Last Friday Americans awoke to the news that the stock market in Hong Kong had crashed, losing 10 percent of its value in a day. The cause was a currency crisis that started in July in a country–Thailand–whose economy is smaller than California’s. The next thing they knew, the Dow was down 154.03 points in the early hours of trading on Thursday, and heading south . . .
Mercifully, history does not often repeat itself. And to the relief of U.S. investors, it didn’t last week. Not quite, anyway. The Dow average closed down 186.88 points on Thursday and an additional 132.36 on Friday. Significant hits, to be sure, but nothing like the 22.6 percent plunge on Black Monday 10 years ago. But in an economy–and an equity market–that has been on an exuberant roll for much of the 1990s, the hit from Southeast Asia was unsettling all the same. It raised a host of questions that will be concentrating minds on Wall Street and in U.S. boardrooms for weeks. Among them: To what extent could the deepening economic crisis in East Asia affect the U.S. economy? How could it hurt stock values? And just why, in the first place, do Americans need to worry about smallish countries so far away? What do they have to do with price of bread in Peoria, let alone the value of the Dow Jones industrial average?
Since July–and right up to the end of last week–the conventional answer to the last question has been: not a whole lot. Asia’s problems, analysts have argued, are specific to Asia. Countries like Thailand, Malaysia and Indonesia got fat and happy on export-driven growth; they began to consume more than they produced, and started investing in assets like office towers and golf courses. To Malaysian Prime Minister Mahathir Mohamad, the fact that his capital city could now claim the world’s tallest skyscraper was proof of his wise leadership.
While Southeast Asia partied, it failed to notice that right next door, China was emerging as an economic powerhouse. China has become a brutally potent competitor for export markets, increasing its share of East Asia’s exports to the United States from 6 percent in 1987 to 26 percent last year. Queasy investors began shifting money from Asia to other promising emerging markets, like Latin America. For countries such as Thailand the party was over. The Thais could no longer count on foreigners to finance their deficits, and the only way to compete with China was to devalue their currency–in effect lowering the price of Thai goods in dollar terms.
Once Thailand took that step in July, competitive devaluations throughout the region were inevitable. Soon currencies in the Philippines, Indonesia and Malaysia came under enormous pressure. Their stock markets fell in tandem. At the end of the third quarter, the six worst-performing markets in the world were all in East Asia. Where the economic ““Tigers’’ once roamed had suddenly become the land of the falling knives–in the form of falling markets.
For the United States, until last week, the fallout from the chaos had been minimal. The markets most badly hit were small, and besides, America’s trade relationship with Asia is mostly as a buyer. If anything, some analysts have argued, far from feeling Asia’s pain, Americans should revel in it. The devaluations are good news because they mean prices of everything from computers to TV sets will drop.
And anything that puts downward pressure on prices, says Desmond Lachman, head of emerging-markets research at Salomon Brothers, is good for the United States because it takes the pressure off the Federal Reserve to raise interest rates. It means ““low-inflation growth in the U.S. well into next year,’’ says Lachman.
As long as investors focus on the buy side of America’s economic relationship with East Asia, the what-me-worry view may be justified. But last week the massive sell-off in Hong Kong raised another prospect entirely: that East Asia, for two decades one of the world’s most rapidly growing regions, may now be in the midst of a massive deflationary bust, one with unavoidable consequences for many U.S. companies.
Hong Kong had been jittery for weeks. In August, as the market routs in East Asia wore on, investors in Hong Kong openly speculated about whether their currency would eventually come under attack. For 14 years, monetary authorities there had formally pegged the colony’s money to the U.S. dollar. For that reason the Hong Kong currency held firm at 7.8 per dollar to the American currency; Hong Kong, with $82 billion in reserves bulging in its pocket, seemed a rock of monetary stability. That fact was critical in easing what otherwise might have been an economically nerve-racking transition this summer, when the colony reverted to Chinese rule.
Hong Kong managed to survive the guns of August in part, The Wall Street Journal reported last Friday, by quietly shoveling government money into the market to support its currency. Its stock market actually gained a bit for the year prior to last week’s debacle, and the currency remained steady. When Taiwan, another economy with massive reserves and apparently sound fundamentals, stopped defending its currency two weeks ago, the jig was up. A test of the Hong Kong dollar ““was a done deal,’’ as one hedge-fund manager put it last week.
And so it came. The pressure on the Hong Kong dollar hit in waves last week, peaking on Wednesday. ““We have absolutely no intention of any kind to change the currency link,’’ Hong Kong Chief Executive C. H. Tung insisted, adding that ““interest rates may have to go up.’’ That was an understatement. Hong Kong jacked up rates to more than 200 percent, hammering core economic sectors of banking and real estate.
The response in the stock market was immediate, and the Hang Seng index collapsed. The cost of defending the precious peg was clear. ““The burden it’s pouring on the economy is savage,’’ says John Reynolds, ING Barings’ head of research. Though the market bounced back Friday, there is probably more damage to come.
The Hong Kong plunge stunned the rest of the world. Tokyo, which has never emerged from its own six-year economic morass, watched its stock market plunge 3 percent–and for good reason. Almost half its exports now go to the rest of Asia. South Korea, which also trades heavily with Asia, continued a two-year slump by falling massively on Thursday. Markets in Europe fell sharply, too, and the United States followed. Investors outside the region focused on several basic facts: Asia’s bust does not just involve a handful of small economies in ““Southeast’’ Asia whose value to America is a source of low-cost products. It closely involves Japan–the world’s second largest economy, where IBM books 75 percent of its Asian sales. It also greatly affects South Korea, whose imports in 1995 were nearly half those of France, and 40 percent of Japan’s.
Even so, most analysts still argue that the fallout from Asia will be limited–““no big deal,’’ as Salomon’s Lachman put it, at least in the immediate future. Exports are still strong to Latin America, and are picking up in Europe–and the U.S. economy itself is still remarkably healthy. But that doesn’t necessarily mean investors in U.S. stocks can assume it’s onward and upward again this week. More than anything, the U.S. market has come to depend on companies’ churning out reliably remarkable earnings growth; any company that doesn’t produce smashing reports every quarter now gets punished–as Boeing, off $4.125 last week after disappointing the analysts, can attest. If economic growth in East Asia slows more than American companies expect, there will inevitably be more earnings surprises to come–possibly many more.
True enough, that is still a minority view in the United States. But the fact itself may be dangerous. The U.S. stock market has long since become what Marc Faber, a contrarian investor in Hong Kong, calls a ““good-time-Charlie market.’’ That’s one that takes any piece of news, no matter how awful, and calls it good. Last Thursday, in the midst of economic disaster in what had been one of the world’s most vibrant regions, no less an institution than Goldman Sachs effectively called it good news for the American economy. Opinions are what make markets, they say. Believe that one at your own risk.
Early July Thailand devalues its currency, the baht, after speculators weaken it by selling large numbers of baht for dollars
August-September Other Asian economies, including Malaysia’s, suffer as traders target their currencies for speculation
Oct. 23 Hong Kong stocks plunge as the government raises interest rates to 300 percent in order to avoid a currency devaluation
Oct. 24 The Hang Seng’s drop is felt round the world as investors across Asia, the U.S. and Britain race to sell their stock
