When one thinks of the greatest economic downfalls, oftentimes, only the West comes to mind. However, in 1997, Asian markets were plagued with an Asian financial crisis known as the ‘Asian Contagion‘. It was a series of events that resulted in the plummeting valuation of Asian currencies throughout the continent.
These currency declines in East Asia caused in turn the stock market to decline, political upheaval and reduced import revenues. This article seeks to break down this event into a digestible read so that you can understand one of the world’s greatest economic events.
The crisis began in Thailand on July 2 with the sudden and drastic collapse of the Thai currency, the baht.
The government was forced to “float” (which means the currency price is set by the forex market based on supply and demand relative to other international currencies as opposed to a government-controlled currency that is a fixed exchange rate) baht. A capital flight — when assets and money flow out of an economy in a drastic measure such as an increase in taxes due to defaulting — began immediately, which lead to an international chain reaction. Due to Thailand’s large foreign debt, the crisis spread and most Southeast Asian nations, including Japan, saw their currencies decline.
What Caused This Crisis?
The export-led growth model that had been adopted by these newly industrialised nations is quoted to be the biggest cause. Export-led growth entails close government relations with manufacturers of products that often get exported. This includes subsidies, beneficial financial deals that would all hinge on the US dollar to ensure an attractive exchange rate.
This diagram indicates how East Asian countries began to see their currencies plummet against the USD, with Indonesia clearly getting affected the most by the end.
While it seemed ideal in nature, it involved many risks. Governments had to bail out industries and banks, a close relationship between large business conglomerates all resulted in moral hazard risks that went by unseen.
What is a moral hazard? This is a risk where a party, up to a certain economic contract, can take risks without the fear of suffering consequences that ultimately results in risky decision making — this is what took place in East Asia.
The International Monetary Fund (IMF) had to ultimately intervene by lending money to stabilise the Asian economies (which you may find at the time, were also known as the tiger economies). It is estimated that around 110 billion dollars were left to Thailand, Indonesia and South Korea in short-term loans to help stabilise their economy. However, this did not come without the conditions of higher taxes, greater interest rates and a drop in public spending. It was a long and very slow recovery, but the tiger economies began to see recovery by 1999.
What Can We Learn From The Crisis?
One thing that we can definitely learn is that investors should be cautious of asset bubbles. These ‘bubbles’ form when the price of an asset rises without any underlying true causes such as an equally rising demand, which would explain the rising prices. If these bubbles burst, as they did in 1997, investors may end up in great problems.
Furthermore, investors should keep an eye out for public spending and any infrastructure that can contribute to asset bubbles.