The Asian Financial Crisis, 25 years later

Ichiro Suzuki In the summer of 1997, mega waves of economic crisis hit the Far East and Southeast Asia region. It began with devaluation of the Thai baht that had been long viewed as substantially overvalued because of persistent current account deficits. In the first half of the 1990s, the international investment community designated Asia as the region of the 21st century. The Far East took off first in the 1980s as the sharp rise of the Japanese yen drove factories out to neighboring countries. The region’s economies were already in a category of developed countries. South Korea hosted the Olympic Games in Seoul in 1988. The Japan Bubble’s burst at the outset of the 1990s caused a major shift in capital flows within Asia. Few still remember that market capitalization of the Tokyo Stock Exchange exceeded that of New York for about a year and a half, showing the magnitude of the bubble. When capital decides to leave the largest market and moves toward much smaller ones, its impact is powerful. It drives up the value of both currencies and stocks in smaller markets. In the Far East and Southeast Asia, equity markets commonly doubled in USD terms in 1993. Such spectacular rises were taken for granted back then since the future belonged to Asia, it was widely believed. However, doubling of a market in 12 months presented a bad sign of over-hyped enthusiasm. (The investment community would learn it again in the 21st century, as emerging markets as a whole doubled in a 12 month period through October 2007, on the eve of the global financial crisis.) Too much frenzy had invited excessive inflows of portfolio investments, which is short-term capital and is always ready to leave on fundamentals’ deterioration, as opposed to long-term capital that builds, for instance, factories. That was exactly what such capital did in the summer of 1997. The baht’s devaluation has proved that the markets were right to worry over Thailand’s current account deficits. After Thailand, the markets hit countries with weak current accounts one by one, just like falling dominoes. In retrospect, the Asian Financial Crisis of 1997-98 was a classic emerging market crisis. If anything, the AFC displayed strong resemblance to the the Latin American crisis in the latter half of the 1820s. After the conclusion of of the Napoleonic wars in Europe, a wave of independence hit the region that until then belonged to Spain and Portugal. The future of Latin America looked so promising that a massive amount of capital flowed from London into bonds in the region. The bulk of those bonds ended up with failing to meet their obligations by the end of the decade. It was the first emerging market financial crisis on record, and Latin America would repeat it time and again in the next 200 years, and probably beyond. At the time of the AFC, the Washington consensus ruled the world of economic management and financial markets. Based on this principle, the International Monetary Fund moved quickly to enforce draconian spending cuts on the crisis-torn countries that danced to the music of a great party. These economies were sent into a tailspin to suffer double-digit contractions that were tantamount to ‘depression’. Some liberal economists, notably Nobel laureate Joseph Stiglitz, criticized the IMF for its too harsh medicine prescribed on the ailing economies. Defying the Washington consensus, Malaysia closed capital accounts at an early stage of the crisis, preventing capital from fleeing. Such capital control appeared to have worked as Malaysia suffered a much milder downturn than the rest of Asia. As a price of this unorthodox policy, Malaysia’s post-crisis recovery was lackluster as is economy did not go through necessary restructuring. Then IMF chief economist Ken Rogoff, who teaches at Harvard today, shot back at Professor Stiglitz that imbalances associated with large current account deficits needed to be corrected by suppressing domestic demand and that there was no other way out of a balance of payments crisis. Professor Rogoff is right. Nonetheless, the IMF’s policy prescription became less harsh after the AFC. Look at Argentina that has already defaulted a few times after the AFC. While the crisis forced taking excesses out of the economies throughout the region, none suffered a deeper downturn than South Korea. Acute shortages of foreign exchange reserves decimated the Korean economy that had enjoyed fast growth for a quarter century until the mid-1990s. The situation was so dire that some people stood on the streets in Seoul to ask for donation of gold stuffs, be they rings or other ornaments; a very patriotic act. The crisis was a perfect storm for Corporate Korea that until then prospered on spectacular high leverage. (Debt to equity ratio of 500% was not uncommon among Korean companies.) Of about a dozen chaebols (conglomerates) that ruled the South Korean economy, half of them were forced to shut down for good. Two countries weathered the storm relatively well. One was Hong Kong. The outset of the crisis had coincided with the British colony’s handover back to the People’s Republic of China on July 1, 1997, on the expiration of a 150 year lease. The Hong Kong dollar had been pegged against the USD at the exchange rate of 7.8 to 1, backed by vast foreign exchange reserves. The HKD, more stable than other Asian counterparts, became the last currency to be attacked by speculators. Withstanding fierce selling of stocks, the HKD did not break until the storm had gone away. The Hong Kong Monetary Authority entered the stock market to keep it from a total collapse and later sold it back to the market when the storm was over. China did not break, either. This is not because of the Chinese system’s robustness. The renminbi was already cheap enough in the summer of 1997. The RMB was ahead of the times, having gone through a massive devaluation already in 1994. Speculators don’t bother to attack what’s not expensive. South Korea came off the crisis as the most aggressively restructured and lean economy. Corporations that needed to be folded disappeared. Leverage was sharply brought down. The ones that managed to survive the perfect storm thrived as they moved into the 21st century. The Korean won was brought down sharply to make South Korean exporters competitive. However, Samsung Electronics rose to prominence was not because of cheap currency. It became a dominant producers of dynamic random access memory (DRAM) chips, beating once dominant Japanese competitors in technology and relegating them to an also-ran league. As Apple’s iPhone gave birth to a new category of smartphones, Samsung led the global market in terms of units sold (though still far behind Apple in terms of profits.) At one point, Samsung’s equity market capitalization edged toward the top 5 in the world. South Korea’s per capita income is catching up fast with that of Japan, which has been stagnant for a generation. The rest of the region also prospered in the years that followed the crisis. China’s entry into the World Trade Organization gave a big boost to the global economy and Asia not surprisingly benefited from the rise of China more than anywhere else. Cheap currencies also helped. The crisis taught developing countries, in Asia or elsewhere, about the risks of running current account deficits. They aggressively built current account surpluses in the first decade of the new century. The Chinese economy’s breakneck growth underpinned their drive toward healthy current accounts. Resource rich countries responded to voracious appetites for commodities in China, which consumed them in a wasteful fashion. Asian countries also exported a variety of raw materials and intermediate goods to China, which then turned them into finished goods to be exported to American consumers. Building up of surpluses among developing countries, including China, led to significant savings glut for the global economy. Only one asset class was large, liquid and safe enough to absorb massive savings glut around the world, and it was U.S. Treasury securities. In the early years of hyper globalization at the outset of the century, Fed Chairman Alan Greenspan shook his head witnessing long-term interest falling amid the U.S. economy’s solid recovery from the 2000-01 recession. He famously called the fall ‘conundrum’. As it turned out, China was buying T-notes to park its growing amount of foreign exchange reserves. As FX reserves swelled among developing countries, their sovereign wealth fund (SWFs) became dominant players in the global financial markets. Low interest rates caused by savings glut in the developing world sowed seeds for the 2007-09 global financial crisis. After the GFC, effects of the AFC’s aftermath waned. The GFC did God’s work of disciplining the U.S. household sector on its habit of aggressive spending on borrowed money. Sellers to spendthrift American consumers had to suffer more than buyers of their goods. The deepest recession since the Depression bought down commodity prices sharply, inflicting heavy blows to commodity exporters. Credit conditions became tighter for developing economies despite almost free money in the developed world. Thus, the post-AFC boom was brought to an end. By the end of the 2010s, Asia has lost its luster it once enjoyed though the region continues to post higher growth rates than the rest of the world. Asian equity markets are delivering lackluster returns despite Samsung’s and TSMC’s rise to prominence. In 2022, China is barely growing at 5%, less than half of what the country boasted of in the early years of the century. Thailand that triggered the AFC is not growing much higher than the U.S., and the country is aging fast. It does not seem that Thailand even reaches the middle income level of $10,000 per capita GDP any time soon. This is also true for relatively younger economies such as Vietnam, Indonesia and the Philippines, whose income levels are much lower than Thailand. They are growing but not growing fast enough to rise to a group of higher income level, in part because their export markets can no longer absorb what they want to sell. The entire Far East, including China, is following the footsteps of Japan in aging of population. In fact, the birth rate of South Korea is even lower than Japan that has been a pioneer of the aging trend. Governments in Thailand and Myanmar are in the hands of a military junta. Generals in Myanmar is inflicting serious damages to the country that was once touted as a future tiger candidate. The shake-up that gave a new lease on life to Asia a quarter century ago has run its course. The region needs another catalyst for revitalization, or recedes into a dull, uninspiring era. About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.