The Southeast Asian Financial Crisis that began in Thailand and quickly spread to neighboring countries was an example of the cyclical nature of capitalism. This crisis caused massive political and economic fluctuations and competitive currency devaluations. Within this context China showed itself to be an economically stabilizing influence and a regional leader, the benefits of which it is continuing to enjoy today.

The Southeast Asian Financial Storm, or Asian Financial Crisis as it is more commonly known, was the result of a decade of rapid economic growth in Asia (the Asian economic miracle) where fundamental economic realities became skewed, leading to a period of adjustment following the boom. In this respect it was simply another part of the boom-and-bust cycle of capitalism. The usual starting point is the run on the Thai baht that began in July 1997.

Boom-and-Bust Cycles of Capitalism

It was this boom-and-bust cycle that the economic planners tried to stop at the end of the Second World War. The Bretton Woods agreement is the most famous, where the International Bank for Reconstruction and Development (later the World Bank) and the International Monetary Fund (IMF) were created. The purpose of the IMF was to make emergency loans to economies that found themselves in dire straits. The IMF would restore public confidence through loans and prevent an economy from sliding further into recession. At the same time, it would provide financial advice to get an economy back on track. It has played an important role in the world economy since its creation (though it is not without its critics).

A final initiative of the Bretton Woods agreement was the stabilization of currency exchange. The prewar gold standard system did not survive the Great Depression and Second World War II. The U.S. idea after the war was to peg gold to the U.S. dollar and then, in turn, link all Western currencies to the U.S. dollar (“as good as gold”). This had the effect of stabilizing both international trade and currency exchange. Under this system it was impossible to have a run on a country’s currency by speculators. Unfortunately, this system did not last. The U.S. government overspent on both the Vietnam War and President Johnson’s Great Society initiative. The result was a massive oversupply of U.S. dollars on the world market to pay for both. When European bankers, in particular, became alarmed about this dollar glut, they began to pressure the United States to pay them in gold at the level agreed upon in 1945. The United States was unable to do this, and President Nixon removed the dollar from the gold standard in 1971, leading to a sharp depreciation in the dollar and the subsequent loss of billions to European banks. The creation of the euro, incidentally, is in large measure a result of this event, so the Europeans do not have to depend on the U.S. dollar as a world currency.

Since this time, the world has moved to a system of floating exchange rates, and hence a high level of instability in the global financial system. For example, how can exporters plan ahead when they do not know how much their products are going to cost in the long term in different markets? What prevents speculators from creating a run on a particular currency to make short-term profits?

Underlying Causes of the Crisis

In Asia the financial crisis had both long-term and short-term beginnings. Through the 1970s until the mid-1980s, Japan had been running a huge surplus with the world in general and the United States in particular. In 1985 the Japanese agreed to increase the value of the yen. However, the yen rose far faster than anyone expected, from about 230 yen to the U.S. dollar in 1985 to eventually 80 yen to the U.S. dollar ten years later. The Japanese government, therefore, became worried about endaka, or high yen recession, where their exported products would cost too much on world markets. One result was that they kept interest rates low (eventually 2.5 percent and today just over 0 percent), and banks were encouraged to lend on easy terms to compensate. Japanese companies also massively invested offshore, especially in Southeast Asia, to make products with lower labor costs and, therefore, be less expensive in global markets.

With low interest rates and easy lending by banks, the Japanese massively overinvested in both the Japanese stock market and real estate, creating an artificially large economy (a “bubble”). After Japan’s financial meltdown beginning in 1991 (the end of the “bubble economy”) Japanese companies continued to invest in Southeast Asia, this time to produce low-cost products for the Japanese market as well, and remain competitive there.

Unfortunately, not all of this investment was used wisely in Southeast Asia. Japanese money was typically channeled through local banks, and their lending criteria were not always rigorous. It was also often put into real estate, and this created inflated real estate prices in the region. Other countries followed the Japanese lead and money poured into the region. The result was a number of economic bubbles created by the inflow of foreign investment.

Short Term Causes of the Crisis

In terms of short-term causes of the crisis, in 1997 it became clear to some currency speculators that local currencies were overvalued, and they attacked them. The idea was to short sell the currencies (to make a contract buying the currency in the future at a low price and then selling that currency to drive it down). The first attack occurred in Thailand in that year. The result was a panic. Everyone holding reserves of Thai baht sold them, which drove down the price. Then speculators began looking around the region and attacked other currencies. At the same time, panicked investors withdrew their funds, and this added to the fall in local economies. Some $80 billion to $100 billion of investment was withdrawn from the region.

Impacts of the Crisis

The result was economic chaos in a number of countries in Asia. Eventually Thailand and Indonesia accepted rescue packages from the IMF (as well as South Korea in Northeast Asia). Massive currency devaluation took place. The worst affected (exacerbated by political turmoil in the country) was the Indonesia rupiah, which dropped from about 2,500 rupiah to the U.S. dollar in mid-1997 to about 18,000 by the time the slide stopped. The Malaysian government took the unprecedented step of introducing currency controls (not allowing its currency, the ringgit, to be freely traded) and the currency’s exchange rate is still managed today though its value is linked to a basket of major currencies. Real estate values plummeted, banks collapsed, unemployment soared, and political turmoil resulted (the authoritarian government of Indonesia, in place for more than thirty years, fell after a period of bloody rioting).

There were a few bright spots. China refused to devalue its currency, to compete with the lower currencies of Southeast Asia, and supported the Hong Kong dollar. It came out of the crisis with substantial political collateral, and became something akin to the savior of Southeast Asia. China’s response showed leadership, where the government put regional above domestic interests. It could have devalued its currency and ameliorated the impact of the crisis on China’s economy but chose instead to support neighboring countries. By doing so China gained substantial political capital in the region that is continuing to pay dividends today. Singapore, where bank lending was more rigorous, also survived with only a minor recession. The very poor countries of Southeast Asia—Vietnam, Laos, Cambodia, and Myanmar (Burma)—were not overly affected bec
ause their economies were already at such low levels. But those economies that had grown substantially because of foreign investment—Thailand and Indonesia in particular—suffered enormously.

The real pain lasted for about two years before there were early signs of recovery, though Thailand and Indonesia had yet to recover fully more than a decade later. The idea of Asia’s “miracle economies” had been shown to be no miracle at all.

The crisis is best placed within the context of the boom-and-bust cycles of capitalism. The Great Depression is the best known of these, followed by the recession in the early 1970s in the United States caused by the dollar default and the dramatic rise in the cost of oil by OPEC. This was followed by the Latin American debt crisis of the early 1980s where Mexico, Brazil, and Argentina, in particular, defaulted on their international loans and had to be rescued by the International Monetary Fund (IMF). Then, after the Asian Financial Crisis, came the collapse of the American hedge fund, Long Term Capital Management, in 1998, and Russia’s loan default and the collapse of the ruble. Finally, in 2008 there was the mortgage crisis in the United States that dragged the U.S. economy into a recession, followed by a banking crisis that spread to financial systems and has affected economies worldwide into 2009.

In this respect the Southeast Asian financial crisis of 1997 and the 2008 global crisis in are similar. When public sentiment for buying goods and investment is strong, business does very well, but this broad-based economic excitement tends to make both borrowers and lenders less prudent. People borrow too much and banks lend on overly easy terms. Prices become inflated, and when the downturn begins, the herd mentality means that everyone rushes to shed their investments (typically either in real estate or the stock market) at the same time. Prices plummet and a recession threatens. The major difference between the crisis of 1997 and the one beginning in 2008 is that the latter downturn, having started in the world’s largest economy and consumer market, necessarily has global repercussions.

Further Reading

Andressen, C. A. (2002). A short history of Japan: Samurai to Sony. Sydney: Allen and Unwin.

Chu, Y. P., & Hill, H. (Eds.). (2001). The social impact of the Asian financial crisis. Northampton, MA: Edward Elgar Publishers.

Das, D. K. (2005). Asian economy and finance: A post-crisis perspective. New York: Springer.

Denoon, D. (2007). The economic and strategic rise of China: Asian realignments after the 1997 financial crisis. New York: Palgrave Macmillan.

Gul, F. A. & Tsui, J. S. L. (2004). The governance of East Asian corporations: Post Asian financial crisis. New York: Palgrave Macmillan.

Haggard, S. (2000). The political economy of the Asian financial crisis. Washington, DC: Institute for International Economics.

Lee, C. H. (Ed.). (2003). Financial liberalization and the economic crisis in Asia. New York: RoutledgeCurzon.

Mo, J., & Okimoto, D. I. (2006). From crisis to opportunity: Financial globalization and East Asian capitalism. Stanford, CA: Walter I. Shorenstein Asia-Pacific Research Center.

Sharma, S. D. (2003). The Asian financial crisis: Crisis, reform and recovery. New York: Manchester University.

Stiglitz, J. E. (2003). Globalization and its discontents. New York: W. W. Norton & Company.

Thirkell-White, B. (2005). The IMF and the politics of financial globalization: From the Asian crisis to a new international financial structure. New York: Palgrave Macmillan.

Source: Andressen, Curtis. (2009). Southeast Asian Financial Crisis of 1997. In Linsun Cheng, et al. (Eds.), Berkshire Encyclopedia of China, pp. 2057–2059. Great Barrington, MA: Berkshire Publishing.

Southeast Asian Financial Crisis of 1997 (1997 Nián D?ngnányà j?nróng w?ij? 1997 ????????)|1997 Nián D?ngnányà j?nróng w?ij? 1997 ???????? (Southeast Asian Financial Crisis of 1997)

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