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December 21, 2011

What the 1998 Crisis and the 2008 Financial Crisis Have in Common



In 1997-98, Asia faced a currency and financial crisis. There were several different mechanisms involved, however, the end result was the fleeting of capital from most of the continent. In 1997, Thailand started having issues with its foreign exchange rate. The Thais practiced a fixed currency which required them to intervene in the foreign exchange marketplace if there was fluctuations in the currency. Thailand's constant intervention of its currency were causing strains on its reserves and in May 1997, they needed the help of Singapore to complete an exchange rate intervention.

On July 2, 1997, Thailand ran out of reserves. As a result, they had to let their currency float, which caused it to devalue by 20% overnight. In addition to this, banks in Asia had been exposed to lax lending practices and even worse, governments were encouraging and backing the financing of unprofitable real estate ventures (sound familiar?).

One of the differences between the '98 crisis and the '08 crisis is that the epicenter of the '98 crisis involved countries that fixed their exchange rates. The results of the Thailand devaluation was a wave of foreign exchange interventions and devaluations. In addition, financial institutions across Asia went bankrupt due to the lax lending policies.

To make matters worse, as the smaller countries devalued their currencies, the larger countries in Asia raised lending standards exponentially. In Hong Kong, the stock exchange and currency began to plummet together. Then, late in 1997, the crisis reached South Korea, the regions second largest economy.

As the currencies devalued, so did the values on finance companies' balance sheets. This further propagated the crisis. Eventually, the fears began to weigh on all global stock markets, including the United States where the Dow Jones lost over 500 points in one trading session. The IMF intervened and lent over $40 billion to Indonesia, and made similar to loans to Thailand and other countries in exchange for a tightening in lending policies and capital requirements.

By November, South Korea requested IMF aid as several Japanese brokerages began to strain and collapse. By the end of 1997, Russia started to have problems and the South Koreans needed IMF aid in order to make good on their short term government debt. On January 12, 1998, Asia's largest investment bank filed for liquidation bankruptcy.

South Korea eventually had to renegotiate some of its debts, and things in Indonesia became much worse. By the spring of 1998, the IMF had delayed aid because the government had failed to hold up its end of the austerity deal. When Indonesia cut enough to receive aid, protests flared in the country to the point that college students were shot and killed at Jakarta University and the President was forced to resign in May 1998.

By June of 1998, Japan had slipped into recession and Russia began seeing economic disruptions. By the next month, Russia had failed to secure the cash it needed (including trying to sell state owned assets) and ended up needing a loan from the IMF. By fall of '98, the bailouts spread the South America as the crisis goes global.

All of this started in Thailand and spread around the world in roughly 15 months.

Much of this should not only sound familiar to those who experienced the 2008 financial crisis, but those in Europe experiencing the 2011 European financial crisis. The Indonesian riots remind me of an amplified version of Greece, although the Greece austerity measures haven't reached their full potential yet.

The scary part about all of this is that if Thailand can trigger such a global event, what would happen if Greece or Italy default on their debts. Italy is larger than Russia was when it defaulted in 1998 and many analysts aren't sure if loans from the IMF (like in Russia) can stabilize the fiscal and economic situation.

Judging by the 1998 financial crisis, the 2008 financial crisis, and now the 2011 financial crisis, the world hasn't learned a single lesson.



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