The crisis started after U.S. interest rates began to rise. Many Asian currencies — particularly the Thai baht — were pegged to the U.S. dollar. When you have fixed exchange rates and there is a big difference in borrowing costs, investors borrow abroad and bring the money home to invest. This is great while it lasts, but it leaves investors open to foreign exchange risk.
Which is exactly what happened. When the Federal Reserve began raising rates in the U.S., investors started pulling money out of emerging markets to bring back to the U.S. The dollar rose, which made Asian exports more expensive on the global markets. The Asian currencies were hit by waves of speculative attacks in the summer of 1997.
By then, a general panic was in the air in Thailand, Malaysia, Indonesia, South Korea and the Philippines. A credit crunch forced many companies into bankruptcy. Governments raised interest rates in a desperate bid to keep international investors from withdrawing money.
It didn’t work, and with governments literally running out of money, they abandoned their fixed pegs to the dollar and allowed their currencies to float.
The IMF stepped in with a series of bailouts, but the damage was done, and that damage that is still with us today:
In political change, President Suharto of Indonesia was forced out after being in power for 30 years, and so was the prime minister of Thailand.
In economic changes, the crisis accelerated Japan’s decline as a global powerhouse. Some 40 percent of its exports went to Asia. Real GDP growth rates slowed dramatically, and Japan fell into a recession in 1998. The GDP of other countries also declined.
There was an oil crisis. Lower global demand caused a big drop in oil (it hit $11 at the end of 1998). This led to several large oil company mergers in 1998 and 1999, culminating in the merger of Exxon and Mobil in 1999.
It also was the cause of a second crisis the following year, the Russian financial crisis. The Russians defaulted on their debt the following summer due to a reduction in oil revenue largely caused by the Asian crisis. This caused the hedge fund Long-Term Capital to collapse and forced Allen Greenspan to intervene, saving the markets from yet another crisis.
There was a weakening of global institutions and the slowing of global trade deals. There was a backlash against the World Bank and the IMF as their prestige declined, which continues. Global trade talks stalled. They are still stalled today. Because nothing can get done on a global scale, trade agreements have become more regional in nature.
And there was an attitude change. Millions of people were forced back into poverty. Central authority was weakened in many countries, which allowed the growth of separatist movements that still exist. Anti-Western sentiment also rose, as the crisis deepened suspicions of foreigners as people who would invest and quickly flee the country when growth slowed.
It’s not too much of a stretch to say that the seeds of the anti-globalization movement began here.
Can it happen again? A lot has changed. Most currencies now float, reducing currency risk. But debt levels are still very high, a point the Chinese have been making repeatedly. And interest rate risk still very much remains. If rates rise notably in the U.S., an ocean of money parked overseas will come home. There will be pressure, though how much depends on the magnitude of the move.
Tomorrow on Trader Talk: Oct. 27, 1997: the day the NYSE floor shut down, as the Asian financial crisis came to a climax.