2008 Is Likely To Be A Bumpy Year At Best

Source : The Business Times, September 20, 2007

Latest ADB report examines scenarios in which things could go wrong in Asia-Pacific

Riding out external shock: Artificial credit-fed demand in the West and elsewhere has created a series of bubbles in housing markets, stock markets and all kinds of other asset markets worldwide. There is a comfortable fiction that Asian economies can survive this kind of shock; but it is almost certainly not true

IF YOU believe the Asian Development Bank (ADB), this will be a 'bumper' year for Asia-Pacific economies with overall growth hitting 8.3 per cent, and we can look forward to much the same thing next year.

But if you are of a nervous disposition, maybe you should not read beyond the first few reassuring sentences of the ADB's latest Asian Development Outlook because the optimistic message these convey are belied by the full report.

In the many years I have been scrutinising such reports from the ADB (or the World Bank for that matter) I have never seen a full, upfront acknowledgement of economic risks confronting the region - not even in 1997 when crisis struck.

Presumably economists in these institutions feel bound to act like central bankers and behave 'responsibly' by projecting an image that all is well. But just whose interests this is supposed to serve is not clear.

The latest report does admittedly examine various scenarios in which things could go wrong, and which could lead to growth falling, it suggests, by as much as two percentage points below the 8.2 per cent baseline forecast for 2008.

But that baseline itself is almost certainly too optimistic, and whether the worst-case scenario of 6 per cent growth next year is bad enough to be realistic is open to serious question.

To employ the words of a journalist, rather than of an economist, the global economy has been intoxicated for far too long, floating along on a champagne sea of financial liquidity, unquenchable optimism and a no-questions-asked attitude towards risk.

This party almost certainly came to an end once the US sub-prime mortgage crisis emerged, but there is still a reluctance on the part of the ADB and others to recognise or admit the fact.

To extend the metaphor, the world economy has been boozed on liquidity supplied by over-indulgent and irresponsible central bankers who were scared to take away the drink for fear of the aftermath.

This has created euphoria or irrational exuberance within the developed world and allowed emerging economies to get rich by pandering to profligate consumption elsewhere.

Credit creation - getting into debt, to put it more simply - cannot continue indefinitely. The worm at the core inevitably shows itself sooner or later and then the rotten apple begins to crumble, which is precisely what is happening now.

The worm in this case is artificial credit-fed demand, within the US especially but equally in the UK and other parts of Europe and beyond.

This has created a series of bubbles - in housing markets, stock markets and all kinds of other asset markets - not just in these basic and recognisable assets but also in a multitude of derivative financial products, some of which are being revealed now to be not worth the paper they are written on.

As this house of cards implodes, so the great sucking sound of consumer demand in the US and elsewhere is likely to ebb to a sigh.

There is a comfortable fiction that Asian economies can survive this kind of shock; but it is almost certainly not true. The next Asian crisis will not be a financial crisis as such but a demand shock triggered by financial crises elsewhere.

The crisis defences that Asia has built, in the form of vast foreign exchange reserves, will be of little use against this - at least in the short term.

Asia has not been tested against a real trade shock and it has been assumed that if such a shock is likely to come from anywhere at all it will be from an outbreak of protectionism in the US or Europe.

But what if it comes instead from an economic recession (followed by protectionism) in either or both of these areas? Again, the comfortable fiction says that this cannot happen nowadays because Asian demand has become 'self-sustaining'.

Again, this is not the case. The ADB report acknowledges in the small print (that probably far fewer will read than those who scan the 'bumper' tidings up front) that just under 80 per cent of the merchandise that leaves Asia's ports eventually ends up in external markets and that 'a chill in the US is therefore likely to send a downdraft along the region's supply chains'. Other studies have shown that only 15 per cent of Asian manufactured production is consumed locally.

The report also admits that, apart from the still very strong trade linkages through which an external economic shock could be transmitted to Asia, the 'explosive growth and integration of global financial markets' is a second reason why the often-touted 'uncoupling' of Asian economies from those in the West may be a bit of a myth.

In short, we have the prospect of tremors from an external quake being strong enough to topple Asian economies.

But a US recession, if indeed it should occur, will be of short duration and therefore its potential for provoking shocks elsewhere will be limited, the report argues.

Again, this looks like wishful thinking, or a bit more false reassurance. It is true that the US Federal Reserve and other central banks are likely to blink in their resolve and throw money at the problem rather than face the awful consequences of their past actions.

But the possibly unique combination of soaring confidence and strong liquidity that has supported the global bubble (or 'froth' of bubbles as former US Federal Reserve chairman Alan Greenspan likes to say) for so long is ebbing now.

Once confidence fails, throwing more money at a recession is like 'pushing on a piece of string' or entering a liquidity trap. Even if 2007 does go down as a 'bumper' year, next year is more likely to be a bumpy one at best.