1. Was the depreciation of the Asian currencies during the Asian crisis due to trade flows or capital flows?

Why do think the degree of movement over a short period may depend on whether the reason is trade flows or capital flows? ANSWER: The depreciation of the Asian currencies during the Asian crisis is mostly attributed to the capital outflows from Asia, as investors in Asia and outside of Asia were exchanging the currency for other currencies. Trade flows do not change as abruptly over a short-term period as capital flows, and therefore tend to have a smaller effect over the short-term. 2. Why do you think the Indonesia rupiah was more exposed to an abrupt decline in value than the Japanese yen during the Asian crisis (even if their economies experienced the same degree of weakness)? ANSWER: Investors knew that Indonesia was attempting to use intervention to prevent the rupiah from depreciating. This signaled a potential collapse of the rupiah if and when the government finally surrenders and allows the rupiah to float toward its natural level. 3. During the Asian crisis, direct intervention did not prevent depreciation of currencies. Offer your explanation for why the interventions did not work. ANSWER: Direct intervention can be overwhelmed by market forces, especially when investors are paranoid and want to move their funds out of a country before the local currency weakens. 5. The Asian crisis showed that a currency crisis could affect interest rates. Why did the crisis put upward pressure on interest rates in Asian countries? Why did it put downward pressure on U.S. interest rates? ANSWER: The crisis put upward pressure on interest rates because the central banks of these countries attempted to boost the values of the local currencies by using indirect intervention to raise interest rates. 9. On August 26, 1998, the day that Russia decided to let the ruble float freely, the ruble declined by about 50 percent. N the following day, called bloody Thursday, stock markets around the world (including the U.S.) declined by more than 4 percent. Why do you think the decline in the ruble had such a global impact on stock prices? Was the markets reaction rational? Would the effect have been different if the rubles plunge had occurred in an earlier time period, such as four years earlier? ANSWER: The decline in the ruble caused general paranoia about a crisis that could be transmitted to other countries. For example, a 50 percent decline in the value of the ruble means that Russian firms may be unable to repay debts denominated in the dollar or other currencies. This could create problems for lenders in those countries, which could result in weak economies. The market reaction to the rubles plunge was probably more

pronounced because it occurred during the Asian crisis when the level of paranoia was already high. 10. Normally, a weak local currency is expected to stimulate the local economy. Yet, it appeared that the weak currencies of Asia adversely affected their economies. Why do you think the weakening of the currencies did not initially improve the economies during the Asian crisis? ANSWER: The weak Asian currencies caused concerns that the firms that borrowed foreign currencies would not be able to repay their debts. In addition, investors expected that the currencies could weaken further, which caused more capital outflows and a lack of funding support in Asia. While non-Asian countries may consider purchasing imports in Asia due to the weak currencies, they may be worried that the firms in the Asian countries would go bankrupt and would not be unable to provide the products ordered. 11. During the Asian crisis, Hong Kong and China successfully intervened (by raising their interest rates) to protect their local currencies from depreciating. Nevertheless, these countries were also adversely affected by the Asian crisis. Why do you think the actions to protect the values of their currencies affected these countries economies. Why do you think the weakness of other Asian currencies against the dollar and the stability of the Chinese and Hong Kong currencies against the dollar adversely affected their economies? ANSWER: Since the currencies of China and Hong Kong were tied to the dollar, they appreciated against the other Asian currencies. Thus, their products became more expensive to the other Asian countries, which adversely affected their international trade balance with other Asian countries. 13. Why do you think the depreciation of the Asian currencies adversely affected U.S. firms? (There are at least three reasons, each related to a different type of exposure of some U.S. firms to exchange rate risk.) ANSWER: U.S. firms were adversely affected because their products became more expensive to Asian customers as the dollar strengthened. In addition, U.S. firms with Asian subsidiaries received lower profits as Asian subsidiaries remitted the profits at the weak exchange rate. Third, the consolidated income statement of U.S. firms showed weaker earnings as the earnings earned in Asian subsidiaries was translated at low rates (due to the weakness of Asian currencies), even if the earnings were not remitted to the U.S.