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The Ghost Of 1997 Beckons, Can Asia Escape? Morgan Stanley, BofA Weigh In
Needless to say, the past 24 hours have done nothing to dispel worries that we’re spiraling towards a repeat of the Asian Financial Crisis.
Asia ex-Japan currencies have been battered along with their EM counterparts worldwide on the back of China’s move to devalue the yuan which seemed to telegraph Beijing’s concern about the true state of the country’s flagging economy.
This has driven commodities to their lowest levels of the 21st century (yes, you read that correctly), pressuring EM FX from LatAm to Asia-Pac and sparking worries that emerging economies - even those armed with far higher FX reserves than they held two decades ago - may be ill-equipped to cope with accelerating outflows.
Indeed the similarities between the current crisis and that which unfolded in 1997/98 were so readily apparent that many analysts began to draw comparisons and that may have added fuel to fire over the past week.
Now, there seems to be a concerted effort to calm the market by explaining that while there are similarities, there are also differences. Of course this goes without saying. No two crises are identical and as the old saying goes, "history doesn’t repeat, but it does rhyme," and to the extent some of the imperiled economies are in better shape to defend themselves this time around (e.g. because they are in a better position from an FX reserve and capital account perspective) that’s a positive, but when attempting to cope with a meltdown, it may be more important to look at where things are similar and on that note, here’s some color from Morgan Stanley and BofAML.
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From Morgan
As highlighted in our answer to the question on “What is wrong with Asia’s macro story”, the region today has a number of similarities with the 1990s cycle in terms of a misallocation led by a low real rate environment led and then an adjustment cycle triggered by reversal in US Fed monetary policy.
Specifically:
- A low real rates environment – aided by starting point of high excess saving and easy monetary policy in the US.
- Domestic misallocation – in both cycles, there has been trailing misallocation of resources into unproductive areas. This is best seen in the rise in the region’s ICOR in both cycles.
- Debt build-up – Since 2008, the region’s debt to GDP has risen by 52ppt, to 206% in 2014. Similarly in the 1990s, there had been a buildup of debt in the run-up to the Asian Financial Crisis.
- External trigger – the adjustment phase in both cycles had been triggered by the rise in US real rates and appreciation of the US dollar (though in this cycle, the slowdown in China has been an additional factor in driving the adjustment).
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From BofAML:
Can Asia escape the ghost of 1997?
The aftermath of CNY devaluation
Asian financial markets are seeing an intensification of selling pressure in the aftermath of the recent CNY devaluation. Investors are now asking if this is a repeat of the 1997 Asian financial crisis that was preceded by China’s 1994 devaluation. Our Asia Chief Economist, Hak Bin Chua, touched upon the similarities last week (see Tremors from China’s devaluation), but in light of the impending sense of crisis it is worthwhile exploring the issue further and asking whether Asia can escape history repeating itself.
Revisionist history and the blame game
The CNY’s recent depreciation and subsequent sell-off in global markets naturally prompts investors to put the blame on China’s doorstep and revisit its 1994 depreciation as the cause of the 1997 Asia financial crisis. The difficulty in blaming China for the 1997 crisis is that its economy was much smaller at the time, and not integrated into the WTO trade system. Its “devaluation” resulted from a merging of two exchange rates (one for trade and another for investments) producing a net devaluation of 7-8% (according to World Bank estimates) as the bulk of Chinese exports were already sold at the swap market exchange rate. This measure is much lower compared to the nominal 33% devaluation.
However, there are two alternative explanations for Asia’s 1997 crisis. The first is the “crony capitalism” narrative, in which Asia undertook unsustainable short-term FX borrowing to finance unsustainable current account deficits. This FX borrowing was guaranteed against implicit FX pegs that funded questionable investments. These investments were premised on the thesis of an Asian Miracle that proved unfounded and resulted in capital outflows and a collapse of Asian currency pegs.
The second explanation is that the seeds of the Asian financial crisis were sown by the 1985 Plaza Accord, which was aimed at halting USD strength and reversing JPY weakness. Ultimately, the subsequent JPY appreciation deflated Japan’s economic bubble in the early 1990s. Asia then faced a triple whammy of slower Japanese growth, ensuing JPY depreciation and a Fed tightening cycle initiated in 1994.
Japan vs China this time
No doubt the truth lies somewhere in between these three narratives. But it is worth exploring the similarity between China and Japan. Indeed, the CNY has embarked on a sustained appreciation since its managed float in July 2005 under pressure from G7 countries to “rebalance” its economy.
Chart 1 shows the similarity of the JPY REER appreciation since the Plaza Accord with the CNY appreciation since 2005 and the call from congressmen Graham and Schumer for a 30% appreciation. Another stylized feature of both economies was their sustained property market appreciation and asset bubble risk – this is illustrated in Chart 2. In nominal terms, the JPY appreciated 65% versus the USD in the decade following the Plaza Accord. Meanwhile, the CNY appreciated 22% since the 2005 de-peg from the USD.
The final key commonality between the Asia crisis and now is the transmission through falling commodity prices and its aftershocks for EM commodity producers, especially those with pegged exchange rates and a negative terms of trade shock. Kazakhstan’s FX shift from peg to float and risk premium being built into GCC FX forwards for the Saudi rial and Omani rial illustrate this fragility now.
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Every bubble will pop sooner or later, the juciest bubbles are those that have grown fat over 40 + years of assumption having created a whole class of QE (welfare) dependency among the affluent..
First Commodities, then Markets, then Real Estate, in short order... The only thing that might get ramped up seriously at this point is Foodstuffs since it's an easy target..
The black swans are returning to Wall Street. When will they leave?
GG China, GG Bernank, GG Yellen, in this game of bridge only the red house wins.
I, for one, welcome our central bank overlords!
If only Greece could develop problems again
We always went up
There's more than enough problems going around for everyone, don't be greedy!
rigged markets are like a dreidel. they need spin, or they fall over.
More like the ghost of 1937.
https://www.youtube.com/watch?v=c4qD8Sp9ouA
Obama's asshats in Kiev are getting ready for round two.
Better hurry.Weather starts turning very early.
Fuck it. Close the boarders. Start up the CC camps and screw everyone else. The world is to big for a group of 1000's of elites to get a hold on. Its each man for themselves. Live long and prosper. The United States of America does not need the rest of the world. We have more than enough to become independently the superpower among nation states. Going for control of the world is idiotic and more dangerous than anyone is going to be willing to risk.
The last place you'll want to be during the "every man for himself" bonus round is the USA.
Why is it that all these analyses and comparisons of 2015 to 1994-97 leave out two very important factors?
Why is China's economy slowing down? Who are their major trading partners to whom they sell all their manufactured garbage?
We may notice that the US consumer is largely toast today.
Actually Europe is China's #1 trade partner and we know that is not a good thing lately. Look at Baltic Dry Index. Shipping rates between Europe and Asia are the most depressed worldwide.
China doesn't want or need a huge inventory build and it can't afford the additional civil unrest that accompanies higher unemployment, hence Yuan devaluation.
If auto sales (sub-prime induced) are stripped out of US consumer 'stats', there ain't been much there for the past 2 years or so.
The demand engine of the West is broken - that transmits to lower economic activity in China. And that means reduced demand for commodities from EM producers. Duh!
Secondly, the bulk of malinvestment and bubble in China is State owned, the bulk of Japanese bubble was private. And by 1994, Japan was more focused on higher end manufacturing. Yes, China has big high tech producers, but so do some SE Asian countries, and most of what China produces is low end. As wages rise in China this is threatened by Vietnam, Indonesia, and up and coming Myanmar, Cambodia and Laos.
Only a simpleton who doesn't understand the region will seamlessly substitute 'China' for 'Japan', and panic.
Asian countries are in a much steadier state now than then - in surpluses, reserves on average 300% larger, less US$ denominated debt, no pegs (except Hong Kong which is mainly a financial and trade capital). Bank reserves and loan portfolios are vastly improved.
The rout in Asian markets ex-Japan have been ongoing for so many days that there is not so much foreign investment in equities or fixed income at this point. Investors need not fear capital controls - most of the flight has already occurred, so it's a little late in the game to wake up to the Asian Economic Crisis analogy.
Yes, I believe there will be a lot more pressure on Asian currencies and markets, but QE has created bubbles everywhere and the story of China rebalancing its economy towards consumption has led to euphoric investment in Asian EM's. Let's not hold our breathe.