International Finance

Third edition

by Keith Pilbeam

Chapter 17 - Currency Crises and the East Asian Financial Crisis

Chapter Introduction
The 1990s and early part of this century were characterized by a number of currency and financial crises. The turmoil started with major speculative attacks against the European Monetary System in 1992–93 which led to devaluations of the pound sterling and the Italian lira (see Chapter 16), followed by the Mexican crisis of December 1994; then, starting with the Thai baht devaluation on 2 July 1997, the so called East Asian financial crisis is generally agreed to have started.

The Asian crisis was characterized by major economic and financial turmoil in many of the East Asian economies with large falls in the values of their currencies, stockmarkets and property prices. The crisis continued into 1998, a year in which there were very significant falls in output recovery of those economies in 1999 and 2000 by which time the crisis was largely over. The Asian financial crisis was swiftly followed by other crises such as the Russian default on its debt in August 1998, and the collapse of the hedge fund Long-Term Capital Management in late September 1998. Other noticeable crises have followed: in January 1999 the Brazilian real was forced to devalue and eventually to float, and it quickly depreciated a further 35%; in January 2001 there was a major banking crisis in Turkey leading to the floating of the Turkish lira; and, more spectacularly, in December 2001 Argentina declared a default on its external debt and had to abandon its currency board on 7 January 2002 with a devaluation from 1 peso to 1.4 pesos, swiftly followed by a dramatic fall in the Argentinian peso to a low of 3.75 pesos per dollar by the end of October 2002.

These periodic crises have stimulated a great deal of theoretical and empirical literature that looks at the causes of currency and financial crises, and in this chapter we look at some of the theoretical models that have been developed to analyse such crises. In particular, we look at what have been termed first, second and third-generation models of currency crises, explaining some of their basic features and differences. We also briefly mention some of the other models that have been developed. We then concentrate on the causes and details surrounding the East Asian financial crisis which was one of the most significant events to confront the international financial community in the last 40 years. We focus attention on eight of the countries most directly involved in the crisis, namely Hong Kong, Indonesia, Philippines, South Korea, Singapore, Malaysia, Taiwan and Thailand, and as such exclude any detailed analysis of other countries affected by the crisis such as China and India. A great deal of money can be made by predicting crises in advance of them happening, and early warning of such crises may help policy-makers avert them; we conclude the chapter by looking at some of the recent literature that attempts to find what economic and financial indicators may be useful to predict currency and financial crises.