AGENDA

• Advantages and Disadvantages of the Fixed Exchange Rate System

• Advantages and Disadvantages of the Flexible Exchange Rate System
• Asian Economic Crisis (1997-1998)
• Role of Exchange Rate Regime in the Asian Currency Crisis
• U.S. Subprime Mortgage Crisis (2007-2009)
ADVANTAGES OF FIXED EXCHANGE RATE SYSTEM

Stability and Predictability

• Reduces uncertainty in international trade and investment
Inflation Control
• Helps control inflation by tying the currency to a stable foreign currency
Prevents Speculation
• Reduces currency speculation and excessive volatility
Encourages Investment
• Foreign investors are more confident in stable exchange rates
DISADVANTAGES OF FIXED EXCHANGE RATE
SYSTEM

Requires Large Reserves

• Governments must maintain large foreign exchange reserves to defend the fixed rate.
Risk of Overvaluation or Undervaluation
• If the fixed rate is set too high or low, it can lead to trade imbalances.
Vulnerable to External Shocks
• Economic crises may force abrupt devaluations, harming credibility.
Loss of Monetary Policy Independence
• Central banks cannot freely adjust interest rates to respond to domestic economic conditions.
ADVANTAGES OF FLEXIBLE EXCHANGE RATE SYSTEM

Monetary Policy Autonomy

• Central banks can adjust interest rates
• Stabilizes the economy
Automatic Adjustment
• Exchange rates adjust naturally
• Corrects trade imbalances
No Need for Large Reserves
• Governments don’t need extensive foreign currency reserves
Protection from External Shocks
• Exchange rate can absorb global economic fluctuations
DISADVANTAGES OF FLEXIBLE EXCHANGE RATE SYSTEM

Volatility and Uncertainty

• Exchange rate fluctuations create risks for traders and investors
Speculation Risk
• Currency speculation can cause extreme fluctuations, leading to economic instability
Inflationary Pressures
• Depreciation of the currency can lead to higher import prices and inflation
 INTRODUCTION TO THE CRISIS

Severe Economic Downturn

• Affected several Asian economies
• Particularly impacted Thailand, Indonesia, South Korea, Malaysia, and the Philippines
Currency Depreciations
• Significant devaluation of currencies in affected countries
Stock Market Crashes
• Sharp declines in stock market values
Economic Recessions
• Widespread economic slowdowns and contractions
 CAUSES OF THE ASIAN ECONOMIC CRISIS IN 1997

Excessive Foreign Borrowing & Overinvestment

• Rapid economic growth attracted large foreign capital inflows
• Governments and businesses borrowed heavily in foreign currencies
• Borrowing directed towards real estate and infrastructure projects, creating asset bubbles
• Short-term foreign currency loans were used to finance long-term project, making it difficult
to meet the demand of the creditors when they want their money back

Fixed Exchange Rate Systems

• Countries pegged their currencies to the U.S. dollar
• Appreciation of U.S. dollar made Asian countries currencies overvalued
• Overvaluation led to trade deficits
 SPREAD OF THE CRISIS

Thailand (Ground Zero of the Crisis)

• Abandoned fixed exchange rate system in July 1997
• Baht depreciated over 50%
• Led to corporate bankruptcies and banking crisis
Indonesia
• Rupiah collapsed, losing over 80% of its value by early 1998
• Inflation soared, causing severe recession and mass unemployment
South Korea
• Corporate debt crisis among major conglomerates Won depreciated by nearly 50%
CONSEQUENCES OF THE CRISIS

Economic & Social Impact

• Millions lost jobs, and poverty rates surged
• Economic contractions in various countries
• Riots and political instability, especially in Indonesia
Currency & Stock Market Collapse
• Currencies lost 30-80% of their value
• Imports became expensive, increasing inflation
• Stock markets fell by 50-70%, wiping out billions in investments
Reforms & Recovery
• Governments restructured financial sectors and improved banking regulations
• Most economies recovered by 2000
EXCHANGE RATE REGIMES IN AFFECTED COUNTRIES
Loss of Investor Confidence
• Rising trade deficits and declining foreign reserves
• Governments' inability to maintain fixed exchange rates
Thailand's Abandonment of Fixed Peg
• Occurred in July 1997
• Baht depreciated sharply
Contagion Effect
• Spread to Indonesia, South Korea, Malaysia, and the Philippines
• Speculative attacks on currencies
Transition to Floating Exchange Rates
• Occurred by 1998
HOW THE FIXED EXCHANGE RATE CONTRIBUTED
TO THE CRISIS
Overvaluation of Currencies
• Asian currencies tied to USD became overvalued as the dollar strengthened
• Weaker export demand and worsening trade imbalances
Loss of Monetary Policy Control
• Central banks had to match U.S. interest rates
• Limited ability to respond to domestic economic conditions
Speculative Attacks on Weak Currencies
• Investors and hedge funds targeted overvalued currencies
• Governments depleted foreign exchange reserves defending pegs
CAUSES OF THE SUBPRIME MORTGAGE CRISIS

Excessive Lending & Subprime Mortgages

• Loans given to high-risk borrowers with poor credit histories
Low Interest Rates & Housing Bubble
• Federal Reserve kept interest rates low (2001-2004)
• Financial Deregulation & Weak Oversight
COLLAPSE OF THE HOUSING MARKET & FINANCIAL
CRISIS
• Housing Market Crash (2006-2007)
• Housing bubble burst as home prices stopped rising
• Mass mortgage defaults due to unaffordable rising mortgage payments
• Bank Failures & Credit Crunch (2008)
• Banks suffered massive losses from bad mortgage assets
• Lehman Brothers filed for bankruptcy in September 2008, triggering global panic
• Global Contagion & Stock Market Crash
• Crisis spread worldwide, causing stock market collapses and credit freezes
• Dow Jones lost nearly 50% of its value, global stock markets suffered severe
losses
GOVERNMENT & FEDERAL RESERVE RESPONSE
• Bailouts & Stimulus Packages
• Troubled Asset Relief Program (TARP) launched with $700 billion to stabilize banks
• Federal Reserve cut interest rates to near zero (0-0.25%) and implemented quantitative
easing (QE)
• Global governments launched stimulus packages to prevent deep recessions
• Bank Mergers & Nationalizations
• Failing banks were rescued, merged, or taken over by the government
• Merrill Lynch acquired by Bank of America
• Washington Mutual collapsed and was bought by JPMorgan Chase
• Regulatory Reforms
• Dodd-Frank Act (2010) passed to strengthen financial regulations
CONSEQUENCES OF THE CRISIS
• Economic Recession & Unemployment
• U.S. economy shrank by nearly 4% in 2009
• Unemployment peaked at 10% in the U.S.
• Millions lost jobs worldwide
• Massive Foreclosures & Wealth Destruction
• Over 10 million homes foreclosed in the U.S.
• Household wealth declined by over $16 trillion
• Loss of Confidence in Financial Institutions
• Trust in banks, rating agencies, and regulators declined
• Global Impact
• Deep recessions in Europe, Asia, and emerging markets