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A nation must think before it acts.
Financial crises and their associated economic disruptions (or vice versa) can alter the international political order among countries by changing their relative power relationships. What precipitates these crises and disruptions have many origins; but in many cases their underlying causes slowly build up pressures that suddenly erupt in a ruinous episode. Decades of declining economic productivity, big budget deficits, and an overvalued currency eventually led Russia to default on its sovereign debt in 1998. Following on the heels of the demise of the Soviet Union, the default led Russia into a particularly nasty recession as well as a particularly dark eclipse of its power across Asia and Europe for over half a decade.
Another crisis that began a year earlier, the Asian financial crisis, also changed what many had at the time expected to be the political trajectory of Southeast Asia. The proximal cause of the crisis was the devaluation of Thailand’s currency, when its central bank ran short of U.S. dollars needed to defend its pegged exchange rate. That triggered several similar crises across Asia and ultimately derailed Southeast Asia’s “tiger economies.” Also derailed was the internal stability that Southeast Asian governments had attained after decades of conflict during the Cold War. After the crisis, Indonesia’s long-ruling President Suharto was removed from office, and Malaysia’s equally long-serving Prime Minister Mahathir Mohammed was weakened (leaving office in 2003). Thailand, whose prosperity in the early 1990s allowed it to become the first East Asian country to acquire an aircraft carrier in 1997, saw its wider ambitions thwarted. Indeed, most countries in the region turned inward, as they shelved military modernization plans and their citizens clamored for political change. On reflection, had the region made those military investments and developed the political self-confidence that often comes with internal stability, it would have been in a better position to balance China’s rise today.
Instead, Southeast Asia grasped at China’s refusal to devalue its currency during the crisis as a sign of friendship and inspired hope that they need not balance China’s rise and could assimilate their giant neighbor into the region’s multilateral norms. Fifteen years on, that hope has proven misplaced. China emerged from the Asian financial crisis relatively unscathed and ultimately became more assertive. While it had to write off a mountain of bad loans on the balance sheets of its state-owned banks, Beijing really had no other choice, since those banks play a key policy role in its management of the Chinese economy. Fortunately for China, continued foreign direct investment and major domestic infrastructure spending allowed it to grow out of its economic problems.
Southeast Asia was not so fortunate. As the economies of countries like Thailand expanded during the first half of the 1990s, they also attracted a great deal of speculative investment and credit. Eventually Thailand’s economy cooled, as less productive investments were made, U.S. interest rates rose, and Japan sharply devalued its currency. As a result, the stability of Thailand’s leveraged economy and the ability of its central bank to defend its exchange rate peg became dubious—prompting money to flow out of the country and credit to suddenly contract. A similar logic played out in other East Asian economies, causing a domino effect that engulfed Indonesia, Hong Kong, Laos, Malaysia, the Philippines, and South Korea. Within a few months, local currencies plummeted, hundreds of businesses were shuttered, and millions found themselves unemployed.
Today, economic clouds are once again gathering over East Asia. And Mark Twain’s quote seems particularly apt: “history does not repeat itself, but it does rhyme.” The region’s economic growth is slowing. Yet Southeast Asian countries continue to pile high consumer and sovereign debt. They are even considering issuing U.S.-dollar denominated obligations, which are more difficult to pay off if their local currencies devalue. But, of course, that may not occur this time, since the countries of Southeast Asia learned to amass large U.S. dollar reserves to forestall any run on their currencies. As China and Taiwan showed during the 1997 Asian financial crisis, large U.S. dollar reserves can help avert the worst effects of such an event.
But such financial defenses are now starting to be tested, as Japanese Prime Minister Abe Shinzō’s economic policies have caused the yen to sharply fall against currencies across Southeast Asia (whether intentional or not). As a result, Southeast Asian exporters are feeling the strain and have already called upon their respective central banks to match the Japanese effort. But without an overt exchange rate peg to defend, Southeast Asian central banks have more leeway than they did in 1997. And fortunately for them, U.S. interest rates are unlikely to jump in the coming year. Still, the groundwork for a second Asian financial crisis is in place. This time, China may not be spared, as many of its exporters are already barely profitable, the structural distortions in its economy are as big as ever, and it seems to lack a clear way to grow out of the next crisis (apart from even more domestic infrastructure spending). But should Southeast Asia again turn inward, the United States should be prepared to do more to maintain the region’s balance of power. A wider Asian financial crisis that ensnares Japan or South Korea may require an even larger American effort. But this does not mean that American military power will be what is needed. Rather, the region’s countries are keen on other sorts of American engagement, particularly economic ones. And it is precisely those ties that will be most wanted if a crisis does occur.