In analysing the European financial crisis, Asia’s experience with the 1997 Asian financial crisis is a useful point of reference. After the forced devaluation of the Thai baht, encouraged by the People’s Republic of China (PRC) and Japan, Thailand was compelled to accept the IMF-imposed austerity programs. As part of the contagion that followed the baht crisis, Indonesia and the Republic of Korea also accepted the IMF program. As the IMF’s prescriptions reduced aggregate demand and contained no “pro-growth” elements, they worsened the crisis in these Asian countries. In contrast, Malaysia rejected the IMF’s prescriptions. The different experiences of these crisis-hit Asian economies led to a change in thinking on the productiveness of “straight” austerity programs as a response to the financial crises. Austerity policies were relaxed and pro-growth policies introduced, which in combination, helped Asia to recover from its financial crisis.

The international dollar standard is malfunctioning. The Fed’s reduction of the interest rate on Federal Funds to virtually zero in December 2008 (a move that was followed by major European central banks) exacerbated the wide interest rate differentials with emerging markets and provoked world monetary instability by inducing massive hot money outflows by carry traders into Asia and Latin America. The disruption could be partially justified if it had helped the United States recover from the 2008–2009 financial crisis. However, evidence suggests otherwise. Speculative money flooding into emerging markets by “carry traders” causes local currencies to be overvalued.

Two episodes of quantitative easing (QE) by the United States (US) Federal Reserve Bank (Fed) since early 2009 aroused widespread concerns in emerging Asia and elsewhere because of the possibility that they would weaken the US dollar (so-called “currency wars”) and stimulate capital inflows in emerging economies that might lead to increased inflationary pressures and asset price bubbles. For example, the vice minister of finance of the People’s Republic of China (PRC), Zhu Guangyao, said on 18 November 2010 that “As a major reserve currency issuer, for the US to launch a second round of quantitative easing at this time, we feel that it did not recognize its responsibility to stabilize global markets and did not think about the impact of excessive liquidity on emerging markets” (Reuters 2010).

The recent global financial crisis has renewed concerns about the inherent instability of the current international monetary system in which the world’s demands for asset or liquidity are met predominantly using the currency of one country, the United States dollar. If the supply of the global currency is inadequate to support global trade, the world faces deflationary risks. However, since the country issuing the global currency has the privilege of borrowing abroad in its own currency cheaply, its borrowing and, hence the supply of global currency, may become excessive. This may eventually become unsustainable, and may have significant systemic implications for the rest of the world, as witnessed in the global financial crisis.