Asian Woes Raise Risk of Deflation
Does this scenario sound eerily familiar? Global stock markets tumble as currencies, commodity prices and interest rates fall, yanking down U.S. stocks as investors sweat the prospect of weakened corporate profits and widespread deflation.
It isn’t exactly a repeat of last October. But after another deep sell-off in world markets Thursday, many analysts believe the U.S. economy and stock market are facing the most serious threat since the Asian financial crisis hit last year.
In the past several days, mounting worries about Japan’s economic malaise have fanned fears of a new round of Asian currency devaluations. That danger has rippled through an array of financial markets, dragging down everything from soybeans to spot interest rates.
“To a considerable extent we’re seeing a replay, and we’ll see periodic aftershocks,” said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco.
The bottom line in the U.S. is that corporate profits could suffer as turbulent conditions overseas offset a strong domestic economy. What’s more, analysts are again talking about the possibility that deflation--a broad drop in prices--could take hold.
And although accompanying low interest rates are good for the economy, investors are preoccupied with deteriorating global economic conditions.
After Asian markets endured another overnight sell-off, the Dow Jones industrial average fell for a third day, losing 160 points, or 1.8%, on Thursday. The Dow plummeted after Treasury Secretary Robert E. Rubin made comments to the Senate Finance Committee indicating that the U.S. would not act to prop up the battered Japanese yen.
Rubin backpedaled from that idea later, but by then, the Japanese currency was suffering a rout that dropped it to an eight-year low against the U.S. dollar.
Why is the sagging yen creating so much anxiety around the world?
As the yen continues to weaken, it makes Japanese exports less expensive. In many industries, in fact, Japanese products now sell at lower prices than those of other Asian nations, said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis.
That creates a big problem for countries such as South Korea, which are battling to overcome the region’s financial disaster by boosting their own exports. The weakening yen has prompted speculation that more devaluations are in store as Japan’s neighbors try to remain competitive.
Investors fear that a dangerous economic spiral could then take hold in the region. For example, already wobbly Japanese banks that have lent heavily to other Asian countries would face the risk of even more defaults.
At the same time, worsening economic woes in Japan mean that country can buy fewer goods from the rest of Asia.
“The weakness in the yen is hurting Asia like the plague,” Sohn said.
Particularly worrisome is the possibility that China will be forced to devalue its own currency along with that of Hong Kong. As rival currencies have become cheaper, China faces the disturbing prospect that U.S. and European investors will build plants and make other investments in those countries instead of its own.
“You have severe implications all around the planet,” said Jeffrey Applegate, chief investment strategist at Lehman Bros. in New York. The radiating crisis in Asia is also taking a toll on the U.S.
The primary concern is that the profits of many U.S. corporations--and thus, their stocks--are in danger. Any devaluation of Asian currencies would raise the cost of U.S. goods in the region, thus impeding sales. Another negative factor: Any sales that U.S. companies do succeed in making in the region must be converted from weak local currencies into U.S. dollars. (On the other hand, there is a benefit to certain U.S. companies and U.S. consumers, due to lower prices for Asian goods.)
Add all this up and there is the potential for more disinflation--even deflation--in the U.S.
Lower prices on imports from Asia and commodities have to this point been considered generally positive for the U.S. They have dampened strong domestic growth, reduced inflation and kept the Fed from raising rates.
However, outright deflation could have some severe negative effects, such as reduced corporate profits, extensive layoffs, a stock market crash and a recession.
The dichotomy between the U.S. and world economies has so far prevented the Fed from raising rates.
For the moment at least, that situation is likely to prevail.
More Financial News
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Falling Yen
In its biggest one-day loss against the dollar in a year, the Japanese yen fell to an eight-year low Thursday. How many Japanese yen a dollar will buy, monthly closes and latest:
Thursday close: 143.79 yen
Source: Bloomberg News
