1997 Asian financial crisis

Based on Wikipedia: 1997 Asian financial crisis

The Summer Everything Collapsed

On July 2nd, 1997, Thailand did something that seemed technical and bureaucratic: it stopped defending its currency. Within months, this single decision would topple a dictator, erase hundreds of billions of dollars in wealth, and force the world's most powerful financial institutions into emergency rescue mode. The Thai people called it the Tom Yum Kung crisis, named after their famous spicy shrimp soup—because like that soup, the crisis was hot, sour, and spread through everything it touched.

What happened in Asia that summer remains one of the most dramatic economic collapses in modern history. Countries that had been celebrated as economic miracles just months earlier found themselves begging for international bailouts. Stock markets crashed. Currencies became nearly worthless. And in Indonesia, the crisis grew so severe that it ended a thirty-one-year dictatorship and triggered riots in the streets.

The Miracle Before the Meltdown

To understand the crash, you first have to understand the boom.

Throughout the late 1980s and early 1990s, Southeast Asian economies were the envy of the world. Thailand, Malaysia, Indonesia, Singapore, and South Korea were posting annual growth rates of eight to twelve percent—numbers that made Western economists look on with a mixture of admiration and disbelief. The International Monetary Fund (commonly known as the IMF) and the World Bank praised these nations effusively. Economists coined a term for what was happening: the Asian economic miracle.

Money poured in from everywhere. By the mid-1990s, Asia was attracting nearly half of all capital flowing into developing countries worldwide. Foreign investors couldn't get enough. The region offered high interest rates, which meant better returns than investors could find in the United States or Europe. It seemed like a sure thing.

But beneath the impressive growth numbers, dangerous imbalances were building.

The Mechanics of a Bubble

Here's where the economics gets important, so let me explain it plainly.

Most Southeast Asian countries had pegged their currencies to the United States dollar. A currency peg works like this: the government promises that its currency will always trade at a fixed ratio to another currency—say, 25 Thai baht to one US dollar. To maintain this promise, the government must hold large reserves of US dollars and be willing to buy or sell its own currency to keep the exchange rate stable.

Why would a country do this? Currency pegs make foreign investors feel safe. If you're an American putting money into Thailand, you don't have to worry about the Thai baht suddenly losing value against the dollar. Your investment is protected. This predictability attracted enormous amounts of foreign capital.

But pegs create their own problems. When your currency is locked to the dollar, you can't adjust your exchange rate to respond to economic conditions. And if investors ever start to doubt that you can maintain the peg, they might rush to pull their money out before the currency collapses—which, ironically, causes the very collapse they feared.

The other piece of the puzzle was something economists call "hot money." This is short-term investment capital that flows quickly across borders, chasing the highest returns. Hot money is fickle. It rushes in when times are good and flees at the first sign of trouble. And by the mid-1990s, Southeast Asia was flooded with it.

The Seeds of Disaster

Several factors combined to make the bubble unsustainable.

First, there was what became known as "crony capitalism"—particularly in Malaysia and Indonesia. Development money flowed not to the most efficient businesses or the best investments, but to people with political connections. If you were close to the centers of power, you got funding. If you weren't, you didn't. This led to spectacularly inefficient allocation of capital. Money poured into real estate speculation and prestige projects rather than productive enterprises.

Second, companies and banks borrowed heavily in US dollars. This seemed smart at the time—dollar loans often carried lower interest rates than local currency loans. But it created a hidden time bomb. As long as exchange rates remained stable, dollar-denominated debt was manageable. If local currencies ever fell against the dollar, that debt would become crushingly expensive to repay.

Third, weak corporate governance meant that even supposedly sophisticated financial institutions made terrible lending decisions. Banks extended credit without adequate oversight. Companies took on debt they couldn't service. Everyone assumed the boom would continue forever.

The External Shocks

Then the external environment shifted.

In the mid-1990s, the United States Federal Reserve, led by chairman Alan Greenspan, began raising interest rates to prevent inflation as the American economy recovered from recession. Higher US interest rates made American investments more attractive relative to Asian ones. Money that had been flowing into Southeast Asia started flowing back toward the United States instead.

The stronger US dollar created another problem. Remember those currency pegs? When the dollar rose, the pegged Asian currencies rose with it—making their exports more expensive on world markets. Southeast Asian export growth, which had been the engine of the miracle, slowed dramatically in early 1996.

China added to the competitive pressure. Throughout the 1990s, China had been implementing reforms that made it an increasingly formidable exporter. Products that had once been made in Thailand or Indonesia could now be made more cheaply in China. Some economists have debated exactly how much China's rise contributed to the crisis, but it certainly didn't help.

Thailand Breaks

By early 1997, Thailand was hemorrhaging foreign currency reserves trying to defend its peg. Currency speculators—traders who bet on currency movements—began attacking the Thai baht, essentially betting that Thailand couldn't hold the line.

The mechanics of a currency attack are straightforward. Speculators borrow the target currency and immediately sell it for dollars. If the currency collapses, they can buy it back cheaply, repay their loans, and pocket the difference. If the government successfully defends the peg, the speculators lose money on their trades. It's a high-stakes game of chicken between traders and central banks.

Thailand lost.

On July 2nd, 1997, after spending billions of dollars trying to prop up the baht, the Thai government gave up. It allowed the currency to float freely, which meant its value would be determined by market forces rather than government intervention. The baht immediately plunged.

Contagion

What happened next demonstrated the terrifying interconnectedness of modern financial markets.

The Thai collapse triggered a reassessment across the entire region. Investors who had been pouring money into Southeast Asia suddenly wondered: if Thailand's miracle was an illusion, what about Malaysia? Indonesia? South Korea? The same doubts that had destroyed confidence in Thailand began spreading to its neighbors.

Capital fled. Currencies that had been stable for years went into free fall. Stock markets crashed. The crisis jumped from country to country like a virus.

Foreign debt-to-GDP ratios tell the story in stark numbers. In the four largest Southeast Asian economies, this ratio had risen from 100 percent to 167 percent between 1993 and 1996—already concerning territory. During the worst of the crisis, it shot past 180 percent. In South Korea, the ratio went from 13 percent to 21 percent, then all the way to 40 percent.

Think about what that means in human terms. Businesses that had borrowed in dollars now owed vastly more in local currency terms. A company that had borrowed one million dollars when the exchange rate was 25 baht to the dollar suddenly owed 50 baht for every dollar if the exchange rate doubled. Many couldn't pay. Bankruptcies cascaded through the economy.

The Human Cost

The crisis devastated ordinary people across the region.

In Indonesia, the rupiah lost more than 80 percent of its value. Prices for imported goods—including food staples—skyrocketed. Inflation made daily life nearly impossible for millions. Unemployment soared as businesses collapsed.

The political consequences were equally dramatic. Suharto had ruled Indonesia as a dictator for thirty-one years. He had presided over the country's economic development, using prosperity to legitimize his authoritarian rule. When the economy collapsed, so did his political support.

In May 1998, following widespread riots triggered by sharp price increases, Suharto was forced to resign. The man who had seemed immovable for three decades was swept away in weeks.

South Korea and Thailand were also devastated. The Philippines saw growth drop to essentially zero. Even countries that avoided the worst of the crisis—Singapore, Taiwan, mainland China—suffered from reduced regional demand and a general crisis of confidence.

The IMF Rides In

The scale of the collapse demanded an international response. Hundreds of billions of dollars were at stake. Some of the world's most dynamic economies were melting down. There were genuine fears that the crisis could spread beyond Asia and trigger a global recession.

The International Monetary Fund took the lead, organizing a forty billion dollar program to stabilize the currencies of South Korea, Thailand, and Indonesia. The IMF functions something like a lender of last resort for countries—when national governments can't borrow from private markets, they can turn to the IMF for emergency loans.

But IMF money comes with strings attached.

Bitter Medicine

The IMF's conditions, known as structural adjustment packages, required crisis-hit countries to implement painful reforms. They had to cut government spending and reduce deficits. They had to let insolvent banks fail rather than bailing them out. Most controversially, they had to raise interest rates dramatically.

The logic behind high interest rates during a currency crisis goes like this: when a currency is falling, higher interest rates make holding that currency more attractive. Why sell your Thai baht if you can earn 15 or 20 percent interest by keeping it in a Thai bank account? High rates are supposed to stop capital flight and stabilize the exchange rate.

The problem is that high interest rates are poison for a struggling economy. Businesses that might survive a mild recession can't survive when borrowing costs double or triple. Investment freezes. Consumption drops. Unemployment rises. You might stop the currency from falling further, but you do it by strangling the economy.

Critics argued that the IMF had the diagnosis exactly backward. The traditional response to a recession, following the theories of British economist John Maynard Keynes, is to increase government spending, lower interest rates, and stimulate demand. The IMF prescribed the opposite: austerity, tight money, and market discipline.

Some economists pointed out the hypocrisy involved. When the United States itself entered recession in 2001, the government responded with lower interest rates, increased spending, and tax cuts—exactly the expansionary policies the IMF had forbidden Asian countries to pursue. The same thing happened during the American financial crisis of 2008.

The George Soros Question

Amid the chaos, some Asian leaders looked for someone to blame. Malaysian Prime Minister Mahathir Mohamad accused the billionaire investor George Soros and other currency traders of deliberately destroying Asian economies through speculation.

Was he right? The question gets at a fundamental tension in modern financial markets.

Currency speculators like Soros don't create economic imbalances—they exploit them. Thailand's peg was unsustainable regardless of what speculators did. The real estate bubble was going to pop eventually. The hot money was going to flee. Speculators arguably just accelerated a collapse that was coming anyway.

On the other hand, the speed of modern financial markets means that crises unfold much faster than they once did. When capital can move across borders with a few keystrokes, panic can spread in hours. A crisis that might once have unfolded over months or years now happens in weeks. This acceleration makes crises more severe and gives governments less time to respond.

Soros himself claimed he was actually buying the Malaysian ringgit as it fell, not selling it short. But the broader point remains: in a world of mobile capital and interconnected markets, the actions of major investors can have enormous consequences, whether those consequences are intended or not.

The Hong Kong Factor

One often-overlooked aspect of the crisis involves timing. The Thai baht collapsed on July 2nd, 1997—exactly one day after Britain handed Hong Kong back to China.

Throughout the 1990s, Hong Kong had served as a crucial financial hub for investment flowing into Southeast Asia. Foreign money often passed through Hong Kong on its way to Thailand, Indonesia, or Malaysia. When the handover created uncertainty about Hong Kong's future as a financial center, some investors decided to reduce their Asian exposure altogether. They didn't just avoid Hong Kong—they pulled back from the entire region.

This kind of contagion effect is hard to measure precisely, but it illustrates how interconnected modern financial markets have become. Uncertainty in one place creates fear that spreads far beyond its origin.

Lessons and Legacies

The Asian financial crisis eventually subsided. By 1999, the affected economies were beginning to recover, and fears of a global meltdown had receded. But the crisis left deep scars and lasting lessons.

For Asian policymakers, the crisis demonstrated the dangers of currency pegs, excessive reliance on foreign capital, and weak financial regulation. In the years that followed, Asian countries generally adopted more flexible exchange rates, built up larger foreign currency reserves, and implemented stronger oversight of their banking systems. These reforms meant that Asia weathered the global financial crisis of 2008 much better than it had weathered 1997.

For the IMF, the crisis sparked intense debate about whether its standard prescriptions—fiscal austerity and high interest rates—were appropriate for this type of crisis. Critics argued that the Fund's approach turned financial crises into economic depressions, and that countries might have recovered faster with different policies. The IMF eventually modified some of its views, though arguments about the right response to financial crises continue to this day.

For economists and investors, the crisis demonstrated how quickly confidence can evaporate and how violently capital can flee. Countries that seemed stable and prosperous could become basket cases in a matter of weeks. The phrase "Asian economic miracle" suddenly seemed naive, a reminder that no boom lasts forever.

The Echoes Today

The Asian financial crisis remains relevant for anyone trying to understand how financial crises unfold. The basic dynamics—overconfidence during the boom, panic during the bust, the difficulty of containing contagion—appear again and again in different contexts.

When the United States experienced its own financial crisis in 2008, many of the same patterns emerged: excessive leverage, inadequate regulation, assets whose prices had been driven to unsustainable levels, and eventually a panic that threatened to bring down the entire system. The American crisis was centered on housing rather than currency pegs, and the government response was very different from what the IMF had prescribed for Asia. But the underlying human dynamics—greed, fear, the herd behavior of investors—were strikingly similar.

Perhaps the most important lesson of 1997 is about humility. The Asian miracle turned out to be partly real and partly illusion. The economies of Southeast Asia were genuinely growing and developing, but they were also fragile in ways that few people recognized until it was too late. The experts at the IMF and World Bank who had praised the miracle were caught off guard when it collapsed.

Financial crises have a way of revealing truths that were hiding in plain sight. The emperor, it turns out, was wearing fewer clothes than anyone realized. And by the time everyone notices, it's already too late to do much about it.