During the second half of 1997, and beginning in Thailand, currencies and stock markets plunged across East Asia, while hundreds of banks, builders, and manufacturers went bankrupt. The Thai baht, Indonesian rupiah, Malaysian ringgit, Philippine peso, and nouth Korean won depreciated by 40% to 80% apiece. All this happened despite the fact that Asia’s fundamentals looked good: low inflation, balanced budgets, well-run central banks, high domestic savings, strong export industries, a large and growing middle class, a vibrant entrepreneurial class, and industrious, well-trained, and often well-educated workforces paid relatively low wages. But investors were looking past these positives to signs of impending trouble. What they saw was that many East Asian economies were locked on a course that was unsustainable, characterized by large trade deficits, huge short-term foreign debts, overvalued currencies, and financial systems that were rotten at their core. Each of these ingredients played a role in the crisis and its spread from one country to another.
Loss of Export Competitiveness. To begin, most East Asian countries depend on exports as their engines of growth and development. Along with Japan, the United States is the most important market for these exports. Partly because of this, many of them had tied their currencies to the dollar. This tie served them well until 1995, promoting low inflation and currency stability. It also boosted exports at the expense of Japan as the dollar fell against the yen, forcing Japanese companies to shift production to East Asia to cope with the strong yen. Currency stability also led East Asian banks and companies to finance themselves with dollars, yen, and Deutsche marks—some $275 billion worth, much of it short term—because dollar and other foreign currency loans carried lower interest rates than did their domestic currencies. The party ended in 1995, when the dollar began recovering against the yen and other currencies....
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