The Vulnerability of Asian Markets Then (1997) and Now (2013)
By Vincent Cignarella
It was a toxic combination that sparked the Asian financial crisis in 1997.
The bad news is that same combination–of Federal Reserve monetary tightening and Japanese fiscal tightening–is looming once again.
Rewind to March 1997. Then, the Fed’s communications policy bore little resemblance to the current era of transparency, so inevitably some investors were taken aback when the central bank raised the discount rate, the rate at which the Fed lends money to commercial banks, to 5.5% from 5.25% after two years of trimming rates. (Remember, this was before fed funds targeting was in vogue.)
One month later, in April 1997, the Japanese government raised a nationwide consumption tax to 5% from 3%. This was seen at the time as a major contributing factor to Japan’s economy falling into a recession in Q41997.
Fast forward to today. The Fed is expected to usher in the beginning of the end of its bond-buying program, put in place after the financial crisis to stimulate growth. Whether the Fed makes a move in September or December will ultimately become a footnote in history. What’s important is that this tapering right now looks inevitable.
Meanwhile, Prime Minister Shinzo Abe is weighing an increase in the same exact consumption tax, to 8% starting April 2014 from the current 5%.
No wonder emerging markets in Asia are freaking out. By any measure, that’s a lot of money that’s going to stop making its way into the financial system. Say bye-bye to the search for yield and those “hot money” flows that propelled those markets higher.
Asian emerging-market currencies are bearing the brunt of the pain. In the four months since April, the Thai baht is down 10% against the dollar, the Indian rupee has fallen by more than 16% and the Indonesian rupiah is down 11.4%.
The question remains: Is this 1997 all over again?
So far, the market moves have been milder. A big reason: Many currencies back then were set at a fixed exchange rate against the dollar. Unmoored, the baht plunged 40% in four months after the central bank was forced to let it float in July 1997. A similar fate met the Indonesian rupiah when the crisis made the managed float rate impossible.
There are other differences this time around, as well. Before the Asian financial crisis, Japan helped drive the growth of the developing countries that neighbored it. This time around, China plays that role. And for all the hand-wringing about China’s growth outlook, no one is making any comparisons between China today and Japan in 1997.
So what’s an investor to do?
My approach: Keep close tabs on the dollar, especially how it trades against the yen. During the Asian financial crisis, investors looking for a safe place to camp out piled into the dollar. In April 1997, one dollar bought about 106 yen. By August 1998–at which point the crisis had spread to Russia and was causing U.S. stocks to reel–one dollar was fetching about 147 yen.
If the dollar begins to gain rapid ground against the yen, the Asian cold may turn into the Asian flu–a bug we’re all likely to catch.
(Vincent Cignarella is a currency strategist/columnist for DJ FX Trader and co-inventor of The Wall Street Journal Dollar Index. His 30 years in currency markets include working as a bank dealer at major money-center commercial banks; managing corporate-hedging for a large multinational; serving as a principal and general partner of a major currency brokerage firm; and most recently working in FX sales with Santander in New York.)
Write to Vincent Cignarella at [email protected]
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