East Asia Is Not Mexico

What was different about the collapse of the Asian emerging markets in 1997? The free fall
of the Mexican peso and the collapse of the Mexican Bolsa produced a “Tequila effect” that spread
through most of South America. But it did not create a sell-off in the global financial markets similar
to that which occurred on 27 October 1997. Normally, sharp declines in prices in emerging equity
markets produce a “flight to quality,” in which international investors shift their funds back into
developed-country markets and local investors seek to protect their wealth by diversifying into
developed-country assets. Yet the collapse in the Asian emerging markets, that started in Thailand,
spread to the other second-tier Newly Industrialising Economies (NIEs), and eventually extended to
the first-tier NIEs produced the largest absolute declines ever experienced in the major developed-country equity markets. If equity markets can suffer from what Alan Greenspan has called “irrational
exuberance,” the Asian crisis suggests that they may also suffer from “irrational pessimism.” Yet
there is much to indicate that in this case the financial markets in Japan, Europe, and the United States were
quite rational in assessing the global implications of the financial crisis in Asia.