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Will Internet Fever Distract the Fed?

If so, world equity markets could suffer.

Greed & Fear

is not wired, but passing through San Francisco this week amid the Internet stock hysteria forces some observations on the phenomenon. What we have in Internet stocks trading is a seemingly unprecedented event, namely retail investors trading with access to a huge amount of information but absolutely no knowledge. The fact that they are trading Internet stocks via the Internet only adds to the intoxication of this particular mania. The danger is then that the Achilles' heel of this bull market proves to be ordinary Americans' enduring faith in the limitless powers of technology. This may prove to be as naive as the Japanese faith in golf course memberships a decade ago.

Whether the Internet bubble proves to be no more than a repeat of similar confined U.S. bubbles of the past (such as the biotechnology stock bubble of the early 1980s) or something more systemic, only time will tell. Still, the fact that three Internet stocks recently each traded more volume than the Tokyo stock exchange that day

never mind the remarkable market capitalizations commanded by Yahoo! ($36.3 billion) and Amazon ($23.4 billion) suggests that the

Federal Reserve

must be watching somewhat warily this example of exuberance at its most irrational.

The first sentence in the latest

Asia Maxima

, namely that "It is better to deal with an asset bubble than a destabilized world," must now begin to be questioned somewhat. The fact is that the more Wall Street goes up and the more absurd Internet fever becomes, the more pressure there will be for the Fed to refocus monetary policy on domestic overheated markets rather than on global deflationary pressure. Any confirmation that the Fed had gone into neutral, let alone tightening mode, would be extremely negative for world equity markets, most particularly interest-rate sensitive Hong Kong.

Fortunately, the crisis in Brazil has probably delayed any such renewed focus on a Fed rethink of its monetary stance. This means that the Fed is likely to remain broadly accommodative for fear that Brazil spills over into a general Latin American contagion.

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Asia Maxima

, that Asia can largely decouple from a Brazilian devaluation. The pick-up in Hong Kong money market rates last week is better explained by the renewed focus on the problems in China as a result of the news that foreign lenders to

Guangdong International Trust & Investment Corp.

will not be afforded special treatment, and the related news about a debt standstill arrangement for Guangdong Enterprises. The exact level of unofficial dollar debt in China remains a mystery. It will clearly, however, be prudent not to assume the best case.

The GITIC news means it will be harder for non-sovereign Chinese entities to obtain credit from foreign bankers. In this respect, one may wonder why Beijing has taken such a hard stance. The answer is that the center is determined to re-impose control on the unruly provinces. This is unfortunate for the red chips and their parents, since the red-chip phenomenon was not driven by the center.

If the consensus has begun to re-examine its extremely sanguine view on China, this is also likely to cause renewed focus on the renminbi. Ironically, the financial markets stopped worrying about the renminbi in the last few months of 1998, just at the time that the slowdown in Chinese exports decelerated. As a consequence, the risk premium on the Hong Kong dollar also narrowed to the point of extinction. That premium has now begun to widen again, but this time the focus on currency risk in China and Hong Kong should not be driven primarily by the yen, as was the case last summer. The decision by the Bank of Japan this week to intervene in favor of the Japanese currency is clearly positive. The yen below 110 is intensely deflationary for Japan, thereby helping to delay any hope of recovery.

It is also interesting that U.S. Treasury Secretary

Robert Rubin

chose the same day to voice his support for a strong dollar. This would seem to mark a complete U-turn from the intervention in favor of the yen last year. That round of U.S. intervention was triggered by Chinese pressure on Washington in the run up to President

Bill Clinton's

visit to Beijing. But the Chinese and Hong Kong currencies could come under pressure again even if the yen remains below 120. The yen is merely an aggravation, not a precondition, of the deflation wave hitting Greater China.

Christopher Wood, the author of Greed & Fear, is the global emerging market strategist for Santander Investment. He is the author of The End of Japan Inc. (Simon & Schuster, 1994). Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy.