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Daily Global Commentary

Asia's Exceptions To The Global Tightening Trend

Tue, Jun 15 2010, 22:13 GMT
by Northern Trust Economic Research Department

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Now that the global recession of 2008-09 is a thing of the past, most major economic blocs are mapping their own routes to a normal monetary and fiscal policy environment. Asian economies were the first to raise interest rates from ultra-loose levels, followed by fast-recovering export economies, commodity producers then major trade hubs. In general the global economy appears to be recovering from the financial crisis (and knee-deep in a new European-based one). However, policymakers in the second- and third-largest economies in the world suggest they will maintain loose policies and even expand their monetary largesse in the near future. Can the global economy be in great shape if Japan and China still need help?

First, let's consider China. This morning the China Banking Regulatory Commission (CBRC) released its annual report in which it stated the global recovery would be "slow and tortuous." This phrase quickly made its way through Asia's markets and people quickly dove into the details of the CBRC's analysis. The Commission (which is held in high regard throughout Asia) made its strongest statements to-date that the (domestic) real estate market bubble is particularly concerning, adding to this that bad loans based on speculative purchases are likely to rise over the next twelve months, bank losses will mount, and credit growth is at risk of being negatively impacted by imprudent behavior. These buzzwords all but state that in the government's opinion, the economy is vulnerable to a market bubble bursting on its watch, and officials will not tolerate anything so disruptive to the Chinese economy.

Some of the other buzzwords mixed into the report included fears of "trade protectionism" and the "US dollar exchange rate," and the placement of these key phrases informally suggests to US policymakers that the yuan will not be allowed to appreciate against the greenback any time soon. The balance of the 120+ page report all but sets the agenda for the People's Bank of China. For the next year, lending levels need to be controlled (but not necessarily contained), interest rates will not rise any time soon, valuable development programs will not be cut back, and exchange rate stability should be maintained. In short, economic growth close to 12% a year will still get some stimulus throughout 2010. (Not surprisingly, the report did not discuss inflation prospects.)

Moving from one end of the spectrum to the other, let's consider Japan. After its latest two-day meeting, the Bank of Japan (BoJ) today left its main policy rate unchanged at 0.10% - not surprising considering the weak state of the economy - and instated a "fund provisioning measure" to extend cheap credit toward productive economic endeavors. When credit markets locked up in September 2008, the Japanese economy was already all but in recession, therefore its fall sank deeper before production staged a modest recovery. Undermining this export-driven rebound, however, was the fact that capital formation has not recovered from its lowpoint in Q3 2009, domestic consumption remains sluggish, and the government has very little capacity to stimulate further growth. After a commodity-induced spate of inflation back in 2008, consumer prices fell the following year as deflation returned with a vengeance. The BoJ had little choice but to hold rates steady after its meeting and needs to find some way to inspire credit growth going forward if the country is to recover from its economic malaise. In short, the global recovery could very well leave the world's second largest economy behind.

If consensus forecasts hold true for these two countries, this year China's annual GDP will surpass Japan in terms of economic size and rank second only to the US. This is indeed an admirable achievement, but both sides should take heed of what lies ahead. For China, it needs to understand that historically, deflating an asset bubble is a difficult feat in the best of cases, and if poorly managed can be the beginning of even greater problems. The country is well-positioned to withstand a period of transition, but without the tough reforms it could easily follow the path Japan took in the wake of the 1990 Nikkei collapse. And as for Japan, it must withstand severe change in its economic structure, otherwise China will be the first of several economies surpassing it in generations to come.

Published on  Tue, Jun 15 2010, 22:14 GMT

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