“Will the world slump?” asks a recent issue of The Economist. It’s a good question without a good answer. All that can be said is that the economic crisis that began quietly in Thailand in July has now spread to much of Asia and moved on to Brazil and even Russia. Will it snowball into a broader economic downturn that would drag much of the world, including the United States, with it?
The prevailing view is “no.” Federal Reserve Chairman Alan Greenspan told Congress last week that Asia’s problems, though serious, won’t trigger a U.S. recession. The Economist also doubts a global slump. But optimism needs to be tempered, because the optimists have–so far–been wrong. The crisis is already worse than they expected, and plenty could still go wrong. Banking crises across Asia are a possibility. Another bad omen: the decision of the Mercosur trading bloc (Brazil, Argentina, Uruguay and Paraguay) to raise tariffs 25 percent. This could signal a protectionist spiral that would depress world trade.
The best that can be expected is that the crisis harms only a handful of countries. For them, economic growth drops sharply. Consider new estimates from Nariman Behravesh, chief global forecaster for Standard & Poor’s DRI. Since late October, he’s reduced Japan’s expected 1998 growth from 2.7 percent to 0.7 percent, Thailand’s from 4.8 percent to minus 0.7 percent, Indonesia’s from 6.3 percent to 2.2 percent, and Brazil’s from 4.4 percent to 1.8 percent.
Japan stumbles because its exports to Asia falter. And other countries are overextended. In the 1990s, these countries have received massive foreign investment. Too much money flowed too quickly. First, foreign capital (mostly dollars) was converted into local currencies. Bad loans were made, bad projects were financed. Next, local consumers and companies converted some local currency back into foreign exchange to buy imports. Trade deficits swelled.
Now the boom is over. Countries must curb trade deficits because they no longer receive the foreign capital needed to gorge on imports. Interest rates go up to slow spending. Countries let their currencies depreciate (this makes imports more expensive and exports less expensive). Yet, Behravesh doesn’t expect the world economy to slump. He’s cut his 1998 forecast for global growth only slightly, from 2.9 percent to 2.5 percent. The United States and Europe continue to expand. So do most developed countries.
It’s plausible. Already, the International Monetary Fund has organized big credits to hard-hit countries: Thailand, $17 billion; Indonesia, $23 billion; and the Philippines, $650 million. In theory, these credits cushion the shock. Countries don’t have to shut down their economies because they can’t afford essential imports. They deal with their problems and shift to export-led growth.
Some comparisons with the Latin debt crisis of the 1980s also seem reassuring. Then, foreign capital arrived mainly through one channel: commercial banks. For years, the banks insisted that they be repaid in full; the Latin countries couldn’t. Political deadlock and economic stagnation resulted. Now, Asian nations have received foreign capital in many ways: bank loans, direct investment (multinationals building factories), stock market investment. Some losses will (and should) be absorbed by foreigners: for example, mutual fund investors.
So far, so good. The crisis is contained. But two dangers could make things much worse. The first is the prospect of banking crises. Banks lubricate any thriving economy. They hold people’s wealth as deposits; they make business and consumer loans. If banks collapse, so may confidence. And Asian banks now face huge losses.
Start with Japan. Even before the present crisis, its banks had at least $250 billion in bad loans left over from the “bubble economy” of the 1980s. (Such non-performing loans don’t meet regular interest or principal payments.) Now there will be more. In 1996, Japanese banks had $299 billion in loans to borrowers in 10 large Asian countries and Hong Kong. The added exposure could push some banks below the required capital reserve of 8 percent. Some banks may be insolvent.
Similar problems afflict banks in South Korea, Thailand and Indonesia. Standard & Poor’s estimates that bad loans at Korea’s eight largest banks range between 3 percent and 14 percent of total credits. As economies weaken, more loans may sour. There are ways to rescue banks, but all are costly and all require political decisions that may elude shaky governments. Japan has dawdled ineptly with its banking crisis for much of the 1990s. It belatedly closed its 10th largest bank just this week.
A second danger is an abrupt halt of foreign capital flows to most developed countries. Investors panic. All countries suffer for the sins of a few. Deprived of investment capital, countries experience slower growth. Trade, production and employment weaken. The United States and Europe soon feel the effects.
A pessimist sees the connections and fears them. An optimist sees the connections and thinks they’ll be avoided. Who’s the realist? What started in Thailand may be a passing economic squall. Or it might be (to quote Churchill) a gathering storm.