Liquidity is getting tight in Asia.
Leave aside Japan, where the printing presses are still pumping out yen. In rest of the region, central banks’ supply of currency plus bank reserves has shrunk 7 percent in real terms since the dollar began surging in April. This is the steepest contraction in base money since the 11 percent fall between January and October of 2008.
Bank of America Merrill Lynch equity strategists recently looked at a similar measure of money supply for the world and asked if the squeeze was a harbinger of something ugly. The inflation-adjusted global monetary base has shrunk just five times since 1980, the analysts noted: in 1982, 1990, 1998, 2001 and 2006. All five episodes either preceded or coincided with global slowdowns.
The Asian tightness is easily explained as the unwinding of the capital flows that came rushing in after Western central banks cut interest rates to zero and expanded their balance sheets – first to deal with the 2008 credit contagion and then to try to put nominal GDP on its pre-crisis path. Now a stronger dollar and higher U.S. interest rates are pulling funds back.
The only major Asian equity markets that have seen year-to-date net inflows of foreign funds are China and Vietnam. Next year could be worse if Goldman Sachs Group Inc. is right in its forecast of only 5 percent earnings growth for companies in the MSCI Asia Pacific-ex-Japan index. That’s half of the current consensus.
Exports, which could mitigate the outflows by bringing dollar revenue into Asia from surging U.S. demand, are also at risk. Container rates of $2,652 per 40-foot box on the Hong Kong-Los Angeles route are the highest since 2012, according to Drewry Shipping Consultants Ltd. But that’s only because everyone’s trying to rush Chinese goods into America before President Donald Trump ratchets up the tariff on $200 billion of imports from China to 25 percent at the start of 2019.
Should there be no trade deal by then, Nomura Research expects Chinese export growth to crash by 5.6 percentage points in the first quarter of 2019, after a 1.8 percentage point acceleration in the current quarter. Meanwhile, global smartphone demand looks fatigued. Foxconn Technology Group, the biggest iPhone assembler, is planning deep spending cuts next year as demand wanes.
If Asian central banks don’t have incoming dollars to buy, the only other way they can print money is by purchasing bonds of their governments. But fiscal policy is lax only in Malaysia and India, with some easing expected next year in China, especially if the trade war gets bloodier. Other governments and central banks are worried about what happens when too much money chases too few goods: inflation. So Bank Indonesia has jacked up rates six times this year, and Jakarta has promised to hold the line on its budget deficit.
Once quantitative easing ends in Europe, and slows in Japan, expect more liquidity tightening in Asia. The private sector in China and India is already squeezed for cash. In China, President Xi Jinping’s administration is cajoling the financial system to lend more to private-sector borrowers. Easier financing for small and mid-size firms has become a thorny issue in already-fraught relations between the government and the central bank in India.
At some stage, the spillover effect of Asia’s liquidity (and growth) deficit could make the U.S. Federal Reserve halt its rate-raising campaign. That respite may not come very soon.