Ten years since Asian financial crisis

This week’s Fund Strategy included a world markets review with a comment by me on the 10th anniversary of the Asian financial crisis.

Ten years after the outbreak of the 1997-8 Asian financial crisis it is worth re-examining what happened. Many commentators have forgotten how wrong they were about the event and its implications.

The crisis started in July 1997 with the collapse of the Thai baht. Currencies and stockmarkets tumbled across the region including Hong Kong, Indonesia, Malaysia, the Philippines, South Korea and Taiwan. There were also widespread fears that instability would spread to the global markets. The near collapse of Long-Term Capital Management, a prominent hedge fund, in the summer of 1998 seemed to confirm such fears.

The conclusions drawn from this experience include the need for greater “transparency” and more robust financial systems. Asian countries have accumulated vast foreign exchange reserves to cushion themselves against currency volatility.

But a vast amount of what was commonly argued at the time has been conveniently forgotten. For example, many experts argued that “Asian flu” or “Asian contagion” would damage the developed Western markets and economies. There was also a widespread view that “crony capitalism” had undermined the rapid economic growth of Asia.

It is clear that these arguments were flawed. The Asian markets, still relatively small in global terms, were always unlikely to destabilise the developed markets. The probability of a significant negative impact on the real economies of the developed world was even more remote.

To the extent that there was short-term market volatility in the West it was a result more of panic than contagion. There was an over-reaction to the likelihood of instability spreading to the developed world.

In fact Western risk aversion played an important role in precipitating the crisis. Western capital that had flowed into the region to take advantage of high growth was quickly withdrawn at the first sign of trouble.

The idea of “crony capitalism” was also flawed. Prior to 1997 many commentators had argued that the Asian “developmental state” had played a key role in promoting the region’s rapid development. In 1997-8 the same institutions were often blamed for Asia’s troubles. Any explanation which is used to account for both success and failure should be viewed with scepticism.

In many ways the key lesson to learn from 1997-8 is the continuing economic dynamism of East Asia. It has recovered rapidly from what was seen by many as likely to be a protracted downturn. From this perspective the lesson to draw is a positive one.