Saturday June 16, 2012
Contagion is a problem of confidence
A QUESTION OF BUSINESS
By P. GUNASEGARAM
Asia needs to be its own source of growth if the slowdown in Europe and the US continues
CONTAGION is a dirty word. It can bring whole countries down if enough people believe in it. The more who believe in contagion, the dirtier it gets and the faster it spreads and the more damage it can do. The insidious thing about it is that belief in it brings it about.
Now there are attempts to bring this dirty word back into play. It is understandable if the word is used in the context of the eurozone countries where proximity and trade is close enough for one country’s fortune, in this case misfortune, to affect another.
But increasingly, it is being used in the context of the crisis spreading to Asia. That is Asia is going to catch the European disease somehow, and that Asia is going to get it by contagion. But how exactly is not clear although the common – and trite – explanation is that a slowing European economy is bad for the rest of the world.
Before we weigh the merits of such an argument, we have to look a bit more into this concept of contagion to understand if it is really applicable in the Asian context right now to see if Asia is in grave danger.
Its biological meaning is simply the transmission of a disease by contact. It now has taken on a financial dimension, which refers to a situation whereby economic troubles in one country can affect, almost infect, other countries too, especially neighbouring ones because they are in contact with the affected or infected country through extensive economic links.
The reasoning is that if the economies are interlinked, then if one country falters, it cannot help but infect the other country, which is very closely dependent on it. That is financial contagion in practice.
Malaysia had its encounter with this word in the 1997/98 Asian financial crisis. The troubles then began with Thailand where short-term inflows of funds financed long-term ventures. When the funds were beginning to be pulled back, the entire economy was near collapse.
The rest of South-East Asia would be affected, the financial wizards said because of financial contagion. Malaysia protested it was not in the same boat and neither was Singapore. But both were painted with the same brush as Thailand and subsequently Indonesia.
It is worthwhile seeing how all of this transpired. When the realisation came that Thailand was too dependent on short-term capital flows, that immediately dried up short-term capital and there were reversals instead as funds fled the country. Yes, Thailand was in trouble but should Malaysia and Singapore have followed suit?
That’s when the theory of contagion was applied to Malaysia and Singapore, even though these countries were not linked closely with Thailand in terms of the economy or financially. Malaysia and Singapore were strong financially but that did not matter. Foreign funds withdrew and caused a huge downward pressure on the currency.
Stock markets fell. Government intervention was not enough as foreign funds mounted a pincer attack by short-selling the currency and the stock market and geared up to increase their firepower. As currencies were supported, interest rates rose and the market fell. Hong Kong came under attack too.
The volatility in the market caused locals with surplus funds too to shift them overseas, adding further problems. Desperate measures had to be taken. Malaysia imposed capital controls and pegged the ringgit, immediately removing the attack on the ringgit and stemming the outflow of funds. Hong Kong used government funds to support the stock market, buying index stocks and making huge profits some years later.
The point to note is that perfectly healthy but open economies were not spared the effects of what amounted to a loss of confidence in their economies because of problems with neighbouring economies as foreign providers of funds, and subsequently locals, behaved as if contagion had happened.
Contagion happened because enough people believed it could happen and these were supported across the board by institutions such as rating agencies that downgraded sovereign and ratings, research firms that downgraded stocks virtually overnight and fund managers who believed what they were told.
That is the main danger – not direct contagion but inducement of lack of confidence in healthy economies by the use of the word contagion and by enough people believing that and acting as if contagion had already taken place.
Asian countries suffered badly during that time because the International Monetary Fund’s standard prescription was austerity and increased interest rates to attract funds in. But with the currency so volatile, interest rates would have been too high to stem the bleeding and would have driven the economies even further down.
Contrast that with the US handling of the subprime crisis, which was to basically reflate the economy by printing more money and reducing the interest rates to practically zero in the hope of reviving the economy.
Europe will eventually solve its problems and it is not likely to be austerity because that won’t do it. You need economic activity. Devaluation may be one option but the problem is the European Union is not a single nation although it has a single currency. Why should the Germans pay for the excesses of the Greeks, go the arguments.
But the worrying thing as far as Asia is concerned is that rating agencies have taken out their pens (or laptops to be more accurate) and are recalculating the risks in Asia following slower growth in China and India. And they are using that dreaded, dirty word called contagion. Watch out!
They say the problem in Europe will affect Asia. The relevant question however is this: How much will it affect Asia. How much are Asian countries dependent on Europe for their exports? And if the Asian countries rode out the downturn in the US without too much problem, why can’t they do the same with Europe as it turns down before it recovers?
What Asia needs to do is to organise itself so that contagion does not happen. Asia needs to recognise that it is the area of largest growth in the world. It’s where things are happening and it is where Asia itself should put its money.
There is now enough money in Asia. Any attack on Asia financially, which is not warranted by the fundamentals and which may be engineered by those interested in making quick gains using contagion as the excuse, can be blunted by the proper coordinated use of this money and the willingness to stand together under attack.
In financial terms, that means making available enough money to affected Asian countries to counter any effects of induced contagion.
In the longer term, Asia needs to have more confidence in itself and put its money back here and enjoy the growth that is taking place. If it does that it may well kill contagion for many years to come.
Independent consultant and writer P Gunasegaram (email@example.com) is convinced that financial crises are manmade, Jamie Dimon’s testimony notwithstanding.