Is Asian crisis a repeat of the past?

This column was first published yesterday in Fund Strategy.

What lessons, if any, does the Asian financial crisis of 1997-98 provide for the present turmoil in the region? Both cases involved falling local currencies and capital flight as investor confidence evaporated but it is not immediately apparent if the similarities go any further.

Nor is it clear what the present crisis heralds for the future. Perhaps it is another bout of volatility, soon to be forgotten, or it could be the harbinger of something more serious.

Probably the best starting point is to look back to the crisis of 1997-98. Given that it was 15 years ago many probably do not remember what happened back then and even at the time there was much confusion.

The starting point for the Asian financial crisis is often put at mid-1997 when the Thai baht came under sustained speculative attack. Eventually the Thai government had to agree to break its currency peg with the dollar and let the baht float freely. The Thai currency rapidly lost much of its value.

Other currencies across the region subsequently suffered in what became known as the “Asian contagion” and the “Asian flu”. The metaphor of a spreading disease was popular at the time with the value of the Indonesian rupiah, Malaysian ringgit, Philippine peso and South Korean won all plummeting. The region also saw falling markets, harsh austerity and surging unemployment.

Back then there was widespread concern, particularly after the collapse of the Long-Term Capital Management (LTCM) hedge fund in September 1998, that the contagion would infect the western economies. America’s President Bill Clinton warned that the world was facing its biggest financial crisis in a half-century. George Soros, a prominent hedge fund manager, warned that the global capitalist system was “coming apart at the seams”.

On the face of it then there are some similarities between the early stages of the crisis in 1997 and recent events. Although currency turmoil, most notably in India and Indonesia, is not as dramatic as it was the first time around it could still be taken as a sign of trouble ahead.

This time confidence has also fallen although the blame tends to be placed on the discussion of “tapering” by America’s Federal Reserve. In the uncertain climate it is feared that, as happened in 1997, speculative investments from abroad could head back to the West.

However, a closer look at the current situation shows that it is more serious than the earlier crisis. Indeed it is possible to argue – as I did at the time – that the importance of the 1997-98 crisis was exaggerated. This is particularly clear if the economic backdrop to the financial volatility is considered. Although the turmoil was no doubt painful for the Asian countries involved they were strong enough to power their way to recovery fairly quickly.

In addition, the idea that the West faced an almost existential economic threat back then was overdone. Although the western markets suffered significant volatility the idea that the economy faced collapse was fanciful.

There are three key reasons why things are potentially much more serious this time around. First, the Asian countries most affected are the core economies of the region. Although Indonesia and South Korea, both affected last time around, are important this time around the stakes are bigger. India is facing stalled growth and a large current account deficit while Indonesia is suffering once again. In addition, the Chinese economy, although not caught up in the currency turmoil, has slowed appreciably.

Second, developing Asia has become a much more important part of the world economy. Its share of global output has roughly doubled since 1997. Although there is room to debate whether this is best measure for judging Asia’s significance there is no doubt that it has more weight in than it did back then.

Finally, and most important, the western economies are in a much worse state than they were 15 years ago. Not that all was well in 1997-98. Indeed one reason that Asia was so vulnerable to capital flight was that a lot of money had initially fled the West in search of better returns in Asia.

This time around, in contrast, the West has been caught in the economic mire since 2007-08. Even in America, which arguably is the strongest of the large developed economies, the recovery path is weak. Despite glimmers of a possible improvement the eurozone and Britain are both on the brink of economic stagnation.

Hopes that the strength of the developed West will help compensate for Asian weakness are likely to prove forlorn. From a global perspective the West is already weak and the emerging world is weakening.

Overall then the picture looks much more difficult than it did in 1997-98. It may be that volatility turns out to be lower than back then – although that remains an open question – but the sources of global growth seem to be diminishing. In particular, China looks less able to act at the locomotive of the global economy and America does not seem nearly vibrant enough to replace it.