Amongst the many motivating forces behind the modern architects of EMU, is a desire to create a currency bloc which will be able to compete with the dollar and yen. The dollar will remain a force to be reckoned with, but the European firmament need not worry about the yen, as its position in the global financial markets will be weak for the foreseeable future. The plight of the yen has come to dominate financial markets in recent weeks and at this stage the relationship between the Japanese unit and the dollar is exerting a key influence over equity markets and bond markets throughout the global financial system.
Against a dire economic background, the yen has looked fundamentally doomed for some time and but for the intervention of the US a couple of weeks back it would now be much lower. It is not yet certain that the intervention has stemmed its decline, only time and the response of the Japanese authorities will answer that question. Regardless of the official response to the crisis in that country, which in the 1980s was tipped by the experts to overtake the United States, the economic outlook looks pretty bleak and it certainly will not be making a significant contribution to global growth for some time.
The US motivation for jumping to the rescue of the yen was based primarily on the fear that further weakness could become too much of a burden for the Chinese, forcing a devaluation of the yuan and possibly a collapse of the Hong Kong peg. Such events would have the potential to force another round of currency corrections throughout the rest of Asia, thereby giving a fresh leg to the crisis which has engulfed the region since the Thai government decided to stop wasting reserves in defence of the baht on July 2nd last year.
This decision immediately had a cascading impact throughout northeast and southeast Asia and what came to light subsequently was the degree of nepotism, cronyism and corruption which prevailed across the region. So far we have seen the financial market impact of the crisis in the shape of volatile and choppy equity markets and currencies. However, it is only now that we are seeing the real economic impact. The Japanese economy is now technically in deep recession and Hong Kong experienced a 15 per cent decline in retail sales in April. The picture throughout the rest of the region is pretty similar.
The other Asian countries hoped that they could export their way out of their troubles, but the subsequent collapse in the yen has accentuated an already difficult task of selling into the key Japanese market.
Following the US efforts to save the situation, the onus is now very firmly on the Japanese to take concrete measures, but one still senses a deep reluctance on their part to accept that the Asian/Japanese model of economic growth based on co-operation between conglomerates has failed. Furthermore, nobody seems to be prepared to stand up and admit the extent of the bad-debt problem afflicting the banking system.
A healthy Japanese economy is absolutely crucial for the other economies in the region, but such a situation is still some distance away. Clearly, this story still has a long way to run and it appears pretty certain that the crisis and its aftershocks will carry over into 1999, if not beyond.
The big question of course is what impact these head winds will have on the US and Europe. On the face of it, the direct dependence of those two regions on Asia is relatively high and certainly not insignificant. Japan accounts for almost 11 per cent of US exports, while the rest of the Asia-Pacific region accounts for 20 per cent.
Germany sells just over 10 per cent of its exports into Asia-Pacific, while the exposure of France is about 8 per cent and Italy is higher at 11 per cent. These are significant magnitudes, but the biggest danger lies in the potential for the crisis to undermine confidence elsewhere and more importantly threaten equity markets.
The US market is the best case in point. We are now getting solid evidence from the US trade figures that exports are being undermined and cheap imports are being sucked in. This situation can only get worse. From Ireland's perspective, the main danger lies in the impact on US multi-nationals operating here. Their order books would be well worth monitoring over the coming months.
From Europe's perspective, Asia will act as a drag on the fledgling recoveries in France and Germany and in pursuing monetary policy over the remainder of its life, the Bundesbank will need to be mindful of developments in that part of the world, as will the ECB when it takes the reins next January.
The latest upbeat assessment of the German economy in the Bundesbank's June bulletin would appear to be sowing the seeds for a possible rate hike over the coming months, but if that turns out to be the case, any move should be limited to 0.25 per cent at most. Thereafter, the ECB shouldn't be too aggressive.
What we are seeing at the moment is the greatest threat to the global economy since the Gulf War. This means that the Irish Central Bank's actions later in the year will have to be all the more aggressive.
Jim Power is chief economist at Bank of Ireland Group Treasury. The views expressed here are personal.
