Fed’s ‘Ghost Of 1994’ Is Haunting Asian Markets

Asia will always have complicated feelings about Alan Greenspan.

In the mid-to-late 1990s, the then-Federal Reserve chairman was a bona fide celebrity. His photo was showing up in People magazine, Entertainment Tonight and the style pages of national newspapers. Greenspan’s command of the globe’s biggest economy earned him a glowing Bob Woodward biography titled Maestro.

Yet Asia mostly remembers the Greenspan era for precipitating the 1997-1998 Asian financial crisis. It was the Fed’s 1994-1995 tightening cycle—doubling short-term interest rates in just 12 months—that set the stage for Asia’s reckoning.

As the dollar surged and capital raced toward the West, officials in Bangkok, Jakarta and Seoul could not maintain currency pegs to the greenback. The resulting waves of currency devaluations also pushed Malaysia toward the brink and nearly dragged Japan into the mix.

In late 1997, extreme market turmoil claimed a major prize: the then-100-year-old Yamaichi Securities, one of Japan’s fabled big-four brokerages. Its collapse panicked officials in Washington. Both the U.S. Treasury Department and the International Monetary Fund worried not that Japan was too big to fail. They thought Japan’s economy might be too big to save.

All this explains why Jerome Powell’s comments on Aug. 26 spooked Asia so viscerally. Suddenly, the region is fearing what former Bank of Korea Governor Kim Choong Soo calls the “ghost of 1994.”

Over the last decade this fear sprung up from time to time. In 2013, when the Fed “taper tantrum” was stalking bond markets, Bank of America strategist Michael Hartnett warned of a “repeat of the 1994 moment.” Lloyd Blankfein, then the CEO of Goldman Sachs, admitted that “I worry now as I look out of the corner of my eye to the 1994 period.”

Hence the impact of Powell warning about the Fed’s hawkish turn persisting “for some time” and necessitating “some pain” for households and businesses. It comes against the backdrop of the most aggressive Fed tightening moves since the 1990s.

In fact, one even wonders if Powell is pulling his rhetorical punches as inflation increases the most in 40 years.

The yen is already on the verge of 140 to the dollar, a level that New York University economist Nouriel Roubini, “Dr. Doom” himself, warns could force the Bank of Japan to “change policy” in ways that intensify global turmoil.

Over the weekend, Isabel Schnabel, a member of the European Central Bank executive board, spoke for many when she talked of the “great volatility” challenge to come. Already, she said, “the pandemic and the war in Ukraine have led to an unprecedented increase in macroeconomic volatility.”

Now comes the threat of powerful central bank tightening. The burning question, Schnabel said, is “whether these shocks, albeit significant, will ultimately prove temporary, as was the case for the global financial crisis.”

The bottom line, Schnabel warned, is that the “challenges we are facing are likely to bring about larger, more frequent and more persistent shocks in the years ahead.”

Nowhere more so than Asia. The downward pressure on Asian currencies as the dollar rallies like it did back in Greenspan’s day will cause plenty of chaos. Already, markets are buzzing about a “reverse currency war.”

Over the last two decades, governments from Seoul to Singapore preferred weaker exchange rates to boost exports. Now, as Russia’s Ukraine war boosts prices of oil, food and other vital imports, Asia fears importing inflation via low exchange rates.

The capital flight problem is real, too. One of Asia’s big frustrations is it’s in many ways paying the price for Powell’s failures. An early one: bowing to former President Donald Trump’s demands for lower rates in 2019, even though the economy didn’t need support.

In 2021, Powell failed to put any tightening moves on the scoreboard. He bought into the inflation-is-transitory argument a bit too enthusiastically. By the time the Fed began hiking rates in March 2022 it was too late. Now, as the Powell Fed plays catch-up, Asia will be collateral damage.

The Fed swinging from quantitative easing to “quantitative tightening” has Asia directly in harm’s way, says economist Tan Kai Xian at Gavekal Research.

This accelerated austerity, he says, “coming on top of further interest rate increases at a time when the U.S. Treasury has finished reducing its cash balance will amplify the liquidity squeeze already under way. Moreover, U.S. commercial banks are tightening their lending standards, and so are unlikely to offset this liquidity drain. This is likely to weigh on U.S. equity prices, and as real borrowing costs rise and choke off demand, it will increase the probability of a near-term U.S. recession.”

That will boomerang back Asia’s way. Though the region has made progress weaning itself off exports, building more vibrant services sectors, any drop in U.S. demand would hit China and the rest of Asia hard. Scary, indeed.