Western health can withstand Asian flu

The theme underlying the weakness in global stock markets in recent months has been the deterioration in the economic and political landscape in the Far East. This has wreaked havoc on Far Eastern stock markets and has also caused weakness in a variety of emerging markets.

The latest economic news from Japan shows that it is now technically in outright recession having suffered from two successive quarters of negative economic growth. The most recent data indicate that Japan's economy is contracting at an annualised rate of 5 per cent far worse than even the most pessimistic forecasters had anticipated.

Elsewhere in the region the economic malaise continues to deepen. Of crucial importance is that Hong Kong and China now also seem to be sliding into recession. The economies of Japan and China (including Hong Kong) dwarf all the other economies in the region. A recession in these two economies will make it virtually impossible for the previously high-flying Asian Tigers to quickly recover from their current plight.

From the viewpoint of the private investor, current market conditions represent something of a crossroads. The vast bulk of Irish investors have very little direct exposure to the Far Eastern stock markets and will therefore be able to view weakness there with a degree of equanimity.

For most Irish investors, the threat posed from the Far East is that it continues to damage sentiment in European and US markets.

In fact, the Asian crisis presents both investment threats and potential investment opportunities. Many canny investors are probably wondering if now is a good time to invest in these Asian markets at bargain-basement prices. At the same time, many investors are beginning to worry that the large profits built up in their Irish, European and US equity portfolios may continue to erode in coming months and quarters.

For the majority of investors, the latter issue is probably the one most exercising their minds. At its simplest the issue boils down to one of economic contagion.

Most commentators and financial analysts have been taken by surprise at the extent to which the Asian disease has spread right throughout the region. Weakness in one economy and currency has quickly spread to neighbouring economies. When one looks at the diverse nature of the East Asia region, both politically and economically, it is even more surprising that the whole region seems now to be engulfed with a similar set of fundamental economic problems. Furthermore, their economic cycles are now almost perfectly synchronised with virtually all economies faced with a cyclical economic downturn.

If the degree of integration within the Asian region has come as something of a shock, there remains the equally puzzling issue as to why the Asian disease has had only a minimal impact on the rest of the world.

Post-war economic experience suggests that major economic cycles do affect all developed economies to some extent. The 1960s was a decade of expansion virtually everywhere: the oil shock of the early 1970 pushed all economies into recession. The early 1980s witnessed a marked slowdown primarily due to tightening monetary policy: again the early 1990s saw a mild recession in many economies.

The current contrast between the West, accounting for two-thirds of global output, and Asia could not be greater. The US is now into its seventh year of economic expansion and is enjoying record low rates of unemployment. Possible overheating seems to be the only serious issue facing the US economy.

In general, European countries have not had it so good but the early years of the new monetary union look as if they will be marked by a steady improvement in Europe's economic fortunes.

Is it inevitable that the Asian disease will eventually be transmitted at least partially to the rest of the world? The most likely answer to this question probably comes in two parts. First, the general weakness in Asia will slow down the pace of economic growth in the West over the next two years. The extent of this is impossible to predict but it could be quite significant.

However, the second part of the answer relates to the fundamental long-term restructuring that has occurred in the West. The banking system is strongly capitalised and vibrant. Companies have restructured and downsized their workforces where necessary. Western economies have rapidly embraced new technologies and policy makers have encouraged the growth of service industries through deregulation.

All of these developments, which are ongoing, have increased the rate of productivity growth in the West. In sharp contrast, Japan and many other Asian economies have run their economies for many years without engaging in structural reforms. Investors in Western stock markets should take comfort from the fact that the only way East Asia will emerge from its current problems is to implement Western-style restructuring. The mistakes made in Asia are not going to transfer to the West.

Therefore, the current weakness in Western stock markets should be viewed as a buying opportunity while any investment in Asian markets must still be viewed as very speculative.