall against D-Mark”
July 10/11 1993 “Franc falls closer to ERM floor”, “Intervention fails the franc”
July 14 1993 “Franc’s ERM parity defended”
July 15 1993 “Franc Spends Bastille Day Under Siege” (International Herald Tribune)
July 24/25 1993 “Lines of defence keep falling”, “French lift rates to defend franc”, “Commission confident ERM will hold”
July 29 1993 “Bundesbank cut raises ERM hopes”
July 30 1993 “Bundesbank ½ point rate cut fails to bolster ERM”
August 2 1993 Widening of ERM bands to + 15% (exception: D-mark/Dutch guilder which retained + 2.25%)
August 7 1993 “Paris sind keine Devisenreserven geblieben” (Frankfurter Allgemeine Zeitung)
April 2/3 1994
From the FT LEX COLUMN: “There is a refreshing candour about Deutsche Bank’s admission that it does not expect much by way of earnings increase this year. Last year’s 23 per cent jump in group net profit owed much to special factors that will not easily be repeated.”
* If not noted otherwise citations refer to Financial Times headlines.

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