I’m doing some research on financial crises, like the Asian crisis of 1997-98 or the Argentian crisis of 2001-02.
One commonality seems to be: Banks borrow foreign currency, then get into trouble when falling exchange rates make those foreign loans difficult to pay back.
But what I don’t understand is, why would, say, an Argentian business / bank / government borrow dollars? People say that it’s because there isn’t enough savings to tap into in their own country, but realistically, what can they DO with dollars?
An Argentinian business must pay its suppliers, employees, and taxes in pesos, no? And wouldn’t the government have to pay its civil servants, pensions, various contractors, etc. in pesos too? The dollars could be used to buy American goods and services, of course, but is there such a massive demand for American stuff in all of these poorer countries who’ve gotten into trouble borrowing too many dollars?
I’m clearly missing something really obvious. Please, can you help me understand what these countries do exactly with all the dollars they borrow?
the dollars are spent paying for imported goods and services. It doesn’t have to be imports from America. Remember that Chinese yuan and currencies of Arab oil exporters are pegged to the dollar, so maybe these Argentinians borrowed dollars and bought stuff from the Chinese or oil from the Arabs.
But if what I want is pesos, why not just borrow pesos in the first place? Is it because the interest rate on pesos is too high, and dollar loans from foreign banks have a lower interest rate?
And if that’s the case, wouldn’t whatever factor is making the peso interest rate so high make the bank reluctant to be handing over pesos to me for dollars? What is the bank going to be able to do with those dollars?
Because unless the bank has the resources to lend, it can’t. Thus a bank facing credit demand greater than its domestic resources (deposits, domestic bonds) either can’t lend out or has to borrow foreign capital.
Well, … sometimes I suppose. Interest rates reflect demand in a free market, so if you can borrow in currency X with interest rate Y whereas your interest rate in home currency is 2Y, good deal. A domestic bank might well do so, although there is risk.
Or if you are a company and the country allows it, borrow from a foreign bank. Dangerous thing to do, though as you take on FX risk. More sensible if you are a multinational, my firm manages financing lines in this fashion, even relative to say its African subsidiaries (which are separate legal entities, with local investors).
If you are a firm borrowing from an overseas bank, you might or might not convert, depends on what you are doing. If you are a bank, you engage in ‘carry trade’ and hope…
I’m not a banker, but I do deal with some of this via my firm.
the actual Argentinian businesses or let’s say mortgage holders may have borrowed in pesos. But if the banks don’t have enough pesos to lend, they need to get the money from somewhere - so they borrow in dollars abroad and then they need to exchange the dollars for pesos to give the loans to the locals. But, who wants to exchange pesos for dollars, i.e. to whom will the bank sell the dollars to buy pesos? Chances, it is the importer. E.g. the gasoline importer in Argentina buys gasoline for dollars abroad and sells it for pesos in Buenos Aires. So this importer needs to exchange the pesos for dollars.
By contrast, if Argentina were to have essentially zero imports (sort of like being a fully self-sufficient agrarian country), then of course nobody would have wanted to exchange pesos for dollars and dollar exchange rate would have been very low. In which case borrowing abroad in dollars would have made little sense.
…until everyone suddenly doesn’t want Baht anymore and want Yen instead.
The bit you are missing is that the countries you are talking about do not have floating exchange rates. If all these foreigners suddenly wanted to lend Yen and thus demand Baht, the value of the Baht vis a vis the Yen would rise. If the Thai govt wants to keep the value of the Baht down, say, to help their export industries, they do so by buying yen with Baht. This is no problem as the Thai govt (central bank) has an unlimited supply of Baht. But when they want to do the opposite - keep the value of the Baht up by buying Baht with Yen, it’s a problem as the Thai government only has so much Yen to spend.
EDIT: Read Paul Krugman’s The Return of Depression Economics for a blow by blow.