STOCKS : Asian Markets Are Only an Excuse

When foolish remarks by someone named Mahathir Mohamad can start a chain of events that help trigger a spectacular 554-point meltdown in the Dow Jones industrial average, it’s a sure sign that professional investors are looking for any excuse to cut and run.

Mahathir is the prime minister of Malaysia, one of Southeast Asia’s “Little Tigers,” and a longtime darling of overseas investors. But when serious problems in Southeast Asian banking and real estate began to surface last summer, Mahathir blamed all the area’s problems on “global currency speculators.” Foreign investors understandably took fright, and currency runs and stock-market crashes spread through Indonesia, Vietnam, Malaysia and Thailand.

Two weeks ago, turmoil in the Little Tigers spilled over into Hong Kong, though the island is in quite decent economic shape. But investors have a herd instinct, and it was a good opportunity to vent worries about long-run stability in China.

Then New York had its big 7% drop Monday, followed by Tuesday’s stupendous billion-plus-share trading day, when small investors pushed the market back up in the teeth of heavy selling by the big boys. By the end of the week, the Dow was roaring up and down in 100-point-plus jumps. Though daily averages were down considerably from their summertime peaks, they were still up some 15% for the year, which in normal times would be seen as a quite respectable performance.

The truth is, all the current nattering about “globalization” notwithstanding, recent events in Asia have only minor implications for the United States. The tremors on Wall Street simply suggest that the stock market has gotten way out in front of what has been solid U.S. economic performance. Stock-market growth over the past three years has been the fastest in all history, and stock prices have doubled just since 1994. U.S. economic news has been consistently good, and is likely to continue to be good for some time to come--just not that good.

The problems in Asia are real, and they do raise doubts about the smarts of fund managers who have been touting the great opportunities overseas. With hindsight, it’s clear that difficulties have been building for years, and signs of trouble have been visible for a long time. The enveloping smog from Indonesia’s uncontrollable forest fires merely adds to the impression of a very un-Asian slovenliness and recklessness.

Most of the smaller Asian countries pegged their currencies to the U.S. dollar to reassure investors of their inherent stability--and ensure a steady inflow of foreign investment. The Hong Kong dollar, for example, has been fixed at a bit less than 8HK:1US since 1983. For many developing countries, it’s a good policy, for it helps keep inflation low and acts as a curb against the kind of politically motivated protectionism that has long plagued Latin America. But it does require a lot of internal discipline, which is hard to maintain in good times.

Discipline broke down in countries like Malaysia and Thailand when the huge influx of money from U.S. mutual funds made it easy for local financiers to borrow dollars at low interest rates and then relend them in local currencies at high interest. It was a great way to make money, as long as the local loans were actually repaid. But cronyism and corruption guaranteed that much of the money was wasted, mostly in local stock markets and real-estate projects.

The consequence is that stock prices and real-estate values are unrealistically high; local banks are stuck with huge portfolios of bad debts, and jumbo loans are falling due that have to be repaid in dollars. Something similar, without the foreign loans, happened in Japan in the late 1980s, and that country still hasn’t recovered from the subsequent real-estate and stock-market crashes.

But U.S. companies actually sell relatively little to Southeast Asia, so the near-term impact of the Little Tigers’ troubles will be small. Japan will be hit harder, and there might be some minor effects on U.S. exports there, but nothing of a scale to move stock markets. On the other hand, problems in Asia will bring a lot of American dollars back home, and attract foreign money seeking a safe haven. U.S. interest rates are thus likely to stay low, while the sharp break in the stock market may restrain any inclination of the part of the Federal Reserve to jack up rates any time soon. None of that is bad, and last week’s stock-market break was accompanied by a healthy uptick in the bond market.

In the medium term, the Asian economies will attempt to recover by expanding their exports at the same time as rejiggered currencies make their goods cheap in dollar terms. As the disruptions settle down, therefore, we should expect a sharp increase in the U.S. trade deficit.

Once again, that is not necessarily bad. With unemployment rates at their lowest levels in years, increased imports will not have much effect on jobs. In fact, cheap foreign goods will help keep inflation under control, which might help keep the boom going a few years longer. The biggest repercussions are likely to be political: Trade issues could dominate next year’s congressional races, and possibly even the next presidential election.

A reasonable bet, therefore, is that the American bull market has still not run out of steam. Federal Reserve Chairman Alan Greenspan seemed to take that view in his scheduled congressional testimony on Wednesday, even suggesting that the market break was a “salutary event” that “could help prolong” the U.S. business expansion.

It’s easy to forget that the stock market is not the same as the economy. Even when the economic engine is chugging along nicely, thank you, markets can get way out of line with fundamental values.

Historically, the U.S. stock market returns about 10% a year. The returns of 30%-plus that investors have come to expect are clearly not sustainable. Troubles in Asia are a handy excuse to burn off some excesses and get on a more realistic course, but it’s not likely they portend a fundamental shift in U.S. fortunes. A reasonable guess is that the market will stabilize at a level quite a bit lower than the most recent highs, but not disastrously so. Look for continued growth from that point, but not at the 20%-30% rates of recent happy memory.