the east asian financial crisis

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Econ 22 Terminal Report

Review of Related Literature:

The East Asian Financial Crisisof 1997 Camasura | Chiu | Co | Del Rio | Diu

6:00 – 7:30 pm, TTh

October 15, 2014



The early 1990’s witnessed an unforeseen boom unlike anything before in the Southeast Asian economies, particularly

in Thailand, Indonesia, Malaysia, and South Korea. These countries and its neighbors were dubbed as “miracle economies”

(Landsberg, 1998) because of their sky-high growth rates (based on gross domestic investment), which reached as high as 16%

while the US only reported a 4.1% growth (Hill, 1998). At that time, people were saying that the Asian Pacific region was on its

way to becoming “the future economic engine of the world economy,” (Hill, 1998) and they weren’t exactly off the mark as these

countries saw “an investment boom in commercial and residential property, industrial assets, and infrastructure.” (Hill, 1998)

Asia’s tigers were lighting up an economic trail with its unique strategy of combining government intervention and market

economy principles, but from there on, everything went downhill.

It all started on the 5th of February 1997 in Thailand when one of its biggest property developers was forced into

bankruptcy. (Hill, 1998) This was the start of a looming economic crisis, popularly known as the “East Asian Financial Crisis of

1997,” which will not only affect Thailand, but its fellow Southeast Asian countries as well. The next several months will see

more private businesses defaulting on their loan payments, which in turn will cause financial institutions to default on their

foreign loans, followed by a panic attack among investors and traders, which will ultimately lead to the devaluation of the baht,

Thailand’s official currency. Similar events will unfold in neighboring countries and now the question on everyone’s head is why.

Up until now, there is debate and speculation on the roots of the East Asian Financial Crisis. On the onset of the crisis,

Malaysia’s Prime Minister, Dr. Mahatmir Mohammed, while halfway in a state of denial, proclaimed that the crisis was caused

by a “conspiracy to impoverish Southeast Asian nations by attacking their currencies” and that there was a “Jewish agenda at

work against the country.” (Hill, 1998) The Malaysian currency and stock market fell the next day. Preposterous theories aside,

there are two dominant views on the real cause behind the crisis.

The first view says that there isn’t anything wrong with the East Asian economic policies. The crisis was merely a

result of a financial panic, which was triggered by the defaulting of loans of some key private companies. (Moreno, 1998) Once

more investors started calling in their loans because of the panic, the borrowers, who at the time didn’t have enough liquid assets

because of their heavy investment in real properties, couldn’t service their debt obligations and thus defaulted. This caused a

similar panic in the currency market and forced the Thai baht, along with other currencies, to devaluate.

The second view points the blame at the heart of the East Asian financial structure. There was a significant lack of

incentive for effective risk management because of governments’ guarantees, both implicit and explicit, to back private

institutions when they suffer financial difficulty. (Moreno, 1998) This assurance resulted to heavy lending of funds from

financiers to private businesses, even though these businesses have a subpar credit standing. Note that this is similar to what

happened in the recent Financial Crisis of 2009, which was caused by the defaulting of loans by borrowers with doubtful credit



standing. Further government intervention also led to trade deregulation and minimal competition, such as in Indonesia, wherein

its president granted monopolies of industries and excessive government assistance to his family members and close friends.

(Hill, 1998) In some instances, banks were even forced to lend to certain businesses because the owners were well-connected,

even if these businesses were poorly managed and were likely to default. (Moreno, 1998)

Many economists and published articles lean more toward the second view. In the years preceding the explosion of the

debt bomb, the aforementioned countries were titled as the “export powerhouses” because their exponential growth was mainly

due to the products they export to other countries. They had cheap and educated labor and less international trade barriers so

developed countries sourced some of their supplies and services from the said powerhouses. The accumulated wealth from the

export income, along with unrealistic forecasts about demand, led to a spike in the building of real property and investing in

industrial assets. Governments also encouraged this economic activity by declaring this industrialization as part of “national

goals” and also built more infrastructures themselves. Most of the money used to finance these projects came from debt securities

and banks were more than willing to lend to these companies because of the increasing GDP growth rate and the forecasted rising

property values at that time. (Hill, 1998)

However, the happy economic tale all too soon came to an end when in early 1997, everyone realized that they already

built far too many buildings and the supply exceeded the demand by a wide margin. (Hill, 1998) So instead of the large income

which should have been generated by the expected high values and high demand, these companies are now facing thousands of

vacant, unsold and unoccupied spaces, whose prices are declining sharply on the market, and with very little liquid assets to pay

back their maturing debt obligations. And once the local banks started collecting from their borrowers, they find out that the latter

are unable to make the payments.

So in turn, these banks and other financial institutions are also unable to pay back their dollar-denominated debt issued

by international banks. This event then appears on the headlines, sends investors and traders into a panic, and causes them to start

exchanging their baht for the more stable dollars. The local currencies then depreciate, despite governments doing everything in

their power to stabilize the exchange rate. With the depreciation of currency comes the implication that in order to pay back the

huge dollar-denominated debts of these countries, they would have to issue larger amounts of their currency to compensate for

the change in exchange rate.

By mid- to late 1997, these countries’ governments have realized that they couldn’t rise out of the depression by their

power alone and have taken their hats in their hands and approached the International Monetary Fund (IMF) for help. The IMF’s

help doesn’t come for free and in exchange for billions of dollars that they will lend, they ordered the borrowing countries to



employ contractionary economic policies such as increase in tax rates and interest rates, reduction in government spending, and

privatization of government-owned entities. (Hill, 1998)

Some economists have criticized the measures taken by the IMF and claim that they’ve worsened the crisis because as

we implied earlier, the crisis was caused by the heavy borrowing of the private sector and not by the governments, who were

incurring budget surpluses. Contractionary measures would just further sink the economy into recession. (Hill, 1998)

Furthermore, the financial structural adjustments made by the IMF in the form of ordering these countries to implement more

international-trade-friendly practices would just make the countries more dependent on foreign countries and would also severely

harm the working class as they get lower wages and work in poorer environments. (Landsberg, 1998) The IMF counters this

argument by saying that “the critical task is to rebuild confidence” in the countries’ currencies. (Hill, 1998) Once this happens,

and when the foreign investors come back, the currencies will appreciate against the dollar and would make the suffering

countries more able to repay their debts.



Bibliography ________________________________________________________________________________________________________

Hill, Charles W. L. The Global Financial Crisis: Causes and Consequences, Postscript 1999. Boston, MA: Irwin/McGraw-Hill,

1998.

Landsberg, Martin Hart. “Causes and Consequences: Inside The Asian Crisis.” Solidarity, 1998. Web. Against The Current,

March 1998. Web. 12 October 2014. <http://www.solidarity-us.org/node/1837>.

Moreno, Ramon. “What Caused East Asia’s Financial Crisis?” Federal Reserve Bank San Francisco, 7 August 1998. Web.

Center for Pacific Basin Monetary and Economic Studies. Web. 12 October 2014. <http://www.frbsf.org/economic-

research/publications/economic-letter/1998/august/what-caused-east-asia-financial-crisis>.

Pettinger, Tejvan R. “Financial Crisis Asia 1997.” Economics Help. Web. 12 October 2014.

<http://www.economicshelp.org/blog/glossary/financial-crisis-asia-1997>.

the east asian financial crisis

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