Asia Ripple Will Reach Our Shores

Worrisome indicators last week signaled that the world economy is entering a period of slower growth, despite continuing robust strength in the U.S. economy.

Warnings from Intel and Motorola that quarterly sales and earnings would be down were only one sign that Asia’s troubles will have a greater effect on U.S. business than is generally acknowledged on Wall Street. Intel blamed weak markets in Asia, Europe and the U.S. for a 10% decline in sales; Motorola cited price wars and slowing of orders in Asia and weak markets almost everywhere.

Yet U.S. job creation continued its marvelous pace--310,000 new jobs in the last month--and unemployment fell to 4.6% nationally. Housing markets are vigorous, incomes are rising and inflation remains low. Stock prices rebounded Friday, as if to underline that the U.S. economy is fundamentally strong.

Yet, with good reason, international economists and financial experts are calling this the lull before the storm, predicting that mounting difficulties in Asia will feed into slowdowns in Europe and other areas.

“There’s a hard 18 months ahead,” says Kenneth Courtis, the Tokyo-based economist and investment strategist for Deutsche Bank Group.

Courtis believes that Asia’s troubles will stall even the U.S. bull market by summer or fall. But the end of this bull market has been predicted before and still it keeps going like the Energizer Bunny.

So we should step back and see what the short-term problems and long-term promises are in the world economy.

To begin, understand that the U.S. economy is connected to the world not merely by imports and exports but through global financial cooperation in which the dollar and other currencies are governed loosely by a system first set up in Bretton Woods, N.H., at the end of World War II.

The idea of that system was that fixed exchange rates would prevent countries from competing unfairly in world markets by cheapening their currencies to cut prices on goods. Although fixed exchange rates were abandoned in 1971, the major industrialized countries have continued to cooperate to maintain rough equilibrium in currencies.

But that equilibrium is under strain right now because many developing economies in Asia, having been allowed to borrow too much for their own good by careless banks, are in severe distress. From South Korea to Thailand and Malaysia to Indonesia, currencies have fallen 50% and more in value. Asian companies and banks are being kept afloat by bridge loans organized by the International Monetary Fund, a crisis-lending agency set up at Bretton Woods.

As with any bridge loan, the hope is that the debt-burdened company can reorganize its operations, change its ways and come back stronger--as U.S. companies restructured in the 1980s. In Asia today, companies and governments are being asked to open their markets and reform their financial systems, hewing to standards of return on investment that made those restructured U.S. companies stronger.

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In Japan, the domestic economy of consumer spending and housing has been more or less stagnant since 1991. Japan is being called on now to revive that economy by reforming its banking and corporate structure. It is also being called on to open its markets to goods from the rest of Asia.

But restructuring won’t happen quickly in Asia. In Japan, the government said last week that it would prop up the stock market by spending tax-exempt post office savings accounts to buy stocks and keep insurance companies and banks from having to post losses on their stock holdings.

Losses would cause painful bankruptcies in the short term but also would indicate that the system was going to reform. Instead, the status quo will be maintained and Japan’s domestic economy will continue in the doldrums.

In South Korea and other countries, companies are using devalued currencies to spur suddenly bargain-priced exports. But those exports are displacing goods from Latin American countries on world markets, spelling trouble for Mexico and economies in Central and South America.

In Europe, banks are nervous because they--unlike U.S. banks--are heavy with hundreds of billions in loans to businesses in South Korea, Thailand, Indonesia and other Asian countries. European banks are extending those loans now but they know that some bankruptcies are inevitable and losses will be heavy. So the banks are nervous even though Europe’s economies have been improving in recent months.

And the world’s economic leaders are worried. The sudden collapse of Asia’s economies and the massive devaluations are just what the global cooperative system was set up to forestall. Yet so volatile are world finances today that stable currencies such as the Japanese yen and U.S. dollar can fluctuate 50% in a year.

Such volatility imposes a high cost on world business “in uncertainty and in the hedging maneuvers that companies are forced to maintain,” explains John Mueller, chief economist of Lehrman Bell Mueller Cannon, a financial markets advisory firm in Arlington, Va.

That’s why Federal Reserve Board Chairman Alan Greenspan said recently that he believes “the international financial system needs to be thoroughly reviewed and altered as necessary to fit the needs of the new global environment.”

And Japan’s Deputy Finance Minister Eisuke Sakakibara called last week for a new agreement “along the lines of Bretton Woods.”

Just the reference to Bretton Woods indicates how seriously economic leaders see the present threat to the world economy. In the next 18 months, we probably won’t see a formal monetary conference to remake the global system.

“Politically, it couldn’t be organized,” says economist Albert M. Wojnilower of New York-based Clipper Investment Group. But we could see “some controls on financial flows into developing countries and possibly a credit-rating system for emerging economies.”

The period ahead will be tense. Earnings of U.S. companies will be affected, as Intel’s and Motorola’s already are. And the stock market will take a decline that will extend over several months or even a year while global problems are worked out.

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Therefore, it’s well in these times to keep in mind that the promise of world development remains intact. In fact, a bright spot of the new era may well be China, which is determined to modernize its economy and has just announced a massive infrastructure program to ease employment strains in the transition. China has problems galore, but it is taking action to deal with them.

And, of course, the U.S. economy is fundamentally in great shape. Its companies and banks, having undergone reforms, are strong. With interest rates and inflation remaining low, housing markets should remain brisk and the long-term future bright.

“When U.S. stocks eventually fall, investment managers will be happy,” quips Wojnilower, “because then they can go in and buy with both hands.”