The Asian financial crisis of 1997: how the baht's collapse spread across a region

On 2 July 1997, Thailand stopped defending its currency's link to the US dollar and let the baht float. It fell sharply, and within months currencies across East and Southeast Asia were under attack. The Asian financial crisis became one of the defining currency crises of the late 20th century.

The build-up

Through the early and mid-1990s, much of East Asia grew quickly. Many countries kept their currencies closely tied to the dollar, which encouraged companies and banks to borrow in dollars at lower interest rates than at home. Federal Reserve History's account highlights the vulnerabilities this created:

• rapid growth in domestic credit, with weak supervision of lenders
• a build-up of leverage and doubtful loans, including in overheated property markets
• widening current account deficits
• heavy short-term foreign borrowing, which left borrowers exposed if the currency fell

How the pegs broke

Once investors doubted a peg could hold, selling the currency became close to a one-way bet: if the peg held, sellers lost little; if it broke, they gained a lot. After the baht fell, markets looked for similar weaknesses elsewhere, and pressure spread to countries including Indonesia, Malaysia, the Philippines and South Korea. Hong Kong's currency board also came under attack, but its link to the dollar held.

A falling currency made dollar debts far more expensive to repay in local money, so the currency crisis quickly became a banking and corporate debt crisis.

The response

The international community mobilised about $118 billion in loans for Thailand, Indonesia and South Korea, in programmes led by the International Monetary Fund. The programmes came with conditions, including tighter policy and restructuring of financial systems, which remain debated. Malaysia took a different path and imposed capital controls in 1998.

Lessons for currency traders

• Pegs fail when defending them costs too much, a pattern repeated from Black Wednesday to 1997.
• Contagion is real. Markets punish countries that look like the one in trouble, even when their situation differs.
• Foreign-currency debt amplifies moves. A weaker currency hurts borrowers with dollar debts, which can weaken the economy and the currency further (trade balance and current account).
• Exotic pairs can gap. Emerging market currencies still see sudden, large moves, and brokers typically widen spreads and raise margin requirements on them (major, minor and exotic pairs).