Source : The Business Times, August 22, 2007Market players are divided on whether the worst is yet to come, but agree Asia will be hit by weaker global demandIS it a case of 'game over' with the financial crisis and Pandora's Box safely closed again? It is tempting to think so as stocks enjoy a partial recovery, currency markets steady and some investors even begin to dabble in yen 'carry trades' again.
A yen for the yen: Japan is an increasingly attractive haven to the global investor; Mr Cutis says its currency is 'undervalued by 30 per cent' A yen for the yen: Japan is an increasingly attractive haven to the global investor; Mr Cutis says its currency is 'undervalued by 30 per cent'
But the answer to this billion-dollar question depends on whom you listen to, and there are some very different opinions out there as to how serious last week's wobbles in the financial system were.
According to Mark Cutis, chief investment officer at Shinsei Bank in Tokyo, a 'securitisation monster' has been unleashed and is set to wreak potentially 'cataclysmic' damage on global finances.
But to hear investment guru Jesper Koll, president of investment advisory firm Tantallon Research Japan, tell it, talk of a monster is 'nonsense' and all that we are seeing is a 'normalising adjustment in the new global financial architecture'.
The two clashed at a financial symposium held this week at the Foreign Correspondents' Club of Japan in Tokyo. But if there was one thing that they and other panellists could agree on, it was that the Japanese yen has nowhere to go but up from here, and that the safest haven for investors now is Japan - whether last week's market turmoil turns out to be a passing squall or the skirts of an approaching typhoon.
Markets were expected to stabilise after the US Federal Reserve unexpectedly cut the discount rate at which it makes emergency funding available to the banking system, and lengthened the period for which banks can borrow from this window. This was a critical step because, as Mr Cutis noted, the financial system was literally in danger of seizing up. Institutions would no longer accept one another's short-term obligations (commercial paper).
But a certain ominous note was injected back into the market by the news yesterday that US Senate Banking Committee chairman Christopher Dodd had sought an emergency meeting with two top US economic policymakers, Federal Reserve chairman Ben Bernanke and Treasury Secretary Henry Paulson, to discuss the recent financial market volatility. The closed-door meeting was due to be held in Washington yesterday.
The implication was that something else is afoot: either more problems that will require further massive injections of financial liquidity into the system by the Fed and other central banks - possibly even an announcement of more banking system distress - or that senior policymakers need to hold a symbolic meeting simply to calm markets further.
Such 'no business' meetings were held at the time of the financial crash in the 1920s.
Another disquieting bit of news yesterday was that the US Office of Thrift Supervision is very closely monitoring events at troubled mortgage lender Countrywide Financial Corp and that yet another ailing mortgage company, Capital One Financial Corp, would eliminate 1,900 jobs and shut down a wholesale mortgage unit it acquired less than a year ago, as it struggles with the housing downturn.
While Mr Cutis, a veteran banker and former treasurer at the European Bank for Reconstruction and Development, was prepared to concede at Monday's seminar that the 'sub-prime fiasco is probably over - for now', and that the unwinding of yen carry trades that sent currency markets into a spin is also 'pretty much over', he was much less sanguine about the overall health of the global financial system in the wake of recent tremors.
'We are expecting to see a much more vicious sell-off (in financial markets) in October,' he said. 'We are still waiting for the other shoe to drop.' There is still a lot of uncertainty about just how far the financial system has been damaged by credit excesses of recent years and whether the emergency measures of the past week have prevented a total seize-up or simply softened the grinding of tectonic plates with temporary lubricant.
'The securitisation machine, or securitisation monster, has created a lot of these problems. Because of that, you will be getting periodic declarations that this institution or that bank has lost money from their positions. The wild position in credit markets, where everyone was able to borrow money and spreads were coming down all the time - that is over,' said Mr Cutis.
But former Merrill Lynch analyst Mr Koll was having none of it. 'Securitisation monster - that is nonsense,' he declared. 'Throughout the past 15 years, the world economic and financial leaders have built a new financial architecture where the bank-based financial system was replaced by a security-based system and that has largely been completed.'
The results of this experiment have been overwhelmingly positive so far, he said.
'The world economy has had an unprecedented period of high growth but we are having some market jitters now. Some of the risks are coming out. There have been more and more players coming into the market and, as a result, returns get squashed, which is exactly what is happening now,' he insisted.
'We are going through a period of normalisation (and) the system is being stress-tested,' he said.
Only time will tell which of these two views is right but the panel produced a broad consensus that the world economy cannot expect to emerge unscathed from the debacle in financial markets - though whether this means one percentage point off global growth or as much as 2.5 per cent in a full year was not something on which anyone was prepared to stake bets.
Asia will be impacted adversely in coming months by weaker demand from the US and elsewhere, the panellists agreed. This seems inevitable given that various studies have shown that the degree of self-sufficiency or self-sustainability of currently buoyant economic activity in East Asia is considerably less than often supposed.
Less than 20 per cent of final demand for products is actually generated within the region, the studies show.
But Japan could be an exception to the rule of inevitable slowdown, it was argued. It has few structural economic problems, very little debt in the household or corporate sector (unlike the public sector) and stands to gain from a potentially huge repatriation of flight capital as the attractions of overseas investment financed by yen carry trades diminish in the wake of the financial crisis.
The yen is 'undervalued by 30 per cent' against a basket of currencies, argued Mr Cutis, while JPMorgan Chase Bank's chief foreign exchange strategist in Tokyo, Tohru Sasaki, was also positive about the yen. It will probably stabilise in a range of 110 to 120 to the dollar for now, Mr Sasaki argued, a conclusion that also drew support from former Bank of Japan senior official Rei Masunaga.
However, if the Fed decides that the financial system is not yet ready to stand on its own feet again and cuts short-term interest rates by around one percentage point in short order, then things could get more 'interesting' for the yen, it was acknowledged. A combination of Fed cuts with interest rate hikes by the BOJ later this year could send the yen soaring to '75 to the dollar', suggested Mr Sasaki.
That plus the fact that the Tokyo stock market has nowhere to go from here but up (as Mr Cutis argued) as domestic investors end their dangerous flirtation with foreign currencies and bonds would make Japan a remarkably attractive haven for global investors.
This would be a strange reversal of the pattern seen over the past decade but as recent events in financial markets have shown, we live in strange times. Anything can happen, it seems.
Prof Walter: The global economy should not spiral into a downswing unless the credit market worsens 
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