Did the Fed just cause Asia’s next bubble?

HONG KONG — Asian central bankers see a ghost from the past in the U.S. Federal Reserve’s plan to pump $600 billion into the banking system. To them it's like the rolling mid-1990s again, except that they know how this party is going to end. Here's the scenario: This tsunami of cheap dollars would flood Asia's stock, property, commodities and other asset markets, pushing up prices, then forming bubbles that would eventually burst and result in another ruinous recession like the 1997 Asian financial crisis.

Even scarier now than 13 years ago is that options to manage this cash onslaught have come down to a hard dilemma for central bankers in Asia: If they raise interest rates to absorb excess capital, which would almost definitely be higher than the rates in the U.S. and Europe, it would only attract more of that cheap money. If they leave the markets alone, the risk of a severe shock multiplies. Hot money comes in fast, and flees just as easily.

Compounding the situation is that these economies have only just come off their own stimulus in 2008-2009. So the Fed's move is like a double stimulus for them, piling on top of the money still sloshing around.

“The launch of QE2 [this second round of quantitative easing] will definitely add pressure to the asset markets in the emerging market economies such as Hong Kong’s. As far as Hong Kong is concerned, we will take measures that are specific to the housing market,” said Norman Chan, chief executive of the Hong Kong Monetary Authority, the city’s de facto central bank.

Property prices in Hong Kong have risen to their highest since 1997, the peak of the last bubble. The Hang Seng index this week reached a two-year high in anticipation of the Fed's loose money. With a highly liquid market and no capital controls (unlike mainland China), Hong Kong is a natural proxy for investors seeking a China exposure. In the first 10 months of the year, HK$345.9 billion ($44.6 billion) was raised in Hong Kong from initial public offerings. That shows just how much money has been circulating. Hong Kong hardly needs more.

Property speculation is a major concern too in China, Malaysia and Singapore — all three already curbing mortgages. In South Korea, stocks reached their highest level in nearly three years this week. Bailed out by the International Monetary Fund in 1997 — South Korea came out with a combative tone against effect of the stimulus, signaling it will “actively” seek measures to control the flow of capital, which could include taxing foreign investments in government bonds. Thailand — another poster country of the 1997 crisis — already did that last month.

Surely, Asian authorities want to see the U.S. economy pick up – after all they sell a lot of their exports to America? However, the Fed’s intervention, although anticipated, still conjures U.S. unilateralism, an attempt by America to save itself regardless of how it would affect others.

“The main issue here is that the United States conducts monetary policy that has consequences not only on the United States. The U.S. dollar, for better or for worse, is the only serious international reserve currency,” said Uwe Parpart, chief Asia economist and strategist of Cantor Fitzgerald in Hong Kong.

The Fed’s stimulus was a de facto weakening of the dollar. Conversely, it means the Fed has just engineered for the value of Asian currencies to go up.

So how is that different from the Bank of Japan intervening in the foreign exchange market to weaken the yen? Or from China managing its exchange rate?

Whatever happened to global coordination of policies to prevent a currency war? Did the Fed just precipitate that? Only a few weeks ago, Treasury Secretary Tim Geithner said there was “no risk” of a currency war.

This only gives Beijing ammunition to counter the expected clamor at the G20 next week for the yuan’s appreciation and it allows central banks in Asia to justify future foreign exchange interventions.

Already, the currencies of big exporting economies such as Japan, South Korea and Thailand have risen to multi-year highs. This makes their products more expensive abroad and they are unsurprisingly, not happy with that (although a strong currency also makes imported components cheaper.) More foreign capital flows further raise the values of their currencies as foreign investors buy local currencies.

The Japanese yen hovers around a 15-year high against the dollar despite a massive purchase of dollars by the Japanese central bank in September to weaken the yen.

There are indications that Asian central banks may take concerted actions to control the flow of capital into their economies. Capital controls work well when done together, but a robust common policy may be hard to come by because some Asian economy stand differently today, than say, in 2008, when all agreed on stimulus measures.

Japan, for instance, has mirrored the sluggish economic recovery of the United States and may even implement its own quantitative easing (expected Friday).

China, too, attracts foreign capital, perhaps more than others, because of its expected 10-percent growth rate this year. But because the yuan is heavily managed by the central bank and because of existing capital controls and foreign investment restrictions, it has some built-in safeguard against capital inflows.

All told, Asian monetary authorities are probably reaching for their antacids now. Yes, they want the U.S. economy to grow to stabilize the global economy. But they don’t want the imported inflation and the instability risks. They didn’t survive two severe financial crises in less than 15 years to be sitting ducks for another one.

The question now is, how far would Asian leaders assert themselves at the G20 talks in Seoul next week (Nov. 11-12) against the United States and the weak dollar?