Although the outlook for overall U.S. economic growth is assuring, the outlook for the U.S. trading position is not as clear. Financial markets instability and substantial depreciation of currencies of several Asian emerging markets could lead to an increase in the U.S. trade deficit. As the dollar strengthens against these currencies arises, exports to these markets decline and imports from these markets increase. Imports from these areas could rise both because of the relatively high growth rates in the United States and cheaper import prices,. As these countries try to earn foreign currency to pay off maturing debts. U.S. exports to these areas could decline due to the impact of the liquidity crunch and austerity measures these Asian markets have been advised to administer to restore investor confidence and to avoid sharply lower or negative growth.
The Asian financial crisis started on July 2, of last year, when the government of Thailand abandoned its efforts to maintain a fixed exchange rate of the baht. The baht quickly depreciated by more than 20 percent. Within a few days most neighboring countries had been forced to abandon their fixed exchange rates. Massive speculation against the baht and other Asian currencies forced Thailand and several others to devalue their currencies. Speculative activity over the next few months had consumed most of the foreign exchange reserves amassed to defend exchange rates. Investors, ordinarily, flee a currency because they expect it to be devalued due to persistent imbalances in the economic fundamentals of the country in question. These include large and persistent deficits in the current account, the erosion of a country's foreign reserves, budget deficits and the accumulation of foreign debts and domestic bad debts. Investors lack of confidence in a country's economic fundamentals is the main reason of currencies crises.
Currency crises have destabilizing effects on trade and investment and much depends on the size of the economies involved. However, the impact of the financial imbalances in the Pacific Rim on the U.S. and other economies is a matter of debate. Economic activity continues to expand in China. In Japan, the recent tax cut by the Japanese government is expected to stimulate the Japanese economy and help pull other Asian economies out of their slump. Nevertheless, Asian financial and economic crisis have caused jitters throughout East Asia as currency traders reassessed their positions and foreign investors withdrew short-term investment funds. A massive flight of foreign capital has already been registered, if persisted, could push several area banks into default. Asian stock markets turmoil could have sent shock waves to other financial markets.
According to a testimony of the US Trade Representative to the Congress on this subject, the causes of the Asian financial crisis are complex and multifaceted. However, in each country across the region, observers find common features-inadequate supervision of Asian financial institutions, speculative real estate and equity booms, excessive close ties between governments, banks and corporations. These ties together with the deep seated resistance to competition including open trade and investment resulted in a misallocation of capital. Many investments that have led to insolvency would never have been made under more competitive conditions.
Foreign investment flowed into the region, quadrupling in less than a decade to expand capacity well in excess of current or projected global demand. Also there have been a fundamental mismatch between short-term bank funding, fueled by foreign investment, and long-term lending transactions for projects of dubious merit, a phenomenon called "a pattern of conspicuous construction".
In Korea, for example, the relationship between government, banks and commercial enterprises resulted in misallocating capital in Korea to ventures of questionable merits. This misallocation of capital fueled the expansion of some kind of conglomerates into lines of business of dubious value, in routine overproduction, and in excessive exports in such targeted industries as autos, steel, semiconductors and ships. This misallocation exacerbated in turn, market access problems in Korea, including import clearances for imports licensing procedures, anti-competitive practices, and other barriers to market access.
South East Asia's financial imbalances could prove to be of longer duration than have been thought, despite the loans provided by the IMF to help these countries pay off maturing foreign debts. Traditional economic adjustments, such as raising taxes, cutting spending, and raising interest rates could prove to be ineffective if not hard to apply in such a deflationary economic environment. Market forces played too little a role in allocating a spurt of foreign investment funds.
The speculative bubble and favoritism were evident in huge public works monuments and over speculation in real estate. Construction of an enormous overcapacity in cars, chips, steel, textiles and electronics also left the region with an overhang of debt and shrinking profits. Structural economic changes seem to be required to open Asian economies wider to disciplinary market forces that promote efficiency and discourage misallocation of resources. More generally, greater transparency and increased efficiency are required.
These changes usually are of long gestation periods. The Organization of Economic Cooperation and Development (OECD) assessed the impact of Southeast Asian financial problems on other countries economies in their latest Economic Outlook report. According to OECD estimates, the crisis will shave 0.3 percent off U.S. GDP growth rate in 1997 and 0.7 percent in 1998. Net U.S. exports will decline by 0.1 percent in 1997 and by 0.3 percent in 1998, table 1.
The negative impact of the crisis will be higher on Japan's economy than on other countries, says the OECD. OECD, however, emphasizes that the final outcome is uncertain. Much depends on the direct effects of the crisis on the Asian economies themselves, the extent of the economic adjustments implemented in an environment of falling equity prices, and the subsequent negative impact on wealth and incomes. The impact of the crisis on world trade is even harder to assess because of the large changes in relative prices of currencies and the difficulty of assessing the speed and magnitude of adjustments of trade flows to exchange rate changes.
Unlike the OECD, the International Monetary Fund (IMF), updating its September World Economic Outlook, stated that, "although financial crisis is inherently nonforecastable because their occurrence and especially their timing are intimately linked to sudden changes in investor confidence, the financial tumult in Southeast Asia and South Korea will batter the region's economies in 1998 but leave the United States, Canada, and Europe largely undisturbed."
The IMF predicted that the global economy will grow by 3.5 percent in 1998, 0.8 percent lower than predicted in September. The effect of the Asian turmoil will differ by region. Asian developing economies will slow down sharply. According to the IMF, Thailand's economy will not grow at all in 1998, Indonesia will grow at 2 percent, Malaysia at 2.5 percent, and South Korea at 2.5 percent. As to developed economies, the IMF downgraded its September forecast by 0.2 percentage point predicting that the U.S. economy will grow by 2.4 percent in 1998, Canada by 3.2 percent, Germany by 2.6 percent, France by 2.7 percent and the United Kingdom by 2.4 percent. Buoyant domestic demand in those nations will outweigh the negative effects of diminished trade and investment in Asia, the IMF stated.
The IMF predicted that the impact of the Asian turmoil will be felt most in the U.S. current account, the broadest measure of a nations's foreign trade in goods and services and investment income. The U.S. current account deficit could swell to $230.2 billion in 1998 from $177.5 billion in 1997, and that could trigger protectionist measures. The IMF predicted that the Japanese economy will be hurt much more than other nations because of Japan's much larger share in trade and investment in distressed Asian nations. Fully 18.2 percent of Japan's trade is conducted with emerging economies in Asia. The comparable figure for the United States is 11.3 percent and for Germany's, it is, 3.8 percent. Japan's economy will grow by a meager 1.1 percent in 1998, a full percent below its September forecast, the IMF said.