The elder statesman of Asian politics wants to be optimistic. He suspects, and hopes, the region will soon settle back into more stable and predictable patterns. But, at 77, he is ever the hard-nosed analyst. Can he trust his instincts, he wonders, or is he becoming too sanguine?

In an interview with The Age this week, Singapore's senior minister discussed the convulsions in Indonesia, and the perilous challenges of reform confronting the nations of the region after the financial meltdown of the late '90s.

"I think we have been able to distinguish between what is a rumble and what is really a final warning, before the ashes spew forth and the lava flows.

"At the moment, we don't see this as a danger. We hear the rumble. But we think it will probably get better in two or three years. Not completely cured, but better. With confidence returning, a new assessment can be made. Perhaps we can return to normalcy, or near-normalcy, in maybe five years."

Lee has spent a lifetime navigating the fickle cross-currents of Southeast Asian politics. The former prime minister and the tiny city-state he founded have shown canny survival instincts in this volatile and often dangerous region. Singapore has endured a Japanese invasion, the confrontation years with Indonesia in the mid-'60s, the fracturing of the federation with Malaysia, and the threat of a Beijing-sponsored communist insurgency. At times it seemed Lee and the three million people of his island nation might be swallowed whole. Yet they have not only survived, but prospered.

Lee visited Australia this week to mark the launch of the second volume of his memoir From Third World to First. The Singapore Story 1965-2000. The book, the prodigious work of a prodigious intellect, is published at a time when the world is asking whether Southeast Asia can get back on to a trajectory of gradual political liberalisation combined with strong economic growth.

There may be no leader in the region better equipped than Lee to answer this question. Although he handed the reins of Singapore government to Prime Minister Goh Chok Tong 10 years ago - the island's economic miracle achieved, he believed that the post-colonial generation had to make way for new leader - he remains a respected voice in Asian capitals, and around the world.

Interviewed in his Sydney hotel suite, Lee talked expansively about his outlook for the region. He sees China's emergence as an economic powerhouse as the crucial dynamic in the years ahead. Not only will it be the biggest kid on the block in raw numbers, but it will also join the US, Japan and the European Union in the big league of economic powers.

Lee sees the potential of a well-educated Chinese workforce as boundless. "There is nothing the Taiwanese or the Hong Kong self- governing state can do that (mainland China) cannot do, and do better. They have more people and more talent. It is as simple as that." Lee cites the example of an official press spokesman who is a nuclear physicist by training: "If you can afford such a person as your PR man, you have talent galore."

Some senior Chinese leaders see Singapore as a mini-model of how to marry economic modernisation with "Asian values" - that is, without going the full distance to a Western-style liberal democracy. Yet Lee says the Chinese are selective in their embrace: "They want to pick up... useful facets, but they do not want to adopt the whole system. If there is a feature they think can be grafted or incorporated into theirs, they study it and transplant it. But often it is not possible to just pick one particular feature. You have to take a cluster."

In a speech to the Asia Society in Sydney this week, Lee predicted China and Japan's combined economic output would exceed that of the United States by 2040. "These developments will shift the economic centre of gravity of the world from the Atlantic to the Pacific," he said.

The one important condition Lee places on his upbeat assessment of China is that tensions with Taiwan must not escalate into violence. Beijing must resist pushing too fast for reunification, and Taipei's new leadership must measure its cries for independence. Lee thinks the opportunities in the Asia-Pacific region will be great if it survives the next 10 years without a significant "mishap" in the Taiwan Straits.

Despite the fiasco of the global trade negotiations in Seattle last year, Lee remains a fervent believer in free trade and open markets across the Asia-Pacific region. He rejects the "historical animosities" argument that such an arrangement, incorporating cultures as diverse as China, Japan, Korea, the US, Australasia and the 10 members of ASEAN, is wishful thinking.

Rather, he sees an open trading system as not only helping quicker recovery in the struggling economies of Southeast Asia, but also as a valuable strategic buffer against the inevitable "irritation and frictions" that will arise in the region.

He wants Australia involved. He happily disputes the prevailing view in Kuala Lumpur and Jakarta that Australia does not belong. "Let's go beyond the recriminations of the past, and move on to the future," Lee says. "How do we solve this problem? Is Australia a hindrance or a help? I would imagine Australia would be a help."

Singapore built its prosperity by promoting itself as a base for multinationals in the developing markets of the western Pacific. Today, with no impetus from the big economies to kick-start a new global trade round, Singapore is spinning a web of bilateral free-trade agreements.

"We have decided, and so have the Japanese, that we want to get on with it," says Lee. "If the Americans feel that they want to opt out for the time being, well, let's get on with it anyway. So Japan has been meeting with us and Korea and New Zealand and Australia."

Lee hints that Australians should not be unduly alarmed by the objections of Malaysia and Indonesia to its participation in the so-called Asian Free Trade Area. He sees an ineffable logic to Australia being invited, ultimately, to sign up: "If you look at it now, after Seattle, it has developed into ASEAN Plus Three - Japan, Korea, China. The next step, after the mood has passed (in Malaysia and Indonesia), would be ASEAN plus the three from the north and the two from the south. That gives you the western side of the Pacific."

He is cautious when asked if this is a strategy to prod the US to reinvigorate its own free-trade agenda in the region, rather than risk being left out. The notion of exclusive trade blocs is anathema to Singapore. He will say only that senior figures in US trade policy understand that if they do not "come back into the act" there will be a series of free-trade agreements in Asia that may be to the disadvantage of the Americas.

But Asia must adapt, too, Lee believes. The globalisation of communications means the exposure of Asian societies to a wider diversity of views. Inevitably, the young will come under Western influences, which must affect the politics of the region. "I do not see Singapore society remaining as it is," he says.

"The interaction with the outside world must change the world-view, perceptions and the norms of Singaporeans. It cannot be stopped. We have fibre optic into every household. Everything is done through the PC or the TV with a set-top. It is a different age."

All the same, Lee maintains allegiance to what he sees as core values of Singaporean society. By Western standards, he is a social conservative, demonstrating a strict intolerance traditional among Asian elites for the unruly, the profane and the disrespectful.

Lee says he hopes Singaporeans do not allow the erosion of their moral code: "What I am hoping is that parents have been careful in the formative years of the child to instil in them some basic cultural values such as respect for the family unit. The family nurtures you and gives you succor through sickness and in health. It is a cocoon without which you are an animal. If we cannot preserve that part of ourselves, we will end up like so many of those single-parent families in America, where the children run wild. I think that is just a disaster."

But whatever the dangers of outside influences, Lee's first priority is for Southeast Asia to rid itself of the demons within. Although he insists the international markets were too harsh on Indonesia, Thailand and Malaysia, leading to unfair damage to their economies, Lee is impatient at the failure of the region's political class to accept the lessons of the financial crisis: their inability or unwillingness to reform their banking systems so as to eliminate perceptions of "crony capitalism".

Lee concedes Malaysian Prime Minister Dr Matahir Mohamad did not help international perceptions with "searing remarks", accusing billionaire investor George Soros of leading a Jewish conspiracy against the Malaysian ringgit. "That left a bad taste among investors," he says, "but it will pass."

What about the contentious prosecution and jailing of Mahathir's former deputy Anwar Ibrahim? "Anwar is a different problem," Lee says. "Anwar has many friends in America and Europe, and they will not allow Anwar to be forgotten. But business is business..."

Lee accepts the threat of communism has gone. But he does not see Singapore abandoning its internal security apparatus as long as racial and religious conflict simmers in the region. "There is a growing extremism, which doesn't augur well for inter-religious relations. That is going to have its fallout in Singapore, and you may have to have protective arrests before people are killed."

Despite the region's instability, Lee thinks Australia should still be going all-out to cement links with its neighbors.

In the '70s, Lee prophesied that Australia risked becoming "the poor white trash of Asia". He admits he has since upgraded his assessment of Australia's potential. He acknowledges Australia is becoming a more robust and competitive economy: "It is belated, but it is better late than not to do it at all. This should have been done 30 or 40 years ago and you would have been part of the boom of the Asia-Pacific... That's the price you pay for a comfortable life. In Singapore, we had no choice. We had to open ourselves up to the world."

Like other Asian leaders, Lee is curious that there should be any ambivalence in Australia about whether its long-term strategic interests lie in the region. In an implicit nudge to any agnostics in the Howard Government, Lee says Australia must do more work to shift perceptions in Asia. This, he says, will require patience and stamina.

It will also require a capacity to cope with the mood swings - or, as the Singaporeans might say, learning not to panic when next the volcano rumbles.