Why we failed to see the Asian contagion coming
At each stage things have turned out worse than expected. There is clearly more bad news to come
Tuesday 16 June 1998
This is natural and normal, for it is after all the job of financial markets to look forward, price risks, and anticipate changes in the world economy. But every now and again the relationship is reversed. The world changes and for a while it is the markets that are scrambling behind. The last few weeks are one such period, for sentiment has suddenly deteriorated. Two questions: why are the markets behind the curve and what events will happen that will push them ahead of it?
The "why?" of course is the easier. Over the last few weeks it has become clear to the markets that Japan would be gravely hit by the fall in demand in the rest of East Asia. Actually it should have been clear months ago that the country would move into recession this year, but the Japanese authorities were utterly resolute in the view that it wouldn't.
I suppose they may have had some influence on market opinion, though I think there was a the greater force. This is the markets' difficulty in appreciating not just the degree of contagion that would occur, but the psychological effect of failure on people in the region who have only been accustomed to success. The developing economies of East Asia knew nothing but success.
Anyway, as each successive economic package in Japan failed to stimulate home demand, and as the regional collapse hit export demand, the message gradually sank home that what was happening in developing Asia could also happen in developed Asia. The first-quarter figures last Friday were worse than expected, so the magnitude of the decline came as a slight surprise, though the direction of the numbers did not. But if everyone is feeling shell-shocked, even modest surprises have a big impact when they are on the downside.
So at each stage things have turned out a little worse than the consensus expected. It is almost impossible to think of any significant piece of news coming out of the region over the last nine months that has been better than the markets had forecast. This process will continue for a few months yet, for there is clearly more bad news to come. Thus there are still people in the markets who believe that China will not devalue, and though the consensus now on balance do probably reckon that it will, there is room for further disappointment for those who don't.
For there is really no evidence anywhere yet. The graph shows the regional trend in industrial production for the region, and though you can just discern a little upward kick for both China and Korea, most of the lines are still heading south. First-quarter figures for gross domestic product are almost universally dire. Last Friday's minus 5.3 per cent figure for the annual rate of decline in Japan compares with minus 5.6 per cent in Hong Kong, minus 19.3 per cent in Korea, minus 23.5 per cent in Malaysia and minus 24.2 per cent in Indonesia. The only pluses I could find were in Taiwan and (just a plus) Singapore.
Just think for a moment about those double-digit minuses. They are sharper than any GDP decline experienced by any major industrial country at any stage since the early 1950s. No wonder people in East Asia have been taken by surprise: these numbers are at the absolute outermost range of the conceivable, even for those of us who have experienced sharp recession. For most people in East Asia, who have had no experience of recession in their working lives, what has happened has been beyond the conceivable.
How long will it be before news starts to turn out better than expected: what does it take to get ahead of curve?
Well, viewed from the West, we may be beginning to get there. The regional economic news is almost certainly going to get worse, as noted above. There is the likelihood of a new round of devaluations, and all the fall- out from that. But the markets are beginning to factor really bad news into their calculations.
For example Nikko Securities now reckons that the Japanese bond market "is discounting a nightmare scenario, in which the Japanese economy has entered a deflationary spiral and the previously unthinkable - still lower official rates - becomes possible". JP Morgan's Asian team in Singapore now acknowledges that "no country in the region appears yet to have hit bottom: news will remain uniformly negative in coming weeks".
Looking ahead, it is important to remember that bad financial news can be good economic news. A further round of regional devaluations is a good example. While not all observers believe that currencies need to fall yet further, if they do the region certainly becomes super-competitive.
The Morgan team reckons that some parts of East Asia, in particular Korea and Thailand, could be on the road to an export-led recovery by the end of the year, based on yet cheaper currencies. Domestic demand will be very weak for several quarters, not just a few months, but if this recession follows the sort of pattern of others, we could be starting to see some signs of an upturn by the middle of next year, and maybe a more general recovery by 2000.
The "maybe" there turns on Japan. It will be almost impossible for there to be a general regional recovery until Japanese growth is restarted, for Japan is simply too big a weight in the region for recovery to happen without it. Nine months ago the conventional wisdom was that the East Asian crisis would not be too serious unless it enveloped Japan, in which case all bets were off. The logic was right, even if the way the view was presented was too optimistic. But even if - and this is a worst case - Japan is still in recession in another 18 months, there will be pockets of recovery in the rest of East Asia.
So expect no good news for several months, for that is the only sensible way to proceed. But expect the occasional pleasant surprise from perhaps the end of this year onwards. When things are plunging downwards it is very hard to realise that they must at some stage head back up. Of course the flip side of that is also true - but that is another story.
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