The severe turbulence seen in global equity markets this autumn will have a lasting impact on the climate in which publicly-quoted corporations operate. In purely economic terms it almost certainly signals an end to the exceptional growth seen around the world over the last few years. But its financial impact will also prove critical.
Equity and bond markets are likely to be less hospitable places for further privatisations and fund-raising exercises through the sale of shares and bonds.
The uncertainty in the equity markets has also left the US dollar looking vulnerable. In much the same way as weaker share prices reflect worries about the future earnings of corporations, a lower dollar illustrates concern over the broader prospects for the US economy. Its expansion is well into its sixth year and the relative strength of the dollar against the deutschmark and a range of other currencies is starting to weaken.
There is now a strong possibility that the current decline in the dollar could become even more marked if there is a switch in the prospects for growth in North America and Europe. As the Continental economies pick up, their currencies might well harden against the dollar in anticipation of a US slowdown.
The main trigger for shifts in the confidence and tone of the financial markets has been the crisis in the southeast Asian economies.When the IMF and World Bank moved into Thailand in July withUS$20 billion in rescue funds, it was assumed that the situation would stabilise. It got worse. The domino effect around the region has gathered momentum, dragging Malaysia, Indonesia, the Philippines, South Korea and, most importantly, Hong Kong into the fray. The assault on Hong Kong has been particularly critical.
Before the British handover to China on 1 June 1997, it was seen as the most secure economy in the region. But Hong Kong's titanic effort to hang on to its currency's fixed link with the US dollar has been at an enormous cost. Interest rates had to be raised to prohibitive record levels in a move which produced a rapid decline in prices of shares and real estate. This slump and the likely effect on the global banking system are among the key reasons for the world equity market reversal.
In purely economic terms the impact of the southeast Asian crisis should be fairly easily absorbed by the main industrial economies. Estimates by investment bankers Goldman Sachs, based upon lower growth rates throughout the Asia-Pacific region, suggest the impact on the US would be to cut growth by 0.4 per cent while in Europe there would be a 0.3 per cent reduction and in Japan a 1.6 per cent fall.
The lowering of growth should not be severe enough to cause recession or lead to higher unemployment outside Japan. As the main economic power in the Pacific - which is struggling with its own financial crisis - the chances are the Japanese recovery scheduled for this year and next could be delayed. And the secondary effects in terms of a further huge write-down of bank loans -- estimated at $20 billion -- mean Japan's financial system will remain unsettled.
The southeast Asian crisis has demonstrated that asset prices worldwide have become inflated. Much of the wealth among the Asian tigers has flowed into unsound property investments and grandiose infrastructure projects, as well as stock market values. This is most apparent in Hong Kong where the 'red chip' stocks (those with significant Chinese interests) have been selling on some of the highest earnings multiples in the world.
Asset prices also have been bid up in the west. In Europe a spate of mergers in the banking and insurance sectors, together with a general surge in transnational takeovers and privatisations, has helped drive equity values to record levels.
In the US a belief in the fairy tale economy -- growth which defies the normal laws of economics -- together with an enthusiasm for technology and computing stocks, led to similar overvaluations.
Events in southeast Asia have instilled an air of reality into equity markets which had lost touch with the fundamentals. The result in investment terms has been a lowering of values, particularly in fashionable sectors like banking and technology, and a switch from shares to government bonds.
In times of uncertainty investors tend to search for safe havens by holding a higher proportion of cash and government bonds and switching into traditionally safe currencies like the Swiss franc, away from those which are near or close to their peak, like the US dollar.
Similarly, all businesses will now be forced to adopt more cautious approaches. Expansion through takeover and share issues can be expected to grind to a halt until the equity markets have settled at lower, safer levels. Newly-privatised airlines will become more dependent on expensive bank finance. Bond issues will also be difficult except for carriers with long private sector track records. And many planned privatisations will be halted.
The slowdown in western economies will also have an effect on trade flows and revenues. Asian currency depreciation has made US products more expensive to Asians, and Asian products cheaper for American consumers. In the view of Chase Manhattan Bank this will speed the widening in the US trade deficit. Downward pressure on the dollar will only increase as the trade deficit widens further.
Moreover, the European economy is likely to be more isolated from the current problems in emerging markets than that of North America. As a result there will be a gradual weakening of the US currency against those of its major trading partners. With the lower dollar costs for many carriers will come downward pressure on dollar incomes.
The autumn break in the equity markets looks like a significant turning point for the global financial markets.
Alex Brummer
Source: Airline Business
