Tremendous technological and structural changes in the global economy have been accompanied by large movements in financial markets. In December 1996, Fed chairman Alan Greenspan described the US stock market as "irrationally exuberant". At that time the Nasdaq was sitting at 1,300 and the Dow-Jones index at 6,500. Over the next three years Nasdaq soared to 5,050 and Dow to 11,720. Sentiment was buoyant because there was convincing evidence of productivity improvements that convinced the market fundamental changes were at work. From time to time Chairman Greenspan reinforced these beliefs when he highlighted the ongoing productivity gains in the US economy. The stock market rise was explained as logical responses to the phenomenal gains from potential winners in the New Economy.

  But within a year, the Nasdaq plunged 67% from its peak. Many dot-com companies, which were trading at astronomical multiples of eyeballs rather than earnings, have quietly gone bankrupt, adding to the glut of second-hand computers and servers. Investment banks, which earlier had to dress down to compete against IT start-ups for bright young staff, once again have their pick of university graduates.

  As Robert Rubin, former US Treasury Secretary, recently explained there is "an inherent tendency to excess in markets, grounded in the human psyche and the pulls of fear and greed - an error manifested repeatedly in recent decades and throughout history".

  In the wake of the technology stock bubble, I asked my staff: Were the economic improvements of the past few years structural or merely cyclical? Can the US economy sustain higher productivity and higher growth?

  A minority of my staff argue that the productivity gains are real, and once inventory adjustments are over, production and GDP growth will return to a stronger pace, leading to a V-shaped recovery by second half of 2001.

  A larger minority predict an L-shaped protracted slowdown. They argue that during the bubble, cheap financing caused firms to over-invest, leaving companies vulnerable with excess capacity and debt obligations, like Japan and Asia in the 1990s. These will undermine corporate profitability for a long time. The US has built up large imbalances in the last 5 years. The personal savings rate has gone negative, and the current account deficit is 4.6% of GDP. Households had also borrowed to increase spending, relying on equity market gains that have now disappeared. As households rebuild savings, consumption growth will be depressed for years. Historically, a combination of such imbalances and an asset bubble burst, had nearly always led to severe economic distress.

  But the majority of my staff took the middle view that a U-shaped recovery was the more likely outcome, but they were not in agreement on how long it would be before the economy trends up. Undoubtedly there has been a period of excessively exuberant expectations and sobriety is now warranted. Nevertheless there has been significant technological and economic progress together with higher productivity growth and profitability.

  The technology stock bubble burst was necessary to get rid of excesses and provide a healthy foundation for future growth. Unlike Japan and East Asia during the recent crisis, the US has both the fiscal and monetary policy tools to avoid a depression. I adopted the middle view of a U-shaped recovery and chose a conservative diversified portfolio of equities, bonds and cash instruments to balance the risks.

  Since my deliberations with GIC staff in early April, we have had a smart recovery in stock prices. From their lows, the New York Dow has bounced back 17% and the Nasdaq 31%. More significantly, long term interest rates in the United States have shot up. The 10- year Treasury bond yield has moved up from 4.76% to 5.37%, despite the Federal Reserve cutting the Fed Funds rate by another 1% over the last two months. Some of this may just represent a removal of the scarcity premium as US tax cuts now seem certain to eat into the budget surplus. These market developments are signalling investor expectations of hopes for a U-shaped recovery. We hope that the markets are right, both for the investment returns of GIC and for the recovery of the Asian economies.

  When regional growth in East Asia is so dependent on technology exports to the US market, we are more than interested observers. East Asia's experiences in the past six months made me understand the Mexican lament "so far from God, so near to the US". Movements on Wall Street are reflected overnight in most Asian bourses. Like the near instantaneous adjustment of inventories in the New Economy, the US slowdown is being delivered to East Asia nearly "just in time". Regional exports started decelerating in October last year, a mere two months lag after indicators in the US turned.

  East Asia has suffered a second blow because of the fitful recovery in Japan. Together, US and Japan absorb about one-third of East Asia’s exports. Indirectly the impact is greater, as much of intra-regional trade is linked to final demand in either the US or Japan.

  Asia’s vulnerability is all the more acute because most countries have not fully recovered from the financial crisis of 1997. A drawn-out slowdown in exports would inflict severe pain. Corporate balance sheet weakness is restraining domestic investment. Furthermore after heavy pump-priming and bank bail-outs in the last three and a half years, the scope for increasing government spending is limited. And the fragility of the region’s banking systems is undermining the effectiveness of monetary policy in many afflicted countries.

  Large economies like China with strong domestic growth momentum will be able to offset the slack in the export sector, with some help, if necessary, from increased government spending. The smaller and more open economies of Singapore and Hong Kong will be more severely affected by the external slowdown. Its impact can be cushioned, provided the economies can keep their costs in line and stay competitive externally.

  But we do not expect a calamity like the 1997 meltdown. In that crisis the IMF, backed by the US Treasury, set out to liberalise the economies of the affected countries. In Indonesia they also set out to change the style of governance of President Suharto and end cronyism. In this clash of wills the president lost and had to resign after riots broke out. The US then encouraged the democratisation of Indonesia. Unfortunately, it has led to the unravelling of the national fabric that held together 210 million people spread over some 17,000 islands. The Indonesians have now found themselves without an effective central government. What started as a financial crisis has become a grave issue of national stability and security.

  But other Southeast Asian countries have been able to strengthen their external position because of their strong savings. By cutting back on excessive investments coupled with support from strong export growth, most countries have accumulated significant current account surpluses, rebuilt their foreign exchange reserves and cut their short-term debt. Most have also abandoned the pegged exchange rate regimes, which were at the root of the 1997 crisis.

  I am optimistic that there will be further technological and productivity improvements in the US. These improvements will spread to other economies. Technology companies will recover as will global bourses. And however daunting structural and political problems are in Japan, should the technology sector pick up, Japanese corporations have the technological and production edge to reap the benefits.

  When this happens, Asian companies with their natural cost advantages should thrive again, especially in those countries that have restructured their banks and corporations, and sorted out their political problems. Asian stock markets, now severely under-valued by economic yardsticks, will rebound. The current mood of pessimism will disperse, and confidence in Asia’s prospects will return.

  The End