08/31 00:01 Is Thailand Bracing for Another Currency Crisis?: David DeRosa By David DeRosa

New Canaan, Connecticut, Aug 31 (Bloomberg) -- Thailand yesterday obtained $2 billion in credits from China's central bank for the sole purpose of defending its currency, the baht. Only last month, the country got a $3 billion facility from the Bank of Japan for the same purpose.

The $5 billion of emergency credits from China and Japan augment $32.6 billion in foreign currency reserves the Bank of Thailand had on hand as of August 17th. Sounds like the Thais want to be armed to the teeth -- but against what, I have to ask?

Thai Finance Minister Somkid Jatusripitak defended the arrangement with China as a necessary alternative source of funds that could be used to protect the baht from currency selling by speculators. This baloney again?

The paranoid school of economic history is again at work right before our eyes. The implicit assumption behind setting up these credit facilities -- and more may be on the way for other Asian nations -- is that evil currency speculators are lying in wait, ready to ambush small, developing nations.

The Victim Complex

That's Thailand's version of events and they are sticking to it. Never mind that the country itself invited the 1997 crisis by poorly managing its financial markets and clinging to a fixed foreign exchange regime.

And once the crisis began, the Bank of Thailand pulled the bone-headed financial move of the decade in May 1997 by purchasing tens of billions of dollars worth of bahts in the forward market at basically the spot exchange rate.

Forward baht had been selling at a steep discount to spot in May 1997 because of the fear that the fixed exchange rate regime would crack. Speculators who bet on foreign exchange regime shifts know to use the forward market.

Forward transactions can be done for settlement, or value, months further out on the calendar than spot. Spot is a foreign exchange trade for settlement in two bank business days.

Hence, for a speculator to bet against the baht, he would have had to sell the baht forward at deeply discounted prices. The risk to the trader was that the crisis would pass. Then forward baht would rise back to its old pre-crisis levels delivering in the process a real clobbering to the short sellers.

But the Bank of Thailand decided to buy the baht forward at prices well above market, almost at spot levels.

I have covered this transaction in practically ever course I have taught since then because there is no better case in foreign exchange history of a central bank undermining its own policy.

The point is that the Thai central bank, instead of stabilizing the baht, created a nearly once in a lifetime opportunity for traders, speculators, bank currency traders, hedge funds, and anyone else to make a virtually risk-free, one-way bet on devaluation.

What Risk Now?

So the facts of what happened in the summer of 1997 are quite different than what some Asian central bankers seem willing to admit. Rather than acknowledge their own mistakes, they much prefer to spin tales about how speculators were then, and are now, prowling the market.

That leads me to a harsh judgment. I am sorry to see the Thais get credit lines from China and Japan because, based on their rhetoric, they seem to have learned nothing from the 1997 crisis. They also appear to be quite capable of doing something just as dense with China and Japan's money as they did with their own in May 1997.

That said, the Thai central bank still has one thing going for it now. Thailand does not now, as it did in the summer of 1997, have to defend a fixed exchange rate regime. Let's hope they keep their hands off the baht. Let nature take it foreign exchange course, gentlemen.

-- steven valdiserri (valsteve11@home.com), August 31, 2001

Answers

At first blush it seems like the Thais learned nothing from their 1997 debacle. But, who knows? New dynamics may be at play.

-- Big Cheese (bigchese@multimax.net), September 01, 2001.