Edward Lotterman - Agricultural Economist
Published January 1, 1998 | January 1998 issue
Recognizing losses on domestic real estate, bonds and loans will force Japanese banks and other financial institutions to liquidate their foreign portfolios. They will sell off their U.S. stocks and bonds, driving down the Dow and raising U.S. interest rates.
Households that have directed mutual fund and 401K investments into global equity or emerging market funds in recent years will "flee to quality." Such investments will be liquidated and the money will flow into safer U.S. stocks and bonds, driving up the Dow and lowering U.S. interest rates.
The structural economic reforms that Japan and Korea are adopting as a result of the current crisis will sooner or later boost real incomes and demand for U.S. exports, particularly of soybeans, pork and fruit.
The devaluation of Thai, Indonesian and Malaysian currencies will make their palm oil and feed tapioca exports cheaper in international markets, thus cutting into U.S. exports of oilseeds and corn and reducing prices to Ninth District farmers.
Weaker Asian currencies will lower the prices of their exports to the United States, thus holding down U.S. inflation.
If you marked any of the above false, you lose points, because each of the above statements has at least some economic plausibility.
Now mentally sketch out an answer to the following essay question: "What are the likely net or overall effects of the economic problems in Asia on the U.S. and Ninth District economies?"
Congratulations! Regardless of your answer to the essay question, you have mastered the economic concepts of partial equilibrium and general equilibrium. In a partial equilibrium setting, one considers the possible outcome of a change in one factor, while holding other factors constant. But in a general equilibrium setting, one must try to discern the net effects of simultaneous and interacting changes in many different factors. The second situation, put mildly, is much more complicated than the first.
So, can we say anything definitive about the effects of events in Asia on the regional economy? A few things seem to be pretty clear: Growth in several Asian economies, notably Korea, Thailand, Indonesia and Malaysia is likely to be slower over the short-term and medium-term future than most observers thought before the crisis began in mid-1997. Slower growth and lower incomes may slow exports of U.S. commodities and consumer or capital goods to the region.
For Ninth District farmers, exports of corn, soybeans, wheat, poultry and pork may be less than would have occurred if economic growth in Asia had continued unabated. Manufacturers may see reductions in what have been strong sales of equipment for auto factories, power stations and golf courses, and of electronic equipment. The reduction of demand for exports will of course depend on the nature of the good. Sales of cardiac pacemakers are likely to suffer less from reduced incomes in Thailand or Korea than are tractors and mowers for golf courses.
In addition to slackening demand due to slower growth, the brusque devaluation of many Asian currencies will further dampen U.S. exports to that region. Devaluation simply means that it takes more Thai baht or Korean won to get a U.S. dollar than before. It also means that the price to Thai or Korean importers of American corn or computers, pork or pacemakers is now higher than it was.
While the overall impact on U.S. exports of a stronger dollar is similar to that of lower Asian incomes, there are some differences between goods. Slower growth and resulting lower incomes reduce demand for all products, those produced domestically in Asia and those imported from the United States and other countries. Changes in the exchange rate alter the relative prices of imported goods vs. those produced domestically. Lower incomes will reduce consumption of all pork; a weaker Thai baht means that South Dakota pork loins will be more expensive relative to Thai pork loins.
U.S. imports will be the mirror image of exports. Weaker baht/yen/ringgit/won mean a stronger dollar than before. Another way of saying stronger dollar is lower prices for goods from Thailand, Japan, Malaysia and Korea. Such goods include apparel, consumer electronic devices, toys, automobiles and auto components. This will be good news for consumers but will mean more pressure on those U.S. producers who compete with imports.
While the general direction of the effects on exports and imports is clear, their magnitude is still very much an open question. Some observers point to the underlying dynamism and entrepreneurial spirit of Asian societies. They argue that with some restructuring of financial institutions, the Asian tigers and tiger cubs can quickly return to strong growth. Mexico serves as an example. Hit by a very similar foreign exchange and banking crisis in 1994, Mexico devalued, restructured and is racking up 7 percent economic growth in 1997.
Other analysts are less sanguine. They argue that the problems of Asian economies are more fundamental, more deeply embedded in those nations' institutions and cultures. Such problems are in part political, for example, too-cozy relationships between politicians and key bankers and industrialists. They are in part institutionala lack of competition and market discipline in lending, too close an association between government agencies and the financial institutions they regulate, opaque accounting and disclosure practices that make it difficult for lenders and investors to accurately assess profitability. Some are argued to be cultural, that is, an excess of family or "old school" relationships that run counter to efficient allocation of resources or rational evaluation of risk.
For these more pessimistic observers, Japan is an example. After strong growth through the 1980s, which terminated with huge runups in real estate and stock prices, Japan has been mired in recession since 1990. Many Japanese and foreign authorities agree on the sort of restructuring that should take place for Japan's economy to return to growth: less bureaucratic direction of the economy, more transparent relationships between firms, more openness to foreign competition, recognition and write-off of bad loans and closing of insolvent firms. However, successive Japanese governments have been unwilling or unable to take such steps in a timely manner. Indeed, many skeptics worry that even Japan has yet to hit the low point of its recession.
This uncertainty about the depth and duration of the current economic crisis renders projections of international financial flows very difficult. Japanese, Taiwanese, Korean and Hong Kong individuals and institutions own substantial quantities of U.S. financial assets including U.S. Treasury securities. If events in these countries motivated wholesale liquidation of such assets, U.S. financial markets might be affected. But there is no clear indication that such liquidation is likely.
With domestic Japanese interest rates near zero, even negative when adjusted for inflation, many investors may prefer to stay with U.S. instruments yielding 6 percent or more. Moreover, with the security of almost any Asian investment subject to some doubt after the closing of once prestigious banks and securities firms, many Asian investors may wish to keep some of their portfolio in the relative security of the United States.
Only time will tell whether the optimists or pessimists are right in regard to the severity of Asian economic problems and the pace of subsequent recovery. But it is likely that for at least the first half of 1998, Ninth District businesses and households will have to make decisions with considerable uncertainty.