Asia needs to fully wake up to the scale of the West's economic crisis

Asia needs to fully wake up to the scale of the West's economic crisis
Asia is not going to rescue the world economy.

By Ambrose Evans-Pritchard Last Updated: 10:06AM GMT 04 Jan 2009
Comments 28 Comment on this article

The news from Japan, China, and the Pacific tigers has moved from awful to calamitous since the global industrial system snapped in October.
A raw reality is being laid bare. The mercantilist export model of the East is proving dangerously geared to the debt-driven excesses of the West. As we go down, they go down too. Some are going down even harder.
Japan's industrial output contracted by 16.2pc in November, year-on-year. "For an economy which lives from the prowess of its industrial exports, this is simply earthquake," said Edward Hugh from Japan Economy Watch.
Japanese exports fell 26.7pc. Real wages fell by 3.1pc, the seventh monthly fall. Taken together, the figures are worse than anything during Japan's "Lost Decade". They have a ring of 1931.
The fall-out in Japan has already shattered the authority of premier Taro Aso. His approval rating has dropped to 21pc. The cabinet is in revolt. The world's second biggest economy no longer has a functioning government.
Credit Suisse warns that Japan could slide into deflation of minus 2pc by the autumn. Since interest rates are already near zero, which means that real rates will rise as the slump deepens – the surest path to a liquidity trap.
Kyohei Morita from Barclays Capital estimates that Japan's GDP shrank at an annual rate of 12.2pc in the fourth quarter. "It's shocking," he says. Singapore has already reported. Fourth-quarter GDP contracted at an 12.5pc annual rate.
Taiwan's exports fell 28pc in November. Shipments to China dropped 45pc. Korea's exports dropped 18pc in November and 17pc in December.
"We are looking right in the face of an unprecedented regional depression," said Frank Veneroso, the investment guru.
"If there is one part of the global disaster that is not reflected in today's massacred markets it is this Asian debacle. The source of the collapse appears to be above all a contraction in China."
One has to careful with Chinese figures. When I covered Latin America in the 1980s, veteran analysts watched electricity use to gauge economic growth since they could not trust official data. It is striking that China's power output fell 7pc in November.
Asia has clearly failed to use the fat years to break its dependency on the West. It has stuck doggedly to its export strategy – by holding down currencies, or by subtle policy bias against consumption.
In China's case it has let the wage share of GDP drop from 52pc to 40pc since 1999, according to the World Bank.
The defenders of this dead-end strategy are now coming up with astonishing proposals to put off the day of reckoning. Akio Mikuni, head of Japan's credit agency Mikuni, has called for a "Marshall Plan" to bail out America by cancelling $980bn of US Treasury bonds held by the Japanese state.
This debt jubilee does have the merit of creative thinking, but it is entirely designed to keep the old game going. "US households won't have access to credit they have enjoyed in the past. Their demand for all products, including imports, will suffer unless something is done," he said.
Let me be clear. I make no moral judgment on the "neo-Confucian" model, nor – heaven forbid – do I defend the debt depravity of the West.
A stale debate simmers over whether the Great Bubble was caused by Anglo-Saxon and Club Med hedonism, or by an Asian "Savings Glut" spilling into global bond markets and fuelling asset booms, as Washington claims. It was obviously a mix.
Two cultural systems interacted through globalisation, locking each other into a funeral dance.
The point is that this experiment has now blown up. Whether or not we slam straight into a global depression depends on how we – East, West, all of us – handle this.
The top sources of net global demand as measured by current account deficits over the last 12 months have been the US ($697bn), Spain ($166bn), Italy ($71bn), France ($57bn) Australia ($57bn), Greece (53bn), Turkey ($47bn), and Britain ($46bn).
Most are tightening their belts drastically, and in the case of Britain the shift has been so swift that the arch-sinner may soon be in surplus. If they are draining world demand, then world demand is going to collapse unless others step into the breach.
The surplus states – China ($378bn), Germany ($266bn) Japan ($176bn) – have not yet done so, which is why the global economy went off a cliff in October, November, and December. Beijing is planning a $600bn fiscal blitz.
But how much of it is an unfunded wish-list sent to local party bosses? It will not kick in until the middle of the year, an eternity away.
For now, China is dabbling with protectionism to gain time – a risky move for the top surplus country. It has let the yuan fall to the bottom of its band. Vietnam has devalued. Thailand and Taiwan are buying dollars.
Watching uneasily, the Asian Development Bank has warned against moves to "depreciate domestic currencies".
Anger is mounting in the West. Alstom chief Philippe Mellier has called for a boycott of Chinese trains.
"The Chinese market is gradually shutting down to let the Chinese companies prosper. There's no reciprocity any more," he told the Financial Times. Optimists say the collapse in oil prices will give Asia a shot in the arm. Governments are still flush, with ample scope for fiscal rescues. Asia's central banks are sitting on $4.1 trillion of reserves.
They have the means, perhaps, but do they have the will to act in time? Or do Beijing, Tokyo, Taipei, Kuala Lumpur, – and indeed Berlin – still cling to their assumption that others will spend for them?

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4093676/Asia-needs-to-fully-wake-up-to-the-scale-of-the-Wests-economic-crisis.html


Also read:
Decoupling dies as half the globe hits crunch
http://www.telegraph.co.uk/finance/markets/2820887/Decoupling-dies-as-half-the-globe-hits-crunch.html

Asian Countries Foreign Exchange Reserves

Asia and the art of war chests
By Rupert Walker
2 December 2008

Asian policymakers have built up protective foreign exchange reserves to ensure history doesn’t repeat itself.

Policymakers throughout Asia have had an overriding objective over the past decade. They have been determined to avoid a repeat of the crisis unleashed in 1997-1998, that exploded the myth of the “Asian miracle”, sending their economies into deep and protracted recessions. They would also rather avoid having to borrow from the International Monetary Fund again and be forced to impose a raft of measures demanded by the agency’s functionaries – measures which 10 years ago induced poverty and social unrest.

To reach this objective they stored up cash. Many governments built up “large protective buffers” against the balance of payment shocks that had put them under so much pressure in the late-90s, says Subir Gokarn, chief economist for Asia-Pacific at Standard and Poor’s, in a report published in early November. Basically, they created war chests of accumulated foreign exchange reserves, by absorbing their current and capital account surpluses. As a result, “healthy foreign exchange reserves are likely to buffer most Asia-Pacific economies during the (current) global slowdown”.

And despite foreign investors leaving regional equity markets in droves, as they either unwind yen carry trades and deleverage, or simply switch into the “safe-haven” of US Treasury securities, the drain on reserves hasn't been that severe.

Among the emerging economies in Asia, Vietnam has suffered the biggest fall in foreign exchange reserves – they now amount to almost 15% less than the 2008 peak – and among the developed economies New Zealand has experienced a 25% decline. The falls in China, Hong Kong, the Philippines and Taiwan have been non-existent or negligible.

Gokarn argues that one reason why the reserves have not declined more is that the region's emerging economies typically used the capital outflow to allow their currencies to depreciate, which meant they could offset the sharp appreciation that most of these currencies experienced in 2007.

He points out that Asia’s growth during the past 10 years has made it an “attractive destination for global investment flows that have been, in turn, facilitated by capital market reforms in many of these countries”. Large current account surpluses and net positive capital inflows would normally have put tremendous appreciation pressure on the region’s currencies – and made them exposed to a rapid depreciation if and when conditions changed.

Restraining currency appreciation

Twin surpluses should have put upward pressure on their currencies, but the authorities sold them and then sterilised the excess domestic currency in their financial systems to avoid monetary instability by issuing shorter-dated central bank bonds.

The depreciation has been particularly sharp since August 2008, when outward capital flows rose significantly. Six months ago, economists worried that any depreciation of domestic currencies might reinforce inflationary pressures due to rising commodity, oil and food prices. But, of course, the subsequent dramatic decline in these prices means that is not an issue now.

Comparisons have been made with the 1997-1998 crisis, although the problems then were largely home-grown whereas today the region is suffering from a deleveraging, liquidity drought and credit contraction that originated in the US and Europe. This contagion, which largely rebuts the de-coupling argument posited by some economists at the beginning of the year, has been exacerbated by a much closer integration between the financial systems worldwide.

The recurrent debt and currency crises associated with sudden withdrawals of Western money led to a rethinking by governments in Asian countries, inspired largely by China. In the past they’d followed orthodox thinking by borrowing from wealthy nations to finance domestic investment and drag their populations out of poverty. But China insisted that foreign capital should be injected as direct investment. Rather than simply providing debt to fund industrial development, the Chinese persuaded foreigners to build factories that couldn’t suddenly be up-rooted when confidence slipped.

Financial imbalances

Paradoxically, it has largely been re-routed Chinese savings which have financed much of China’s investment. Cash from household savings or corporate retained profits have been lent to the United States, fuelling that country’s consumer spending boom, and have then been channelled back to China as export earnings.

To ensure that its exports stayed cheap, China has kept the renminbi from appreciating beyond a prescribed rate by buying billions of dollars in world markets. Today China has foreign exchange reserves of more than $1.9 trillion and has surpassed Japan as the biggest holder of US treasury securities. Other Asian countries have adopted a similar strategy. For example, India entered the current crisis with around $300 billion of foreign reserves, which provide a comfortable level of “self-insurance” against capital flight.

This has led some commentators, such as the economic historian Niall Ferguson, to argue that these “financial imbalances” are the main cause of the excesses that produced the current crisis. Asia kept lending and the US (and Europeans) kept borrowing. The Asian savings glut supported a surge of consumer and corporate leverage, funding hedge funds and private equity firms, and of course, the US mortgage market which fuelled the rapid growth of derivative instruments.

Nevertheless, as Gokarn says, “it is now evident that for almost all the region's economies those handy reserves have allowed countries to avoid a potential balance-of-payments meltdown, especially as the flow of capital has reversed so sharply in the past few months”.

Whether this will hold true for the future is another matter. There is a standard Greenspan-Guidotti rule that says that reserves should cover external debt falling due within one year – but that is insufficient when foreign borrowings by private companies and overseas holdings in equity markets are taken into account. Also, debt coverage can soon disappear.

Korea, for instance, had about $240 billion of reserves – the sixth biggest in the world – at the beginning of November, which easily covers the $80 billion of short-term debt owed and even exceeds the $235 billion total external loans owed by Korean banks. But the central bank has been spending up to $280 million a week to inject liquidity into the country’s banking system, and in the first six months of the year, net foreign direct investment turned negative for the first time since 1980 as investors pulled out a net $886 million, according to the Bank of Korea.

Spending the reserves

“For Asia, the problem is not inadequate foreign exchange reserves,” says TJ Bond, Asia economist at Merrill Lynch. “It is uncertainty about how existing reserves will be used to meet maturing debt obligations and foreign sales of domestic assets.” Already, however, some of that uncertainty is being resolved.

Transparent foreign exchange intervention and currency swap agreements between the US Federal Reserve and Korea and Singapore worth $30 billion each have helped. Plus, regional currency swap agreements between 13 Asian countries (led by China, Japan and Korea) have created a pool of foreign exchange reserves to be tapped to protect their own currencies – an extension of the 2005 "Chiang Mai Initiative". The deal allows them to lend each other money at favourable terms if help is needed to stabilise exchange rates.

Capital controls restricting resident capital flight might also be an option. This was the approach taken by Malaysia a decade ago which protected the country from the worst of the crisis which afflicted other Asian economies.

But another problem is that by building up foreign exchange reserves by promoting export earnings through a competitive exchange rate, Asian economies make themselves vulnerable to growth slowdowns in the countries they export to.

On the other hand, although currency depreciation won’t help exporters as economies throughout the world fall into recession, they should be able to take advantage of any eventual recovery in consumer spending in major export markets.

Certainly, intraregional trade has lessened the export dependence on the US over the past decade, as richer Asian countries have proved increasingly significant markets for Asian exports. But, this affluence has had a cost which would make the region especially vulnerable, had it not been for policies introduced to prevent a repeat of the devastation that afflicted the region at the end of the last century.

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