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“Default”––– 2 Lessons from the 1997 Asian Financial Crisis

Image Source: Yahoo! Hong Kong Movie

The Korean movie Default depicts different actors making different choices in the wake of the worst economic crisis that swept Korea in 1997. Every day, investors like us face many difficult choices of our own. Let’s recap the real-life events the movie depicts, and discover at least two ways it can teach us to improve our decision-making skills.

What is the Asian Financial Crisis?

For younger Fools, it may be worthwhile to retell what happened in 1997. The Asian Financial Crisis was a banking and currency crisis triggered by the outflow of foreign capital. At first, foreign investors, such as international asset managers and some world-famous hedge funds, started pulling their money away from East Asia. Later, local funds caught wind of those withdrawals and panicked, selling their East Asian assets and currencies as well. The crisis started in Thailand in July 1997, and later spread to Indonesia, South Korea, the Philippines, Malaysia, Hong Kong, and to a lesser extent, many other East Asian countries. Currencies of the hardest-hit countries depreciated by 30% to 80% within a year, and these countries were eventually forced to abandon their currency pegs with the US dollar.

Like many other financial crises, what started in the financial sector soon spread to the whole economy, damaging East Asian economies for years to come. Economic historians still debate the capital outflow’s fundamental causes today; potential culprits have ranged from unsustainable foreign borrowing to excessive trade and fiscal deficits.

As the movie depicts, the South Korean government – like many crisis-hit countries – at first denied what was happening to its economy, currency, and banking systems. Officials denied, denied, and denied the crisis until they could no longer ignore its symptoms. The initial official responses to the crisis were to play down the potential seriousness of the crisis, and were to project a rapid recovery from the crisis.[i] Months into the crisis, some countries continued to insist that stress tests undertaken by the regulators on banks showed a sound financial system.

[i] Stanford, J. D. (1999). The characteristics of the Asian financial crisis. Economic Analysis and Policy, 29(1), 87-100.

How Malaysia took the road less travelled

The movie also rightly depicts the next move of many crisis-hit countries once they accepted its reality: seeking loans from the IMF. Pundits at that time believed that currencies were dropping because money was flowing out of the countries faster than it flowed in. Thus, many countries asked for IMF loans to pump up those inflows and revive investors’ confidence.

Meanwhile, the IMF––– true to its long advocacy of open economies, and the global sentiment favoring that idea at that time––– conditioned the loans on a series of reforms which it intended to bring lasting stability to the financial and economic systems of the crisis-hit countries. These remedies notably included opening up capital accounts and allowing the free entry of foreign enterprises.

Nonetheless, one country defied this universal prescription. Malaysia worked to stem money outflows instead, imposing capital control and currency control. This policy move was so defiant that it drew condemnation not only from the IMF, but also nearly every economist in the world.

The movie also depicts a conspiracy theory that the United States rigged the IMF, exploiting the crisis to open up countries such as South Korea to U.S. investment. While this notion may be overblown, Malaysia, the only major crisis-hit country that refused IMF’s aid and defied its policy recommendations, became the first country to recover from the crisis. Its stock market index nearly doubled during the first week of the controls.[ii]

What, then, can we learn from both the movie and the events that inspired it?

[ii] Andrew Sheng (2009), From Asian to Global Financial Crisis: An Asian Regulator’s View of Unfettered Finance in the 1990s and 2000s, p.215

Lesson 1: Don’t be fooled

Though “Fool on” is our motto, investors definitely should not be small-f fooled by media noise. In the movie, the former banker who thought the crisis was a lifetime chance for investment (played by Yoo Ah-in), was able to stick to his own analysis and a short position on Korean Won and equities, even though the Korean government repeatedly announced through media that everything was in control.

In real life, investors similarly need to distinguish facts from the noise and arrive at their own analysis of a particular situation. Don’t just listen to what others say. Do your own research, look hard at the facts, and make up your own mind.

Lesson 2: Don’t buy into popularity

Just as Malaysia took the less popular policy measure and became the first country to stem the crisis, sometimes the right investment decision is not the one that is the most conventional or agreeable. In the movie, the Bank of Korea central banker (played by Kim Hye-soo) does oppose the IMF rescue plan, and comes up with measures more like Malaysia’s. But the Korean government, being the government, remains adamant in pursuing the more popular, conventional, and politically safe IMF plan. In real life, investors do not need to act like the government, which sticks to the popular path to reduce political risk; investors should choose the most effective approach instead.

Remember, investors can outperform the market only by holding a different opinion than it does. To truly succeed, whether in a crisis or in your day-to-day investing, you must be ready to take the road less travelled by.


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