Judging from the performance of the stock market yesterday, you would think the subprime scare is as good as over.
In fact, the crisis may just be beginning. And far from decoupling from the United States, as optimistic analysts like to hope, Hong Kong and the mainland are likely to suffer severely in the event of a US slowdown.
The Hang Seng index leapt 4 per cent yesterday, boosted largely by hopes that the US Federal Reserve will cut interest rates when its policy board meets on December 11. Mainland markets rose by a similar amount.
The rise, which mirrored Wednesday's gains in the US, shows a touching belief in the capability of the Fed to right all wrongs.
Never mind, for a moment, that the signals were ambiguous. It is true that the Fed's vice chairman Donald Kohn said that recent market turbulence and current uncertainties 'require flexible and pragmatic policymaking'. But his colleague Randall Kroszner argued that the current policy stance appears appropriate, even in a slowing economy. The market chose to ignore his remarks.
Investors clearly believe that the Fed will continue to cut and that its cuts will be effective. But whether rate cuts will work in the current environment is debatable. Nouriel Roubini, professor of economics at New York University's Stern School of Business, argues that because the subprime crisis is a problem of credit and insolvency rather than illiquidity, rate cuts are ineffective and the Fed is impotent. 'An ugly recession is inevitable,' he warns.
So far, most analysts have assumed that the mainland and Hong Kong will escape a US slowdown relatively unscathed. They point to the relative decline of the US as an export destination and strengthening domestic demand as evidence that the mainland has successfully decoupled from the US economic cycle.
