Henry Paulson’s visit to Asia couldn’t be more timely. The US treasury secretary is in the region after global equity markets plummeted last week. While purely coincidental—Paulson’s trip was planned well before China’s stock plunge on 27 February—this week he is getting a first-hand look at some of the world’s most vibrant and, supposedly, risky economies.
Unfortunately, Paulson will probably leave China, Japan and South Korea concluding two things that many investors already claim: this global market decline is merely a repeat of May 2006, and it has Asian fingerprints all over it. Paulson should dig deeper and learn the truth on both counts.
The growing reassessment of risk from Shanghai to New York suggests this rout will be far more painful than May 2006, when emerging markets swooned only to recover soon after. The continued proliferation of traders borrowing in yen and putting the funds in riskier assets will only have made investors more susceptible to panic. If the so-called yen carry trade unwinds broadly, all markets will be affected.
Even if the optimists are right and equity prices rebound, it won’t necessarily be a good thing. It just means the liquidity bubble caused by ultra-low Japanese interest rates and a Federal Reserve that kept US borrowing costs too low for too long would get even bigger. Left to grow, bubbles only get more dangerous.
The other misperception is that what’s unfolding in markets has its roots in Asia. The 9.2% plunge in the Shanghai and Shenzhen 300 Index on 27 February certainly spooked investors, but only because they were already on edge. Observers have long watched China’s markets more for entertainment than for insights into global trends, and rightfully so. “Investors shouldn’t be misled by these arbitrary, after- the-fact musings,” Richard Salsman, president of Durham, North Carolina-based Intermarket Forecasting Inc., wrote in a note to clients. “China’s stock performance is virtually irrelevant to US performance. What matters is the US yield-curve spread.”
Since July, the graphic depiction of US yields from the short to long maturities has pointed towards a bad end to America’s dependence on international capital to finance its imbalances. If China did anything, it reminded investors that something is amiss in the global system.
Alan Greenspan deserves more blame than China. In the late 1990s and early 2000s, the former Fed chairman’s low-rate policies fuelled asset bubbles from US housing to Mumbai stocks. Greenspan’s utterance of the word “recession” recently is likely to have a more lasting impact on US assets than China’s currency policy will.
The equity decline speaks to the massive blame-game undermining the global financial system. There are imbalances everywhere, yet no one sees their own as the culprit. “Last week’s global sell-off was triggered by a myriad of seemingly unrelated factors, such as a plunge in Chinese shares, concerns about Greenspan’s prior comments, a weak US durable-goods report, a technology glitch on the US exchange, and market chatter about sub-prime risks,” says David Cohen, director of Asian economic forecasting at Action Economics in Singapore.
What may surprise many is which economies end up winning and losing amid the current market turmoil. Huge ones, such as the US, Japan and Europe, were negligibly affected by the 1997 Asian crisis. This time around, developing Asia may fare better than the US or Japan.
For all the hyperventilating over market froth, nothing has changed in China’s economy in the last 10 days, or Asia’s for that matter. China’s outlook is loaded with big risks, but they are well documented and investors tend to take a so-far-so-good approach towards Asia’s No. 2 economy.
“From a fundamental viewpoint, I think the argument that emerging Asia will be the new centre of economic gravity stands,” says Chrisanne Chin, finance faculty head at MIMS Business School, Malaysian Institute of Management and INTI University College in Kuala Lumpur. “The geopolitical balance requires a Japanese recovery to hedge the new upstarts of China and India, but that’s occurring.”
Chin points out that Asian stock markets are mainly momentum-driven, and don’t often reflect economic fundamentals. The sharp dips during May 2006 and those last week reflected emerging-market volatility or country-specific risks, rather than serious economic shortcomings.
In other words, consider these gyrations as growing pains, not reasons to rush for the exits. Perhaps Tuesday’s rally in Asian stocks suggests investors realize that. The US and Japan may not get off so easily. The world’s two biggest economies have, to varying degrees, relied on low borrowing costs to boost growth—much of that liquidity fed back into the global system and is distorting markets.
Now, as investors wake up to all the risks, it may be the developed world’s turn to bear the brunt. Paulson will see that if he pays close attention.