The Chastening

Inside the crisis that rocked the global financial system and humbled the IMF

Book by Paul Blustein

Article & Review by GlobalMacroForex

In 1997 multiple Southeast Asian nations suffered currency crises, and a massive recession followed.  Foreign debt-to-GDP soared from 100% to 167%, requiring a total of $40 billion in IMF loans to stabilize these economies and its currencies.

Author Paul Blustein captures the crisis so vividly that you won’t be able to put the book down.  You’ll gain an understanding of the political decisions and why the corporate sector acted as they did.  From Bangkok, Seoul, and Jakarta to the IMF and Federal Reserve offices in the US, Blustein truly takes the reader on a journey around the globe…


Paul Blustein points out how surprising the crisis was to so many market participants because Thailand on the surface seemed to be growing so strongly.  Since 1986, Thailand’s GDP had been growing at 9% per year to over $182 billion by 1996.  The main source of Thailand’s growth was exports, which grew by 19% per year in the first half of the 1990s.

But beneath the glowy exterior GDP numbers, the corporate, bank, and personal debt rose to sky-high levels that exposed the region to a sudden risk shock.  The banks had gone on a real estate lending binge.   Bank loans went from $89 billion in 1992 to $204 billion just a few years later in 1996.  This exposed the economy to rises in interest rates that would send real estate loan collateral down.

Thailand’s currency, the baht, was pegged to the US dollar for stability.  This allowed companies to borrow USD at a cheaper interest rate than if they had borrowed locally, but they didn’t worry about foreign exchange risk because of the peg.  Prior to 1995, the US dollar sank, so to enforce the peg all Thailand had to do was print money to drive the baht down when compared to the US dollar. 

However, starting in 1995, once the USD started rising, to maintain the peg, Thailand’s central bank needed to use its USD reserves to buy baht in the open market.  As Paul Blustein notes, this also had a big effect on Thailand’s exports:

 “But the dollar began a powerful rebound in mid-1995, and the fixed-rate system started working inexorably against Thai exports, making prices for those same clothes, shoes, auto parts, and electronics less attractive.  Compounding the problem was a downturn in the worldwide market for electronic components, of which the country had become an important manufacturer.”

To keep the peg, Thailand raised interest rates.  And in 1996 with the rate rise, the stock market collapsed, sinking prices by 34%.  This left Thai finance companies with $4.8 billion in margin loans on the hook.  In May of 1997, 12% of real estate loans became nonperforming, which ate into banks’ margins.  As these events unfolded, the Thai baht rapidly deteriorated in value, and the central bank’s USD reserves shrunk.

On May 15, 1997, to stop the downward pressure on the baht, the central bank banned banks from loaning baht to anyone outside the country.  This prevented hedge funds from shorting the baht, and the sudden move squeezed $400 million to $500 million in losses out of hedge funds.

 “At a press conference, Chaiyawat [Thailand’s central banker] declared sternly that speculators ‘have to pay the price.’  Stanley Druckenmiller, Soros’s chief lieutenant would later admit, ‘They kicked our butt.’”

To replenish the Thai central bank reserves and help stabilize the situation, the IMF lent Thailand $4 billion.  But quickly the crisis spread to…


Indonesia’s situation was slightly different than Thailand’s; Indonesia’s currency (the rupiah) didn’t have a peg.  But that didn’t stop Indonesian corporations from borrowing heavily abroad because at the time of the crisis, Indonesian banks owed $55 billion to foreigners.  The primary reason Indonesian corporations did this was that the USD had a much lower interest rate.  Paul Blustein gives an example of the average numbers Indonesian corporations borrowed at the differing currencies.  The rupiah rate was at about 18%, while on USD loans they only had to pay 10%.  That rate differential was a strong factor in inciting the foreign loans, and while the exchange rate wasn’t officially pegged, it moved similar enough to encourage the risk.

“The rupiah wasn’t rigidly fixed against the dollar, but the central bank had kept the currency’s rate of decline predictable, about 3 to 5 percent a year.  So with the rupiah that Indonesian companies earn on their business transactions, they could repay their foreign loans and still come out ahead.”

While the Central Bank of Indonesia started with $20 billion in foreign currency reserves, this was quickly depleted and needed IMF intervention.   However, the IMF had its hands full because the crisis spread to…

South Korea

South Korea was in a different situation than either Thailand or Indonesia.  Their economy had a unique chaebol structure, which has large hierarchical state-run enterprises that only recently have been transitioned to become a part of the private sector.  These chaebol conglomerates were interlinked with the political system and there was an unspoken understanding among investors in the country that if the chaebol were ever to get into trouble, the government would bail them out.

Because of this societal acknowledgement of a backstop, chaebols were allowed to rack up massive amounts of debt that normally wouldn’t be accepted by the market.  The debt of Korean firms ballooned up to 400% of shareholder equity prior to the crisis.  As banks lent indiscriminately to favored chaebol customers, a lot of this debt wasn’t be used that efficiently.  As Blustein notes:

 “Although heavy borrowing is sensible when the money is used productively, Korea’s overconfident tycoons were spending as if there were no limit to the world-beating facilities they could build.  From 1994 to 1996, spending on new plants and equipment rose by nearly 40 percent per year.”

One aspect of Korea’s debt that differed from the other countries was the heavy reliance on interbank loans, as opposed to Thailand’s more moderate use.  It was primarily Japanese banks who were lending.  This was okay as long as the yen was falling in value compared to the Korean won.  Before the crisis, the currencies reversed and the loans’ foreign exchange risk quickly worked against the Japanese.

 “Japanese banks held $97 billion in loans to the five Asian countries hardest hit by turmoil-Thailand, Malaysia, Korea, Indonesia, and the Philippines-four times the amount they lent to US banks.”

Korean firms relied heavily on short-term interbank loans, so once the currency started to move against the Japanese banks, the banks didn’t roll over the loans.  Korean banks were borrowing at short-term rates and lending on the long end of the yield curve.  Now this sudden inversion of the interbank yield curve was causing a hemorrhaging of financial outflow from the country.  Korean’s central bank reserves went down to $6 billion, and the central bank was unable to support the value of the won.  This led to the international community lending a total of $60 billion, with $21 billion from IMF, making it the largest IMF loan to a single country ever in its history.


Paul Blustein covers in-depth the gripping tale of how this crisis spread from Thailand through all of Southeast Asia.  The extent of the crisis was shocking to politicians and market participants alike.  And the amount of debt leveraged on the exchange rate made the situation quickly deteriorate once things reversed.  As Blustein refers to it, the “electronic herd” pulled their money out in mass, and this depressed the Southeast Asian exchange rates, further causing the central banks to lose all their reserves trying to defend their respective currencies.  While this brief summary article covered only parts of the story (in Thailand, Indonesia, and Korea), the crisis ultimately also hit the Philippines, Hong Kong, Singapore, Taiwan, Brazil and many others.  I highly recommend this book, not only for the author’s captivating writing style but also for his useful description of exactly how this crisis unfolded.