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June 19, 1998
Wobbles by the Big Domino have transformed the year-long crisis in Asia from a painful but regional affair into a genuine danger to the world economy.
There is a certain unreality about the news from Japan. For one, to most people the story is a boring, long-running cry-of-wolf with no consequence to the average American. It's been yen-this and yen-that for a decade; first, Japan will own us, now they're going to cause a depression.
Second, so far -- so far -- the few consequences from the Asia troubles have been pleasant: a strong dollar, cheap imports, no inflation, cheap gas, a job and a rising stock in every pot, and low interest rates.
The menu of consequences changed last Thursday night as Japan reported a rate of economic shrinkage consistent with self-reinforcing downward spiral. As word of this free-fall spread west with Friday's sunrise, the yen went straight down, as did stock markets world wide.
Monday's new, 30-year 6.875% low in mortgage rates was to most Americans just another goodie rolling out of the Asian cornucopia.
However, that transient blessing did not compensate for the following imminent chain of events: if the yen heads north of 150, it will trigger a round robin currency devaluation throughout Asia, as everybody tries to maintain export export earnings. A few weeks of "competitive devaluation", and money will be wallpaper throughout Asia, contraction spreading to the weak, worldwide; Latin America, Russia....
If that seems an excessively grim scenario, here's how bad the panic got in the Treasury market on Monday. At no time in this century (except at the end of aggressive tightening by the Fed) has the 10-year Treasury yield fallen below the Fed funds rate. On Monday, with Fed funds at 5.50%, the 10-year traded at 5.35%. Panic.
Treasury Secretary Rubin, the bright, competent light of the Clinton administration, who made his fortune as a currency trader, and does not believe in currency interventions, asked the Fed to intervene on Wednesday. He caught the markets completely unprepared: on Monday, Sanwa trader Yukihiro Hashimoto: "Everybody knows the U.S. isn't going to intervene." (The last words of General John Sedgwick, 1864: "They couldn't hit an elephant at this distance...").
The intervention caused an immense reversal: stocks up, yen up, dollar down, bonds down (yield up), mortgages from 6.875% to 7.25%. Since then, a nervous, precarious wait to see if Japan will... move. Nobody in the markets believes they will.
If they take serious, immediate action, mortgage rates in the sevens will be a small price to pay. If they don't, we'll soon see how big a domino China turns out to be.
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