The Great Asian Currency Contagion

Did October ever happen? Remember the stock market's plunge as the world recoiled in horror at Asia's financial troubles? Today, the U.S. stock market is only a short distance from its all-time high.

Why? A growing confidence among investors that Asia's governments and the international community are acting to contain the crisis. Another key reason is the underlying strength of the U.S. economy. And interest rates have come down sharply. The yield on the 30-year Treasury briefly dipped below 6% as global investors sought safety in U.S. bonds. Inflation is tame, and the federal budget deficit as a percent of gross domestic product is the smallest it has been since 1969 - the last time the federal budget was in balance. Interest rates are poised to head lower.

Still, I would not get comfortable - let alone join in the euphoria. The Asian situation will get a lot worse before it begins to get better. The Great Asian Currency Contagion continues to spread, bringing an end to the great growth miracle of the developing world. The epidemic has even infected Brazil, the biggest economy in Latin America. Yes, the International Monetary Fund is spearheading rescue packages totaling at least $80 billion - and maybe as much as $120 billion - for South Korea, Thailand, and Indonesia. But even after this strong stand shores up investor and business confidence, the region will remain deeply depressed. Japanâs economy is crippled by a sclerotic bureaucracy and a banking systems with some $160 billion in bad loans. China is a wild card in more ways than one, but its financial condition appears even more fragile than its immediate neighbors.

I expect a lot more wild rides and heart-stopping moments in the stock market. Think of it this way: We know that strong corporate profits and low inflation powered the stock market to record heights. Now ask yourself: How much will hard times in Asia cut into U.S. corporate profits? A little or a lot? Will low inflation turn into deflation as the world's troubled economies flood the U.S. with cheap goods? If deflation does emerge, will it be the mild deflation that ruled during the last third of the 19th century, a time of vast increases in international trade and material living standards? Or will falling prices signal a long period of economic stagnation like Japan in the 1990s?

Hold on to your hats, folks.


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