Crisis Moves Closer to U.S.
by Martin Wolf
The west is blooming, while most of the rest of the world economy is wilting. The contrast is startling, even unprecedented. But is it also sustainable? The falls in western stock markets at the end of the week, as the yen tumbled to an eight-year low against the dollar, suggest investors are beginning to wonder.
The divergence between the west and much of the rest is becoming a chasm. Alan Greenspan, chairman of the US Federal Reserve, told Congress this week that "the current economic performance [of the US], with its combination of strong growth and low inflation, is as impressive as any I have witnessed in my near half-century of daily observation of the American economy". Where the US has led, Europe is following. Of the bigger European economies, the UK started its recovery some years ago, but France, Germany and Italy are all now expanding, at rates generally forecast at 2-3 per cent in 1998 and 1999.
At the end of the 20th century, the western countries that were dominant a hundred years ago appear once more triumphant. Meanwhile, the plight of Asia, which until last year was the world's most dynamic region, worsens almost by the day.
Japan's gross domestic product contracted 1.3 per cent in the first quarter, an annual rate of 5.3 per cent. This followed a fall of 0.4 per cent in the last quarter of 1997. The economy is now unquestionably in recession. Against the background of declining profitability and loose monetary policy, the yen has collapsed to 144 against the dollar - a devaluation of 44 per cent over the past three years. Most analysts see no end to the slide.
The Asian financial disaster has assisted domestic incompetence to turn Japan's sluggishness into a severe recession. For the rest of Asia, the combination of feeble Japanese demand, a falling yen and financially fragile banks is terrifying. These countries are threatened by fiercer Japanese competition in third markets, which is particularly important for South Korea and Taiwan; by the unwillingness of Japanese banks to write off bad old loans or offer new credit; and perhaps by repatriation of some of the production relocated within Asia while the yen soared.
As Japan weakens, the Asian plague returns. By Thursday, the Korean stock market had fallen 43 per cent from the post-crisis peak reached in early March. Similar reversals have hit other Asian stock markets: Thailand's market is down almost a half since February. The Asian crisis has not bottomed out yet.
The longer term view is even more frightening. Since the beginning of June 1997, stock markets have fallen, in dollar terms, by 89 per cent in Indonesia, 75 per cent in South Korea, 73 per cent in Malaysia, 71 per cent in Thailand, 57 per cent in the Philippines and 47 per cent in Hong Kong. This is no orderly reversal; it is a panic-led rout. Meanwhile, the markets of the US and western Europe have been soaring. Italian equities have, amazingly, risen 17-fold relative to Indonesian equities and seven-fold relative to Korean ones, since last June.
What is happening is a global flight by nervous investors into what is, at least today, perceived as quality - into the dollar, into the stock markets of North America and Europe and into bonds issued by industrial countries.
Not everything Japanese is bad: Japanese equities have been dreadful assets to hold since 1991 and the yen has been falling since 1995, but Japanese government bonds yield 1« per cent, a level only fear of prolonged deflation might justify. In western countries, however, low bond yields have underpinned buoyant equity markets. On Thursday, the yield on the US treasury 30-year bond fell to its lowest level, of 5.66 per cent, but US equities are still close to all-time highs.
As for emerging markets, they struggle almost everywhere, not just in Asia. The rouble has been under huge pressure, amid much talk of the need for greater western assistance. Yields on Latin American Brady bonds - issued in dollars - have been rising since March, though they still remain well below peaks reached last October: on Brazilian Brady bonds, yields are up two percentage points since March.
Violent changes in valuations have responded to shifts in underlying economic conditions. But they have also exaggerated and, most important, exacerbated them. The world economic stage offers market collapses and disarray at the eastern end, market buoyancy and prosperity at the western one. Eastern currencies sink; western ones soar.
Above all is the US, the one and only superpower, unscathed and, despite Wall Street's current hiccup, so far largely unbothered. As many Americans see it, the US is not just guaranteed prosperity forever, it is the one true model - a light unto the economic gentiles.
Yet whether the present divergence in global economic conditions works outs so benignly is, at the very least, uncertain.
The optimistic view is that the disarray in Japan and many emerging markets is helpful for western Europe and North America. Since the western economies generate 60 per cent of global economic output, the principal determinant of their growth is, inevitably, internal demand. But the Asian crisis is a benign deflationary shock from the outside, lowering commodity prices, cooling the overheating US economy and eliminating all risk of inflation from continental Europe.
This relatively cheerful view is contained in the latest set of forecasts from the Organisation for Economic Co-operation and Development. In the US, suggests its Economic Outlook, internal demand will expand 4.2 per cent in 1998 and 3.1 per cent in 1999. But after a welcome deterioration in net exports, this becomes overall output growth of 2.7 per cent and 2.1 per cent, respectively - about what the US needs at full employment.
Demand in the European Union is forecast to expand only 2.5 per cent this year and 2.7 per cent in 1999. But the EU is expected to be far less affected by the Asian external adjustment than the US. Its GDP is forecast to grow 2.7 per cent this year and 2.8 per cent in 1999, perfectly sustainable rates, particularly given present capacity under-utilisation.
Suppose the market turmoil were also to halt - perhaps because the Japanese fiscal package turned the economy round and the most damaged Asian economies reached economic bottom. Then a turnaround in investor sentiment towards Asian emerging markets might arrive, creating a much needed and widening recovery.
There is, alas, a more pessimistic perspective, well laid out by Brian Reading of London-based Lombard Street Research in his aptly-named "Return to the Golden Age of International Financial Crises", released on June 4. Capital flows create current account deficits, says Mr Reading. But the deficits frighten investors, force reversals in the flows and create financial crises. Where then is the next crisis due? In the US is the answer.
The OECD believes that three-fifths of the adjustment to the Asian external adjustment between 1997 and 1999 will occur in the US alone, as the table shows. Suppose also that the yen continues to slide, that China lets the renmimbi fall and the Hong Kong peg fails. This would trigger a fresh round of devaluations and economic collapses.
If so, the external adjustment in the US and Europe could end up far bigger than is now forecast. The US, with its sizeable initial deficit, would be in a worse position to cope - and the protectionist backlash could also be severe. The growing squeeze on profits could lead to the widely expected reversal in US and European stock markets. Again the impact would be larger in the US and the UK, where equity holdings are a bigger proportion of private wealth than on continental Europe.
At present the west, in general, and the US, in particular, seem blessed even by the dire misfortunes of others. But the stability of this world of divided fates is doubtful - economically and ultimately politically. Either sustained prosperity in the west will help bring stability and renewed growth to Asia and elsewhere, or the spreading crisis is all too likely to export instability to the west. Today's western complacency could tomorrow look mere vainglory.
The Financial Times, June 13, 1998 |
