There’s that word again: “contained”.
It’s popping up in more and more media reports about the state of the credit crisis. Asian stocks rose for a third day on Thursday after better-than-expected profits at US banks boosted optimism that the worst is over.
News from JPMorgan Chase and Co., the third largest US bank, and Wells Fargo and Co., the biggest West coast bank, managed to buoy shares of Asian banking powerhouses such as Mitsubishi UFJ Financial Group Inc. The crisis, it seems, has been contained.
The decoupling story has come full circle. A year ago, Asia had outgrown the West. Then, as Asian shares fell, those arguing the region could stand alone became very quiet. Now, the talk is that even with the US teetering on recession, Asia’s rapid growth will allow its markets to rise. Call it Decoupling Theory 2.0.
There are problems with this thesis, not least of which is the surging price of oil and food, and risks of wage-related inflation. Asia has avoided the worst of the credit market crisis; its banks were less exposed to dodgy debt than Europe’s. Yet, the effects of the turmoil—shattered US consumer confidence and aggressive Federal Reserve rate cuts— have barely begun funnelling Asia’s way. Asian central banks and governments will soon face their gravest challenges in a decade. News on Thursday that Merrill Lynch and Co. posted its third straight quarterly loss after at least $6.5 billion (Rs26,000 crore) of write-downs also raised doubts about whether the crisis is over. The results were announced after Asian markets closed.
Much also has been made of how well Asia is weathering high oil prices, now about $115 a barrel. The forces behind the rise aren’t just driven by supply, but also demand and fear. While the Organization of the Petroleum Exporting Countries holds the cards on the supply front and the war in Iraq isn’t helping, rising demand and fear might make economist Michael Englund and investor Marc Faber look very smart.
In October 2004, Englund, chief economist of Action Economics in Boulder, Colorado, explored the worst-case scenario for global markets in a report titled “Anyone Willing to Forecast $200 Oil?” A column mentioning the report—back when oil was around $40 a barrel—was met with a barrage of testy emails. The basic reaction was that commodity prices were already a bubble that soon would burst. Oil at $100 was seen by most as fanciful. Yet, three-and-a-half years later, oil is well above that level and climbing.
Hindsight is 20-20, yet what many analysts failed to appreciate was that oil hasn’t just been driven by former Fed chairman Alan Greenspan’s easy money policies and more recent rate cuts by his successor, Ben Bernanke. It’s more about Asia’s rise.
Central banks can raise rates to mop up excess liquidity. Curbing the enthusiasm of almost three billion Asians growing wealthier is far more complicated—and morally suspect. Hundreds of millions of Chinese, Indians and South-East Asians have yet to own their first motorbike or car. That alone probably makes oil trends secular, not cyclical.
The fallout from $200 oil might be extreme. “If the rise in oil to this level wasn’t triggered by geopolitics in the first place, I think it would dramatically increase the risk of conflict in parts of the developing world,” says Benjamin Pedley, investment strategist at LGT Group in Singapore, who isn’t predicting that level.
JPMorgan chief executive Jamie Dimon may be right when he says the credit market crisis is nearing an end. Even so, Asia will longer be dealing with the fallout. The frail dollar, for example, is feeding the rise in oil prices.
Food and energy costs haven’t crippled Asia, thanks partly to subsidies. There will be big fiscal implications if governments act to shield consumers further from price increases. That could result in higher bond yields and lower credit ratings. In fact, governments in countries such as Indonesia may soon be forced to reduce subsidies.
Of course, weaker growth in Asia could slow demand for oil in the short run. The broad direction in the longer run still is towards higher energy costs.
One of the ironies is that Asia’s growth is accelerating the very trends that may knock economies off balance. It’s here where Hong Kong-based Faber, one of Asia’s best known contrarians, had a point in 2004, when he said oil prices might approach $200.
Faber’s argument was largely about demographics; Asian incomes and consumption have nowhere to go but up. Asked on Thursday about oil, Faber joked: “With Bernanke at the Fed, it’s likely to go to $1 million per barrel.” The problem, Faber says, is that US officials are “now beyond the point where they can implement sound monetary policies.” Add in rising Asian demand, and you have the perfect recipe for high energy costs even if the Fed begins raising rates.
It’s never fun to sound like Chicken Little. No, the sky isn’t falling. That doesn’t mean Asia’s latest wave of this-crisis-is- containable thinking will prove correct.