Europe now is Asia in 1997

Why a crash is inevitable

by William Pesek 04:47 AM Jun 29, 2011

Watching Greece slide into chaos from 6,000 miles away is painful. Asia, after all, was the last region to experience what Europe may be about to endure.

Asia's implosion in 1997 toppled leaders, touched off riots, set back living standards a decade or more and tarnished the International Monetary Fund's (IMF) reputation. Expect similar developments as Europe's grand monetary experiment cracks.

Asia and Europe are half a world apart and it is true that the differences are considerable. Indonesia, South Korea and Thailand were much less developed 14 years ago than their euro-zone counterparts are today. China had yet to emerge as a dominant manufacturing economy. The United States was also in a better position to offer international assistance than it is today.

With that in mind, here are five lessons Europe might learn from Asia.


One: A default is unavoidable

What makes Europe's bailout efforts so hard to watch is that they are so futile. The Greek public has been very consistent about one thing: The belief that it bears no responsibility for all the debt its leaders took on over the last decade. If that does not provide the backdrop for debt repudiation, what does?

As Greece runs through more and more of the funds its European neighbours throw at it, other dominos will fall. We saw that in Asia after Thailand devalued the baht in July 1997. Indonesia swore up and down it would not get dragged into Thailand's mess - until it was. Korea assured the world it would avoid an IMF aid package - until it could not.

The US and Japan are near recession. China's boom continues to squeeze wages in uncompetitive economies such as Greece. This won't end well for the euro zone.


Two: Recovery is quicker once debts are purged

Greece fudged its way into the common currency with the help of Goldman Sachs Group Inc's financial creativity. That leaves the government in Athens with a yawning credibility gap. When it says the country can close its budget deficit with stop-gap measures, traders roll their eyes and policy makers lose more sleep.

In December 1997, Korea caved in and sought a US$57-billion (S$70.8-billion) IMF bailout. It acted quickly to let weak companies fail, closed insolvent banks, clamped down on tax cheats and came clean about the magnitude of its debts.

Greece will have to restructure its debt, and the fallout from this will increase pressure on Portugal, Spain and Italy. If Greece had acted a year ago, markets might not be spending every waking moment on edge over how and when a default will arrive.

"Asia's crisis showed that the quicker you deal with the root of the problem, however painful that may be, the quicker you are likely to recover from it," says Mr Simon Grose-Hodge, head of investment strategy for South Asia at LGT Group in Singapore. "Europe could do worse than to heed that lesson."


Three: Don't forget reforms

In all the obsessing over debt, European leaders are taking their eyes off the need to retool in a world increasingly influenced by China. Fiscal austerity is important, of course, but so is altering policies to make economies more nimble, competitive and conducive to entrepreneurs who create jobs.

In the years following its crisis, Asia worked to open service sectors to competition. It also cut red tape and took steps to limit cronyism.

It is a work in progress. Asia is still home to many of the world's poor and corruption is pervasive. What Asia got right is that crises cannot only be about austerity. While you are trimming spending, you must be creative about generating new dynamism. Since euro nations cannot resort to currency devaluation to revive growth, reform is the only way.


Four: Growth beats taxes when repairing fiscal balance

Japan is a cautionary tale when it comes to rich nations getting incentives wrong. It issued mountains of debt, assuming for 20 years that it was only one stimulus plan away from 5 per cent growth. That never happened. Then, amid a ballooning budget deficit, it increased consumption taxes in 1997. That killed a nascent recovery.

In the current global environment, growth is the route to balanced budgets, not higher taxes. The latter would simply destroy the former.


Five: Markets are quick to forgive and forget

Yes, there is a heavy price to pay for going hat-in-hand to the IMF. The key will be conditionality. There is much griping in Asia about how the terms of Greece's IMF package are far less stringent than those forced on Indonesia, Korea and Thailand.

Fresh starts are possible, though, as the powerful gains in Asian markets over the last 14 years attest. So drop the denial, Europe. Let Greece do what it needs to do, even if it means default, and move on. Asia shows there is life after crisis. BLOOMBERG


William Pesek is a Bloomberg View columnist. The opinions expressed are his own.