Asia is next
So, I am back in the saddle after a great weekend in Palm Beach. And three days almost entirely away from Newspapers, Televisions, Telephones, and Computers is a very good thing to clear the head. (Although I did happen to catch Sarah Palin on “Saturday Night Live” and I thought it was well done.)
Let me start off this week with some thoughts that come out of conversations with friends in the financial industry that I spoke to at the weekend. I sincerely believe the panic that we experienced over the past few weeks is over. In time, risk premia like the TED Spread and LIBOR-OIS spread will damp down somewhat and they have already begun to do so.
However, much of the underlying problem: leverage, excessive debt and inflated asset prices remains. Moreover, we are now about to experience the pain of recession, which is an entirely different beast than what we have experienced to date. And all of this will take time to work through.
However, my focus will be on Asia because Asia is next. Let me explain why?
This crisis and downturn is a manifestation of how markets respond to a realization that an unsustainable mania has weakened the entire banking system. In Manias, Pancs and Crashes, Charles Kindleberger outlines the stages of a financial mania and crisis.
The events begin as a result of legitimate speculation in a promising asset class: metallic coins in the Holy Roman Empire in 1618-23, British Government Debt in Amsterdam in 1763, Railroads in the U.S. in the 1870s, Technology and Telecom stocks in 1995. However, easy money steps in and monetary expansion fans the flames of the speculation turning legitimate speculation into a bubble.
As the bubble takes form and money is to be made, swindlers enter the scene. Time and again, this has bee the case and in the present case things were no different. However, at some point the unsustainability of things becomes evident. Warning signs appear, leading to changing expectations, and, eventually, financial distress. Then comes the crash and panic. This is what we have seen to date in the present crisis.
However, Kindleberger also mentions the infection of asset classes due to the speculative mania in Chapters Seven and Eight. The speculation and bubble events do not happen in a vacuum. Easy money and large profits spill out into other asset classes domestically and are also propagated internationally.
Now, I would argue we have seen the spill over events in terms of residential real estate infecting leveraged loans, high yield debt, Collateralized Debt Obligations and so on. Moreover, we have seen that a number of countries have experienced housing manias that are in unwinding right now. However, I would argue that, in a globalized economy, no one is going to “de-couple” — no nation can insulate itself from the global effects of this largest speculative mania in history, That is why Asia is next.
In August, I penned a blog post “Europe is next,” in which I said:
As you could probably tell — from all the stories I have been writing about the Baltics, Denmark, Sweden, you name it — I believe that Europe is the next leg down in the global housing bubble. As such, it will pay to focus as much attention on events outside the US, where the housing bubble began as it will to focus on the continuing U.S. problem.
Make no bones about it, with distress in Alt-A, Prime, Option Arm, and Negative Amortization mortgage products still rising, the U.S. has many more writedowns to come and some bankruptcies. Yet, it is Europe where the next leg down will be interesting.
–Europe is Next
I went on to elaborate on how I saw distress in Europe and that Europe was going to suffer along with the U.S. in this downturn. And the script has largely unfolded as expected. Now, it is Asia which should move center stage. The signs of weakness are readily apparent. Three major economies are in recession: Japan, New Zealand and Singapore. Others will follow.
Moreover, the financial distress that we saw first in the U.S. and then in Europe is also apparent as well. Look at the Bloomberg headlines from Asia today:
India Lowers Key Rate for the First Time Since 2004
Citic Pacific May Lose $2 Billion From Currency Bets
Kazakhstan to Use Oil Reserves to Avert Bank Failure
Asian Stocks Rise as Government Policies Provide Market Support
Dollar Hoarding Fuels Won, Rupee, Real Drop on Losses
Pakistan May Seek IMF Bailout to Avoid Debt Default
China’s Economy Grows 9%, Slowest Pace in Five Years
All of this suggests that the ill effects of the global economic crisis have finally made their way to Asia and emerging market countries in Latin America and elsewhere. For me the South Korean banking mess is the canary in the coalmine here:
South Korea sought to rescue its financial system by guaranteeing $100 billion of lenders’ foreign-currency debts and providing $30 billion in U.S. dollars to banks.
The won rose and the Kospi was little changed after the government said it will also give tax benefits for long-term investors, and the central bank will provide “adequate” currency liquidity to the markets. The plan, unveiled yesterday, aims to help lenders overcome overseas funding difficulties.
South Korea, struggling with Asia’s worst-performing currency and a stock market that has lost 38 percent this year, joins Europe, Australia and Hong Kong in providing banks with state backing amid a global lending drought. The measures should boost confidence in the banking system and return attention to “Korea’s solid macroeconomic fundamentals,” the International Monetary Fund said.
The guarantee is “essential,” said Kim Hag Ju, head of research at Samsung Securities Co. in Seoul. “Rather than give banks the money they need, it’s much cheaper and effective to back their debts so they can borrow it. With the credit freeze, it’s extremely difficult for a bank or company to be able to borrow money without a sovereign guarantee.”
The Kospi slipped 0.3 percent to 1,177.11 at 9:29 a.m. in Seoul after initially rising as much as 1.3 percent. The index fell 9.4 percent on Oct. 16, the biggest drop since September 2001, and is heading for its first annual decline since 2002.
The won gained 4.1 percent to 1,280.80 against the U.S. dollar today. The currency fell last week by the most since an IMF bailout of South Korea in 1997 after Standard & Poor’s said it may cut the credit ratings of the nation’s largest lenders.
South Korea’s government said it has no immediate plan to recapitalize lenders or increase deposit guarantees.
If you recall, these were measures initially undertaken in the U.S. and across Europe. Eventually, greater support in the form of bank recapitalization and explicit deposit guarantees were necessary. Why would it be any different in South Korea or elsewhere in Asia?
My last though on this issue is about China. China has had a massive property and stock bubble. The stock bubble has burst and the monetary authorities are doing all that they can to keep the property bubble from collapsing in a disorderly, panic-filled way. However, it seems to me that China will suffer a hard landing as the magnitude of these bubbles become evident.
What’s my point? Asia is in a much better situation than either North America or Europe. Yet, it will not completely de-couple. The speculative mania certainly spilled out into Asia in terms of excess capacity across Asia, stock market and property bubbles in China in particular, and inflation and easy money across the entirety of Asian economies. Therefore, while Asian macro data is better than it is elsewhere, I believe we are about to witness the next leg down in the global credit crisis and it will be in Asia where the action takes us.
Asia is next.
Manias, Panics and Crashes – Charles Kindleberger