What was the ‘Asian crisis’?
Ten years ago this week the Thai baht began a devastating slide after currency speculators destroyed its peg to the dollar. For months, the baht had been seen as overvalued, in large part due to Thailand’s huge current-account deficit of 8%. From 24 baht to the dollar in July 1997, the currency slid to 56 to the dollar by January 1998. Speculators quickly moved on to other southeast Asian economies. Malaysia, South Korea, the Phillipines and Singapore all saw their currencies crash, while Indonesia’s rupiah slumped by 85% over the next year. As the crisis spread, it deepened beyond the currency markets.
Why did the crisis spread?
As currencies crashed, investor sentiment on east Asia – admired for its dynamism, rapid growth and macroeconomic stability – did a swift U-turn. Downsides that had been quietly overlooked while growth was strong and stable – such as too-rigid exchange rates and capital flows, lax supervision of banks and firms, weak legal structures, and endemic corruption and cronyism – leapt to the forefront of investors’ minds. As confidence vanished, the currency turmoil swiftly became a financial and banking crisis and then a wider economic and political upheaval.
How serious was this turbulence?
Devastating – for both financial markets and the population. Stockmarkets and property prices crashed (stocks by an average of 47% in two years across the region) and thousands of companies went bust as currencies plunged and interest rates surged. The worst-affected – Indonesia, Malaysia, Korea and Thailand – saw average real incomes fall by some 11% in 1998. At least five million people were thrown out of work. Political turmoil ensued. In Indonesia, the Suharto regime collapsed after 32 years and in Thailand the tycoon Thaksin Shinawatra was swept to power on a wave of populist support.
So have lessons been learnt?
To judge from the region’s strong recovery, the answer is yes. Economic growth rates are high (around 5.5%), if not yet at pre-crisis levels; inflation and interest rates are low; and stockmarkets are comfortably above pre-crisis levels. But most economists would argue that it’s not that straightforward. The first big lesson, that emerging economies need robust, transparent regulatory and policy-making institutions, has been learnt fairly well.
Central banks are more independent, government debt has fallen, and banking systems are stronger. But many Western economists argue that the lesson on exchange rates – never again would Asian governments be caught with insufficient reserves to defend their currencies – has been learnt too well. Today, a repeat of 1997 is inconceivable, because Asia’s central banks are stuffed with foreign currency – some $3.3trn. After ten years of keeping their currencies artificially low and exporting like crazy, southeast Asia has an impressive buffer against volatility in the markets. That’s good, in that it makes speculators wary and builds the confidence of longer-term investors (though foreign direct investment levels are still below those of 1997). However, holding such massive reserves is a costly and arguably counter-productive form of insurance that brings its own problems.
What kind of problems, exactly?
For the countries of east Asia – and that includes China, which took the lessons of 1997 to heart as much as anyone – there are enormous opportunity costs involved in holding reserves that could otherwise be invested in infrastructure, health-care or simply higher-yielding assets. In short, they could be spending and investing in domestic demand and growth, rather than remaining as highly export-dependent economies acting as the lender of last resort to the US consumer. Also, if a large chunk of the world economy is generating huge current-account surpluses, it means someone else is running huge deficits.
And why is that bad for Asia?
Because that someone is America, easily the world’s largest economy, whose current trade deficit (of around 6%) is near the level that got Thailand and Indonesia in such trouble. It might seem that the greater risk is to the US, struggling to reach even half its trend growth rate this year. But the truth is that such a huge global imbalance is not desirable for anyone – least of all the Asians. The third big lesson of the Asian crisis ten years ago is not to borrow too heavily in a foreign currency. The Americans don’t – they borrow almost exclusively in dollars. If push came to shove, the US could avoid bankruptcy by printing more dollars and letting their currency slide. In such a scenario everyone loses – but the Asian countries holding more than three trillion dollars’ worth of a declining asset would lose most of all.
Why was the Asian crisis so severe?
In a lengthy analysis of the background to the crisis in the FT this week, Chris Giles cites several factors common to each of the crisis economies. Each had seen a period of high foreign capital inflows into short-term assets before the crisis hit (‘hot’ money); and each had current-account deficits (none higher than Thailand’s), fixed exchange rates to the dollar, poor regulation of the banking and financial sector and massive borrowings in foreign currency. This combination of factors left them vulnerable to a forced devaluation, but it also meant that when devaluation came, the consequences were severe – bankruptcies in the financial sector damaged the economy as a whole, igniting a vicious downward spiral.