TOKYO — When Larry Summers says it’s bad, you know it’s bad.
Ex-Treasury Secretary Summers made his bones amid the wreckage of the 1997-98 Asian financial crisis. Summers was a key member of the financial fire brigade tending to — and at times making worse — a blazing meltdown that left big scars.
As such, there’s nothing comforting about him speaking of the collapse in UK assets in “contagion” terms – terms similar to those he and other senior US Treasury officials used, in an Asian context, 25 years ago.
“I do certainly think we’re living through a period of elevated risk,” Summer told Bloomberg on Thursday. “Earthquakes don’t come all of a sudden — there are tremors first. Most of the time, when there are tremors, they’re just tremors and it goes away, but not 100% of the time.”
Indeed. The woeful moves made by UK Prime Minister Liz Truss, just 24 days on the job, have transported her economy into Thai territory – late 1990s Thai territory, that is.
Then, Thailand led Asia into a regional financial crisis. Today, Thailand could teach Truss a lesson in Economics 101. And it should – before the hapless prime minister, presiding over an already-creaky economy, finds her incompetence has transformed the UK into a third-world state.
The real worry hanging over Summers’ argument – an argument that looks far beyond the UK’s shores – is that it looks dead on. Along with having many global investors somehow, impossibly, missing Boris Johnson’s leadership (!), Truss-era UK is reminding markets that the global financial system – Asian currencies included – is heading for a meat grinder.
Asian crises past, Western crises present
Back in 1997, the International Monetary Fund (IMF) was right there alongside Summers and his ilk battling contagion in Asia. Now, it’s the West that’s scaring developing Asia and top IMF officials, who are already calling out the UK’s fiscal negligence.
For now, it’s the 2007-08 parallels that are keeping IMF and current Treasury chief Janet Yellen up at night. “In the same way that people became anxious in August of 2007, I think this is a moment when there should be increased anxiety,” Summers says.
The reference here is to another crisis – the signs of stress that were building up with little notice in mid-2007. The subsequent crash in US housing values that nearly drove the globe into another Great Recession came as a surprise to virtually everyone, save a few vocal Cassandra’s.
It’s worth noting that some of today’s Cassandras are not just looking at the decrepit UK. They have plenty to mull in Europe where markets are being carpet-bombed from all sides and something big could snap in asset markets at any second.
The current chaos is leaving punters with little time to assess the risks of a sharp rightward turn in Italy. Or Vladimir Putin’s hints at using nuclear weapons against Ukraine or perhaps its allies.
They are also looking at the dwindling Japanese yen with growing alarm. Among them: New York University’s Nouriel Roubini and former IMF economist Raghuram Rajan.
Both worry that the yen’s plunge toward 150 to the dollar will shake Japan’s yield curve in globe-rattling ways. Rajan, who once ran the Reserve Bank of India, was an early predictor of the subprime loan meltdown. Now, he’s warning global investors to be on the lookout for any signs of pressure on the bond market increasing in Tokyo.
Ditto for Roubini, who’s known as “Dr. Doom.” He worries the yen going “well above 140” to the dollar will force the Bank of Japan to “change policy” on efforts to keep bond yields near zero in ways that quake world markets.
With the yen now past 144, traders are bracing for that stumble. And things could get even more chaotic than investors realize.
“If you have forex intervention without a change in monetary policy by BOJ, the intervention is not going to be enough to stem the fall in the yen,” Roubini says. In fact, it might accelerate the move to 150 or beyond. That would force China into the depreciatory fray.
The trouble with the yen’s declines — and that of the British pound — is the microcosm factor. Both mini-crises threatening the global order tell stories of once-dominant economies undone by decades of complacency, neglected reforms and nativist politicians.
To be sure, officials in Tokyo take great exception to any comparisons with the Trussonomics disaster unfolding far to the West. Japan has a crushing debt load but Tokyo’s brand of financial management has proved far more sustainable than the UK mess, Japan’s policy mandarins would argue.
The UK, despite being the issuer of one of the globe’s five most-used currencies, is currently making shock acceleration toward third-world status.
It would be hard for IMF head Kristalina Georgieva to give Thailand or Indonesia grief considering London’s long-in-the-making fiscal reckoning. With a current account deficit of 8.3% of GDP, the UK is arguably not far out of the orbit of developing countries.
Save Cambodia, you’d be hard-pressed to find an Asian economy running on those kinds of fumes.
Capital inflows from the Gulf and Russia that long fueled London’s finance and real-estate growth engines have dried up. In recent years, the UK’s dwindling manufacturing sector has gone massively under-weight. Piling on further pressure, the country’s post-Brexit woes continue to mount up.
Fears of a pension meltdown forced the Bank of England to intervene in gilt markets on Wednesday. The Financial Times reports that many executives believe the UK barely dodged a Lehman-Brothers-like collapse this week.
While Truss is taking massive flak, her disastrous Chancellor of the Exchequer Kwasi Kwarteng is under growing pressure to reverse planned tax cuts.
But there’s no denying that the yen’s plunge has Tokyo reverting to late 1990s-like intervention to stabilize its exchange rates.
Former Goldman Sachs uber-economist Jim O’Neill worries about a 1997-98 redux thanks to the yen’s 26% decline this year.
If it keeps falling, Beijing “will see this as an unfair competitive advantage, so the parallels to the Asian financial crisis are perfectly obvious,” O’Neill warns. “China would not want this devaluing of currencies to threaten their economy.”
The déjà vu factor here is impossible to miss.
Contagion, redux
In the late 1990s, I was a Washington-based reporter covering the US Treasury, Federal Reserve and IMF. I was on US Air Force planes for many of the whistle-stop trips Summers and his then-boss Robert Rubin made to Bangkok, Jakarta, Kuala Lumpur and Seoul.
I was in the room in Jackson Hole, Wyoming, in 1997 when development economist Jeffrey Sachs savaged the Rubin-Summers-IMF axis for making Asia’s troubles worse with demands for fiscal tightening as GDP cratered. Sachs called it the financial equivalent of yelling “fire!” in a crowded theater.
In September 1997, I also was in Beijing when Rubin and Summers cajoled Chinese officials not to devalue the yuan. Their biggest fear back then was not that 100-year-old Japanese brokerages like Yamaichi Securities were collapsing. It was China devaluing the yuan that scared them the most.
The worry was that a weaker yuan might trigger a fresh wave of competitive devaluations not just in developing Asia, but Japan, too. That is once again a live concern as the yuan blows past 7 to the dollar at a moment when China’s economy is growing at the slowest pace in 30 years.
Oddly, global markets have taken the yuan’s declines largely in stride – but we may put that down to the drama that has been unfolding in London. What, then, about next week?
The calculus for Federal Reserve Chairman Jerome Powell in Washington is growing ever more complex. Should the Fed press forward with the most aggressive tightening cycle since the mid-1990s? Or might it be risking yelling “fire!” anew in global markets crowded with trades about to blow up?
Turning eastward, the yuan’s 12% decline so far this year is never far from center stage. And that has knock-on effects – notably, the growing sense of alarm in Beijing about a fast-weakening exchange rate.
Yuan headed south
This week, the People’s Bank of China stepped up its defense of the yuan, cautioning against one-way bets on the currency. In language echoing what investors normally hear from the BOJ, PBOC officials told key market participants to “voluntarily safeguard stability” in currency trading.
To many, that sounded like code for “Don’t overtalk the yuan’s decline.” Reuters reported, meantime, that Beijing is requesting that top state-owned banks stand at the ready to sell dollars for yuan in offshore markets if needed. The directives include institutions based in Hong Kong, London and New York.
The reason for the urgency: the yuan seems on course for its sharpest annual loss since 1994, the last time the Fed tightened as aggressively as it has so far in 2022.
So far, Chinese officials aren’t showing signs of panic. As Goldman Sachs analyst Maggie Wei puts it, the PBOC is serving up “verbal guidance against the recent rapid depreciation of the currency.”
The fact the yuan has gone as far as 7.2% “suggests Chinese policymakers are not necessarily defending a particular level of the exchange rate,” Wei says. The objective, she adds, seems to be to “slow the pace of yuan depreciation on the margin.”
On Wednesday, Premier Li Keqiang told state media that Asia’s biggest economy is recovering and stabilized in the quarter ending on Friday. Li said Beijing will accelerate efforts to implement fiscal stimulus programs in the fourth quarter.
Guan Tao, a former official with the State Administration of Foreign Exchange, says policymakers should be working to improve policy focus and effectiveness and strengthen coordination with monetary officials. Chinese officialdom should not “fire blank shots,” he says.
Thanks to the yuan’s downward trajectory, PBOC policy options are increasingly a mystery. “On the monetary side, the quick depreciation limits the room for PBOC to cut rates in the near future,” notes economist Betty Wang at Australia & New Zealand Banking Group.
Analyst Meng Xiangjuan at Shenwan Hongyuan Securities Co notes that “expectations on monetary easing in the short term have cooled due to August’s rate cut, a depreciating yuan and low volumes of reverse repo operations” by the PBOC.
“Domestic policies,” she adds, “are facing rising constraint as the dollar continues to strengthen and US bond yields spike, resulting in widening yield gaps between China and the US and intensifying downward pressure on the yuan.”
Analyst Sun Binbin at Tianfeng Securities Co says “it can’t be ruled out that the rhythm and magnitude of the PBOC’s future actions may be affected.”
Sun says investors would be wise to scrutinize year-on-year growth in money supply, particularly M2, and the levels of China’s foreign-exchange reserves for clues about any PBOC shift to come. “The PBOC has to control the pace of M2 growth,” Sun says.
Yet as currency chaos of the kind emanating from the UK suggests, the idea that any central bank can control things in the last three months of 2022 seems a reach. And a growing one, at that.
Follow this writer on Twitter at @WilliamPesek