Sample Essay on Fraud as the Cause of the Indonesian Currency Crisis

Fraud as the Primary Cause of the Indonesian Currency Crisis

Background and History of Indonesian Currency Crisis

The Indonesian currency crisis links to the Asian financial crisis, which began on 2nd July 1997 due to failures of the Thai government to take full responsibility of its foreign debt. In the event that the country’s huge foreign debts became a burden, instead of offsetting its debt balances the Thai Government decided to float its baht. Floating baht became the only solution since potential investors and currency speculators were beginning to attack the country’s reserves of foreign exchange. The major aim of the government in such a course was to create a monetary shift in order to stimulate inflow of revenues from exports. However, the policy could not work since the country had already accumulated foreign debts that had to be settled first before engaging in any form of trade with another country. The higher foreign debts in addition to the lower export revenues led to significant contagion effect across Asia because foreign investors found Asia vulnerable, and lost confidence in various markets within the region.

The release of baht by the Thai government had impact on Indonesian economy as the Indonesian rupiah was becoming too strong compared to other currencies across Asia. The Indonesian government therefore had to set its currency floating freely from August 1997 (Biswaro, 2012, p. 23). The market value of Indonesian rupiah began to depreciate and by the beginning of 1998, the normal market value of rupiah was already 30% of its value in mid-1997 (Biswaro, 2012, p. 23). Prior to this instance, many private companies in Indonesia had obtained and accumulated unhedged, short-term loans whose values were calculated in dollars. The accumulated private-sector loans seemed to be a burden, which the country could not offset because of its fallen currency against other dollar currency. People hoped that the country’s currency would stabilize and become much stronger but instead, the rupiah’s nominal value continued to depreciate. As a response, companies decided to buy more dollars in order to create a downward pressure on the rupiah and to enhance loan repayment.   It is a common knowledge that investors are risk averse and any situation that will expose them to financial losses derail their investment decisions. Therefore, the investment activities in Indonesia prior to 1997 started to reduce as foreign investors were beginning to dump Indonesian currency and national assets as quickly as possible.

Fraud as the Primary Cause of the Indonesian Currency Crisis

Even though policy makers in Indonesian refute the fact that financial fraud was the main cause of the country’s currency crisis, elements of fraud can still be traced within the country’s financial systems and institutions (Meissner, 2004, p. 13). Other than the release of baht by the Thai government, the collapse of the Indonesian financial market is closely linked to evidences of gold mining scandals by the Bre-X Canadian mining company at Busang (Indonesia). During the springs of 1997, the Indonesian junior mining sector had collapsed by over 25 percent of its average earning. The collapse of the junior mining sector was as a result of Bre-X Company announcing a rise in stock prices on the claim of gold deposits discovered at Busang in 1993. In 1997 (Meissner, 2004, p. 13), Bre-X Company collapsed before completing its mining contract after the samples of gold presented in the market for examination and final purchase were found to be a fraud (Meissner, 2004, p. 15). Indonesian stock market collapsed after the investors realized that they had been corned their finances. The Busang gold mining and the fraudulent act of Bre-X Company are some of the factors that led to the collapse of the Indonesian financial market and finally the observed depreciations in the nominal value of rupiah.

The Economic Effect of Indonesian Currency Crisis

The major economic problems that followed from the onset of the Indonesian currency crisis emerged from the Indonesian finances and the banking systems. Indonesian currency crisis led to rapid fall in exchange rates against other foreign currencies especially the dollar bill. Policy makers thought that the currency problem would last for only few months or year but since then, the impact is being felt even in other markets like export and the import markets, the domestic markets and the labor markets. The events that followed the 1997 Indonesian currency crisis meant that residents of the country and investors would import goods at higher costs while the exports would sell at lower prices than the normal rating. The high costs of imports and domestic products signified higher inflation rates (Grant & Wilson, 2012, p. 81). At the same time, local producers lacked the incentives to export their products in foreign markets because of the reduction in prices of exports. High inflations are associated with high demands for domestic goods and services, and because local firms will be competing to meet the rising demand the economy comes closer to full employment but at a much riskier position (Grant & Wilson, 2012, p. 81). The diagram below summarizes the contrast between high inflations, high demand and high employment and its application in providing a solution to the Indonesia economy according to both Keynesian and Classical economists.

 

 

 

 

 

 

 

P2
P1

r2

r1

AD1
AD2

 

 

QD1      QD2
Real GDP

i2    i1            inflation

The two graphs show that aggregate demand and total supply in both the commodity and labor market have impact on employment and inflation rates. Keynesian and Classical economists agrees on the fact that when the demand is high for example at QD2, firms tend to increase their production capacity by employing more factors of production. The high employment levels would mean that there is more goods and services released into the economy, and therefore as P2 moves towards P1 due to an increase in supply, the economy stabilizes at inflation rates i2.

Policy Implementation for High Inflation Rates in Indonesia

The case of Indonesia could be given two approaches according to the economic theories presented by Keynesian economists and the Classical economists. In the period of 1997, the increase in local demand for the country’s domestic products was triggered by an increase in money supply in the economy (Haggard, 2000, p. 27). The first policy implementation according to the Keynesian economists would involve the government instructing the central banks and other lending institutions to raise interest rates in order to reduce lending to the public while encouraging people to save more money in order to take advantage of the higher rates. As the public becomes net savers, the amount of money circulating in the economy reduces making the local currency to gain value.

On the side of classical economists, flexibility in market prices would help in creating a balance between the demand and supply. When the demand is high like in the case of Indonesia, firms may either decide to increase prices and may respond by increasing their production capacity. An increase in price reduces consumer’s willingness to purchase, and therefore a larger proportion of their net earnings is saved.

 

 

 

 

 

 

 

 

 

References

Biswaro, J. M. (2012). The quest for regional integration in the twenty first century: Rhetoric versus reality : a comparative study. Dar es Salaam: Mkuki na Nyota.

Grant, W., & Wilson, G. K. (2012). The consequences of the global financial crisis: The rhetoric of reform and regulation. Oxford, UK: Oxford University Press.

Haggard, S. (2000). The political economy of the Asian financial crisis. Washington, DC: Institute for International Economics.

Meissner, G. (2004). Credit Derivatives: Application, Pricing, and Risk Management. Oxford: John Wiley & Sons.