Andrew Sheng, Distinguished Fellow of Asia Global Institute, says Asia has to find a way to invest its massive savings in a forward thinking way.
Anyone who thinks they can predict the future of Asian finance has to know first how Asia's real economy will be doing. Projections of the future based on past data are notoriously inaccurate. But there are general scenarios that we can paint about the mega trends in the global economy that will certainly shape what will happen to Asia.
Roughly every five years, the U.S. National Intelligence Council publishes scenarios about the future, the latest being for 2030. The key trends are well known, including demographics, urbanization, technology and social media, globalization, climate change and growing risks through social conflict - including terrorism, civil disruption and regional wars.
The main trend is the move from a unipolar world to one where America's dominant position has weakened relative to the other major players. Not only are new powers emerging, but also non-state players like the terrorist group Islamic State. This makes coordinated and consistent action much more difficult to manage, which is why there is little agreement at the level of multilateral institutions.
The McKinsey Global Institute has tried to help corporate captains and policymakers frame the future, between now and 2025, into four possible outcomes. The best scenario is globally coordinated and distributed growth underpinned by broadening productivity increases. Next are pockets of global growth with imbalances. Scenario three is low but stable global growth, with lots of muddling through. And the worst is continuing rolling regional crises with volatile and weak growth all round.
Much will depend on what is happening in the near term to stimulus packages like quantitative easing and the outlook for energy prices. Over the long term, the ageing of advanced economies, rapid urbanization (or labour migration) and technology and global connectivity will shape the final outcome.
The outlook in the post-crisis period is bleak. Having shot the world full of steroids in terms of quantitative easing, the world's central banks are moving in divergent paths. The Federal Reserve wants to withdraw, while the European Central Bank and Japan are still bent on using very loose monetary policy. But, post crisis, growth in advanced countries is roughly 2 per cent below potential, and their demand for Asian imports is likely to remain weak.
Which is why Asian finance will depend on what happens in the next decade to the Asian global supply chain. Historians remember that the Japanese led the post-war revival of the Asian economies by being the first to meet the demand for consumer goods in the West. After growth in Japan peaked in the 1980s, it invested heavily in the rest of East Asia to exploit cheap labour and increase its productive capacity. China's emergence consolidated Asia's key role as the global factory.
This success meant that Asia ran a current account surplus with the rest of the world, but mostly with the U.S. With rising incomes and savings, Asia became a net lender to the world, further stimulating global growth as domestic investments, an emerging middle class and demand took most of Asia to middle-income levels.
But these excessive savings were never properly intermediated within Asia. Instead, they were parked in New York and London, returning to Asia in the form of foreign direct investment or portfolio investments. Fundamentally, Asia did not upgrade its bank-dominated system of using short-term deposits to fund long-term investments. Despite an ageing population, the level of long-term pension and insurance funds, and therefore the institutionalization of long-term savings, remained small compared with the banking system.
Much of this has to do with a penchant for low interest rate policies. Excessively low interest rates meant investments did not necessarily go to the best type of funds, while speculation in asset bubbles became more profitable than upgrading total factor productivity.
China's stock market gyrations this year symbolise the contradictions within Asia's financial system. The market should be the source of long-term equity needed to give the whole economy an equity cushion against overleveraged fragilities. Yet, it became a casino for retail punters with margin funding.
This is why the Fed's decision on raising interest rates has so much impact on the future of Asian finance. Capital outflows back to New York and London are expected to occur precisely because, as Asian excess savings unwind, interest rates will adjust upwards and Asian asset bubbles will accordingly also unwind.
The irony of Asian growth is that while Asians think long term, their institutional framework remains distinctly short term. Asian pension and insurance funds remain too small and lack the firepower and imagination to be market stabilisers.
The Japanese pension system is the classic example of Asian institutional weakness. By putting the bulk of its savings in domestic government bonds, the system is trapped in terms of returns, since the large Japanese fiscal deficit and debt overhang can only be sustained by low interest rates. We then have the world's largest net saver becoming the largest borrower, owing everything to itself. Can the right hand of an ageing person rescue the left hand? Over any demographic cycle, it is the young who will support the old, so one must invest in the young for the future to be bright.
The future of Asian finance is less a technical issue and more a mindset problem. Unless Asian policymakers start thinking more about long-term funding for its young, it will continue to be subject to the whims of monetary policy decisions in Washington DC.
This article first appeared in the South China Morning Post on September 21, 2015.
The views expressed in this article are the author's own and do not necessarily reflect Asia Global Institute's editorial policy.