Asian Financial Crisis and the International Monetary System

The International Monetary System: Structure and Origins

The international monetary system (IMS) is a structure of rules and principles that manages international finance. It carries major distributive consequences for the authority and well-being of states in the international system. The IMS does not maintain a neutral status, either economically or politically, and deals with three core technical issues: the liquidity of money supply to fund business and monetary assets; the fine-tuning of appropriate short-term imbalances; and the restoration of trust in national currencies to avert damaging swings in exchange rates.

The gold standard was the foremost modern global monetary system. In force during the late nineteenth and early twentieth centuries, it provided for the free movement of gold coins of standard specification among countries. Within the system, gold was the sole standard of value. In the decades after World War II, international trade was conducted according to the gold standard's logic, but in a modified form: countries determined the value of their currencies not directly in relation to gold, but in relation to a foreign currency — the U.S. dollar — that was itself linked to and exchangeable for gold. Most countries fixed their currencies to the dollar and maintained dollar reserves in the United States, which became known as the "key currency nation."

The United Nations Monetary and Financial Conference held July 1–22, 1944, at Bretton Woods, New Hampshire — commonly called the Bretton Woods System — gave birth to the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (now the World Bank). By December 1945, the requisite number of governments had ratified the agreement, and both organizations began functioning by the summer of 1946. Bretton Woods established a system of managed exchange rates designed to enable unhindered flows of trade and commerce.

During the 1960s, U.S. overseas commitments drew down the country's gold reserves, undermining confidence in the dollar. Some countries holding dollar reserves, along with currency speculators, began seeking to exchange their dollars for gold. U.S. gold reserves fell sharply, and as a remedy, the so-called two-tier structure was introduced in 1968. The eventual abandonment of the Bretton Woods and gold standards signaled that currency values would henceforth be determined by market forces.

During the later decades of the twentieth century, Japan's yen and Germany's Deutschmark grew progressively more important in global financial markets, while the U.S. dollar — still the dominant national currency — weakened relative to them. The euro was launched in financial markets in 1999 as a replacement for the currencies of eleven European Union member nations and entered physical circulation in 2002 in twelve EU countries. It soon became the second most widely used currency in the primary bond market, after the dollar.

The IMF serves as the pivotal body of the international monetary system, using a fund pledged by member countries to lend foreign currencies to members in need, in order to settle international obligations and stabilize exchange rates. Its stated objective is to prevent systemic disaster by encouraging nations to adopt sound economic policies and to provide short-term funding to members facing balance-of-payments difficulties. Nevertheless, the IMF was widely criticized during 1998 for worsening the Asian financial crisis by requiring Asian economies to raise interest rates to historically unprecedented levels.

Causes and Triggers of the Asian Financial Crisis

The Asian financial crisis, which spread from Thailand to other nations in the region during the second half of 1997, pushed affected countries into deep recession, causing mounting unemployment, poverty, and social displacement. The outbreak challenged certain fundamental assumptions: the nations most severely affected were "tiger economies" that possessed few of the weaknesses normally associated with countries that seek IMF assistance. These countries had ample monetary reserves, high rates of private savings, and low inflation — and in most cases their exchange rates had appeared to be on track.

The Asian crisis was not easy to forecast compared to the Mexican, Russian, or Brazilian crises, partly because these economies had been regarded as models of sound and sustained economic policy, and because of the prevailing confidence in the infallibility of markets and the unqualified benefits of free capital movements. There were, however, some early warnings. The Bank for International Settlements (BIS) Report of 1996 cautioned about exposure in East Asia. The 1996 Trade and Development Report similarly warned about South-East Asia, noting that growth in the region depended heavily on foreign resources and that these economies were losing competitiveness and were highly vulnerable to sudden reversals of capital inflows.

As in other regional crises, the East Asian crisis erupted suddenly — triggered by a loss of confidence and a massive withdrawal of capital by both domestic and foreign investors as well as unhedged debtors. Both external and internal factors, including domestic policy choices, appear to have played vital roles. Four fundamental issues were embedded in the crisis: a shortage of foreign exchange in Thailand, Indonesia, South Korea, and other Asian nations that caused sharp falls in the value of currencies and equities; inappropriate development of financial sectors and capital-allocation systems in affected economies; the impact of the crisis on the United States and the world economy; and questions about the responsibility, functioning, and resourcing of the IMF.

The disaster was triggered by a two-phase currency depreciation beginning in the early summer of 1997. The first phase was marked by steep crashes in the Thai baht, Malaysian ringgit, Philippine peso, and Indonesian rupiah. Once these currencies stabilized at lower values, a second phase began in which downward pressure struck the Taiwan dollar, South Korean won, Brazilian real, Singaporean dollar, and Hong Kong dollar.