Asia generally refers to the region bounded by Japan to the east， Siberia to the north， Indonesia to the south， and Turkey and Saudi Arabia to the west， an area containing one-half of the world's population. East Asia， as we use the term， includes China， NIEs¹ (Korea， Taiwan， Hong Kong， Singapore)， and ASEAN 4² (Philippines， Thailand， Malaysia， and Indonesia).³

East Asia has gained worldwide acclaim in recent years due to the region's sustained high economic growth rate over the past several decades. This growth was led by NIEs in the 1960s， ASEAN in the 1980s， and countries such as Vietnam in the 1990s. Interest in this success story culminated in a World Bank report in 1993 entitled， "The East Asian Miracle."⁴

Nowadays， however， the World Bank is asking， "Is the East Asian 'Miracle' Over?" The unexpected financial crisis has shaken confidence in some quarters regarding East Asia's ability to maintain its high economic growth going forward.

Asia's currency crisis， which has rocked the world economy since July 1997， continues to fester throughout the region， leaving the outlook for East Asian economies obscure. In this paper， we look at the causes behind the recent currency problems and how the situation grew out of hand.

(1) Slower Growth

Although the crisis emerged in July 1997， signs of trouble had appeared earlier. Doubts over the "East Asian Miracle" began growing around 1996， when the region's export growth showed signs of sluggishness， and economic growth rates declined as a result.

However， the general consensus at that time seemed to be that the Asian economy was taking a pause， and would resume its strong growth in a few years.

The reasoning behind this view was as follows: Since exports have supported East Asia's rapid growth over the medium to long term， the recent sluggishness in export growth has seriously impacted the East Asian economy. However， entering 1996， slower export growth was caused mainly by external factors such as the global semiconductor market slump and strong dollar/weak yen. Since East Asia's export competitiveness remains sound， exports are sure to recover when the external environment changes.

But the currency crisis struck in July 1997 before any major changes had occurred in the external environment.

Put simply， the Asian currency crisis refers to a sharp decline in East Asian currencies (of course， not all currencies fell， nor by the same amount) from July 1997， when they became unable to withstand devaluation pressures and floating rates and other measures were implemented.

A rapid currency devaluation can affect the real economy through both direct and indirect routes. For instance， large interest rate hikes and other excessive measures to protect the currency have a negative impact on the real economy， and may lead to economic turmoil. In addition， if the IMF⁵ is called in to protect the currency from insufficient external liquidity， the austerity measures imposed by the IMF will slow down the economy in the short term. (Indeed， a weak currency makes exports more competitive and thus helps export to recover. In this sense， East Asian exports have the opportunity to recover without waiting for changes in the external environment.)

(2) Causes of the Currency Crisis

In addition to the external factors mentioned above， East Asian economies were also being gradually weakened by structural factors.

While there are minor differences in each country， the structural factors include: (1) high real effective exchange rates， (2) financial crisis from the collapse of a financial bubble driven by foreign capital inflows， (3) catching up of low-wage countries China and Vietnam， and (4) large current account deficits caused by the above factors.

The most important of these is the high real effective exchange rates， which reduce the price competitiveness of exports. This rate is a trade-weighted average of the Nominal exchange rate (per unit of own currency) x Price index of own country / Price index of trading partner. A rising index (base year = 100) indicates a higher real effective exchange rate and hence lower export price competitiveness. From 1995 until the currency crisis erupted， the real effective exchange rates of most East Asian currencies were rising.

While each country varies， the factors behind the high real effective exchange rates were: (1) the U.S. dollar's surge against the yen and DM from 1995， since most East Asian currencies are closely linked to the dollar， (2) higher inflation rates in East Asian countries compared to the trading countries Japan， the U.S. and Europe (and China， where the inflation rate declined from 1995)， and (3) China's renmimbi devaluation in 1994.

(3) Significance of the Currency Crisis

From this perspective， the Asian currency crisis represents a correction of high real effective exchange rates. Given the external and structural factors mentioned above， exchange rates underwent a process of correction to provide symptomatic relief in a situation where all other structural factors were invariable. The sense of crisis stemmed from the rapidity of the decline.

In addition， the currency crisis consists of two aspects−adjustments with non-regional currencies， and within the region (especially between China and the ASEAN 4). From 1995 to the currency crisis， real effective exchange rates rose comparatively higher among the ASEAN 4， Hong Kong， and Singapore due in part to China's renmimbi devaluation and lower inflation rate.

Since July 1997， the decline and continued selling pressure among East Asian currencies has been greatest among the ASEAN 4， Hong Kong， and Korea (Singapore and Taiwan currencies fell but not as much as the ASEAN 4). The sharp devaluation of the Korean won cannot be characterized as a correction of the real effective exchange rate， since this rate was not especially high to begin with. However， downward pressure on the won， already present due to large current deficits， was exacerbated by the Asian currency crisis， and finally released by the domestic financial crisis. In this sense， Korea should be considered part of the Asian currency crisis.

While China is generally not considered to be a part of the Asian currency crisis， it is nonetheless significantly affected， as we will explain later.

Below we look more closely at how the Asian currency crisis erupted and expanded.

(1) The Sharp Baht Devaluation

The Asian currency crisis began with the sharp fall of the Thai baht. From May 1997， the baht came under strong selling pressure， which monetary authorities responded to with market intervention. However on July 2， as concern grew that further defense of the baht would harm the real domestic economy， Thailand shifted from a currency basket to a managed float， which in effect was a variable rate system. This move effectively devalued the currency. Three factors in the background were the financial turmoil following the collapse of Thailand's financial bubble， high real effective exchange rate， and large current account deficits resulting from the above two.

(2) Spread Throughout Southeast Asia

From July to August， the baht's fall impacted other Southeast Asian currencies struggling with current account deficits (Indonesian rupiah， Philippine peso and Malaysian dollar; the Korean won was still steady). As more foreign funds began flowing out of Southeast Asia (we refer to the ASEAN 4 here and below)， the decline in Southeast Asian stock markets， soft since July， accelerated in August.

With all Southeast Asian currencies falling， on August 14， Indonesia shifted to a full floating rate system amid concerns that continued defense of the rupiah would harm the domestic real economy.

On August 20， the IMF responded to the Thai government's request to help avoid a liquidity crisis by officially approving a loan package.⁶ The conditions for the IMF loan were: (1) reduce the ratio of current deficit to GDP to 3 percent in 1998， (2) impose fiscal and monetary tightening， and (3) restore confidence in the financial system. The loan package later reached $17.2 billion (as of late August).

(3) Plunge of the Indonesian Rupiah

After the Thai loan package was approved， the decline in Southeast Asia's currencies and stock markets stabilized somewhat. However， from late September the Indonesian rupiah began falling more rapidly against a backdrop of lower domestic interest rates and forest fire damage.

The plunging rupiah and murky economic outlook caused Indonesia's stock market to fall. In addition， currencies and stock markets of other Southeast Asian and NIEs countries also turned downward. The sharp drop in Hong Kong's stock market on October 23 caused stock markets to decline further.

To prevent a liquidity crisis， the Indonesian government turned to the IMF， who announced a loan package on October 31. The conditions for the package were: (1) imposing fiscal and monetary tightening， (2) restoring the strength of financial institutions， and (3) increasing competition through deregulation and privatization. The loan package grew significantly larger than initial predictions， reaching $30 billion as of early November.

(4) Mounting Downward Pressure on the Hong Kong Dollar

Meanwhile， the plunge in Hong Kong's Hang Seng index⁷ on October 23 pulled global stock markets downward in sympathy. The main factor behind the plunge was the market intervention by Hong Kong monetary authorities to defend the currency from rising selling pressure since July (and maintain the dollar peg⁸)， causing interest rates to rise. The stock market also underwent a correction following the euphoric rise over the handover of Hong Kong (in anticipation of closer economic ties with the mainland and growth).

The strong selling pressure on the HK dollar stems not only from the ripple effect of the Asian currency crisis but also from the structural factor of a high real effective exchange rate.

Entering the 1990s， China's currency devaluation and other factors caused the HK dollar's real effective exchange rate to rise. Since 1995， the HK dollar has continued to rise due to: (1) the strong dollar/weak yen and DM， and (2) declining inflation rate in China. From July 1997， while the yen and East Asian currencies were falling， the HK dollar rose against these currencies. Even so， Hong Kong monetary authorities and China have， since before the return of Hong Kong， regarded the dollar peg as the basis of Hong Kong's economic development and stability， and have repeatedly emphasized their willingness and ability to maintain the peg system.

However， maintaining the dollar peg puts a premium on the HK dollar， which hurts the trade balance， brings strong selling pressure on the HK dollar， and leads to turmoil in financial markets. In addition， the HK dollar also risks being influenced by China's currency. Since July 1997， the Chinese renmimbi has risen against other East Asian currencies and the yen， raising the possibility that China may devalue the renmimbi to maintain trade competitiveness. (In this sense， China has been greatly affected by the Asian currency crisis.)

Thus while monetary authorities will essentially strive to preserve the peg system， there is still the possibility for a devaluation or switch to a floating rate system if the situation gets out of hand due to: (1) concentrated selling of the HK dollar， (2) increasing concern that defense of the HK dollar will lead to higher interest rates， which would hurt the economy by rocking the stock and real estate markets， and (3) a worsening trade balance.

(5) The Korean Won Plunges

Since late October， Korea's currency and stock markets have plunged due to a financial crisis triggered by a series of large business failures during the year.

After Indonesia's IMF loan package came out， other East Asian and NIEs currencies rose temporarily until early November， but turned downward again fueled by concern that the Asian currency crisis would hurt their economies.

After the Hang Seng plunged in late October， stock markets in East Asia and the NIEs rose temporarily until early November as the New York Dow recovered and currencies rose. But stock markets in Southeast Asia and Korea then turned downward as their currencies fell.

Due to Korea's credit downgrading from the massive problem loans， financial institutions who had difficulty buying dollars began selling won to buy dollar assets. Moreover， the Bank of Korea， low in foreign reserves， decided against market intervention. As a result， the won's depreciation began to accelerate， the capital exodus continued， and the stock market plunged.

On November 19， with financial markets in crisis， the Korean government announced a financial stabilization plan that included the use of public funds for the early disposal of non-performing loans.⁹ However， both the won and stock market continued to fall because the plan was ineffective in alleviating the dollar funds shortage that persisted through December.

Amid concern of a further capital exodus， on November 21 the government sought relief from the IMF to preempt a financial crisis， and on December 5 an agreement was announced on a loan package (which totaled $57 billion as of early December). The conditions imposed by the IMF for the loans were: (1) economic growth of approximately 3 percent and inflation held within 5 percent for 1998， (2) a current account deficit to GDP ratio no greater than 1 percent for 1998 and 1999， and (3) fiscal and monetary tightening， consolidation of financial institutions， greater transparency in corporate management， market opening measures， etc.

(6) From Korea to East Asia

Southeast Asian currencies remained weak going into December. But the Malaysian dollar rebounded on December 5 when Malaysia announced an emergency economic package， and other currencies rose as well.¹⁰

Stock markets in Southeast Asia and the NIEs recovered slightly in early December in response to policy announcements by Malaysia and other countries， the strong New York stock market， and Korea's IMF agreement.

Later， however， with Korea unable to brush off the financial crisis including dollar shortages at financial institutions， both the won and stock market continued to decline. In Southeast Asian countries， the demand for dollars was increasing toward the end of the year as companies sought to repay dollar loans. Thus the weak won caused Southeast Asian and NIEs currencies and stock markets to turn downward as well. Indonesia's rupiah was hit particularly hard， owing in part to concern over the deteriorating health of President Suharto.

On December 16， Korea converted to a fully floating exchange rate system by abandoning the 10 percent daily limit on exchange rate fluctuations. East Asian currencies and stock markets have since remained unstable (as of December 1997).

Some observers warn that the present Asian currency crisis may develop into a global financial panic similar to the 1930s.

The global financial panic of the 1930s， which began with the 1929 New York stock market crash and lasted until 1933， can be divided into two phases−1929 to 1931， and 1931 to 1933. The apparent similarity with today's Asian currency crisis lies in the second phase， when an Austrian bank failure in 1931 had global repercussions. By financial panic， we mean a situation where troubled or failing banks and a currency crisis trigger a financial crisis that escalates into panic.

(1)　Financial Panic of 1931-33

While the world was still reeling from the New York stock market crash， a single bank failure in Austria started a chain reaction throughout Europe and the U.S. The effects of the panic later became one of the causes of World War II.

As the panic spread， the flow of U.S. capital into Europe reversed course. This was a severe blow to the European economy， whose recovery after World War I depended heavily on U.S. capital and U.S. leadership on the issue of war reparations.

(2)　Lessons of the Financial Panic

Two lessons can be learned from the financial panic. First， the austerity policies that governments adopted to maintain the international gold standard actually fueled the panic. Second， the panic gave rise to a strong protectionist sentiment and the formation of economic blocs(exclusive economic areas linking countries to their colonial possessions)， creating conditions favorable to the rise of totalitarianism in Germany and Japan. Hitler's rise to power in 1933 and Japan's "May 15" incident of 1932 set the world on a path to war.

Today， while weak currencies may help East Asia's trade competitiveness and exports， the damaged domestic economies and implementation of IMF austerity programs point to an inevitable slowdown in the region in the near term.

While similarities can be drawn between the austerity policies being implemented today and in the 1930s in response to financial crises， there are major differences between the two cases.

First， since the IMF support is aimed at preventing a liquidity crisis， some of the economic turmoil accompanying the currency and financial crises can be avoided. In this sense， the role of the IMF in stabilizing the Asian currency crisis is an important one. Second， the austerity measures imposed by the IMF are being combined with market opening measures， deregulation， privatization， and other liberalization reforms. And third， countries are shifting to floating rate systems at a relatively early stage.

Considering these differences， it is highly unlikely that global panic or protectionism will occur in the near future. Looking further ahead， whether East Asia will resume its high rate of sustainable growth will depend on each country's progress in implementing the necessary structural reforms.

1. NIEs refers to the newly industrializing economies in Asia−Korea， Taiwan， Hong Kong， and Singapore. However， recently the IMF has begun referring to these four nations as newly industrialized Asian economies.

    

2. ASEAN is the Association of Southeast Asian Nations. When formed in 1967， it consisted of five countries−Indonesia， Singapore， Thailand， Philippines， and Malaysia. Four more countries have since joined-Brunei Vietnam， Myanmar， and Laos. The ASEAN 4 refers to the Philippines， Thailand， Malaysia， and Indonesia.

    

3. Japan is sometimes included in East Asia， but not in this paper.

    

4. The World Bank's definition of East Asia differs slightly from that used in this paper.

    

5. IMF refers to the International Monetary Fund， formed in 1945 to maintain exchange rate stability and otherwise support the international monetary system.

    

6. IMF nations can request loans from the IMF in case of foreign currency shortages due to a balance of payments deficit or other reason. One of the primary objectives is to prevent foreign currency shortages in one country from triggering an international financial crisis. The loans entail certain conditions such as the implementation of austerity program. Although the loan package has a ceiling consistent with the country's investment in the IMF， the amount may be increased if a financial crisis is imminent.

    

7. The Hang Seng index is Hong Kong's main stock index. Due to the peg system， it has a strong tendency to move with the New York Dow index.

    

8. The Hong Kong currency， which had been tied to the British pound since World War II， was tied to the U.S. dollar in 1972 when the U.K. switched to a floating rate system. Although Hong Kong switched to a floating rate system in 1974， following a period of instability in 1983 that saw the HK dollar plunge， it was switched to a peg system in which US$1 = HK$7.8， and has remained unchanged to the present.

    

9. Korea's financial stabilization plan includes: (1) increasing the non-performing asset management fund to 10 trillion won， and (2) contributing 7.5 trillion won in government-owned shares to realign and consolidate troubled financial institutions.

    

10. The Malaysian government's emergency economic measures included: (1) reducing federal government expenditures in the fiscal 1998 budget， and (2) postponing more large-scale projects.