Hong Kong and the market scare

SCMP March 19 2007

What is the apparent synchro- nisation of world stock markets telling us? Does it reflect underlying realities? Or is it attributable to those grossly overindulged sheep who manage the public's savings or run the billions of dollars of gambling money which are the main source of earnings for so-called investment banks.

How strong are the threads that cause sub-prime mortgage problems in the US to shake markets from Seoul to Sydney and Sao Paulo? Does Hong Kong really need to worry about the rapacious recent behaviour of US mortgage sellers?

Here are some reasons why Hong Kong may need to worry.

Cross-border portfolio investment has been growing rapidly thanks to the removal of barriers to foreign investment and currency exchange, among other factors. Then there is the impact of vastly increased flows of financial capital resulting from current-account imbalances - especially the US deficit and East Asian and oil exporter surpluses. Money has naturally flowed from low-interest, surplus nations like Japan to higher-interest, deficit countries like the US and Australia.

The US mortgage problem will most likely lead to sharply lower US economic growth and quite possibly a prolonged, if shallow, recession. The sub-prime mess is probably just the tip of an iceberg of excess household debt throughout the economy. Some of the US problems are also to be found in Britain and Australia.

The sudden slowing of these western, global-growth engines will hit manufacturing-export-dependent East Asia. That includes China, which is currently also trying to rein in domestic demand, and commodity producers from Russia to Brazil and Indonesia, who have benefited from concurrent expansions in China and the US.

Here are some reasons why Hong Kong may not have to worry. Asian markets vary widely in their current levels of valuation. Foreign interest can have a very significant impact, particularly in the short term and - in cases like South Korea and Thailand - where foreign ownership makes up a relatively high proportion of heavily weighted stocks. The differing valuations say more about domestic conditions, domestic investor expectations, market structures and so forth.

Almost all Asian financial markets are highly liquid, and companies as well as households have strong balance sheets. The credit booms in the west have been made possible by Asian surpluses. The collapse of those credit excesses will cost Asians dearly in terms of credit institution collapses, bond default and a flight from the US dollar, sterling, and so forth. But, on balance, cash-rich Asia will come off much better. Indeed, a reversal of flows may, after a pause, see a rebound of Asian cash into Asian markets.

At the very least, Asians will want to keep their cash in Asian currencies, which reflect external strength. Maybe the whole world will follow the US into recession: most Asian countries have the capacity - though they may lack the will - to spend their way out of trouble. Even if they do not, their assets look likely to retain their value better than those in economies that can only escape debt traps in two ways: promoting inflation in order to devalue debt, or risk bigger collapse by keeping interest rates at today's still moderate, real levels.

The answer to the present quandary thus seems to be that major dangers still lie ahead for most stock markets and the world economy. But with the exceptions of the currently overpriced markets of China, India and the Philippines, Asia is less in danger than western pundits like to believe. Indeed, a wholesale shift of assets from the deeply indebted Anglophone economies to cash-rich Asia looks as good a bet as one can make in these turbulent times.

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