What was the Asian financial crisis?
The Asian financial crisis, also known as the “Asian contagion,” was a sequence of currency devaluations and other events that began in the summer of 1997 and spread to many Asian markets. Currency markets first failed in Thailand due to the government’s decision to no longer link the local currency to the US dollar (USD). Currency declines spread rapidly across East Asia, which in turn led to declines in the stock markets, declining import revenues, and government upheavals.
Understanding the Asian financial crisis
Due to the devaluation of the Thai baht, a large part of East Asian currencies fell 38%. International equities also fell to 60%. Fortunately, the Asian financial crisis has been somewhat stemmed by the financial intervention of the International Monetary Fund and the World Bank. However, market declines were also felt in the United States, Europe and Russia as the Asian economies collapsed.
In the wake of the crisis, many countries have adopted protectionist measures to ensure the stability of their currencies. This has often led to massive purchases of US Treasuries, which are used as global investments by most governments, monetary authorities, and the world’s major banks. The Asian crisis led to much-needed financial and government reforms in countries like Thailand, South Korea, Japan and Indonesia. It is also a valuable case study for economists trying to understand today’s intertwined markets, particularly with regard to currency trading and the management of national accounts.
The causes of the Asian financial crisis
The crisis was rooted in several threads of industrial, financial and monetary phenomena. In general, many of them are linked to the export-led economic growth strategy that had been adopted in the developing economies of East Asia in the years before the crisis. This strategy involves close government cooperation with manufacturers of export products, including subsidies, favorable financial agreements and currency parity with the US dollar to ensure a favorable exchange rate for exporters.
While this benefited the growing industries of East Asia, it also entailed certain risks. Explicit and implicit government guarantees to bail out industries and national banks; pleasant relations between East Asian conglomerates, financial institutions and regulators; and an influx of foreign financial flows with little attention to potential risks, all have contributed to massive moral hazard in East Asian economies, encouraging major investments in marginal and potentially unhealthy projects.
With the cancellation of the Plaza agreement in 1995, the governments of the United States, Germany and Japan agreed to coordinate to allow the US dollar to appreciate against the yen and the Deutsche Mark. It also meant the appreciation of East Asian currencies that were pegged to the US dollar, which resulted in strong financial pressures building up in these economies, as Japanese and German exports became increasingly competitive in relation to to other exports from East Asia. Exports have fallen and corporate profits have declined. East Asian governments and connected financial institutions have found it increasingly difficult to borrow in US dollars to subsidize their domestic industries and also maintain currency parity. These pressures reached their peak in 1997, one after the other, they abandoned their ankles and devalued their currencies.
Response to the Asian financial crisis
As mentioned above, the IMF intervened by providing loans to stabilize the Asian economies – also known as “tiger economies” – that have been affected. About $ 110 billion in short-term loans have been advanced to Thailand, Indonesia and South Korea to help them stabilize their economies. In turn, they had to follow strict conditions, including higher taxes and interest rates and lower public spending. Many affected countries began to show signs of recovery in 1999.
Lessons from the Asian financial crisis
Many of the lessons learned from the Asian financial crisis can still be applied to current situations and can also be used to alleviate problems in the future. First, investors should beware of asset bubbles – some of them may end up bursting, leaving investors embarrassed once they do. Another possible lesson is that governments keep an eye on spending. Any infrastructure spending dictated by the government could have contributed to the asset bubbles that caused this crisis – and the same goes for any future event.
Modern case of the Asian financial crisis
World markets have fluctuated sharply in the past two years, from the start of 2020 to the second quarter of 2020. This has raised concerns with the Federal Reserve about the possibility of a second Asian financial crisis. For example, China sent a shock wave to the U.S. stock markets on August 11, 2020, when it devalued the yuan against the U.S. dollar. This caused the Chinese economy to slow down, leading to lower domestic interest rates and a large amount of floating bonds.
The low interest rates adopted by China have encouraged other Asian countries to lower their domestic interest rates. Japan, for example, cut its already low negative short-term interest rates in early 2020. This prolonged period of low interest rates forced Japan to borrow more and more money important for investing in global stock markets. The Japanese yen reacted counterintuitively by increasing in value, making Japanese products more expensive and further weakening its economy.
The US equity markets reacted with an 11.5% drop from January 1 to February 11, 2020. Although the markets have since rebounded by 13% from February 11 to April 13, 2020, the Fed is still concerned about persistent volatility in the rest of 2020.