Markets’ Judgment: Government Is Good

With financial markets in a deepening panic, it’s time to step back and assess what the Asian crisis really means. It is a turning point not only for the economies of Asia, but for global economic thinking.

After more than a decade in which prevailing opinion has held that markets alone can be relied on for solutions to every problem, the professional investors and traders who make up world markets are saying that strong, competent governments are needed for the functioning of productive economies and financial systems.

That was demonstrated most clearly in Indonesia last week with the erosion of confidence in the government of President Suharto. Suharto, 76, upset world markets by refusing to make economic reforms ordered by the International Monetary Fund, which is funneling emergency loans to Indonesia, and by declining to arrange an orderly transition of power for his 32-year-old government. The markets’ reactions were severe. The Indonesian currency, the rupiah, fell 80%. Stock losses over two days in U.S. markets amounted to more than Indonesia’s annual output of goods and services.

Indonesia’s economic troubles didn’t cause that reaction. “Though presently the economy is in very bad shape, without clear direction, I believe long-term fundamentals are strong,” says B.P. Banka, managing director of PT Ispat Indo, a big Indonesian steel producer.

“Within six to 12 months,” Banka says, his company and others will recover through exports facilitated by the currency devaluation.

It will recover only if the Suharto government can prevent a spiral of unrest and economic chaos. Fear of just such chaos is why the U.S. government dispatched Treasury Undersecretary Lawrence Summers and Defense Secretary William Cohen to Jakarta.

The contrast with South Korea speaks volumes. In South Korea, the incoming government of President Kim Dae Jung is cooperating with the IMF in reforms of the country’s potentially powerful but closed economy. World markets’ reaction has been positive. Korean issues rose in price last week as markets elsewhere fell.

And that’s significant. Critics of the IMF say it should let the free play of markets work out Korea’s problems. But global investors are backing the monetary agency. “The IMF is a surrogate for what the markets want to see--a discipline, a plan to guide the economy,” says Jeffrey Garten, a former U.S. undersecretary of commerce who is now dean of the Yale school of management.

To point out the need for competent government in these times is not an abstract, academic matter. The way ahead for the world economy is perilous. Firm actions will be needed by governments in China, Japan and the U.S. to prevent Asia’s restructuring from turning into a global calamity.

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China’s government is being tested right now. With deepening currency devaluations in Southeast Asia, goods from Indonesia, Thailand, Malaysia and the Philippines are becoming competitive with China’s exports, on which it depends for 25% of its gross national product.

Market watchers are saying that China’s economic boss, Zhu Rongji, will be forced to devalue China’s currency, the yuan, now valued at 8 to the dollar. Zhu devalued the yuan in 1994 to make China’s goods super-competitive, experts point out.

But if China devalues now, the Hong Kong dollar would have to cut its peg to the U.S. dollar and be devalued also. And after that, the spiral of currency devaluations would pick up speed, with unpredictable consequences for world economies, say experts in Asia and the United States.

The better course would be for Zhu not to devalue. And that is his intention if he can stick to it, say China experts, because competition from Southeast Asia will force China’s state industries to improve.

“China has 1,000 factories producing automobiles that are totally uneconomic,” says a Chinese investment banker. The economic vision of China’s government is that the 1,000 plants should shrink to a handful of efficient factories, with displaced employees put to work in new service industries.

But whether China will be able to fulfill that vision depends on Zhu’s standing firm. If he devalues, watch global markets go into greater turmoil.

In Japan, the market’s recent judgment is clear. Because the Japanese government has not dealt with a problem of bad bank loans, the Tokyo stock market remains at levels less than 40% of those reached seven years ago. Last week, the Japanese and U.S. governments had to step in to keep the yen from falling precipitously against the dollar.

World market fears about Japan have nothing to do with the competitiveness of Toyota or Sony. Rather, the fear is that Japan’s government systems won’t be able to react with sufficient agility to prevent a deep recession. Unless Japan’s government shows signs of change, the yen and Nikkei stock index will remain under pressure.

But with Japan out of action, the pressure mounts on the U.S. government to provide relief in the Asian crisis. That’s why the dollar has been strengthening against most other currencies.

But the U.S., too, will be tested. One outcome of the Asian devaluations--even the currency of Taiwan, a highly developed economy, has been devalued 25%--will be a flow of ultra-low-priced apparel and machinery, rubber, lumber and other commodities to U.S. markets.

Such imports will put pressure on U.S. small companies and the wages and jobs of their employees--”of the people who haven’t had all the great benefits of our new, high-tech economy,” notes Garten.

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What is needed from government are careful policies to keep jobs open and business percolating. “Central banks must support lower interest rates and availability of capital,” says economist Philip Suttle of J.P. Morgan & Co.

In the U.S. economy, that appears to be happening. Federal Reserve Board Gov. Lawrence Meyer, using unheard-of words for a Fed official, said Thursday that the Fed will be open to lowering interest rates if the economy appeared to need a boost.

Meyer also said that “the Asian crisis won’t cause a Great Depression,” using a word that underlines the serious dangers of this time.

Our perspective should be clear. Long-term, Asia’s economies will come back and be strong. The trend toward progress continues in the world’s economies. But in the short term, economies will be tested. And after years of saying that government didn’t matter, or was even a hindrance to economic progress, the world markets are saying that competent authority in government is, well, bullish.

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James Flanigan can be reached by e-mail at jim.flanigan@latimes.com