If you thought everything that could go wrong with Asia has gone wrong, you are wrong. Something else is about to happen that will make the long-run pain even greater, but may provide a little short-term gain for investors.
One of the great benefits of globalization is that the US benevolently spread the largesse of its riches among the emerging markets of the world by putting its electronic and other factories abroad. This boosted growth for the poor countries dramatically, as long as US IT demand was growing at 25% a year.
But what if the US goes into hi-tech recession? Then the US suffers less and Asia more. And the US hi-tech boom is over. In 2001, US import demand for what Asia sells could disappear entirely.
Take electronics. Asia’s exports of electronics are very big expressed as a percentage of GDP (though the impact on GDP is actually a function of the value-added in the producing country and not the gross value of the export figure itself). If Asia’s technology exports to US fall 6% in the first half of this year, as I expect, and then recover to where we are now by year-end, most Asian countries will lose between 1% and 4% points of real GDP growth in 2001. That will contribute to halving the growth rates achieved in 2000.
Turning off the tap
And here lies Asia’s other big problem. Back in the mid 1990s, Asia wasted capital like free water out of a faucet. That brought on the crisis of 1997-98. But since then, Asia has failed to reform the root cause of its crisis: the financial system. Leverage in Asian economies has barely shrunk since1996. That tells a sad story.
Banks were not restructured. They were bailed out, but not reformed. In other words, their lousy loans may have been bought out and their balance sheets puffed up with taxpayer’s money, but their customers/borrowers got off with hardly a scratch. Where borrowers should have been bankrupted and the economy cleansed of dead investments, the insolvent have been kept alive on a drip feed of failed foreclosure laws and rescheduled debts. The price of Asia’s softly-softly approach will be paid for by lower growth and higher taxes for the next decade.
Back in the days of the ‘Asian miracle’, the mantra of investors was that “politics didn’t matter”. The argument was that the Asian litany of family values, work ethic and the pursuit of the last buck made the economic miracle an investment miracle without the need for the backing of the rule of law or solid institutions of state.
Of course, that was nonsense. The Asian crisis of 1997-98 may have been caused by mispriced capital unprofitably invested, but sustained recovery requires solid institutions of state that Asian despot capitalism has yet to give way to. After the crisis, political and financial reform started in Korea, Taiwan and even Thailand and Indonesia. And everywhere, the old politicians were replaced.
Looking for a miracle
Since the crisis, Asia has gone in for democracy in a big way. That’s great news. But the cyclical recovery has duped Asia’s leaders into thinking the crisis was over. Now reform has slowed to a crawl (or even reversed). Yet Asian countries remain saddled with the unresolved problem of a stock of bad assets and bad debts. And most have dysfunctional institutions and markets to allocate capital. Only a strong civic society, solid instruments of state and visionary political leadership could address these needs. But these are the commodities in shortest supply in the region. As a result, Asia’s miracle will not be repeated.
Instead, the price of democracy is that you can be quite sure that Asia’s elected leaders will do something populist about the growth-less state of their restive electorates. That something will be this: they will bail out their banks and very probably spend money they don’t have to do so.
Now Asia can just about afford to bail out its banks of their remaining bad debts at inflated prices. Bailing out the banks would move interest payments (in relationship to government revenues), public sector debts and deficits up to the limits of what’s tolerable for emerging markets. Tax burdens would jump. And if the record so far is anything to go by, the bank bailouts are most unlikely to create efficient banking systems as the core of any return to the Asian growth ‘miracle’.
But the bailout will create a liquidity cycle that could give a fillip to stock markets – particularly banks. But don’t confuse it with reform. If you go for the greater fool theory, equity markets, gunned on by locals, may perform for a while. But populist policies can only be financed if interest rates are kept low. Asia’s current account surpluses and international reserves will suffer as domestic demand is boosted and electronic exports fall back.
A false sense of security?
The most likely scenario for Asian markets is that they get a boost from falling US interest rates and rising risk appetite globally. But exchange markets will weaken East Asian currencies. Indeed, they are already doing so. The growing gap between Asia’s current account surplus and the accumulation of international reserves tells a sad tale of capital fleeing the region for safer shores. Even Japan’s woeful state and collapsing yen is starting to send its huge stock of surplus savings to safer climes for better gain.
And foreign investors are less likely to be suckered than locals by Asia’s liquidity cycle. If world equities are set to recover as the Fed cuts rates, there are plenty of opportunities stateside and in relatively well-run emerging markets like Singapore and Hong Kong that may make our better fortune than buying the equities of the likes of Malaysia, Philippines, Indonesia or Thailand.
David Roche is head of research firm Independent Strategy.
