Trapped in the System

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The grinch didn't steal Asia's Christmas, grumpy Americans did. Poor consumer spending during the holiday season confirmed predictions of an economic slowdown in the United States, and sucked all the cheer out of Asian bourses and boardrooms. Remember the Asian contagion of a couple of years ago? Well, brace yourself for the American flu. When the U.S. sneezes, the world catches a cold. That old saw has traditionally held true for Asian stock markets—when Wall Street or the NASDAQ tumbles, it sets off a chain of dominoes from Bombay to Tokyo—but not necessarily for the real economy. The last time the U.S. suffered a severe economic downturn, the recession of 1990-91, Asia didn't even sniffle. If anything, it got healthier: exports zoomed, as did foreign investment. That occurred partly because the region had fortuitously hitched its wagon to the one sector of the U.S. economy that escaped the brunt of the recession: electronics. Through the worst of it, American companies kept buying computers and telecommunications equipment, and consumers bought video-game consoles for the home. From Taiwanese chips to Singaporean disk drives to Japanese laptops, Asian exports boomed. No such luck this time round. Far from escaping the downturn, America's paltry electronics purchases are leading it. High interest rates have persuaded American companies to scale back spending on IT hardware, and slack consumer spending means Christmas Day stockings had fewer-than-expected electronic gizmos. Worse, sales are expected to remain slow in the months ahead. That's bad news for Asia because the region's penchant for electronics exports has over the past two years grown into a full-blown dependency. Electronics exports led Asia's recovery from its own flu in 1997-98. But too much medicine can be harmful. According to a report by Deutsche Bank Global Markets Research, electronics account for 75% of exports in Singapore, 60% in the Philippines, 58% in Malaysia and 37% each in Taiwan and South Korea. This heavy dependence, the report says, could be an important liability for these countries.For years, Asian countries have sought to boost intra-regional trade as a buffer against downturns in the U.S. On paper, they have been successful: 38% of Taiwan's exports go to other Asian countries. In Singapore the total is 40%, while in both Malaysia and Hong Kong it's 42%. But most of these exports are electronic components and assemblies; the finished products are eventually sold in the U.S. or Europe. What this means is that if America sneezes now, Asia could contract pneumonia. This is what happens when you have an export-driven economy that leans heavily on a single sector, says Markus Rösgen, chief strategist in Hong Kong for ING Barings. Being part of the global economy is usually a good thing, but it also means that when the biggest element in that economy—the U.S.—goes down, it takes you down with it.How far down? Many forecasters are betting the U.S. economy will enjoy a soft landing, in which GDP growth will slow to around 3% in 2001, from a little over 5% in 2000. This assumes the U.S. Federal Reserve will cut interest rates, perhaps as early as the end of January, thus encouraging companies and consumers to start spending again. If the Bush White House weighs in with a tax cut, that could help too. Even so, analysts expect a time lag of six to 10 months before the cuts have the desired effect. Unless [Fed chief] Alan Greenspan makes a massive mistake—and he hasn't made any so far—a soft landing is very much on the cards, says Paul J. Alapat, regional economist with Nomura International in Hong Kong.But rate and tax cuts might not be enough to rouse American consumers. They have seen a big chunk of their net worth vanish on Wall Street and on the NASDAQ in 2000, and may not be inclined to splurge on that new flat-screen TV. There's a clear pullback on discretionary expenditure, says Anirvan Banerji, director of research at New York's Economic Cycle Research Institute. People are putting off plans to buy consumer durables like cars and PCs. It wouldn't take a great deal to turn the mood from blue to black. Wall Street is already abuzz with rumors of major companies planning big layoffs in anticipation of weakening demand. A few high-profile retrenchments would heighten consumer anxiety and delay—even undo—the benefits of rate and tax cuts. This could lead to a hard landing—growth of 2% or less—or even a full-fledged recession. If that happens, expect things to get ugly in Asia, too. Nowhere is the scene likely to be uglier than in Japan, where the economy has been moribund for a decade. Although GDP grew an estimated 2% in 2000, the best rate since 1996, the last quarter of the year brought signs of an imminent setback: corporate and consumer confidence are running low. The fragile recovery was led by exports and capital investment by high-tech companies—both of which ultimately depend on the state of the American economy. When the U.S. slows down, Japan will be jolted, says Kenji Yumoto, senior economist at the Japan Research Institute, a Tokyo think tank. Even Japan's nonelectronics exporters are vulnerable. Noriyuki Matsushima, an analyst at Nikko Salmon Smith Barney in Tokyo, predicts that the U.S. car market will contract after seven years of expansion. He warns that this could reverse Nissan's recent recovery. The struggling carmaker's surprising return to profitability earlier this year was the product of strong sales in the U.S. What can Tokyo do to stave off a recession? Not a lot. Interest rates are already close to zero, so cutting them in an effort to spur investment and growth is out of the question. Prime Minister Yoshiro Mori has promised a $100 billion economic stimulus package, but nobody thinks it will help. Over the past eight years, every one of Japan's attempts to spend its way out of trouble has failed. Now the bloated public debt is adding to the country's economic mess.If Japan is likely to feel America's pain the most, China will probably bear it better than the rest of the region. After all, as U.S. consumers tighten their purses, where will they turn for bargains? In all likelihood, they will look to China, as they have since the country a decade ago became a regular Santa's workshop for toys, clothes and electronic gizmos. China's exports to the U.S.—worth $100 billion a year—tend toward the low-tech, low-cost items that middle-class Americans want even as they await fatter times for that new Nissan or Taiwan-made computer. China's economy would suffer from a U.S. slowdown, but not as much as the rest of Asia, says Dong Tao, senior regional economist for Credit Suisse First Boston. Still, he predicts that flagging U.S. markets will slow China's export growth from 27% in 2000 to just 7% this year.The shock won't hit the rest of Asia evenly. Expect Taiwan's tech-heavy stock market to continue to plummet. The Taiwan Institute of Economic Research predicts export growth will drop from 23% in 2000 to 7.5% this year. P.C. Wang, associate vice president of computer maker Mitac, expects sales to stay depressed through October. He won't rule out the possibility that Mitac may have to lay off workers for the first time since 1983. It will, says Wang in classic understatement, be a very tough year. The Philippines, Malaysia and Singapore could take it on the chin because of their heavy reliance on electronics exports. In anticipation, the Singapore government has announced it will devalue its currency to make its products more competitive. Malaysia's ringgit, pegged to the U.S. dollar, will surely come under pressure. For Hong Kong, strong consumer spending in China should provide a cushion, even if a weak stock market makes local consumers cautious. In the end, some good might come from an Asia-wide economic slowdown. Economists hope it will force countries like Thailand, Indonesia and South Korea to return to the urgent task of economic reforms after slacking off in recent months. Nomura's Alapat cites Seoul's uncompromising stance against agitating bank workers last week as a sign of stiffening resolve. On Wednesday, riot police broke up a week-long strike by 23,000 unionized employees of two major banks that have announced plans to merge, in line with reforms instituted after the 1997-98 crisis. The workers fear massive layoffs and want the merger nixed. The authorities are refusing to budge. Eight months ago, the government would have been more inclined to negotiate, says Alapat. Now, the economic planners know they have to get tough in order to face the hard times ahead. That's as good a prescription for the American flu as any. With reporting by Matthew Forney/Beijing, Sachiko Sakamaki/Tokyo and Don Shapiro/Taipei