The key is Japan. If the East Asian economic collapse spreads to Japan then things do become very serious. In the past few weeks, there have been disturbing signs that the regional slowdown has, indeed, been spreading to the world's second largest economy.
As background, have a look at the graph. On the left you can see the consensus forecast for economic growth in the US, Germany and Japan this year. These are not showing what happened - just what, at each month last year, the forecasters thought would happen this year. Thus, back at the beginning of 1997 the consensus expected the three countries to have about the same growth rate of between 2 and 2.5 per cent in 1998. Then, the expectations for the US and Germany were gradually nudged upwards, while those for Japan plunged. The fall for Japan came in two stages, a downward revision around the middle of the year following the fall-off in domestic demand in the spring, and then the absolute and still continuing collapse towards the turn of the year.
In fact, that graph will be too optimistic, for forecasts are always being updated and they are still being revised downwards. Quite a few forecasters are now expecting negative growth this year and I heard one this week privately forecasting minus 2 per cent growth.
Part of the reason for the deterioration is illustrated in the middle graph, showing what has been happening to Japanese exports over the past year. Exports to the US and Western Europe have been doing pretty well since the spring. Exports to the five East Asian "tiger" economies - Korea, the Philippines, Indonesia, Malaysia and Thailand - are now running 25 per cent down year-on-year. It is true that the five are the countries in the region that have been most seriously hit, but they are also enormously important to Japan. Last year, even after the declines, Japan exported more to those five countries than it did to the whole of Western Europe.
Not only are Asian developing countries very important to Japanese exports, they are also very important to Japanese banks. The third graph shows just how important. In the past few years, Germany and France have rapidly expanded lending to East Asia, but they are far outstripped by the Japanese, who, according to Bank for International Settlements figures, lent nearly $124bn to the region in the middle of last year. (Please note, British and American banks have been very cautious on this front.)
Given this, it is difficult to know just how secure Japanese banks really are. Not all the loans to the region will be dud, of course, but there have to be question-marks over some. Both the timing and the scale of the crisis could hardly be worse, for the Japanese banking system has already been gravely weakened by excessive property lending and property prices in Japan are still falling. Further, the concern about bad debts abroad inhibits the ability of the Japanese banks to lend more at home. Result: a further inhibition on the domestic Japanese economy.
What happens next? The information is partial, sketchy and frequently biased, but it is beginning to become possible to see the vague outlines of how the world economy might develop in the next two to three years. The rule of thumb calculation seems to be that East Asia will knock about half of one per cent off growth this year. This seems a sensible working assumption, but should be seen as the bottom of the likely range, particularly if growth in Japan goes negative (and I am now convinced that it will).
But if what happens in Japan will dictate to what extent the East Asian collapses hit the rest of the world this year, what happens to the world economy in 1999 and beyond will turn to quite a large extent on what happens in the various other East Asian economies where the crisis started. What do we know about that?
The answer is really very little. For a start, we don't yet know to what extent the regional crisis will spread to China. Some work by the Bank Credit Analyst group shows that price deflation has taken a serious hold in China. The retail price index has just gone negative - there have been about four months of falling prices. There is also a grand shake-out occurring in manufacturing, with a series of liquidations, closures and bankruptcies. Land and property prices have plunged.
We simply do not know how China will respond to these pressures. We know that the Chinese authorities must be profoundly concerned about price competitiveness, given the large devaluations by their neighbours. But China has an enormous and growing current account surplus, an indicator of excessive saving and lack of domestic demand. China may devalue, but it cannot hope to dig itself out of deflation by exporting much more. The only way it can dig itself out is by stimulating domestic demand. It is not clear that China knows how to do so.
Given the experience of the past six months, anyone who asserts with any confidence that they know what will happen to the region's economy invites, at best, polite scepticism. Nevertheless, I think it is plausible to argue that the economic shock will be more long-lasting than is reckoned. The usual sensible guess is that the region will have a difficult two, maybe three, years and then growth will resume. But I think we need to admit to the possibility that the whole time-zone will be pretty depressed for five to seven years. There will be some rebound from the present chaos, but the region will not recover its vibrancy until well into the next century.
Japan, paradoxically, may stage an earlier recovery, provided it pushes through a much more radical series of structural reforms than it has to date. But the region, which has provided about two-thirds of world growth since 1990, may well go into a period of relative stagnation.
This is bound to have a profound effect on us .For a start, it reasserts the position of the US. Next, it takes an enormous amount of pressure off commodity markets, for rising imports of commodities into Asia were the main force supporting commodities until the middle of last year. The world will enter the next millennium with falling commodity prices, maybe falling prices everywhere. Meanwhile, the most successful developed countries will be those that push through reform fastest. The US is in the lead; Japan faces an interesting dilemma: should it dump a series of economic structures and relationships that worked very well for a while, but no longer seem to be working. And European progress will turn on whether it is too preoccupied with internal matters (such as EMU) to carry through structural reforms in it financial and labour markets.
If this is right, there are two big themes to ponder in the coming months. The first is how quickly will Japan make structural adjustments to its economy, for the faster it does so the less likely it will be that the rest of us will catch the East Asian flu. The second is how strong the deflationary gale will be in the new millennium. It is a remarkable change, isn't it, from the century that has seen the fastest inflation in recorded history to one in which, maybe, prices will be stable. Maybe.