Japan, Asia, now Russia. Who's next?
Saturday 22 August 1998
Q. Why are world financial markets so jittery?
A. The shakiness of the financial systems of many less developed economies has been brought to the fore again by this week's turmoil in Russia. After blowing $3.8bn (pounds 2.3bn) of IMF money in a futile defence of the rouble, Russia's central bank chief, Sergei Dubinin, threw in the towel on Monday and announced what was effectively a substantial devaluation of the rouble. He also announced a 90-day moratorium on trading in short-term government debt.
Meanwhile, other countries in Asia are still mopping up the debris from the financial collapses that dominated last year.
Q. Which countries are most seriously affected?
A. In addition to Russia, there are crises in Korea, Thailand, Malaysia and Indonesia. Currencies as diverse as the South African rand, Indian rupee and Czech crown are under pressure, as are currencies and debt markets in emerging markets in Eastern Europe and Asia, joined significantly yesterday by Latin America. But the biggest worry is Japan, which is dragging its feet on much needed financial reform.
Q. Are these crises all linked?
A. Yes: they are all rooted in the bigger problem of a creaking Japanese economy, which in turn has slowed down other Asian economies and is now impacting the rest of the world. The problems in Russia have focused attention on the fragility of all emerging economies, which are now being shunned as investors move money away from risky territories.
Few of these economies have much in common by way of trade, except that all are having to use their weaker currencies to export their way out of trouble. That means they are effectively fighting each other to sell their goods to the US and Western Europe, which are the only parts of the global economy still growing at the moment.
There is also the vexed question of to what degree speculators such as George Soros and similar hedge funds are fanning the flames by "shorting" currencies to provoke devaluations from which they can profit. For instance, this week's crisis in Russia was at least aggravated, if not exactly caused, by the flight of capital worth $4bn since May.
Q. So it is all the speculators' fault, then?
A. It is tempting to put the crises down to the globalisation of capital markets, which has resulted in larger pools of hot money flowing around the globe at the flick of a switch. There is some truth in the argument that the crises in some Asian countries, as in Mexico in 1992, were accompanied by a sudden reversal in sentiment among foreign investors.
However, the big foreign investors say that even if the crises are exacerbated by these flows, they would not happen if underlying economic fundamentals were sound. Most Asian states had unbalanced economies after decades of government-directed investment in heavy industry. Overcapacity tended to go hand in hand with an underdeveloped banking system. Add corruption, cronyism and a lack of proper accounts and statistics, and you have a very unstable cocktail.
In Russia and South-east Asia much of the speculation was in fact domestically driven. As long as local currencies remained pegged to the dollar, it made sense for locals as well as foreigners to borrow in dollars to invest in high-yielding securities at home - until the peg breaks and hapless borrowers are left with assets suddenly worth less than liabilities.
The exception is Japan, in most respects a very advanced economy. Its problems, of a very different order, predate the crisis and may take longer to solve.
Q. Does the Russian crisis matter?
A. Russia is the world's largest country, but far from the largest economy. Its stock market, even on a good day, is worth less than, say, Tesco. There is very little real trade between Britain and Russia, and UK banks have generally avoided Russian lending.
However, Russia remains a very important power, and serious political instability could bode ill. There is a real fear that Russia could revert to a period of ultranationalist isolationism.
Also the leading investment banks, many with large emerging market teams in London, have committed heavily to Russia and are now looking at some very serious losses.
In a top-heavy financial system we are all dependent on investor confidence, which at the moment is very fragile.
Q. Who's next?
A. Having piled into ever more exotic areas in search of higher returns, the process is reversing sharply. After Asia and Eastern Europe, the crisis was yesterday threatening to engulf Latin America, with everything from the Mexican peso to the Venezuelan bolivar falling.
What really keeps central bankers awake, however, is the prospect that Hong Kong may be forced to devalue. Then comes China, at which point we really are in trouble.
Q. Will this tip the world into recession?
A. Much of the world already is effectively in recession. Consumption in Asia has plunged, and production aimed for there is going to the growth markets in Europe and the US.
The UK is labouring under a strong pound and much higher interest rates than its immediate rivals. Japan is stalled, and only France and Germany of major OECD economies are forecast to grow faster this year than last. Even in the US, the dreaded 'R' word is heard. The big driver of the US economy has been technology, but prices of key parts have plummeted because of competition from Asia, and the US trade balance has moved sharply into the red.
Q. What can the rest of the world do?
A. The IMF has committed $40bn to tackle the crises, but Western donors are much less willing to stump up more. In most cases, we can do little more than leave the victims to pick up the pieces themselves.
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