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'The Fed can Hold the Line'
But U.S. monetary policy faces uncertainty

When David Hale spoke with Asiaweek on Aug. 11, he said his conversations with Bank of Japan officials gave him a sense that changes were afoot. Later that day, the BOJ made a U-turn on its zero interest-rate policy and raised rates by 0.25%. As global chief economist of giant Zurich Financial Services, Hale has access to the world's movers and shakers, including the U.S. Federal Reserve, which kept U.S. interest rates unchanged on Aug. 22. He spoke with Laxmi Nakarmi in Seoul.

Is the U.S. Federal Reserve done with interest-rate hikes?
I saw [Fed chairman Alan] Greenspan in Washington and he made it clear that the concern is productivity. When the economy is slowing, typically productivity declines. But this time, it may be different. Productivity growth may stay high. The numbers in the second quarter were spectacular. This gives [Greenspan] more reason to believe that productivity may remain high enough to constrain inflationary pressures. The Fed can hold [the line] for a few months.

But we have uncertainty in future monetary policy. We may see five vacancies in the [seven-member] Federal Reserve Board [when President Bill Clinton's successor takes office next year]. We have two right now. In addition, Gov. Edward Kelley, who has health problems, is telling friends he may retire at the end of the year. Gov. Laurence Meyer's term expires next year and he tells me he will probably step aside even if the Democrats win. And the Republican-led Senate is refusing to hold confirmation hearings on the renomination of vice chairman Roger Ferguson. Never before in American history has a new president had the chance to appoint five Fed governors in a space of 12 months. We especially don't know what kind of officials George W. Bush will appoint if he wins the election.

What are the implications on Asia?
The rise in U.S. interest had a negative impact on emerging markets in general in the first half of this year. If we stop raising rates, this could help them recover somewhat. But what we have right now in Asia is increasingly a two-tier region. You have strong growth in Korea and China and enthusiasm for their markets. But you have laggards in Southeast Asia — Indonesia with its continuing political problems, a languid sense of recovery in Thailand, lack of confidence in President Joseph Estrada in the Philippines.

Is China's recovery for real?

Yes. The government is addressing structural problems. Membership in the World Trade Organization will help encourage further reforms. China will come to the center stage in the next three to five years with a dramatic increase in foreign direct investment. It will not only be the overseas Chinese, but international companies in Europe, North America and Australia. I was in Shanghai last September and I was very impressed with the huge turnout of global CEOs everywhere.

And South Korea?

It had a great 1999 on the back of lower interest rates, a robust stock market, good export growth and a resurgence in confidence. But this year you have the unresolved restructuring problems of the chaebol and the banking problems associated with them. I am also concerned with the winding down of President Kim Dae Jung's term. The reform process could grind to a halt. Still, the cyclical recovery has just begun.

If we are heading for some kind of reunification [with North Korea], the consequence will be very dramatic. It will cost at least $1 to $2 trillion to rebuild North Korea's economy. But we are seeing a gradual opening that may be followed in the next two or three years by normalization of relations between North Korea and the U.S. and Japan. North Korea will perhaps join the World Bank, ADB and other organizations. If North Korea makes the right gestures, there will be money to help it. The question is how far it may go without jeopardizing the survival of the regime.

How do you see Japan?

The economy has touched bottom, but the recovery is still sluggish. There is a great deal of corporate restructuring to be done. Prime Minister Mori Yoshiro is viewed as a backward-looking man. He is also riddled with scandals in the cabinet and it is possible that the ruling party LDP will [replace] him in the next [few] months. The prime candidate to replace him is Kato Koichi, who is committed to a program of fiscal restraint. Fiscal policy may get more restrictive in a one-year view if there were to be these political changes.

Is a second economic crisis looming?
We don't have the kind of leveraging and capital-flow excesses that we had in the mid-1990s. I think the problem is the sense of paralysis, of stagnation and a lack of momentum at a time when the world economy offers a lot of opportunities. In Asia, the issues [will remain the same] for some time. Attracting foreign investment in the banking system to both revitalize and restructure it. Further improvement in corporate governance to allocate resources more efficiently. Political systems supportive of these reforms and which will not bring a return to crony capitalism.

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