The Asian Currency Crises Essay, Research Paper
The average Canadian has become conditioned to rising prices, however it is impossible to ignore the impending threat of a sustained decline in prices and wages. Roger Bootle, a respected British analyst, points out that the chronic inflation experienced by Western economies in recent decades is unusual, as in the past centuries prices tended to fall as often as they rose. Today, however inflation has almost disappeared, due to globalization and changes in technology that have made markets more competitive and decreased the power of unions. For millions of consumers, the resulting drop in interest rates has made mortgages, car loans and other major expenses more affordable. Investors have benefited as well, because lower corporate borrowing costs and increased consumer demand have contributed to big profits and generous returns for shareholders. Unable to raise prices at will, companies have endeavored to improve productivity, which ultimately leads to a higher standard of living for all.
Asian Crisis Background
Was Asia’s economic boom a miracle, or just a mirage? That is the overriding question facing economists today. For nearly a decade, Asian economies grew rapidly where industries such as textiles and semiconductors took over fishing villages. This impressive growth was the result of the natural flow of capital to regions with cheap land. Government built infrastructure, which aided in the production of goods and their transport to market, as well as inexpensive labor were also factors.
Gradually, costs rose and time exposed weaknesses, such as the misuses of capital, in the Asian economic shell. Corruption, greed and government interference directed capital to uses that were unproductive or wasteful, such as property development and security speculation. Moreover, because of this overinvestment, the remarkable economic growth in the early years went overboard, producing excess capacity in a wide range of industries as well as weighing companies down with unserviceable debt. The outcome was that the price at which these companies thought they would sell their product came up short. The net result was that the Asian currencies pegged to the U.S. dollar became overvalued. When speculators realized that some currencies were overvalued, they began attacking those Asian currencies they thought were most vulnerable; the Thai baht was the first to fall under the attack. Several of Southeast Asia’s currencies have lost nearly half of their values against the U.S. dollar after foreign exchange turmoil broke out on July 2, 1997, with the devaluation of the Thai baht.
In turn, with the collapse of one economy, another followed. The most significant was Japan. Japanese banks are the biggest lenders to Southeast Asia and Japanese manufacturers are the region’s largest investors. As foreign markets collapse, the Japanese banks struggled to absorb large collections of domestic bad debt. Moreover, Asian corporations had been drastically overborrowed in foreign currencies (mainly the US$) on the assumption that their own currencies were either stable relative to the US$ or pegged to that currency. Many of these borrowers were huge conglomerates using high debt leverage. With the decline in their currencies, those conglomerates are now looking at average debt ratio’s of eight-to-one.
All in all, the Asian crisis has raised many questions as to it’s effects on the Canadian economy. Will consumers be able to bargain-shop with lower priced goods, which stocks are the safest bet for investors, will Canadian importers and exporters benefit? The situation is fraught with differing opinions, but one effect is quite certain in that the Asian crisis represents less of a threat to the economy as a whole than it would have been 50 years ago. Inflationary (and more importantly deflationary) pressures due to an accelerating Canadian economy must be kept in check in order to avoid recessionary type circumstances. However, Canada’s strong fundamentals – lower government spending, higher revenues and low interest rates – have paved the way for sustained stability which allow our economy to absorb and adjust to international shocks.
Deflationary Effects on Growth
Deflation refers to a sustained period of declining prices that have a devastating effect on an economy, and while the decline in inflation has had several positive effects, too much deflation can be dangerous. Prices do fall, but so do personal incomes. Widespread price declines worry economists because they foster uncertainty for businesses and consumers. Businesses are inclined to postpone planned investments and consumers would postpone purchases as long as possible in the expectation of further price cuts, as we see happening now in the computer business. A decrease in demand would have serious repercussions on the economy: reduced corporate profits, mass layoffs, production slows down and bankruptcies. Workers have less money for goods and services causing prices and profits to drop further. Interest rates cannot fall below zero, and therefore as prices and incomes fall, the effective rate of interest increases and makes it difficult for borrowers to repay their loans. The $600 billion federal debt would become impossible to reduce.
The current economic crisis in Asia shows that deflation in indeed looming in the shadows. In Japan, prices in many industries have been falling for most of the 1990’s. The entire region is suffering its worst deflationary spiral since the 1930’s. Lower priced imports and reduced Asian demand for Canadian and American products is the first noticeable effect. A drop in the prices of existing assets can affect real economic activity, not only by changing incentives to consume and invest but also by impairing the health of financial intermediaries. In dollar terms, the Asian markets have now fallen 75%. By contrast the decline in the Dow in the early years of the Great Depression was 80%, occurring over a period of four years. The Asian stock markets made their decline in a mere six to eight months.
Moreover, the Asian debt burden is a crucial issue; corporations were drastically over-borrowed in foreign currencies (mainly US$), and had high debt leverage. With the decline in their currencies, those companies are now looking at drastically high debt ratios. Many Asian companies rely on high volume sales for profit and run thin profit margins; the result being drastically decreased profitability. Their reduced profitability correlates to stagnant economic growth in their home markets; it is estimated that Chinese GDP will likely fall to 4-5% from 8-9%, and growth of countries with GDP in the 4-6% range will decline to zero or lower. These factors all point to a deflationary environment not only in Asia but in the rest of the world (i.e. Canadian GDP prediction falls to 3.3% from a predicted value of 3.6%).
Slower growth is already on the way. Canadian export growth is already hampered by low commodity prices and there is consumer nervousness because of the instability of the market.
Because of high consumer indebtness, it may be hard to get the consumer to open her purse even with lower foreign prices. The desire for larger homes in Vancouver has already diminished even though prices have fallen off. A year ago, the average home in Vancouver’s affluent west side sold in the $800 000 range while today most homes go for closer to $600 000. However, housing growth across Canada is expected to continue growing, but at a much slower pace than in the past two years. The Asian currency crisis may indirectly influence the housing industry by leading to higher short term mortgage rates, slower income growth and reduced commodity prices. These effects are expected to be temporary, as steady job creation and economic expansion is predicted by CMHC.
The shift from inflation to deflation would be brought on by a decrease in global capacity and devaluation of currencies, which are seen as the cause of Asia’s woes, and are only beginning to take their toll on the rest of the world. Decreasing Asian demand has put downward pressure on base metals such as copper, nickel and aluminum. The continuing decline in gold prices, likely points to a coming collapse in commodity prices, says a chief economist in New York. Deflationary pressures on the commodities are expected to be boosted by lower prices in manufactured goods and other exports from Asian countries who have a price advantage due to their devalued currencies. On the car lot, this means that prices are being slashed up to $3000, and in the high tech sector prices of computer chips tumbled more that 60% last year. Massive increases in productivity is one of the only reasons the sector is performing relatively well. Rapid price deflation in assets such as real estate or equities could have severe repercussions on the economy, and the government does not have the weapon of higher interest rates handy to cool the market.
Previously, it was thought that the new engine of the world economy would lie in the billions of consumers in Asia. Now it appears that these consumers face certain financial hardship, and political uncertainty. One effect from the Asian crisis that Canadian consumers can anticipate is a wave of cheaper Asian goods. Many economists expect the comparative strength of the U.S. dollar and efforts by some struggling Asian companies to raise cash with bargain sales to result in cheaper imports on Canadian soil. “There is no question that is what they will try to do, suggests Bank of Montreal chief economist Tim O’Neill. For most Asian companies that is the only option they’ve got”. However, any flood of cheaper Asian goods is at least three months away as exporters in places such as South Korea and Indonesia reorganize themselves and work through their existing inventories. Furthermore, the fall in import prices will keep domestic competitive pressures strong. Canadian companies that compete with Asian imports will be forced to reduce prices to maintain their market share. The situation will be amplified by over-capacity of Asian corporations in many consumer product sectors.
One example is the automotive industry where two South Korean automakers are getting set to target Canada. These two companies are faced with massive excess capacity in their home markets. Canadian industry sources predict South Korean vehicle sales to drop to less than one million (compared with the industry’s capacity of more than six million). With their home market collapsing, these companies are forced to make a push into North America as a way of garnering incremental volume increases at no great additional cost.
This type of situation is beneficial for the consumer as it creates more competition pushing prices downward. However, it does foster worries for Canadian exporters as the increased competition could spur U.S. protectionism. “If the United States moves to shelter its markets, Canada could suffer collateral damage”. There are different opinions about what is going to happen to the Canadian economy as a result of the Asian currency crises. While most agree that the troubled countries will try and export their way out of the crisis, there are differing views on what the prices of their goods will be like. Some believe that because the productive capacity of Asian countries are incredible, the labour rates are low and the Asian worker is willing to work hard for a low wage, that everything produced in Asia will be drastically cheaper that anywhere else. This means that all goods exported to North America could be sold at impossibly low prices. Others believe that Asian countries will want to make profits with their exports to make up for their losses at home, and therefore they will not significantly lower their prices even though they can produce them at a lower cost. However it is more likely that their only way out of the crisis is to viciously export and sell everything they produce at the lowest possible price. This is good news for Canadian consumers but not good news for the Canadian producers or the Canadian economy.
It will be some time before Canadian consumers see any cheaper imported goods due to the fact that most of the goods in stores right now were contracted before the decline in the Asian currency took place. While most sectors have an inventory turn over 3 or 4 times a year, the fashion industry turns over their inventory 5 or 6 times a year; therefore, the first people to benefit may be the buyers of low to medium priced clothing produced by Asian’s large textile industry.
The Asian currency crisis has affected the choices facing a Canadian investor. This crisis has had both detrimental and beneficial effects on domestic and international markets. Individual investors must attempt to maximize the opportunities and minimize the risks which have been created by this ongoing crisis in Asia. Canada’s weak dollar has caused the government to raise interest rates several times over the past few months. However, these interest rate hikes did not halt the slide of our dollar, and it has only recently climbed above seventy cents. Despite repeated predictions and warnings of stifled growth, Canadian and American stock indexes are at record levels; an amazingly strong rebound after the initial plummet. The Dow Jones Industrial Average is nearing 9000 points while showing no sign of a reversal. These bullish markets were quick to resume their ascent after the initial set back from the Asian crisis. As of late March, the Dow was up a whopping twelve percent for the year, and the TSE has followed close behind the Dow’s lead. Therefore it is evident that Canadians still have plenty of investment opportunities.
Certain industries and sectors within our country have encountered problems related to the crisis. Some problems have already surfaced, while others will be detected in the future and traced back to the Asian crisis. The currency devaluation in Asia has made forestry products less attractive as exports to Asian counties. The Canadian government is looking into lower tree-cutting fees and deregulation in rail and electricity costs in order to make exports more attractive.
Canadian companies may get dragged down in the aftermath of Asia’s troubles, as many products become unaffordable. Many Asian firms will become increasingly more competitive as products such as automobiles and technologies enter our markets at lower prices.
For now, deflation is only a theoretical threat, however there are several relatively painless investment strategies that Canadian investors can make use of. Experts advise that some savings should be in the form of long term government bonds. The current yield on thirty year treasuries is just under six percent. If it drops to five percent, as some economists believe is likely next year, it may be possible to sell them for a profit or retain them for a richer yield. Credit risk must also be paid attention to. Companies that are loaded up with debt would be among the hardest hit in a period of deflation, since their real debt burdens would be even higher. A good plan is to look for companies that sell unique products and are in a position to maintain or even raise prices when the overall economy is weak. Although deflation may never hit, investors will sleep better knowing they are in good shape to ride through it if it does hit.
As inflation rates continue to shrink in Canada and the US, commodity prices tumble. In Canada, the annual inflation rate for November 1997 was just .9%, down from the average year long rate of 1.65%. Lower energy costs have caused a major slide in the Consumer Price Index, the largest since oil prices collapsed in 1986. Oil has fallen 36% in price, from $22 a barrel to $14.06, its lowest level in four years. Warmer weather and increased supply have been cited as some of the causes of the dropping oil prices. Among the soaring stocks in New York are the airlines. Fuel is the second biggest operating cost for this industry, and therefore led to the record highs set this week. Most other commodities’ prices have also been weak, with the Journal of Commerce index citing a decrease of 9.5% for the period in industrial commodities. Canadian commodity prices dropped sharply in January as the economic slump in Asia continued to put pressure on the prices of raw materials. The lack of trade credit in countries such as South Korea decreases demand for commodities. Falling commodity prices lead to a decrease in inflation, and interest rates in Canada, the US and Europe have fallen. Another booming group is retailers. The imported merchandise is becoming cheaper, but these savings are not being passed on to the consumer. Bank stocks are also soaring due the fact that the competition, Japanese banks, are seeking government subsidiaries in order to keep their doors open. Agricultural prices posted a big decline, dropping 3.5% during the month. The 1997-1998 world harvest is expected to hit a record high, which will likely bring about further price reductions as demand declines in Asia.
However, most economists agree that deflation is upon us yet. Services, which account for more than half the CPI in Canada have to fall as well, which they aren’t. “While it is clear that there is deflation in goods prices, services inflation remains relatively stable at just under three per cent. Outright deflation would require these costs to crack”. Many sectors such as airline tickets, and hotel rooms evidence that inflation is still rampant. “I think inflation is yesterday’s bogeyman. I don’t think we could see deflation in 1998, but I wouldn’t dismiss it for the future.” Disinflation, which refers to a decline in price advances, in much more likely. Periodic declines in prices are common for commodities and other cyclical sectors.
It appears that there is no consensus as to what the Asian Currency Crisis has in store for consumers and investors worldwide. We are bombarded by statistics citing falling GDP due to a decrease in exports. About 8% of our exports involve Asian markets. Luckily, the U.S. economy accounts for 80% of our exports and remains remarkably robust. However, Canadian sales in the U.S. have already slowed to only half the pace of earlier years despite the advantage of our undervalued dollar. On the other hand, CIBC predicts strong growth fuelled by growing domestic demand and strong consumer spending.
The Canadian dollar has been sideswiped by foreign capital fleeing the instability of emerging markets and taking refuge in the US$ and bond markets. Steadily declining commodity prices and Canada’s international reputation as a company whose economy is dependant on resources have conspired to place added pressure on an already weak currency and large corporations dependant on resources.
As of yet, Canadian consumers have seen no real decline in the prices of Asian imports. Although the likelihood of this appears strong, consumers are likely to postpone major purchases in the event of price savings down the road. Investors still have plenty of good opportunities as the Dow and TSE indexes continue their bull run. However, some sectors such as base metals, forestry products and other commodities (i.e. Oil & Gas) should be avoided due to the drastic reductions in demand stemming from the Asian ripple effect in Canada.
The falling growth rates in Asia and the effects on other countries worldwide may have a deflationary effect on global economies such as Canada in the months and even years to come. However, these effects are difficult to predict leaving consumers and investors to the mercy of the market. If the effects currently being demonstrated in Asia (falling demand, decreased production, lower profits) are duplicated across the worldwide economy, such a deflation would induce a slowdown in spending, devestate growth, drive thousands of companies into bankruptcy and throw millions out of work.