Wanting to understand simply how and why the Asian financial crisis began in July 1997 with Thailand’s Baht.
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* Various Asian countries had taken out debt. It is perfectly normal for countries to take out debt.
* The debt was denominated in US Dollars. This is uncommon for (non-US) developed countries, which will borrow in their own currency. However, a country with a smaller economy might have more difficulty borrowing in their own currency than borrowing in a more established currency such as the US Dollar or Euro.
* The debt was not unreasonably large, as national debts go, and was quite servicable given the respective countries’ GDPs.
* At some point, though, investors began to wonder about the direction of exchange rates between those Asian currencies and the US dollar. If the value of those currencies dropped enough, then the US-denominated debt would become unstainably large compared with the local currency denominated GDP. Eg, a 100 billion baht debt might be servicable, but a 150 billion baht debt would be 50% harder to service – even though they’re the same amount of US dollars.
* If this happened, the economies of those countries would suffer, since the governments would have to allocate a larger portion of their budgets to servicing the debt. This means either less spending in the local economy (depressing the economy, lowering demand for imports, and thereby depressing the currency), or by printing more local currency (depressing the currency directly).
* If an investor thought that the currency was going to drop, it therefore became prudent to sell off the currency before other investors did the same. Other investors would then see this happen, and do the same.
* As a result, the affected Asian currencies values dropped precipitously (eg, 100 Malaysian Riggit was about US$40 before the crisis, dropping to about US$22 before being pegged at about US$26) in a self-fulfilling spiral of doom.
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