THE FINANCIAL TURMOIL AND RECESSION RISK

Some excerpts from Chedet :

I am glad to hear that Malaysia will be spared from the fallout of the systemic collapse of the whole world's financial system. This ability to isolate Malaysia and Malaysian banks from the effect of the bankruptcies of all the biggest banks in the world must be regarded as a miracle. Our ability to manage our financial system better than others must earn us the admiration of the world.

I hope we are right in forecasting the effect on us of the collapse of the world's financial system. But I have a sneaking feeling that all is not well.
When the Government withdrew the subsidy for oil the pump price increased by 40 per cent. The immediate result was to increase the prices of a wide range of food, goods and services commonly needed by the people. In other words the purchasing power of the people had been reduced.

Since then the price of oil had been reduced three times. But the prices of food, goods and services have stayed up.

Maybe we will not need several hundred billions to bail out our banks. But the banks will also face the problem of unpaid loans incurred by their credit card users. They have been rather lax in providing credit card facilities to their customers, many of whom have no accounts with them. It is believed that unpaid credit card loans is in excess of RM20 billion.

Will the Government guarantee depositors will not lose their deposits when the banks which had in the past made huge profits now go bankrupt because of their mismanagement?

We are told that six billion Ringgit in Foreign Direct Investment would flow into the country. But what about the RM30 billion outflow as foreign investors pulled out of the stock market?

But when hundreds of thousands of house buyers find themselves unable to pay simply because they have no money, and could not sell the houses and could not borrow from banks, Freddie Mac and Fannie Mae would not be able to pay the hedge funds. Then the hedge funds would collapse and drag down the banks with them.

This simply is what happened. The same applies to credit cards. People with little or no money would be given credit cards. They would spend more than they can afford and the banks would be faced with huge amounts of non-performing loans. The banks cannot pay the bills submitted by the sellers of goods or suppliers of services. The banks would collapse and there would be a run on the banks and on other banks which had lent the money to the affected banks. And so we see one after another of the giant banks of America and Europe going bankrupt.

Actually I am giving a very simplified version of what is happening. All these shuffling of papers and figures cannot but encourage cheating. The bigger the amount of money involved the bigger would be the returns. The tendency is therefore to play with very large sums of money.

But where does the money come from? From nowhere. The Government and the banks, including the Federal Reserve Bank conjured up the money from nothing. If you ask yourself where do the US700 billion Dollars come from when you know the United States' Government has to borrow US1.5 billion every day, you will find no answer. Is the US Government holding US700 billion Dollars in its treasury just in case it has to bail out the banks? Not likely when it cannot even make ends meet, when it has twin deficits.

Recession Risk

The malfunction in the financial systems of the US and Europe is affecting the entire economic system, including international trade as evidenced by the collapse in shipping rates. The validity of their government policies will determine the duration of the crisis.

Currently, forecasts for Malaysia’s growth for 2009 range from about 3.4% to 1% by Macquarie which compared it to the experience of 2001.

In 2000, Malaysia’s economic growth for 2001 was forecast at about 6% but due to the Sept 11 terrorist attack in New York, the actual growth was 0.4%.
At this time of change — not what Barack Obama had in mind — the economic policies set out by governments are critical. They would either shorten and moderate the downturn, or prolong and deepen it.

Policy errors in the aftermath of the 1929 stock market crash infamously led to a long and deep depression.

This is the hour of government leaders. After years when the business sector in the US and Europe was deregulated, it became in effect unregulated, and government leaders now have to steer their economies away from the abyss.

So far, governments in the US and Europe have gone out on a limb to save their banking sector, injecting fresh capital and guaranteeing all deposits. That raises the risks of their sovereign debt and high inflation in later years.

“But what else can they do? If the banking system fails, there’ll be no economy,” a fund manager said.
Asia is again experiencing the outflow of foreign equity funds. While foreign portfolio funds are a destabilising force, no country rejects the foreign funds.

Perhaps, that’s because foreign portfolio funds can destabilise stock markets, but not the banking system or the currency, unless there is massive speculation or manipulation of the currency.

External borrowings are a more potent destabilising force as shown in the current exposure of Iceland and South Korea.

Both countries have huge amounts of external borrowings, surprising in the case of South Korea, considering a similar experience in 1997. In Iceland, even consumer loans were taken in foreign currencies.

A sharp turn in the credit cycle led to questions as to whether they can rollover their foreign debts that were largely taken by their banks.

That uncertainty caused the Iceland krona to plunge 40% and the Korean won 30% since July.

It is to Bank Negara’s credit that the banking system and currency are relatively stable. In the banking system, the loan/deposit ratio is about 75%, which is very healthy.

In the west, the financial system is gradually being patched up, with UBS of Switzerland among the last big banks being rescued by its government last week, and the benchmark London interest rate for loans in dollars making its first weekly decline since July, according to Bloomberg.

(From: The Star Online C.S.Tan "Between the Lines")