BT: Mini meltdown may be good thing for Asia (08 Mar 2007)

Mini meltdown may be good thing for Asia

By ANTHONY ROWLEY
TOKYO CORRESPONDENT

IT came out of the blue and then seemed to subside back into that ether, almost as though it had never happened. And yet, the mini meltdown in world stock markets that has occurred over the past week is unlikely to prove a transitory phenomenon.

The spell of ever-rising markets buoyed by an infinite tide of financial liquidity has been weakened, even if it has not yet been broken. For Japan, where the meltdown seems to have originated (despite the common belief that it began in China), the lessons of the past week will be salutary provided that they are heeded.

For the rest of Asia too, turmoil in currency markets could prove to be a wake-up call to abandon mercantilist policies aimed at reserve building and to focus instead upon building domestic demand. The theory that it was the 9 per cent plunge in Chinese stock prices along with signs of shakiness in Indian stocks that tipped global markets into turmoil hardly holds water.

The proportion of global portfolios invested in these markets just is not big enough to provoke selling of other financial assets by global investors who had lost their shirts in Shanghai or Mumbai.

And it is surely no coincidence that the turmoil erupted close on the heels of the Bank of Japan's decision to raise short-term interest rates for the second time in the space of seven months after holding them at zero for six years. It then only needed weak data on the US economy, suggesting that rates there had peaked out to provoke jitters among the speculating classes.

Warnings had been mounting that yen-financed speculation in stocks, real estate and commodities was dangerous, and that emerging markets were 'priced for perfection'. The warnings came from the likes of the IMF and the Institute of International Finance in Washington but no one wanted to listen because they were too busy making money to see sense.

Some took comfort from the idea that yen 'carry trades' (where yen are borrowed on the cheap and sold for other currencies in which high-yielding assets are denominated), would not unwind so long as the nominal interest rate differential between the yen and the US dollar remained above 3 per cent.

But, in the event, speculators fled at the first whiff of gunpowder from the BOJ rather than adopting a calculating stance. Having closed out short-term yen positions, Japanese small investors (the myriad who nowadays challenge institutional investors when it comes to speculation in foreign exchange markets or longer-term investment in foreign bonds) are unlikely to step back into yen carry trades, unless either the BOJ changes course and drops rates again or the US Fed raises them.

Both are unlikely. Without the propellant of yen-fed global liquidity to support them, prices of stocks, commodities and real estate will not rise in future as they have in the past. What stops going up must come down, because speculative investment in financial assets is not made for the long term or for yield but rather for quick capital gains.

In the absence of new liquidity-fed profits, more investors will sell out and go into cash. This process will unfold in coming months. It will feed upon itself as losses in one market force institutional and individual holders of diversified portfolios to sell in one market to compensate for losses in another.

Even if the mounting problems of the sub-prime mortgage market in the US do not provoke a crisis, real estate markets will not remain immune to the rout. At the end of the day, the yen will emerge stronger against the dollar, euro and other currencies.

This will slow Japan's reliance upon exports and force the government to stimulate personal consumption by pressuring Japanese companies to raise basic wages. Provided the BOJ does not lose its nerve and continues to raise rates, other distortions in the Japanese economy will also be ironed out.

A stronger yen will make Asian exporters - South Korea and Thailand especially - happier but it will also raise pressure on China to appreciate the yuan. That would force Beijing to put more emphasis on domestic demand and help cool China's overheated economy, although the impact on the Chinese agricultural sector could be harsh.

Just what the impact on the global economy of falls in stock, commodity and real estate prices will be is hard to determine. It all depends on how severe those falls prove to be and on whether the Fed, then BOJ, the European Central Bank and others are tempted to reach for the liquidity switch again by dropping rates.

But saving a global recession, some good should come out of all this for Asia.

Copyright © 2005 Singapore Press Holdings Ltd. All rights reserved.