A new bubble arises in Asia

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William Pesek
In the annals of unintended consequences, Asia's reserve bubble deserves a mention. Ten years after the start of the Asian crisis, the region's $3 trillion-plus of foreign-exchange reserves are having two noticeable effects. One, scaring away the speculators who attacked the region's currencies in 1997. Two, giving Asia enormous financial influence around the globe.
Asia's rising stature was amply on display at a symposium Monday sponsored by the Asian Development Bank in Manila.
Since the late 1990s, Asian economies "have re-emerged to be among the fastest growing in the global economy," Zeti Akhtar Aziz, governor of Bank Negara Malaysia, said at the symposium. "Our steadfast reform and restructuring effort have rewarded us with strengthened macroeconomic fundamentals and sound and stable financial systems."
That offers insights into why Asia's "tiger economies" are partying like it's 1997 once again. Investors also have reason to cheer as Asian markets offer the diversity, liquidity and profits many of the West's more mature economies aren't.
While things have changed for the better, broadly speaking, a bit of sobriety is in order.
For example, when you compare the period of 2000 to 2006 with 1990 to 1996, growth has, on average, slipped 2.5 percentage points a year in the nations most affected by the 1997 crisis. The Asian Development Bank's chief economist, Ifzal Ali, points out that Indonesia, Malaysia, the Philippines, South Korea and Thailand have all sustained permanent losses in income levels.
Roberto de Ocampo, who was finance minister of the Philippines in 1997, said: "There is a compelling need to increase economic growth. Without this, there is nothing to be distributed."
Yet de Ocampo is the first to admit things aren't that simple. In the Philippines, for example, half of the nation's 91 million people live on less than $2 a day. Unfortunately, there's a tendency for politicians to think their job is done when growth exceeds 5 percent. First-quarter growth was 6.9 percent.
The trouble is getting that growth to those who need it most. President Gloria Arroyo of the Philippines aims to keep the country expanding about 6 percent for the next few years. Yet Asia needs to make its economies more efficient and tackle the corruption that keeps the fruits of growth concentrated among the elite.
The plot has thickened with Asia's unprecedented buildup of reserves. To economists like Nouriel Roubini, chairman of Roubini Global Economics in New York, the reserve glut suggests Asia learned the wrong lessons from the 1990s. He predicts "a new and different type of financial crisis in Asia" triggered by excessive liquidity and asset bubbles.
Overall, said Anwar Ibrahim, Malaysia's finance minister during the crisis, "fundamental flaws have not been corrected." Currencies, he argued, are still inflexible, showing that "we are still in a state of denial."
That also goes for Asia's reserve fetish, which is rapidly becoming one of the globe's most complicated bubbles. The president of the Asian Development Bank, Haruhiko Kuroda, listed the accelerating accumulation of reserves as one of the areas of concern for the region's outlook. Kuroda sees the challenge as one of balancing the management of these vast sums of money and using them more productively to improve infrastructure.
The reserves offer a shield that Asia lacked in 1997. Should another global crisis occur, the region's economies are far less vulnerable to the whims of markets. Amid so many uncertainties - including U.S. deficits, a Chinese slowdown, higher Japanese interest rates, terrorist attacks, bird flu and many others - Asia must avoid complacency.
"It is important that we make sure that we don't become overconfident that a crisis can never happen," said Finance Minister Chalongphob Sussangkarn of Thailand.
The irony is that the tool Asia hoped would protect it from market turmoil - foreign-exchange reserves - may be sowing the seeds of bigger problems.
The dynamic has taken on a powerful inertia. Central banks can't easily dump their reserves; markets would react by driving asset values lower, leaving governments with massive losses. If they stop stockpiling reserves, their currencies will surge. It's inevitable that currencies will strengthen as economies grow rapidly, stocks rise and more investors pile into Asia. The region is still fighting the laws of economics.
It's one of Asia's more unappreciated dilemmas. Having gotten themselves into an untenable situation, governments are looking for ways to use the money more productively. That's leading to the creation of more so-called sovereign wealth funds, or government-owned investment entities. Their assets will grow to $27.7 trillion by 2022 from about $2.5 trillion today, Morgan Stanley predicts.
The financier George Soros was absolutely right when he said last month that many Asian economies "are incomparably better than they were 10 years ago." Yet markets are far more complex than in 1997.
Today, untold numbers of hedge funds are trolling the globe for profits, and taking on huge leverage to do it. The boom in private equity firms is another new wrinkle, as are sovereign wealth funds. Add to the mix countless investors borrowing cheaply in yen and investing in higher-yielding markets and you have a multifaceted recipe for shaky markets.
Roubini Global Economics began a recent report with a prescient question: "Have Asia's Reserve-Accumulation Policies Shielded It From Another Crisis or Led to Increased Vulnerabilities?" While only time will tell, Asia needs to keep its latest asset bubble from getting further out of hand.
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Bloomberg News