In Focus This Quarter

The Asian Economic Crisis: Implications for the U.S. Economy

• The impact of the Asian economic crisis on the U.S. economy has been increasingly evident, with some sectors experiencing slower growth as conditions in Asia continue to deteriorate.

• U.S. exports to Asia have decreased in recent months owing to falling demand for commodities, manufactured goods, and agricultural products.

• Slower U.S. growth resulting from reduced export sales and lower corporate profits could affect institutions throughout the nation.

The economic crisis in Asia is now more than one year old, yet the consequences of the unprecedented slide in currency values are still reverberating throughout the global economy. There are growing indications that some sectors of the U.S. economy are beginning to experience slower growth directly attributable to problems in the Asian economies. It is difficult to assess how significant and long-lasting the effects of the crisis will be, but it is clear that earlier views that the crisis would pass quickly and be followed by renewed growth were too optimistic. The consensus among economists and analysts now is that the recovery will be measured in years, not months.

Causes of the Crisis

¹ Unless otherwise noted, "Asia" refers to the economies of China, Hong Kong, Indonesia, Japan, Malaysia, the Philippines, Singapore, South Korea, Taiwan, and Thailand.

² A comprehensive survey of recent events and links to other information sources is available at the Asia Crisis Home Page, www.stern.nyu.edu/~nroubini/asia/AsiaHomepage.html.

• Reduced Export Competitiveness: Most of the Asian economies had effectively pegged their currencies to the U.S. dollar. Between mid-1995 and early 1997, the U.S. dollar increased in value by more than 42 percent against the Japanese yen and by 23 percent against the German mark. This increase significantly worsened the international competitiveness of many Asian firms relative to Japanese or European competitors in export markets, since the value of their currencies and the price of their exports rose along with the U.S. dollar. By late 1995, export growth among the Southeast Asia economies was slowing, and by mid-1996 it was near zero.

• Excess Production Capacity: Although Asian savings rates were among the highest in the world, domestic saving was not sufficient to fund the desired levels of investment in factories, roads, housing, and telecommunications. The resulting inflow of foreign capital funded rapid capacity expansion in key sectors such as autos, chemicals, and microchips. For example, capital inflows to Thailand totaled $1.9 billion in 1980 but rose to $15.2 billion by 1996. The increase in production capacity put downward pressure on prices and reduced earnings growth in key export sectors.³

³ A case in point is the growth of the auto industry. During the past several years, Korea invested heavily in new auto plants to satisfy both domestic and export demand. By 1999, Korean capacity is expected to reach 4.66 million light vehicles annually--2 million more than domestic demand. In Japan, excess capacity of 2.8 million vehicles is expected through 2002. Worldwide excess capacity in light vehicles is expected to reach more than 20 million units by 2002--more than the total 1997 production of General Motors, Ford, and Chrysler combined (Wall Street Journal, March 2, 1998). The result has been downward pressure on prices of domestically produced autos--down by 1.9 percent on the basis of the first-quarter 1998 producer price index--and imports, which have experienced price increases of less than 1 percent since mid-1996.

• Rapid Asset Price Appreciation: Real estate, land, and share prices on the region's stock markets soared during the 1980s and early 1990s. In Indonesia, for example, the Jakarta Composite stock index increased by nearly 53 percent in the two-year period ending in the first quarter of 1997.

• Deteriorating Credit Quality: Slower export growth and eroding competitiveness hampered Asian firms' ability to repay debt incurred to finance the growing levels of investment. Some Korean conglomerates were burdened with a debt load equal to 300 to 400 percent of equity. As much as two-thirds of this debt was short-term, with a maturity of less than 12 months. Additionally, the debt denominated in foreign currencies, such as the U.S. dollar, ballooned as local currency values dropped. With some firms struggling to repay mounting debt, banks began to experience a further deterioration in credit quality.

Some of the uncertainty about the strength and speed of the recovery in Asia is attributable to concerns about the faltering Japanese economy. As the second largest economy in the world and the engine of growth in the region, Japan must have a healthy economy if sustainable growth is to occur in the rest of Asia. With Japan currently in a deep recession and the outlook for its economy clouded by the halting pace of financial reform efforts, there is considerable uncertainty about how quickly economic and financial weaknesses throughout the rest of Asia can be repaired.

Impact on the U.S. Economy

Banking

Table 1

Agriculture

On the basis of analysis performed by the U.S. Department of Agriculture's (USDA's) Economic Research Services,⁴ U.S. exports of red meat and poultry are expected to drop by 5 to 6 percent in fiscal 1998 and 1999 as a result of the Asian crisis. Exports of grains are projected to fall by at least 2 percent in fiscal 1999 as other world producers increase production in response to changing relative prices among major grain exporters. Overall, USDA expects agricultural exports to fall by 3 to 6 percent in fiscal 1998 and 1999, compared with the level of exports had the Asian crisis not occurred.

⁴ "World Agriculture and Trade," Agricultural Outlook, pp. 10-11.

Commodities

Manufacturing

Between 1990 and 1996, U.S. imports of manufactured goods from Asia rose from $176 billion to more than $285 billion. Increased imports from China accounted for about one-third of the gain. U.S. imports from Asia are dominated by machinery and manufactured goods, including electronics and semiconductors, which together account for 93 percent of imports.

Asia's demand for U.S. exports will continue to weaken following the dramatic increase in import prices resulting from the drop in currency values. The latest trade data show that the dollar volume of U.S. goods exports to Asia (including both manufactured goods and other commodities) fell by 22.5 percent in May 1998 compared with one year earlier (Chart 1).

Chart 1

Changes in the volume of exports at the national level do not adequately describe the variation in the export exposure of different regions of the country. Chart 2 shows the percentage of state-level exports that are destined for Asia.⁵ Clearly, Western states are most exposed to changes in the demand for U.S. exports, especially electronics, transportation equipment, and industrial machinery. A significant share of exports from the Midwest also is destined for Asia, including chemicals and machinery such as construction equipment.⁶

⁵ The state-level export data are from the Export Locator series published by the Bureau of the Census. These data tabulate the value of exports as determined by the location of the exporter, which may differ from the location of the producer. Although these data are an imperfect measure of state-level export performance, they are still of value in assessing regional exposures and remain the most complete data available.

⁶ A state-by-state analysis has been prepared by the U.S. Treasury and the U.S. Department of Commerce.

Chart 2

In the initial stages of the crisis, the consensus view suggested that the United States would be overwhelmed by cheap imports from Asia, as Asian countries exported their way to economic recovery. Although there has been an increase in U.S. imports from Asia, the growth has been well below expectations. In May 1998, goods imports were up by just 4.8 percent over the previous year. The reason that U.S. imports of Asian goods have not been greater is due in part to the severity of the economic downturn and the weakness of Asia's financial institutions. Many Asian manufacturers are dependent on components imported from neighboring countries or purchased on world markets. With the drop in currency values, all imported goods, including finished goods and intermediate goods that are used in the manufacturing sector, have become more costly. At the same time, Asia's weak financial systems have come under increasing pressure as the economic slump deepens. Many banks cannot, or will not, lend. Consequently, Asian firms cannot secure the capital to acquire imported inputs or to finance the sale of exports abroad. As the "credit crunch" abates, imports from Asia should rebound, placing greater pressure on U.S. manufacturers.

Corporate Profits

A number of recent earnings announcements have failed to meet analysts' expectations. According to IBES International,⁷ the crisis has contributed to a reduction of profit growth, although most of the slowdown is attributable to both falling prices and weak demand for semiconductors and oil. Operating profits of all companies tracked in the Standard & Poor's 500 stock index increased by 4.4 percent in the first quarter of 1998, the smallest increase since 1991. Excluding the energy and technology sectors, profits of the S&P 500 firms increased by 8.6 percent in the first quarter. On the basis of these results, the impact of the crisis on corporate profits appears to be highly concentrated among firms in a few industries.

⁷ As quoted in the Wall Street Journal, June 22, 1998, p. C1.

Summary and Implications

Lenders should be cognizant of their customers' exposure to a continued drop in demand for exports or to further deterioration in the pricing environment. More generally, slower U.S. growth could affect even those borrowers that have little or no direct exposure to export markets. What is clear for insured institutions is that at this stage of the economic expansion and with a number of uncertainties about the global economic outlook, lending and strategic decisions predicated on an assumption of continued robust economic growth should be carefully scrutinized.

Table 2

References

Asia Crisis Home Page. New York University. www.stern.nyu.edu/~nroubini/asia/AsiaHomepage.html.

"Automobile Glut Worries Analysts Even as Some Cut Back on Output." The Wall Street Journal. March 2, 1998.

The Importance of Asia to the State Economies. 1998. U.S. Treasury and U.S. Department of Commerce. www.treas.gov/press/releases/pr2317.htm.

"World Agriculture and Trade." Agricultural Outlook. United States Department of Agriculture, Economic Research Service. February 1998.

Paul C. Bishop, Economist

Table 2