Korean Economics in 1997 South Essay

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(Hahm, 2000)

However, they faced an entirely new problem; the currency was pegged to the U.S. dollar. This allowed interest rates to remain artificially low, because the peg would make the different investments in Korea look less risky. Once interest rates began to rise, a divergence would occur as the policy of the maintaining the peg would invite speculators to take advantage of this. This could cause the financial system to collapse, as the central bank would lose control of the economy. If they removed the peg, this would allow the forces of supply and demand to balance everything out. Where, the currency would face increased short-term pressures and interest rates could rise even more. Yet, over the long run this policy would help to force the banks to address various balance sheet issues. Once this took place, is when they could begin to have confidence in the financial system. As interest rates would fall because the overall fear associated with lending has been greatly reduced. The problem with removing the peg; is that it would have effects that would be felt throughout the financial markets around the world.

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(Hahm, 2000)

Clearly, the Korean financial crisis began with large amounts of risks that bankers were taking. This was because the peg on the currency was in place, which allowed the overall risks to appear to be less than they were. As a result, large amounts of foreign investment capital would flow into the country, helping to fuel the excessive risk taking. Once the various loans began to go into default is when the financial system would face collapse, as the central bank would have no choice other than to remove the peg on the currency. This would create short-term pain as the crisis would spread around Asia, while at the same time forcing financial institutions to clean up their balance sheets. It is through examining the factors of excessive risk taking, rising interest rates, the peg on the currency and the way that they are all connected; that provides the greatest insights as to what where the major causes of Korean financial crisis......

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