TIME Asia | There Is a Way Out

	ASIA	FEBRUARY 9, 1998 VOL. 151 NO. 5
There Is a Way Out The Big Three helped create Asia's mess. Now they must set things right BY KENNETH S. COURTIS While violent debt deflation is squeezing asia's economies, some of the region's most troubled markets have begun to breathe in recent days. Is this just a pause in the maelstrom? Or is it the first sign that there is a bottom, somewhere, and that we are getting close to it? The answer depends on the decisions of Beijing, Washington and Tokyo. The origins of Asia's crisis are woven of many threads: insufficient supervision of domestic financial markets, local regulation that sheltered industries from the vast changes in the global economy, new technology that collapsed borders, the emergence of powerful new competitors--in particular China--for Asia's now-tattered tigers, and the integrated global flows of money and information. At the core of Asia's crisis is excess investment in insufficiently profitable assets, whether apartments in Bangkok, or cars and chips in Korea. With cash flows inadequate to service the debts incurred to make these investments, a deadly cycle of default is devouring Asia's growth. But unwise investment is not the sole explanation. Broader forces have been at play. First was China's decision to devalue its currency at the end of l994. That move was designed to cushion the downward pressure on the economy as part of a campaign to smother the runaway inflation of the early 1990s. With that decision, East Asia's low-end exports were essentially priced out of the market overnight. Second was the decision of the U.S. to adopt a strong-dollar policy in the mid-'90s. With East Asia's tigers having tied their currencies to the greenback, many of their investments quickly became unprofitable. Third was Japan's unwillingness to resolve its own financial crisis, a lapse that caused a near-meltdown. As it scrambled to shore up its crumbling banks, Tokyo cut interest rates virtually to zero. Together these three decisions set up the dynamic for disaster. As Japan's financial institutions desperately searched for new sources of profit, they flooded East Asia with new lending. As the dollar went up, so did East Asia's currencies. That made the region's economies sitting ducks for China's suddenly muscular exporters, doped with a super-cheap renminbi. Almost overnight the region saw its current-account balances melt. At the same time, East Asia's central banks--the very best students of the IMF!--were trying to prevent their hothouse economies from running higher inflation rates, so they kept local interest rates high. Normally, these two forces--overvalued currencies and high local interest rates--would have provoked a welcome economic downturn. But with the yen sliding and Japan driving its interest rate through the floor, ultra-cheap credit suddenly became available. Virtually every entrepreneur in the region became a George Soros. They could borrow almost limitless amounts from profit-starved Japan--and in yen that were being devalued against their own dollar-linked currencies. The cost of capital became in effect negative! Just as the three superpowers of the Asia-Pacific set the region on course for crisis, so now they have it within their power to help reverse course. CHINA must awaken--quickly--to the downward drift of its economy. Consumer spending and investment are falling across the country. Prices are deflating. Unemployment is climbing. Profits are squeezed, and investment has slowed. Beijing has indicated it will not devalue, but if it doesn't take a few quick measures, that promise will be hard to keep. Already in the black market, the renminbi has fallen 10% in the past month. China can do three things to put its economy back on track. It has the scope to cut interest rates by as much as three percentage points. It can increase public investment for infrastructure. It can open its economy more fully to imports from Southeast Asia. THE U.S. in these deflationary times can reduce interest rates without any fear of inflation. That would send a positive signal to markets and ensure that America's own economy continues to churn smoothly. Whatever the U.S. does, its trade deficit will increase dramatically as East Asia's economies face the simple dilemma of export-or-die. Lower rates in the U.S. would guarantee continued strong growth and full employment, the two key ingredients in neutralizing what could otherwise be a sharp increase in protectionist sentiment. JAPAN has in recent weeks begun to address its vast problems. But it has to do more. It must adopt tax cuts and targeted measures of deregulation that will free up domestic demand. As Japan's economy begins to expand it will help keep East Asia's deflation from spreading beyond the region. Japan's problem is not money: its citizens are manic savers. Japan's problem is its unwillingness to use that financial might in its own interests. Beijing, Washington and Tokyo now have a rare opportunity: they can transform the current hiatus in Asia's crisis into a reversal. But the moment is now. Should it be missed, large problems lie ahead, not just for Asia, but for the world. Kenneth S. Courtis is strategist and chief economist at Deutsche Bank Group Asia Pacific in Tokyo
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The Big Three helped create Asia's mess. Now they must set things right

BY KENNETH S. COURTIS

While violent debt deflation is squeezing asia's economies, some of the region's most troubled markets have begun to breathe in recent days. Is this just a pause in the maelstrom? Or is it the first sign that there is a bottom, somewhere, and that we are getting close to it? The answer depends on the decisions of Beijing, Washington and Tokyo.

The origins of Asia's crisis are woven of many threads: insufficient supervision of domestic financial markets, local regulation that sheltered industries from the vast changes in the global economy, new technology that collapsed borders, the emergence of powerful new competitors--in particular China--for Asia's now-tattered tigers, and the integrated global flows of money and information. At the core of Asia's crisis is excess investment in insufficiently profitable assets, whether apartments in Bangkok, or cars and chips in Korea. With cash flows inadequate to service the debts incurred to make these investments, a deadly cycle of default is devouring Asia's growth.

But unwise investment is not the sole explanation. Broader forces have been at play. First was China's decision to devalue its currency at the end of l994. That move was designed to cushion the downward pressure on the economy as part of a campaign to smother the runaway inflation of the early 1990s. With that decision, East Asia's low-end exports were essentially priced out of the market overnight.

Second was the decision of the U.S. to adopt a strong-dollar policy in the mid-'90s. With East Asia's tigers having tied their currencies to the greenback, many of their investments quickly became unprofitable. Third was Japan's unwillingness to resolve its own financial crisis, a lapse that caused a near-meltdown. As it scrambled to shore up its crumbling banks, Tokyo cut interest rates virtually to zero.

Together these three decisions set up the dynamic for disaster. As Japan's financial institutions desperately searched for new sources of profit, they flooded East Asia with new lending. As the dollar went up, so did East Asia's currencies. That made the region's economies sitting ducks for China's suddenly muscular exporters, doped with a super-cheap renminbi. Almost overnight the region saw its current-account balances melt. At the same time, East Asia's central banks--the very best students of the IMF!--were trying to prevent their hothouse economies from running higher inflation rates, so they kept local interest rates high.

Normally, these two forces--overvalued currencies and high local interest rates--would have provoked a welcome economic downturn. But with the yen sliding and Japan driving its interest rate through the floor, ultra-cheap credit suddenly became available. Virtually every entrepreneur in the region became a George Soros. They could borrow almost limitless amounts from profit-starved Japan--and in yen that were being devalued against their own dollar-linked currencies. The cost of capital became in effect negative!

Just as the three superpowers of the Asia-Pacific set the region on course for crisis, so now they have it within their power to help reverse course.

CHINA must awaken--quickly--to the downward drift of its economy. Consumer spending and investment are falling across the country. Prices are deflating. Unemployment is climbing. Profits are squeezed, and investment has slowed. Beijing has indicated it will not devalue, but if it doesn't take a few quick measures, that promise will be hard to keep. Already in the black market, the renminbi has fallen 10% in the past month. China can do three things to put its economy back on track. It has the scope to cut interest rates by as much as three percentage points. It can increase public investment for infrastructure. It can open its economy more fully to imports from Southeast Asia.

THE U.S. in these deflationary times can reduce interest rates without any fear of inflation. That would send a positive signal to markets and ensure that America's own economy continues to churn smoothly. Whatever the U.S. does, its trade deficit will increase dramatically as East Asia's economies face the simple dilemma of export-or-die. Lower rates in the U.S. would guarantee continued strong growth and full employment, the two key ingredients in neutralizing what could otherwise be a sharp increase in protectionist sentiment.

JAPAN has in recent weeks begun to address its vast problems. But it has to do more. It must adopt tax cuts and targeted measures of deregulation that will free up domestic demand. As Japan's economy begins to expand it will help keep East Asia's deflation from spreading beyond the region. Japan's problem is not money: its citizens are manic savers. Japan's problem is its unwillingness to use that financial might in its own interests.

Beijing, Washington and Tokyo now have a rare opportunity: they can transform the current hiatus in Asia's crisis into a reversal. But the moment is now. Should it be missed, large problems lie ahead, not just for Asia, but for the world.

Kenneth S. Courtis is strategist and chief economist at Deutsche Bank Group Asia Pacific in Tokyo