Chapter 15: Net Exports and International Finance

Start Up: Currency Crises Shake the World

It became known as the “Asian Contagion,” and it swept the world as the 20th century came to a close.

Japan, crippled by the threat of collapse of many of its banks, seemed stuck in a recessionary gap for most of the decade. Because Japan was a major market for the exports of economies throughout East Asia, the slump in Japan translated into falling exports in neighboring economies. Slowed growth in a host of economies that had grown accustomed to phenomenal growth set the stage for trouble throughout the world.

The first crack appeared in Thailand, whose central bank had successfully maintained a stable exchange rate between the baht, Thailand’s currency, and the U.S. dollar. But weakened demand for Thai exports, along with concerns about the stability of Thai banks, put downward pressure on the baht. Thailand’s effort to shore up its currency ultimately failed, and the country’s central bank gave up the effort in July of 1997. The baht’s value dropped nearly 20% in a single day.

Holders of other currencies became worried about their stability and began selling. Central banks that, like Thailand’s, had held their currencies stable relative to the dollar, gave up their efforts as well. Malaysia quit propping up the ringgit less than two weeks after the baht’s fall. Indonesia’s central bank gave up trying to hold the rupiah’s dollar value a month later. South Korea let the won fall in November.

Currency crises continued to spread in 1998, capped by a spectacular plunge in the Russian ruble. As speculators sold other currencies, they bought dollars, driving the U.S. exchange rate steadily upward.

What was behind the currency crises that shook the world? How do changes in a country’s exchange rate affect its economy? How can events such as the fall of the baht and the ringgit spread to other countries?

We will explore the answers to these questions by looking again at how changes in a country’s exchange rate can affect its economy—and how changes in one economy can spread to others. We will be engaged in a study of international finance, the field that examines the macroeconomic consequences of the financial flows associated with international trade.

We will begin by reviewing the reasons nations trade. International trade has the potential to increase the availability of goods and services to everyone. We will look at the effects of trade on the welfare of people and then turn to the macroeconomic implications of financing trade.

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