CLSA gives Europe 10 lessons from Asia6 June, 2012, 18:05. Posted by Zarathustra
Tags: Euro Crisis
Can Europe learn from Asia?
The answer is yes, according to CLSA’s Eric Fishwick and Ines Lam. They looked back to 1997 and the subsequent years when Asia was suffering the the crisis and the aftermath of it.
Sure enough, no crises are 100% identical, but they offer 10 lessons that Europe can learn.
1. Economic forecasts will be too conservative.
Even CLSA was among the most bearish house at the time of financial crisis, they were wrong for being not bearish enough. And subsequently though, their underestimated the rebound:
2. Countries don’t export themselves out of recession.
Countries did not export their way to correct imbalances. Instead, they just stop importing.
3. Imports will collapse, selling to crisis countries is bad business.
This point is obviously related to the previous point.
4. Contagion will be worse and take longer than you think.
If Asian experience was any guide, contagion will be much worse than people would have thought, and will take much longer than people would have imagined. Hong Kong, for instance, did not suffer the worst of currency speculation more than a year after Thai Baht was devalued.
5. Pegged or depegged you end up in the same place (but how quickly and how painfully?)
The adjustment to the imbalances entailed more savings and less investments. Whether or not a country went for currency depreciation or not, the adjustment has to be the same. The only question is just how quickly and how painfully. Hong Kong, for instance, was successful in depending the currency peg, thus did not go down the path of currency depreciation, but the adjustment was arguably more prolonged and painful because Hong Kong did not went for depreciation.
Admittedly the immediate trough in Hong Kong was shallower than in Indonesia, Korea, Malaysia and Thailand, though the Philippines was even less affected. However the rebound was much less persuasive also. We can combine these two effects by looking at how long it took variables to regain their 1997 level. Hong Kong fares poorly on such a comparison. Its real GDP was back to 1997 levels by 2000 but real household spending took much longer. In fact real consumption took longer to regain its 1997 level in Hong Kong than in any of countries whose currencies collapsed: Figure 15.
6. Deleveraging is deflationary, even if achieved through currency weakness.
Deleveraging is deflationary. With currency collapse, inflation initially spiked for most crisis countries which went for depreciation in the first year after depreciation, but fell below pre-crisis level in the years after.
7. Focusing on real variables doesn’t work in deflationary environments.
In a debt deflation where everyone is trying to repay debts, it would cause money supply to contract, thus drive down prices (asset prices included). . “The more the debtors pay, the more they owe”, said Irving Fisher. Thus only looking at the real term variable no longer works. Nominal variables count.
Hong Kong provides a good lesson here. Growth in real terms variables in 2000 was good compared with previous business cycles. And, property affordability was better. Residential property models based on variables such as unemployment or real income growth were suggesting that, after the fall in prices between August 1997 and October 1998, the market was due a rebound. It didn’t. As Figure 19 showed, property prices continued to fall until the end of SARS (Severe Acute Respiratory Syndrome) in July 2003.
8. The credit environment and the investment environment matter most.
The Asian crisis shows the importance of healthy banking and credit environment. Half-hearted and piecemeal approach will not work.
The Indonesian experience is critical in the Eurozone context. Half measures, which erode the public’s confidence in a country’s ability to deal with a crisis, are as bad as doing nothing at all. And some problems are simply too large for individual countries to deal with. The Eurozone needs an immediate supranational blanket deposit insurance scheme; national schemes are no longer credible… it would remove one pressure that, at the moment, threatens to force countries’ hands: loss of bank deposits.
9. Isolationism doesn’t work.
In this regard, they draw the experience of Malaysia, which rejected IMF assistance and reverse course in terms of austerity in favour of infrastructure investment, and repeg the currency with USD and impose capital control. It was subsequently, according to CLSA, ejected from MSCI, and “for many investors it remains uninvestable”. And this is important because a Grexit would represent the highest degree of economic isolationism for Greece:
The decision [to exit the euro] would represent economic isolationism of the highest degree. The mechanics of reinstating a national currency mean that capital controls to prevent flight of savings back into euro are a given. Any new drachma would not therefore be convertible. But ostracism from the EU would mean much more. The EU offers free labour mobility as well as free capital mobility; an exiting country would find its workers no longer welcome. Preferential access to European markets would be closed. And, for a country that would be in an even harder recession than it is today and desperately in need of supply-side reform, access to EU structural and development funding would be cut off. So would access to EU agricultural policies and payments. The Asian crisis shows that isolationism as a policy doesn’t work. Yet the isolation facing any country that exits from the euro would be much greater than Mahathir chose in 1997.
10. It’s critical that everyone buys into the plan.
Or, stop striking and protesting, and do something concrete. Korea, according to CLSA, recognised the need for sacrifice, and the nation was pulled together in solving the problem:
Consider this excerpt from David Cotterchio’s first person account of what it was like to be in Korea in 1997 (see p81):
‘The government asked people not to drive to save on the national oil import bill—they all stopped driving. They asked people not to buy imported goods— again that stopped overnight. They asked them to bring back into Korea (or out from under the mattress) any illegal or legal USD deposits and gave them assurances that they would not be prosecuted for doing so. People responded and the illegal and overseas USD-held money poured into the banks. Korean people were not going to stand by idly and do nothing, they wanted and were compelled to chip in, in any way they could. The realisation had set in that the only way out of this would be for all people, rich, poor, private or public sector to give all they had to turn the country around. The streets were lined with people with signs calling for austerity and self-sacrifice as were the radio and TV airwaves.’
Unfortunately, this is obviously not what some the Europeans have been doing.