In 1997, Asian boom countries were brought to their knees in a crisis on par with the later 2009 financial crisis. Luckily, the scope of the crisis was limited to Asia due to swift actions by world leaders and a global economy that was then not as integrated as it is now. Still, with the U.S. Fed aiming to roll back its quantitative easing program and many investors across Asia getting jitters, it's fair to wonder if another Asian Financial Crisis may be brewing. And if so, what's the best way to protect one's wealth, or even profit off of any potential crisis? Forex traders should closely consider investing in the U.S. dollar and betting against Asian currencies, such as the Singapore dollar and Thai baht.
For those unfamiliar with the Asian financial crisis, it began in July of 1997 in Thailand and quickly spread to several other members of ASEAN, including Indonesia, Singapore, Malaysia, and the Philippines. South Korea was also adversely affected. Up until 1997, Thailand had enjoyed a booming economy with moderate inflation. Then, in May of 1997 the Baht came under "speculative attacks," essentially meaning that investors began to bet against the baht and people began to pull their money out of the currency. At the time, the baht was tied to a basket of currencies and the government refused to devalue their currency. The government also failed to defend the baht by purchasing it and propping up its value. These actions sparked the financial crisis, which quickly spread to many of Thailand's closest trading partners.
While the individual circumstances varied from country-to-country, there were some common underlying trends. In most of the countries caught up in the crisis, investors began to bet against the national currency and people started to pull their money out. This sent the values of Asian currencies plummeting as investors fled to the dollar and elsewhere. Several governments failed to fully defend their currency by propping up prices through purchases. In many cases this was because the governments actually lacked the capital reserves to do so.
Numerous other issues plagued individual countries. Indonesia, for example, had experienced a sustained period of growth that had encouraged local corporations to borrow massive amounts of U.S. dollars. Once the crisis began, these companies were swamped with unsustainable debt loads. Within a year the value of many Asian currencies dropped by between 34% to 84%.
Of course, you're not here for a history lesson are you? What's important about these events isn't that they happened once, but that they could happen again. Some analysts will quickly reject this claim. Now, Asian countries seem far more well-prepared to defend their currencies. For example, Indonesia and Thailand have both built up their capital reserves. Indonesia has expanded its reserves from roughly $20 billion in 1997 to $112 billion in 2012. Thailand is in an even better position with nearly $185 billion in reserves sitting on its balance sheets. Meanwhile, Singapore has well over 200 billion dollars in its reserve accounts, a staggering sum for a city-state home to only five million people. Indeed, analysts would have a strong case in arguing that no financial crisis will be starting in the countries that previously suffered a near collapse.
Asia, however, is a massive region and other countries may not be in as good of a position. In fact, at this very moment India is facing a simmering fiscal situation that could quickly deteriorate into a full blown crisis. The Indian rupee has hit record lows against the U.S. dollar as Indian investors send their money overseas, or else buy up Gold and other precious metals. The Bombay Stock Exchange has also come under pressure as investors have come to favor more tangible investments, such as real estate. India has also suffered from inflation rates in excess of 7 percent in recent years and the consumer price index inflation broke 10 percent (yoy) as of May 2013.
Either way, investors are increasingly shifting their money out of the Rupee in favor of U.S. dollars, gold, or tangible assets. The continuing turbulence of Indian stock markets also suggests that investors are losing faith in local businesses. Indeed, other analysts have pointed out that the exuberance of Western investors is artificially propping stock markets up. If trends continue, India may reach a breaking point.
Even if India holds strong in the coming months, the Fed's decision to eventually ease off quantitative easing should send the U.S. dollar higher against Asian currencies. As long as the ease off is controlled and policy positions are communicated well to international governments, Asian leaders should be able to guide their country into a soft landing. Asian economies may cool off and investors could move to buy up dollars, but strong capital reserves should allow Asian governments to protect their currencies. What they cannot do, however, is prevent the dollar from rising against their currencies. At this point it is nearly inevitable that Asian currencies will drop against the dollar. Whether by 2% or 15% remains to be seen.
Still, investors would be wise to consider betting on the U.S. dollar against the Indian Rupee, Thai Baht, and others. Both the Thai Baht and Indian Rupee are relatively easy to find Forex pairs. By betting against either the baht or rupee in favor of the U.S. dollar, investors may be able to tap into huge returns as markets shift in the coming months. Trading Singaporean dollar in favor of the U.S. dollar may also offer strong returns, but is well protected due to the government's cash reserves, which are estimated at some $250 billion dollars. Another option would be to short-sell the Barclays Global Emerging Market Strategy Asia 8 Index ETF, which consists of a basket of exotic Asian currencies. Anyone considering this strategy, however, should make sure they understand the risks of short-selling.
Those who invest in dollars will almost certainly see gains even if no financial crisis develops in Asia. The dollar is all but certain to rise once the government eases off quantitative easing, and the U.S. Fed has given strong indications that it plans to do so in coming months. So even if no crisis emerges in Asia, investors could profit handsomely off a strengthening dollar.