Welcome back to the latest entry of Bitesize Finance, where we take you through different financial related topics, from gold prices to how to allocate your savings, and give you the 101. This week, we’re giving the rundown on global financial crises, because it seems like the appropriate time.
First off, financial vs. economic crises are different but related. They can both trigger each other.
An economic crisis is typically a broader crisis where the overall economy of the country falls down. A financial crisis however, is when some financial assets lose a major amount of value rapidly like a stock market crash.
According to Marc Peter Radke’s book, “Explaining Financial Crises”, he writes:
“Economic history has been characterized by a permanent change between tranquil periods with balanced economic development and smoothly functioning financial markets, and periods of severe disruptions.”
These so called disruptions are typically then accompanied by collapses of a large number of asset prices, sharp rises in interest rates, widespread bankruptcies among business firms and financial institutions. Low or negative growth, high inflation, high unemployment, rising income inequality, and of course, political instability. It’s all correlated and tangled up together.
There’s no escaping mentioning Covid-19 in this context. The pandemic has triggered an economic crisis (rising unemployment, domestic consumption slowdown, a 12.2% GDP contraction in Q2) in Thailand, but not yet a financial crisis. Thailand’s GDP is forecast to contract 8-10% this year, before recovering to 4-5% growth in 2021.
Although we are not experiencing a financial crisis, the macroeconomics shocks will trickle down and be felt throughout the country, from which experts say it may take until 2023 to fully recover.
Real GDP is not expected to reach its pre-Covid level until 2023, according to the Thailand Development Research Institute (TDRI), a Bangkok-based independent think tank.
Putting that into context, there has been a series of financial crises that has played their part in shaping the world (and Thailand’s) order. Here, we take a look at the major crises in modern history.
Asian Financial Crisis (Tom Yum Kung)
More than your average tourist’s go-to meal, the significant Tom Yum Kung crisis of 1997 began in Thailand with the financial collapse of the Thai baht after the government was forced to float the baht due to lack of foreign currency to support its currency peg to the US dollar. Long story short, a series of events were set in motion, and Thailand had acquired a burden of foreign debt at that time, which made the country bankrupt.
From 1985 to 1996, Thailand’s economy grew at an average of over 9% per year, the highest economic growth rate of any country at the time.
Then, it all changed. Lay-offs in finance, real estate and other industries were made nationwide.
There were 4 key causes of this crisis.
- Deficit Current Account: Thailand’s Current Account was deficit by US$14,350 million because of the country’s development that focused on exporting.
2 . High Foreign Debt: Foreign debt rose to USD$109,276 million, especially short-term debt accounted for 65% of the total debt
- Overinvesting and economic bubble in Real Estate: The price of real estate was inflating. The influx of foreign investment primarily concentrated in stocks and real estate, which eventually created an economic bubble as investor speculation caused the prices of assets to surge without much justification.
Think about “The Big Short” movie (based on the 07-08 financial crisis), and you’ll get the idea about the real estate bubble.
- Thai Baht was attacked: There are several layers to this. First off, power player investor George Soros’s Quantum Fund (which was generating annualized returns of 33% for investors), played a controversial hand against a basket of Asian currencies, especially Thai and Malaysian. Soros calculated a short selling of Thai Baht, and bet just under $1 billion of his total war chest of $12 billion against the Thai currency.
The Thai baht then depreciated much more than expected, from THB25/USD to THB50/USD in a short span of time. The sudden weakening of the baht took a hit to the economy, as the amount of foreign debt (in USD) became relatively higher.
In an attempt to resist devaluation, the Bank of Thailand, purchased baht with dollars in the foreign exchange market, raised interest rates and restricted foreigners’ access to the baht in the beginning.
By the end of 1996, Thailand’s external debt stood at U$100 billion. The irony? The Quantum Fund suffered only marginally from this move.
The Dot-Come bubble, also known as the internet bubble defined the late 1990s-early 2000. Let’s trace it back a few steps.
Companies like Qualcomm and Cisco lost significant portions of their market cap, but eventually recovered, eBay & Amazon (which had its IPO in 1997) also recovered quickly.
The IPO rally made investors very bullish on the growth prospects of tech stocks, and this bullish conviction caused an uptick in trading volume. Investors were willing to get in the game at any valuation, investment banks also encouraged investments in tech companies. A bubble was coming.
The evidence? The high P/E ratio and spike in the NASDAQ index. Tech stocks eventually became overvalued.
*Bitesize Note: P/E ratio refers to ‘Price-to-Earnings’ ratio, the ratio of current share price relative to the company’s per-share earnings. The P/E ratio is often used by analysts to determine the value of a company’s shares, basically to decide whether the price they’re paying is worth it.
NASDAQ index had risen five-fold, rising from under 1,000 to more than 5,000, between 1995 and 2000.
Around the turn of the millennium, spending on technology was volatile as companies prepared for the Year 2000 problem. Then, came a series of fell through acquisitions, questionable merges (Time Warner & America Online).
Hyped up companies like Pet.com shut down only 9 months after IPO, and then came the scandals which affected investor confidence, from the Enron scandal of 2001 to the WorldCom scandal in 2002. Japan’s 2000 recession also triggered a global sell off that ultimately impacted tech stocks.
As you can guess, then came the massive dumping and sell-offs. By October 2002, NASDAQ fell 76.81% to 1,139.90, from its peak of 5,048.62.
Subprime Mortgage Crisis
This crisis was arguably the most severe recession in decades. The US based crisis kicked off in mid 2007 and lasted throughout 2010, and ultimately played a hand in triggering the US Financial crisis.
Here’s the bitesize version: The crisis occurred when banks sold too many mortgages to feed the demand for mortgage-backed securities sold through the secondary market. When home prices fell in 2006, it triggered defaults. There were too many mortgages floating around to finance house purchases.
When home prices fell in 2006, it triggered defaults. The risk spread into mutual funds, pension funds, and corporations that held onto those derivatives.
What happened was that borrowers were unable to pay for their mortgages, and banks were suddenly saddled with huge amounts of loan losses on their balance sheets. This ultimately led to a lack of liquidity for banks, which threatened their stability.
At that time, economists thought that as long as the Federal Reserve dropped interest rates by summer, the housing decline would reverse itself. What they didn’t realize was the sheer magnitude of the subprime mortgage market. It had triggered a domino effect in the financial markets.
Many big firms in the US went bankrupt during this time as well. Wall Street bank Lehman Brothers went bankrupt, marking the largest bankruptcy in US history and became somewhat of a symbol of the crisis. Lehman’s collapse basically resulted from having held onto large positions in subprime and other lower-rated mortgage tranches.
By November 2008, the US stock index; the S&P 500, was down 45% from its 2007 high. Investors were selling their US stock market positions.
Effect of The 2008 Subprime Mortgage Crisis:
The after effects of the subprime mortgage crisis was long lasting. Major financial markets lost more than 30% of their value
It also led to the US having lower credibility, which in turn affected the USD currency. Typically, when people lose faith in a particular currency, they start turning their attention away to which they believe may be more credible.
This ultimately led to the birth of Bitcoin, which exists on Blockchain technology. It emerged from the ashes of the 2008 financial crisis as investors began to seek alternatives to traditional financial systems.
Those who are bullish on Bitcoin like that it’s not controlled by a central authority; no one can print it like cash and inflate the currency. It’s typically easier to exchange than fiat currency; all cryptocurrencies transactions can be done on the exchange online.
In Thailand, there are several digital asset exchanges such as Zipmex, Bitkub, and Satang.Pro. Zipmex is the latest exchange to launch in Thailand and the first with a 0% commission fee.
Key Takeaways: History Knows Best
- Economic crises are cyclical and linked to business cycle fluctuation, where the outbreak of a financial crisis generally coincides with the peak of a business cycle.
- Investors will move their capital to alternative forms of investment or stores of value as traditional asset prices drop. This leads to the rally of alternative asset forms, such as cryptocurrency and gold. They are becoming increasingly popular as investors seek to hedge against fiat currency inflation (like the US dollar).
- History dictates that all crises will eventually subside, and bring about a series of new opportunities. When the next crisis ensures, we’ll probably see the birth of new stores of value as well. Ultimately, we should learn that history often repeats itself, and there’s no better to anticipate the future than understanding the linkage of the past.