The Asian Financial Crisis of July 1997 was the most significant event of my career as an economist. Although I was a young researcher at the time and Thailand—the epicenter—was not my assigned country, I was responsible for monitoring the Philippines and Malaysia. As such, I was a direct witness to the unfolding chaos from within my institution. As the “sell Baht / buy US Dollar” trend accelerated and the Thai central bank failed in its currency defense, the selling pressure spread like wildfire to neighboring Southeast Asian nations. Eventually, the contagion jumped to emerging markets beyond the region, plunging the global economy into turmoil.
The chaos eventually subsided after a certain point. While I recall that the reasons for this stabilization weren’t widely discussed, my understanding is that it was triggered by the collapse of LTCM—a US hedge fund that failed due to bad bets on Russian government bonds—which created instability in the US financial system. In short, the rationale for buying US dollars evaporated. This is, of course, my personal view, and others may have different interpretations of how the turmoil ended.
The Asian Financial Crisis yielded several lessons, the most fundamental being the “Policy Trilemma”: it is impossible to have a fixed exchange rate (pegging to the dollar), free capital movement, and an independent monetary policy all at once. To be fair, this was already textbook economics even then, not a new discovery. Once the Baht-selling started, the central bank was forced to buy Baht and sell Dollars, leading to the depletion of foreign reserves and an eventual currency collapse. However, this particular lesson isn’t especially relevant to Japan, which consistently maintains a floating exchange rate system.
The second and more crucial lesson is that this was a private-sector-led crisis. Any assessment that viewed Thailand as “sound” based solely on the government’s financial statements turned out to be wrong. To elaborate: the debt crises in Latin America and the Philippines in the 1980s were largely caused by deteriorating government finances—specifically, the explosion of external debt that became impossible to repay. But what was the situation in Thailand? When the Baht began to be sold in 1996, the government’s external debt was only about 10% of GDP, and total debt (including Baht-denominated debt) was a mere 15% of GDP. Furthermore, the fiscal balance was actually in surplus by nearly 3% of GDP. By any standard for emerging markets, Thailand had “ultra-sound” public finances.
So, why did the crisis happen? It was driven by private-sector-led economic overheating. This “overheating” didn’t manifest as domestic inflation, but rather as a surge in imports of goods and services. The current account deficit reached a staggering 8% of GDP.
While I won’t say this second lesson applies to Japan exactly as it did to Thailand, it serves as a vital reference. It suggests that in a private-sector-led economy—unless the government plays an outsized role in economic activity—fiscal “soundness” has absolutely nothing to do with the onset of a crisis. According to IMF data, Japan’s current account in 2024 was in surplus by nearly 5% of GDP. Moreover, Japan holds a massive 500 trillion yen in net foreign assets. My assessment is that Japan is the nation furthest from a crisis in the entire world. The fact that we are still pursuing austerity despite this is truly mind-boggling. The metric we should be focusing on is not the fiscal balance, but the current account.
To those who instinctively associate deteriorating fiscal balances with an impending crisis, I am tempted to say: “Your common sense is stuck in the 1980s era of the Latin American and Philippine debt crises.” Decades have passed; it is high time to update your knowledge. To my knowledge, across debt, currency, fiscal, or financial crises, there are only a handful of cases where a country with a current account surplus has ever succumbed to such a crisis—and each of those was a highly exceptional case.
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