Overview of the Asian currency crisis and the potential for such crisis to occur in other nations including the potential for crisis in the United States. Written in May 2007.

1. Megan Crookham
May 17, 2007
IA 216
Professor Dube
The Asian Currency Crisis
The following paper will discuss the causes and implications of the Asian Currency Crisis of
1997. The overall aim of the paper is to prove that such an economic crisis could occur again if the
proper economic policies are not carried out. An analysis of the economic policies carried out prior
to the crisis will be presented in order to demonstrate how and why the crisis came about and how it
could have been prevented. This topic is of particular interest due to the fact that since 1997
national markets have become even more integrated and interdependent. If such a crisis were to
occur today it is likely that the effects would be even more severe. In this globalized world not
even developed countries are immune to poor economic policy (Shapiro, 2005, p. 16). As such,
countries including the United States should be highly cautious in their economic endeavors and
should take all measures necessary to prevent a future economic crisis from occurring.
The Asian Currency Crisis started when Thai businesses began to default on the loans they
took out in order to finance investments in commercial and residential property (Hill, 2006, p. 363,
See Figure 1, Appendix A). Excessive investment in property resulted in an oversupply of available
real estate (Hill, 2006, p. 362). Because the investors were unable to make any profit on the surplus
real estate they could not pay the loans they took out from Thai financial institutions (Hill, 2006, p.
363). It was feared that because the investors were unable to pay the Thai institutions that in turn
the Thai lenders would default on their loans from international banks (Hill, 2006, 363). As a result
of this speculation, foreign investors fled the Thai stock market selling their positions and
converting them to dollars (Wong, 1999, p. 392). This led to an increased demand for U.S. dollars
and an increased supply of Thai Baht which pushed down the dollar/baht exchange rate and caused
the Thai stock market to plunge (Hill, 2006, p.363). The dollar to baht exchange rate dropped from
$1 = Bt 25 to $1 = Bt 55 by January of 1998 as the Thailand stock market index declined from 787
in early 1997 all the way down to 337 by the end of the year (Hill, 2006, p. 363, See Figure 2,
Appendix A). The wave of speculation spread to other currencies causing them to be marked lower
as well which resulted in an explosion of debt throughout the region and hence an Asian Currency
Crisis.
The crisis was the result of a few factors which when combined ended up creating a deadly
arrangement. The first of the major causes for the crises was the previous decade of unprecedented
export driven grown experienced by the countries of Southeast Asia. Export grew so much and was
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2. Megan Crookham
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IA 216
Professor Dube
so successful from 1990 to 1996 that investors even began to make the transition from exporting
basic materials to exporting more technical products (Hill, 2006, p361). Specifically, the value of
exports from Thailand had grown by 16 percent per year, Malaysia had grown by 18 percent
annually, Singapore’s exports grew by 15 percent, Hong Kong’s by 14 percent and South Korea and
Indonesia’s exports grew by 12 percent annually (Hill, 2006, p. 361). The high level of success in
exports thus encouraged bolder investment and led to an investment boom in commercial and
residential property, industrial assets and infrastructure (Hill, 2006, p. 362). In particular gross
domestic investment grew by 16.3 percent annually in Indonesia, 16 percent in Malaysia, 15.3
percent in Thailand and 7.2 percent in South Korea in the years 1990 to 1995 (Hill, 2006, p. 362).
In certain Southeast Asian nations the governments encouraged investment in certain areas
of the economy in order to reach national goals and as part of the industrialization strategy. For
example, South Korea urged investment in new factories to boost growth but these “diversified
conglomerates” borrowed heavily, some of them creating debts up to four times their equity (Hill,
2006, p. 362). In Indonesia crony capitalism prevailed in the economy limiting competition through
the creation of monopolies (Hill, 2006, p. 362). Banks in Indonesia as a result were forced to give
loans for potentially risky investments such as auto production. The overarching theme here is that
the mid 1990s investment boom was financed with borrowed money and gross domestic investment
in the countries of Southeast Asia was higher during this time period than in any other (Wong,
1999, p. 393). As the number of investments continued to increase, the quality of investments
began to decline. To make matters worse, many of these long term investments were carried out
using short term loans (Wong, 1999, p. 393). Eventually these investments which were made based
on unrealistic projections of future demand conditions resulted in significant excess capacity.
Excess capacity resulted in plunging prices on everything from property to semiconductors (Hill,
2006, p. 362).
Another major factor behind the crisis was the fact that the countries of Southeast Asia had
pegged their currency to the US dollar (Wong, 1999, p. 393). Investors borrowed in US dollars
because interest rates on dollar borrowings were less than rates on domestic currency.
Unfortunately, as excess capacity began to drive prices down, the governments of the affected
countries could not maintain the dollar peg and their currencies started to depreciate against the
dollar (Wong, 1999, p. 392). This was not helped by the fact that inflation was higher in Southeast
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3. Megan Crookham
May 17, 2007
IA 216
Professor Dube
Asia than the U.S. (Hill, 2006, p. 363). This drove up the debt burden when measured in local
currency and resulted in companies defaulting on debt due to even higher borrowing costs. The
expanding of imports was also a factor in the crisis especially since the expansion in imports came
with a decline in the selling of exports in 1996 as China emerged as a major exporting nation in the
region (Wong, 1999, p. 392). Following a period of export led growth, the nations of Southeast
Asia had been investing in foreign goods at unprecedented rates causing their current account
deficits to increase which made it even more difficult for them to maintain their currencies against
the U.S. dollar as they lacked the currency reserves to intervene to keep the market from raising or
lowering the rates (Wong, 1999, p. 392 and Van den Berg, 2004 p. 473, See Figure 3, Appendix A).
Moreover, all of the borrowing in dollars and importing of goods created an extensive supply of
Southeast Asian currencies in the hands of foreigners which was extremely problematic as the
currencies began to fall against the dollar and demand for anything but Southeast Asian currency
increased (Van den Berg, 2004, p. 473).
The damage to the Asian economies caused by this financial tsunami was devastating.
Property and goods were devalued and left unsold due to over supply, prices plunged,
unemployment increased, debt grew and local currencies depreciated relative to the dollar while
inflation increased (Shapiro, 2005, p. 16, See Figure 4, Appendix A). Some countries in an effort to
maintain the dollar peg exhausted or nearly exhausted their foreign exchange reserves (Wong, 1999,
p. 395). Moreover, investors from other countries pulled out of deals and as a result the stock
markets of the affected countries crashed. This all led to a significant drop in economic growth
measured by GDP in the years following the crisis (See Figure 5, Appendix A). Specifically, by
1998 GDP fell 11 percent in Thailand, 8 percent in Malaysia and 13 percent in Indonesia (Van den
Berg, 2004, p. 473). Moreover, the crises resulted in political turmoil in some countries such as
Indonesia
As for the rest of the world, the Asian Currency Crisis led to downward pressures hitting
other foreign currencies such as the Brazilian real (World Bank, 1998). Asia's problems had an
effect on markets in Russia, Latin America, Europe, and the United States (World Bank, 1998). In
fact, the US economy was greatly affected by the crisis as was demonstrated by the roughly 7%
drop in the Dow Jones industrial in October of 1997 and the fact that the New York Stock Exchange
even suspended trading for a short time which in turn resulted in a decrease in consumer spending
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Professor Dube
(Nanto, 1998). Even Japan, the strongest economy in Asia at the time of the crisis, and the largest
holder of currency reserves experienced a slow in economic growth following the crisis and Russia
underwent a financial crisis in 1998 that likely would not have occurred had it not been for the
Asian Crisis which reduced the price of oil and made international investors even more reluctant to
lend to developing nations (World Bank, 1998). The only country that seemed to really benefit
from the crisis was China which was able to make economic gains due to the losses of other Asian
nations though it did temporarily experience a decrease in economic growth (Wong, 1999 and
World Bank, 1998).
Some Southeast Asian nations have still not fully recovered from the effects of the currency
crisis though conditions have improved. The crisis was resolved for the most part through action
taken on behalf of the IMF, which provided emergency loans to countries such as South Korea,
Indonesia, Thailand and Malaysia so that they would not default on all of their international
financial obligations (Nanto, 1998). Specifically, the IMF put together a 37 billion dollar rescue
package for Indonesia, a 17.2 billion dollar package for Thailand and a 55 billion dollar package of
loans for South Korea (Hill, 2006, p. 365). In return for the loans each of the nations had to adopt
certain practices which the IMF believed would foster a return to economic growth. The IMF asked
that the affected nations cut public spending, raise taxes, raise interest rates, deregulate certain
sectors to allow competition, privatize state owned assets and improve financial reporting overall
(Hill, 2006, p. 365). Unfortunatley, in several nations all these requirements did was worsen the
economy by causing an increase in unemployment and further recession so really those nations that
received aid from the IMF are the ones who continued to suffer in the aftermath of the crisis (Hill,
2006 p. 366). The IMF as a result has come under much criticism for the effectiveness of its
policies. The IMF and its supporters consider its efforts in the Asian Currency Crises a success
because with out the intervention of the IMF, they believe the crises would have continued to spread
and the after effects would have been much worse (Fischer, 1998). Nevertheless, the IMF is
reviewing its policies should it need to step in to curb another economic crisis which is
unfortunately a very real possibility.
Even after the lessons of the Asian Currency Crisis there still remains the chance that
another crisis could occur. This is due to the fact that despite the many warnings and past economic
crisis, some nations continue to carry out reckless economic policies. What is even more frightening
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5. Megan Crookham
May 17, 2007
IA 216
Professor Dube
is the fact that such an economic crisis could happen to even to the world’s largest economic
superpower, the United States (Bergsten, 2007). The pattern of economic growth the United States
has experienced of late is eerily similar to that of the Southeast Asian nations. The U.S. had a
period of export led growth through which it generated a high level of income that could be used for
international investment. Resultantly, the United States began importing most of its goods as the
spread of globalization or the increased opening of markets has increased market competition
making it cheaper for the United States to import rather than to produce and export goods (Shapiro,
2005, p. 475, See Figure 6, Appendix A). Due to this increase in international investment which is
sending U.S. dollars abroad, the U.S. currently has a current account deficit of nearly 800 billion
dollars which is the largest current account deficit it has ever had (Bergsten, 2007, See Figure 7,
Appendix A). This means that there are more dollars in the hands of foreigners than ever before.
As long as the US keeps buying foreign goods and those foreigners invest dollars in the United
States everything will be fine, but should they stop investing the dollars back in the US, that is
where the problems will arise (Ghosh and Ramakrishnan, 2006).
For instance, should someone speculate the downfall of the dollar or should one nation such
as China suddenly want to sell all of their dollars, or stop investing in the United States the supply
of the dollar would be so large that demand for the dollar will fall and the demand for other
currencies will rise therefore resulting in a devaluation of the dollar in relation to another foreign
currency or currencies. A devaluation of the dollar to due over supply could be devastating to the
US economy and could throw the United States into a currency crisis or at least in to a recession
(Bergsten, 2007). Ironically, nations such as Japan and China are now less vulnerable to a currency
crisis because they both have a current account surplus and have taken steps to build up their
foreign currency reserves following the lessons of the past (Ghosh and Ramakrishnan, 2006.) Other
than the United States, any nation which holds a current account deficit, pegs its currency to another
(making it susceptible to exchange rate risk), lacks foreign reserves, borrows too much money over
the short term, or makes a large number of investments with an inaccurate forecast of future demand
and supply logistics, is vulnerable to a currency crisis. (Hill, 2006). The United States and other
nations with any of these characteristics would be wise to remedy them as soon as it is fiscally
possible.
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6. Megan Crookham
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Professor Dube
References
1. Bergsten, C. Fred. (2007). the Current Account Deficit and the US Economy. Peterson
Institute for International Economics. http://www.iie.com/publications/papers/paper.cfm?
ResearchID=705 . (Accessed May 14, 2007).
2. Fischer, Stanley. (1998). The Asian Crisis: A View From the IMF.
http://www.imf.org/external/np/speeches/1998/012298.htm. (Accessed May 14, 2007).
3. Ghosh, A. and U. Ramakrishnan. (2006). Do Current Account Deficits Matter? Finance and
Development, IMF, Vol. 43, No. 4: pp. 44-51.
4. Hill, Charles. (2006). Global Business Today (4th Ed.). New York: McGraw-Hill. 361-67.
5. Nanto, Dick K. (1998). The 1997-1998 Asian Financial Crisis. CRS Report for Congress.
http://www.fas.org/man/crs/crs-asia2.htm . (Accessed May 14, 2007).
6. Shapiro, Alan C. (2005). Foundations of Multinational Financial Management (5th Ed.).
New Jersey: John Wiley & Sons, Inc.
7. Van den Berg, Hendrik. (2004). International Economics. New York: McGraw-Hill.
8. Wong, Y.C.R. (1999). Lessons from the Asian Financial Crisis. The Cato Journal, Vol.18,
No.3: pp. 1-8.
9. World Bank. (1998). What Effect Will East Asia’s Crisis Have On Developing Countries?
http://www1.worldbank.org/prem/premnotes/premnote1.pdf .(Accessed May 14, 2007).
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7. Megan Crookham
May 17, 2007
IA 216
Professor Dube
APPENDIX A
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8. Megan Crookham
May 17, 2007
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Professor Dube
Figure 1
Source: National Graduate Institute for Policy Studies.
www.grips.ac.jp/.../hp/image_f2/lec11_1cc.gif
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9. Megan Crookham
May 17, 2007
IA 216
Professor Dube
Baht to U.S. Dollar Exchange Rate 1995-2001
Figure 2
Source: Federal Reserve Bank of St. Louis. (2004). www.research.stlouisfed.org
Figure 3
Source: International Monetary Fund
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10. Megan Crookham
May 17, 2007
IA 216
Professor Dube
Figure 4
Source: National Graduate Institute for Policy Studies.
www.grips.ac.jp/.../hp/image_f2/lec11_1cc.gif
Figure 5
Source: Park, Yung Chul and Lee Jong-Wha. (2002). “Financial Crisis and Recovery: Patterns of
Adjustment in East Asia 1996-1999.” Asian Development Bank Institute. Research Paper No: 45
http://www.adbi.org/files/2002.10.rp45.asian.crisis.recovery.pdf . (Accessed May 14, 2007).
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11. Megan Crookham
May 17, 2007
IA 216
Professor Dube
Figure 6
Source: Federal Reserve, Bureau of Economic Analysis.
Figure 7
Source: U.S. Bureau of Economic Analysis
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