ON July 2, the Thai government gave up its longstanding policy and allowed its currency, the baht, to float. Once again, a government had wasted billions of dollars of taxpayer money -- as much as $30 billion in this case -- trying to fix an exchange rate without thinking about why the currency was under pressure.

The decision to float did not end the crisis. The Thai baht remained under pressure, and the pressure spread to neighboring countries -- principally Indonesia, Malaysia, and the Philippines. They all abandoned their currencies' fixed exchange rates with the dollar and, like Thailand, permitted them to float. Still the crisis didn't end. It spread to Taiwan and Hong Kong and from Hong Kong to the world's stock markets.

Readers of the Wall Street Journal must be mystified. They have been told repeatedly that a fixed exchange rate cures all economic problems. Only a currency board or the gold standard is better, according to the Journal, because these systems not only fix the exchange rate but also do away with a central bank, eliminating any chance of mistakes by wrong-headed central bankers.

All these troubled countries had fixed exchange rates against the dollar, and Hong Kong has a currency board. And yet, mirabile dictu, the system broke down. And the fixed exchange rate was a major reason for the breakdown.

The Wall Street Journal argument is wrong. There is no exchange-rate system that will cure all problems. Fixed exchange rates under the Louvre agreement were one of the reasons for the stock-market crash in 1987. Ronald Reagan's decision to end that agreement by letting the dollar float, and the Federal Reserve's assurance that it would provide liquidity to financial markets, ended that crisis soon after it started.

TYPICALLY, fixed-exchange-rate systems get into trouble because government policies are incompatible with the fixed exchange rate or with the policies of other countries in the system. That is what happened to the gold standard in the 1929 crash. It happened again under Bretton Woods, in 1987, and now again in Southeast Asia. The currency of each of the troubled Asian countries became overvalued against the dollar for two main reasons. First, the dollar began to appreciate against the yen, the Deutsche Mark, and most other European currencies, so that all the currencies pegged to the dollar appreciated against these currencies also. Second, the Asian countries had a history of economic growth, low inflation, and small budget deficits or budget surpluses. Returns to investors have been high. Capital flowed in to take advantage of relatively low production costs and attractive returns. Under a fixed exchange rate, the capital inflow is a source of new money. The central bank buys the foreign exchange, issues domestic base money, and accepts higher inflation.

With the exception of a few years in the 1980s, the dollar had been devaluing against strong currencies like the yen and the Deutsche Mark for 25 years. Dollar devaluation kept the prices of the Southeast Asian countries' exports highly competitive in Japan and Europe because their currencies devalued along with the dollar. When the dollar began to appreciate in the mid Nineties, the prices of Southeast Asian exports began to rise in Europe and in Japan, which is a major market for Southeast Asian exports. Higher prices reinforced the effects of the Japanese recession and the increased competition from China, particularly after China devalued. Exports grew more slowly. Trade balances became less robust. By the spring of this year, many investors were expressing concern about an impending recession in these Asian economies.

A fixed-exchange-rate system works best when all countries in the system have the same rate of inflation. Starting in 1993, inflation rates in the U.S. and Southeast Asia began to diverge. Inflation rates remained around 6 per cent in most of these countries as the U.S. inflation rate dropped to 2 or 3 per cent.

AT 6 per cent, prices double every 12 years. Real estate is one of the assets that people buy when they anticipate inflation. In Thailand people built golf courses. In Hong Kong, it was apartment houses. Both gave buyers some protection against expected inflation. As the prices of land and real estate rose, more people joined in, borrowing to buy real estate.

Much of the borrowing was in foreign currency. As foreign currency poured in, the central banks continued to increase the monetary base and the money supply, as they must under the rules of a fixed-exchange-rate system. But the growth of money was a sign that inflation would continue and probably increase. The answer: buy more real estate. And that's what people did.

Accelerating inflation added to these countries' problems in another way. Exchange rates became increasingly overvalued. This problem was particularly severe for Thailand and Indonesia, which send 25 to 30 per cent of their exports to Japan in most years. Since the yen fell against the dollar, these exports -- prices in dollars -- became more and more expensive.

The result was that demand shifted to competitors like China, slowing export growth and leading to ever greater trade and current-account deficits. By 1996, the current-account deficit -- the difference between exports and imports of goods and services -- was between 4 and 8 per cent in the four Southeast Asian countries. Thailand's was the highest of the four.

As early as last February, one of the largest Thai real-estate developers could not pay the interest on its loans. The following month, ten Thai finance companies had difficulty making payments. In May and June, new problems emerged. As these spread from the financial markets to the exchange rate, the central bank sold dollars to defend the exchange rate.

It was too late. The time for action to avoid the exchange-rate crisis was at least a year earlier, before the fixed-exchange-rate system had become grossly misaligned. Once the dollar had appreciated against the yen and other currencies, there were only two choices open to the Southeast Asians: devalue or disinflate to realign their price levels with the United States'. The fixed exchange rate limited monetary policy to maintaining the exchange rate, and so the governments needed to tighten fiscal policies to reduce foreign borrowing, deregulate, and privatize to increase efficiency. They failed to do so.

The Thai devaluation sent the alarm bells ringing. Devaluation called attention to the misalignment of exchange rates and, by lowering the dollar prices of Thai exports, shifted part of the problem to competitors in other countries in the region. Their prices were now much higher than Thailand's, and so their fixed-exchange rates no longer seemed secure.

Devaluation also made it more difficult for Thai borrowers to earn the dollars needed to service their debts. Much of the money that these countries borrowed was in short-term loans, and many lenders refused to renew loans to the region as they came due. The problem spread.

The lesson in the Asian story is an old one. A fixed exchange rate does not assure stability. Neither does a floating rate. In the long run, it doesn't much matter whether a country has one system or the other. Under either system, a country achieves stability only if it follows stabilizing policies and adjusts those policies promptly to new circumstances.

After the fact, people discover excessive real-estate lending, a weakened financial structure, and other problems. These problems are usually the result of expected or actual inflation, not its cause. Repairing the banking and financial structure is important in some of these countries, but it is hard to argue that Hong Kong has had a profligate government or has been overregulated. Although there are differences between countries, the main, common problem was a misaligned fixed exchange rate and the failure to adjust policies to the new circumstances these countries faced.

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