Specter of Another Bond Crash Spooks Asia
Kim Choong Soo is seeing ghosts, and that should scare you.
No, the Bank of Korea governor isn’t seeing ghouls or hearing things that go bump in the night. The nightmare preoccupying him involves Alan Greenspan and what traders call the Great Bond Market Massacre of 1994. Kim worries that history is about to repeat itself, potentially devastating Asian growth rates.
Back in the 1990s, when he was Federal Reserve chairman, Greenspan doubled benchmark lending rates over 12 months, causing, according to Fortune magazine, more than $600 billion in losses on U.S. Treasuries. The chaos drove Orange County, California, into bankruptcy; sank Kidder Peabody & Co.; pushed Mexico into crisis; and precipitated Asia’s 1997 meltdown as a surging dollar strained currency pegs.
Now, Greenspan’s successor, Ben S. Bernanke, is under pressure to unwind the U.S. central bank’s unprecedented $3.3 trillion balance sheet. A growing number of staff members want to scrap the Fed’s quantitative-easing experiment or at least curtail its $85 billion purchases of debt each month. Once the “tapering” process begins, debt yields from Seoul to Sao Paulo will probably jump in sudden and destabilizing ways.
Fed officials insist they will tread carefully, but Kim can’t help but fear that the “ghost of 1994” will again wreak havoc on bond markets. And he’s not alone. Bank of America Merrill Lynch strategist Michael Hartnett warns of a “repeat of the 1994 moment,” and Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein admits “I worry now” as “I look out of the corner of my eye to the ’94 period.”
“We all experienced that, and we all know what happened, and I hope not to experience that again,” Kim told the Wall Street Journal last week. He wants policy makers to “find a compromise solution so that all things will happen in an orderly fashion. If not, then we are likely to face another series of difficulties.”
That could be a huge understatement in Asia, where last time around, Indonesia, Korea and Thailand were forced to seek International Monetary Fund bailouts. There are three big risks if Bernanke & Co. withdraw liquidity: higher borrowing costs, huge swings in financial markets and lower economic growth. And that’s if the Fed restores normalcy to monetary policy in an orderly, gradual and transparent way. If the process is handled clumsily, as it was in 1994, then 2014 could be a disastrous year for the world’s most dynamic region.
“The markets that are particularly volatile are high-yield and emerging-market debt,” says Dan Fuss, who manages the $23.3 billion Loomis Sayles Bond Fund in Boston and is a veteran of many bond-market crashes dating back to the 1960s. “The scenario isn’t pretty.”
The Fed may not move for some time. U.S. unemployment is more than 7 percent, and the risks of deflation are at least as high as those of accelerating inflation. Also, Bernanke’s Fed is far more open and communicative than Greenspan’s Kremlin-like organization. The odds favor Bernanke telegraphing policy shifts well in advance.
Yet any missteps could quickly panic markets. Sovereign-debt levels have more than quadrupled to $23 trillion since 1994. Concerns about too much debt chasing too few buyers could amplify market swings. The world economy was a far healthier thing 19 years ago, before the euro existed, China’s economy mattered and high-frequency trading dominated the world’s bourses. Asia now holds trillions of dollars of currency reserves.
Korea has been creative in managing giant waves of hot money emanating from zero-interest-rate policies in Frankfurt, London, Tokyo and Washington. Although that liquidity inflated property prices and fanned inflation, Korea never lost control. The government imposed levies on banks’ financing in foreign currencies and may impose taxes on financial transactions.
For all the problems that ultralow rates cause, they also boosted gross domestic product. Asia must find ways to fill the void with looser fiscal and monetary policies of their own. The real worry, though, is full-blown financial contagion. Korea is better positioned than many peers, thanks to a sizable current-account surplus. The same goes for the Philippines, Taiwan and, to a lesser extent, Singapore. The region’s fiscal weak links, notably Indonesia and India, won’t fare as well.
Southeast Asian economies that didn’t use the rapid growth of recent years to retool economies -- here, think Malaysia, Thailand and Vietnam -- are vulnerable. Export-addicted China could be in for a rough ride.
Nor will Japan be unscathed. When Bernanke followed Tokyo’s example by cutting rates to zero and beyond, he couldn’t have expected the Bank of Japan to one-up the Fed’s experiment. Bank of Japan Governor Haruhiko Kuroda would have to venture even further into uncharted monetary territory to offset a Fed reversal.
Policy makers must act now and in concert to prepare for the worst. “Coordination seems to be the name of the game,” says Marshall Mays, director of Emerging Alpha Advisors in Hong Kong. “The Fed, for example, could allow the BOJ to do more of the flooding if it wished to start flattening out the monetary growth.”
Everyone knows that sooner or later, the Fed will have to yank away the proverbial punchbowl. Asia can hope for Bernanke to act soberly and with caution. But the region had better be prepared for a scare, too.
(William Pesek is a Bloomberg View columnist.)
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