Updated: May 20, 2022
As we approached the one-year anniversary of the collapse of Lehman Brothers memories of that fateful event last year have faded fast. Consumer confidence is improving, some major economies have started to recover, and some banks are paying big bonuses again. It is as if we have awoken after a bad dream.
"Only when that happens will true decoupling have been achieved"
But investors’ relief that financial collapse has been averted - manifested in rising equity markets over the past five months - is likely to fade and be supplanted by the realisation that the world economy still faces a number of challenges. Chief among these is that the western consumer is still overburdened with debt and thus likely to remain at home.
Asia’s situation however is more promising; its big battle was its financial crisis of 1997. In its aftermath the region built up strong defences that have provided it with resilience during the past two years. Banks became prudent, building up substantial capital reserves, often under instruction from their respective regulator. Companies strengthened balance sheets, raising equity, and increasing their focus on profitability. Governments on the whole improved their finances, and individuals also changed their behaviour in the wake of the crisis.
Of course a major reason Asia was able to recover quickly was that the western consumer went on a big shopping spree aided by Alan Greenspan's easy monetary policy response to the paralysis that followed 9/11. Moreover, Asian governments, keen not to let their currencies appreciate, willingly sterilised dollar payments by buying US Treasurys in order to keep exports cheap. This relative stability enforced the idea of decoupling - the simple notion that emerging countries can grow even in the absence of a strong West.
Lately Asia has been dependant on developed economies for much of its exports but instead of frittering export dollars away on non-productive items such as luxury cars and high-end housing as it did in the early 90s, it has in recent years been building up its own productive capital stock. In other words, it has gradually been enhancing its ability to stand on its own feet.
That is why we are seeing investors funnelling money back to the region in the belief that strong fundamentals will allow it to spend its way back to growth quickly and without the debt burden implications of the West.
However, it is not yet clear how far Asia can sidestep the global imbalances to which it is it has inadvertently contributed. The hope is that its factories can switch from making goods for export to goods for home markets, but in order to empower that goal governments are spending furiously, focusing on infrastructure, welfare, and transport. Their efforts have sparked a sharp turnaround in growth from earlier this year - when the region faced contraction - and paves the way for private demand growth.
This has been particularly true in China where economic robustness has surprised almost everyone. Economist Henry Liu wrote in December last year, “The structural problem of the Chinese economy can be described in one sentence: China produces from plants financed by foreign investment that operate with low domestic wages for foreign markets that pay with dollars that cannot be used in the domestic economy.”
He continued, “The solution to this problem can also be summed up in one sentence: China must finance plants with sovereign credit to produce for the domestic market where purchasing power will come from high wages with sovereign credit repaid from increased tax revenue from a vibrant domestic economy.”
Only when that happens will true decoupling have been achieved. However, a conclusion will not be reached until policies start to respond to domestic conditions, rather than those confronting the Federal Reserve in the US. A corollary is that as regional exchange rates become more buoyant, Asians will finally benefit from the true purchasing power of their savings.
Published in The Herald
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.