An ancient tale recounts
the experience of a cat that is scalded with hot
milk while still a kitten, and lives its life
without ever tasting milk again. In the aftermath
of the Asian financial crisis, regional
authorities vowed that they would never again
place themselves in a disadvantageous position
with respect to foreign hot money, typified by
avaricious hedge funds that were castigated for
currency manipulation by many a leader.
The result of the crisis, which has yet to
fully reverse itself when one looks at various
indicators of credit-worthiness, has ironically
been
for Asian governments to emerge as the leading
currency manipulators in the world, bringing in
their wake a new financial crisis that threatens
both America's heartland and their own exporting
industries.
In a series of recent
articles, I wrote about the social impact of
government manipulation on the economies of India
and China [1], which are related to the issues of
planned economies and currency manipulation [2].
The issue at hand is that being over-eager to
manipulate currencies for the benefit of their
exporters, even the two largest and fastest
growing of emerging Asian economies are unable to
provide enough economic growth for their
underclass.
There is nothing to boast
about having US$200 billion in reserves (India) or
indeed more than a trillion (China), when basic
infrastructure such as water and roads is lacking
(India) and poor people still leave the country
illegally in shipping containers in search of a
better life (China). Perhaps the Indian government
frets that if it provided roads and ports, its
poor will also find their way into shipping
containers as economic refugees even though that
doesn't explain why so many Indians still have no
access to clean drinking water.
Southeast Asia For those who
came in late, the Asian financial crisis in 1997
was caused by significant current account deficits
in Asia, that were almost entirely funded by
short-term flows from banks, hedge funds and
similar investors who were keen to grab the high
interest rate differential on offer between the
bonds issued by Group of Seven countries such as
the United States and those issued by Asian banks.
The underlying logic was that so long as Asian
currencies remained stable against the US dollar,
one could capture a substantial premium for
essentially no risk of losing money.
However, as money flows accelerated and
Asians started taking higher risks, there soon
emerged an unsustainable gap between the maturity
of assets and liabilities for Asian companies, and
in turn, their governments that had either fully
or partially guaranteed the banking system that
was facilitating such transfers of money.
Eventually, smart investors worked out that the
risks were actually higher than returns, and
initiated a series of attacks on Asian currencies
with a view to forcing the governments to allow
them to depreciate.
The countries at the
epicenter of the Asian crisis were of course those
of Southeast Asia, which is not surprising given
that hedge funds first focused on pushing the Thai
baht away from its unsustainable peg to the US
dollar. Indonesia was the next country to be
hollowed out, although most of the damage was done
by locals as compared to foreigners.
That
being so, it is also true that it was the resolute
action of Malaysia to establish a new peg along
with capital controls in 1998 that helped to
reverse the tide from the Asian crisis and
eventually usher in a stable macro-economic
environment. Most observers though quibble about
giving Malaysia any part in the turnaround,
instead preferring to focus on Hong Kong's
intervention in its stock markets around the same
time, as the action that broke the back of many
hedge funds.
Whoever takes the credit for
the reversal, it is perhaps beyond argument that
Southeast Asia's economic growth has generally
lagged behind the rest of Asia in the past 10
years, as officials have focused on retaining
stable currencies at the expense of pursuing
higher economic growth. This comment will probably
strike the officials as counter-intuitive as they
still believe that the path to economic stability
lies with exports despite the patent inability of
such countries to compete with China in
manufacturing or India in services.
A
variety of factors, including language and
education, have prevented Southeast Asian
countries from moving to higher value-added
products, such as what Japan and more recently
South Korea have achieved. To a large extent, the
dysfunctional set up of ASEAN itself is to blame,
[3] as the main promise of economic co-operation
has been realized in an overly staggered fashion
that has done nothing for improving the
competitiveness of local industry. In turn, that
left many sectors such as textiles and auto parts
too small and specialized thereby disallowing any
advantage as Chinese manufacturers improved their
product profile and production efficiency.
Allowing their countries to focus on areas
of competitive strength, namely higher value
industries, tourism, design and technology,
logistics and other related businesses would have
allowed Southeast Asia to emerge stronger than it
currently is. Of course, that process also would
have caused more painful structural reforms of the
kind that Malaysia [4] has consistently eschewed
in the name of illusory social cohesion. By
freeing up the currency and domestic ownership
constraints that allow its entrepreneurial Chinese
minority to flourish, Malaysia could have easily
added many percentage points to its overall
economic growth in the past ten years, instead of
playing second fiddle to Singapore on services and
Indonesia on manufacturing.
Pointless
reserves Asia has accumulated significant
reserves well above what is strictly required,
because of enduring fears about being found short
of money to repay debt ever again - the scalded
cat argument. As most of the countries, with the
significant exception of the Philippines, do not
have any external debt to speak of anymore, the
problem has become one of currency peg maintenance
that displays the utter lack of imagination of the
ruling elite in these countries.
These
foreign exchange reserves are used to buy assets
in developed countries, but are mainly deployed in
bonds. Returns being earned on such holdings
barely compensate Asian central banks for even the
managed depreciation of the US dollar against
their local currencies, let alone the opportunity
cost of investing such proceeds more productively
in their own economies or indeed, those of
neighbors. For example, Asian central banks do not
invest significantly within the Asian region, due
to self-imposed constraints on credit quality
requirements. In turn, this has prevented the
development of a strong bond market in Asian
currencies that has perpetuated the vicious cycle
of having to invest purely in "hard" currencies
such as the US dollar.
The rule of the
markets is that no good deed goes unpunished for
very long. True to form, the excessive investments
in America and Europe have engendered over
consumption in the case of the former that now
stands to collapse sharply as the housing debacle
reaches its crescendo. As millions of Americans
find that they cannot afford even mortgage
payments on their houses, they will default - but
the American financial system will not have to
pocket the losses as the risk has already been
sold down to Asian central banks in the form of
mortgage backed securities.
Thus, the
release of excess liquidity into the American
economy that caused locals to borrow too much
money will come around full circle to hurt Asian
lenders. The circle can be stalled for some time
by continued intervention, but eventually it will
have to obey the law of gravity. House prices are
falling everywhere in America now, and this
combined with rising interest costs will create a
painful recession. Painful for creditors, that is
: ironical given that the Asian financial crisis
was more painful for borrowers rather than the
lenders.
Thus Asia finds itself in the
unenviable position of having to take losses on
billions of dud securities issued by American
companies and individuals in months to come. If
any central bank chooses to take action now and
sell down its holdings of American and European
bonds, it risks setting off a panic sale by
compatriots around the region. I assume that any
central banker who initiates such an action can
kiss his invitations to major golf tournament a
firm goodbye.
A conspiracy of inaction
thus rules the corridors of Asian central banks
even as their citizens toil outside in sheer
ignorance. If that's called progress for 10 years,
you can keep it. [4]
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
