Ludwig von Mises Institute

1997 Asian Financial Crisis

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The 1997 Asian Crisis originated in Thailand and spread throughout Southeast Asia — the Malaysian ringgit, Singapore dollar, Philippine peso, Taiwan dollar, and Indonesian rupiah all declined. The Asian Crisis sent ripples across financial markets all over the world.[1]


The Plaza Accord of 1985 had improved the profitability of U.S. manufacturing, as the G-5 powers agreed to subsidize U.S. exporters by artificially lowering the exchange rate of the U.S. dollar. (The Plaza Accord and the accompanying monetary expansion in Japan was the beginning of that country’s own Austrian-style boom and bust.) The American economy had come out of the recession of 1990–1991 in fair shape, with some of the misallocations of the 1980s boom having been corrected.

Japanese manufacturing firms were faltering in 1995. By April 1995, the yen had reached an all-time high of 79 to the dollar. With the currency at such a pinnacle, Japanese producers could not even cover their variable costs. Many Japanese banks were facing insolvency. The U.S. had just gone through the Mexican bailout, and authorities were not enthusiastic about having to face a similar bailout scaled up to the size of the Japanese economy.

The "Reverse Plaza Accord" of 1995 was an important factor in creating the late nineties boom: By that agreement, the big three powers [the U.S., Japan, and Germany] bailed out a Japanese manufacturing economy that was slowing to a halt under the pressure of the record-breaking ascent of the yen. They did so by engineering a reversal of the steep decline of the exchange rate of the dollar that had taken place over the previous decade.

The Reverse Plaza Accord was, in effect, an agreement that the U.S., German, and Japanese governments would subsidize American consumers’ purchases of Japanese and German manufactured goods. The reversal of the exchange rate trend "was to be accomplished by lowering Japanese interest rates with respect to those in the U.S., but also by substantially enlarging Japanese purchases of dollar-denominated instruments such as Treasury bonds, as well as purchases of dollars by Germany and the U.S. government itself."

Driving the dollar up against foreign currencies would allow the U.S. government to maintain a stance of monetary ease without raising the CPI, since the artificially lowered price of imported goods would tend to counter the price-raising effect of the increased liquidity.

But liquidity has to go somewhere. One place it went was into the U.S. stock market. Another was into the asset markets of the East Asian countries whose currencies were tied to the dollar. The perverse effect of the flows was that, even as the manufacturing profitability of American and East Asian producers was undermined by the rising cost (in the yen and in various European currencies) of both their imported capital goods and their exported output, American and East Asian asset prices were given a further impetus upwards, as Japanese and European investors earned profits from both exchange rate movements and the rise of the American and East Asian stock markets in terms of the native currencies of those markets.

A significant portion of the enormous increase in liquidity worldwide, originating primarily from the American and Japanese central banks, had flowed into investments in that region. Between 1990 and 1995, 74.5 percent of capital flows to less developed countries went to East Asia. Governments there, operating on the mercantilist Japanese model of development, subsidized a rapid industrial buildup, often channeled into certain "strategic industries" such as high tech manufacturing. Because they partially funded the subsidies by borrowing in dollars, they were reluctant to loosen their pegs, as the cost of paying back dollar loans would increase in terms of the local currency.

However, between April 1995 and April 1997, the yen fell by 60 percent with respect to the dollar. If East Asian governments wished to maintain their peg to the dollar, they had to let their currencies rise against the yen as well. But that led to a steady rise in the price of their exports compared to those of their Japanese competitors. The East Asian countries had committed to the U.S. policy of subsidizing German and Japanese manufacturers and their own consumers at the expense of their own manufacturers. However, with smaller economies, manufacturing bases already distorted through extensive subsidies, and without being able to print the world’s reserve currency at will, East Asian governments lacked the ability to sustain such a policy as long as their American counterpart.[2]

Boom in East Asia[edit]

The Pacific Rim countries such as Hong Kong, Malaysia, Singapore, Vietnam, and South Korea experienced significant economic growth during the 1980s and 1990s.

With the region's leading economy, Japan, in recession and stagnation for much of the 1990s, the "Asian Tigers" were considered miracle economies because they were strong and durable despite being small and vulnerable. The Petronas Towers were completed in Kuala Lumpur, Malaysia in 1997 setting a new record for the world's tallest building at 1,483 feet beating the old record by 33 feet. It marked the beginning of the extreme drop in Malaysia's stock market, rapid depreciation of its currency, and widespread social unrest. Financial and economic problems spread to economies throughout the region, a phenomenon known as the "Asian Contagion."[3]


Prior to the Asian Crisis, Thailand had a pegged exchange rate tied to the dollar. The Thai baht became weaker in the marketplace and investors exchanged the baht for dollars. The Thai central bank spent more than $20 billion trying to maintain its pegged rate but ultimately had to lift it. Quite simply, the supply of baht exceeded the market’s demand for it and the government’s intervention only delayed and exacerbated the crisis. Over a five-week period, the Thai baht lost more than 20 percent against the dollar. Other Southeast Asian countries also had to surrender their fixed exchange rates.[1]

Corporate profits declined throughout East Asia. In South Korea, for instance, they fell 75 percent in 1996, and went negative in 1997 and 1998. With speculators sensing that East Asian governments could not maintain their pegs in the face of slumping exports, those governments raised interest rates in an attempt to hold the peg. Speculators made repeated runs on East Asian currencies, and capital began to flow out of the region: "Over the course of 1997, East Asia suffered a net decline in capital inflows of $105 billion (from $93 billion inflow to $12 billion outflow).

When, one by one, the East Asian governments finally surrendered their pegs, the value of their countries’ dollar debt rose dramatically in terms of the local currency. The crisis in East Asia steadily worsened. Throughout much of 1998, stock markets continued to fall and, as money flooded out of the region, currencies swooned, placing great pressure on the rest of the world economy.

The crisis spread to Russia in the summer of 1998, when it defaulted on its sovereign debt, much of which was held by U.S. investment banks. The Brazilian economy started to melt down shortly thereafter. And Japan labored under a "hefty new value-added tax," which, along with other factors, "subtracted . . . the equivalent of 2 per cent of GDP".[2]


  1. 1.0 1.1 Christopher Mayer. "The Failure of Fixed Rates", The Free Market, Volume 24, Number 1, January 2004. Also published here. Referenced 2011-06-29.
  2. 2.0 2.1 Gene Callahan and Roger W. Garrison. "Does Austrian Business Cycle Theory Help Explain the Dot-Com Boom and Bust?" (pdf), The Quarterly Journal of Austrian Economics, Vol. 6, No. 2 (Summer 2003). Referenced 2011-06-29.
  3. Mark Thornton. "Skyscrapers and Business Cycles", Mises Daily, August 23, 2008. Referenced 2011-06-29.


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