The Asian Flu
Jude Wanniski
October 23, 1997


The 25% collapse of Hong Kong’s Hang Seng index this week in part reflects a harsh discounting of the recession that looms throughout the Southeast Asian economy, although the action in the currency futures market clearly indicates the heavy betting is on devaluation of the HK dollar. When overnight interest rates hit 150%, as they are now, we should soon know whether the fever breaks or the patient expires. What began as the sniffles in Bangkok has turned into a widespread influenza that threatens the financial structure of all of Asia. There is not a doctor anywhere in sight, either at our U.S. Treasury Department, at the International Monetary Fund, or at the Federal Reserve, who seems to know how to arrest its spread. There are literally hundreds of billions of credits and debits in the network of the global economy, with Europe’s weak link traveling through the London/Hong Kong nexus. Our weakest link is the Japanese economy, where old fashioned Keynesians at the Finance Ministry and Bank of Japan are combating recession with an insanely deflationary monetary policy of close to zero interest rates and tax increases designed to balance the budget. Meanwhile, the witchdoctors of the IMF are running amok in the region, demanding tax increases and “free floats” in exchange for cash.

If the decision about the Hong Kong dollar is going to be made in Beijing, we would of course hope that it would be to defend the currency to the last yuan. There are ample monetary reserves in Hong Kong and China to do this as long as it takes to persuade the markets that there will be no devaluation. We continue to believe the geopolitical consequences of devaluation would be so great, to Hong Kong and China, that they are unacceptable. Once the market sees there is nothing up Beijing’s sleeve, interest rates will plummet and the Hang Seng will soar, having survived at least this test of its resolve. Michael Kurtz, who will have a report for our Global clients tomorrow after observing tonight’s action, points out that there is actually a codicil in Hong Kong’s Basic Law that promises a pegged currency, and that its credibility as a financial center would be smashed if it abandoned the dollar peg -- without at least repegging to gold or the mainland yuan at equivalent rates. Kurtz believes local money is betting the peg will be maintained with high interest rates, and the financial and property stocks that comprise the greatest part of the Hang Seng have been clobbered because they are interest-rate sensitive. There should be no one who suffers a capital loss by holding a currency that is now under the sovereign cloak of the Chinese government.

China cut its domestic interest rates last night in order to goose its economy, where the growth rate is floundering below 8%. The last thing it needs is to be pulled into a currency devaluation against the U.S. dollar, at a time when the U.S. Congress is already wondering why their trade surplus with us is at record highs. We remind you that the Chinese revolution of 1949 was in reaction to the hyperinflation of the Kuomintang government, with Mao Tse-tung coming to power promising to end the inflation. The Communists made every economic mistake imaginable trying to make communism work, but they never inflated. Their intent now is to build world confidence in their currency in order to create a global market for their government bonds, a goal that would be severely set back if they allowed their currency or Hong Kong’s to devalue.
We remain fairly isolated in our argument that the major culprit behind this Asian flu is the Federal Reserve, which must be thought of as the world’s central bank. By allowing the dollar gold price to rise in 1994 to $385 from $350, where it had hovered since 1985, the Fed introduced a mini-inflation that Alan Greenspan & Co. tried to beat back with higher interest rates and a weaker economy. The gold price decline, to $320 from $385, began a year ago as the demand for dollars picked up in expectation of a stronger economy and was not met by an increase in dollar liquidity. Our economy survived this minor deflation because of the success of the budget deal and the long-awaited cut in capital gains tax. Thailand caught a cold, though, because of its currency’s link to the dollar. It inflated with the dollar’s in 1994-96. It made the further mistake of imposing capital controls in 1995 on the advice of MIT’s Paul Krugman, who warned against “hot money” flowing into their stock market. When the dollar deflated this year, Thailand was the weakest of the Southeast Asia countries and the logical place for speculators to hammer. When its currency fell, the speculators moved on to the other countries of the region, just as they attempted to make a killing in Argentina after the killing they made in Mexico.

There was no Domingo Cavallo in Kuala Lumpur or Jakarta when the speculators arrived to test the ringgit and rupiah, and these currencies quickly fell. The Philippine peso and Korean won followed, then joined by the Taiwan dollar -- helpless individually against the onslaught and with no clear leader to rally them jointly. They could have arrested their declines simply to match the dollar deflation, but once the IMF began circulating with its bag of poison, the bad colds became serious and life-threatening. How appropriate that former U.S. Treasury Secretary Bill Simon this morning writes on the WSJournal’s editorial page, calling for an end to the IMF.

It is too easy, though, to potshot the IMF at this point, when Alan Greenspan and Treasury Secretary Bob Rubin should be on the hotseat. Instead, they are hiding in the weeds, pretending all that bad stuff going on over there in Asia is the result of bad loans by bad bankers. Greenspan will argue that these countries want to have it both ways, desiring the dollar peg for currency stability, but also wanting a cheaper currency to spur exports. This is not what’s happening, though. Greenspan knows the Asians are suffering because they put faith in the dollar and his conduct of monetary policy. He also knows the $320 gold price is bad for us and bad for them, and should be lifted back to $350 by liquidity additions to the banking system. This would instantly relieve pressure on the Hong Kong dollar and the rest of Southeast Asia, China and Japan. If the dollar weakens against gold by even this small amount, the relief that would be felt in Japan would be enormous, and we could soon see the Nikkei doing a hop, skip and jump over 20,000 from 17,000.

How do I know Greenspan knows all this? Well, he knows everything, especially these arguments, which he can’t dismiss because they are part of his entire belief system as he has tried to explain to Congress in the last decade. He knows any country that pegs to the dollar while we are not pegged to gold simply imports all our monetary mistakes. My guess is that Rubin does not understand what’s going on, unless Greenspan has been trying to tutor him. Two weeks ago, I went to Washington and met with Deputy Treasury Secretary Lawrence Summers for the sole purpose of giving him this analysis in person. Which I did, and I know he did not immediately see any holes in it. As long as everyone in the system knows someone else can be blamed for anything really, really bad that happens, they can hide in the weeds. President Clinton, who is either playing golf or pondering his prosecutors, I’m sure has no idea what’s up. He is getting briefed on China, we can be sure, as the President of China, Jiang Zemin, is coming Sunday for a summit. What perfect timing!