Global economy headed for
danger By John Berthelsen
HONG KONG - The precipitous falls in
equities markets across the world this week are
raising concerns whether, after years of
central-banker complacency, the global economy
could be headed for a real crisis. They could be
simply hiccups, but if they are, they are vicious
ones. The entire year's gains in almost every
world equities market have been erased in less
than a week.
On Wednesday, the London
market registered its biggest one-day percentage
loss in three years; Germany's DAX index fell
3.4%; France's CA lost 3.2%; the Dow Jones
Industrial Average fell 1.8%; the Nasdaq Composite
fell 1.5%; and the broader Standard & Poor's
500 sank 1.7%. Compounding the gloom, prices for
US Treasuries fell along with stocks, with yield
on the benchmark 10-year note rising to 5.15%.
Bond prices and yields move in
opposite directions. Though
most bourses seemed to regain ground in early
trading on Friday, the ominous signs remain.
At issue are fears that while the world's
biggest central banks - the US Federal Reserve
Bank, the Bank of Japan and the European Central
Bank - have been watching out for interest rates
and money growth, they have been ignoring, or at
least been complacent about, the rapid
proliferation of derivatives and the soaring price
of gold and other commodities such as oil and
copper. The Indian and Chinese governments, both
of which have tame central banks and concerns
about restive populations, have kept monetary
policy relatively loose as well. Now, some
economists believe, the sharp global market falls
in both commodities and equities over the past few
days could be the start of an economic nightmare.
The central banks may have waited far too long to
try to control inflation.
For instance, Dr
Jim Walker, the Hong Kong-based economist for CLSA
Asia-Pacific Markets, told investors in a private
newsletter this week, "We are possibly in the most
dangerous period for global financial markets in
my working life."
Walker is not alone.
"The Fed is grappling with two risks: (i) that it
has already tightened too much and that a sharp
economic slowdown is in the works and (ii) that it
has tightened too little and an acceleration of
inflation is on the way," write Ethan Harris, Drew
Matus and John Shin, economists with Lehman
Brothers, in their May 12 Global Economics
Monitor.
Geoffrey Barker, economist and
macro-fund manager at Ballingal Investment
Advisors in Hong Kong, says central banks have
forgotten the lessons of the early 1980s, when Fed
chairman Paul Volcker applied historic and painful
brakes to inflation, driving up interest rates to
the point where US five-year T-bills were
commanding rates as high as 20% annually.
Until just this week, when the markets
have started to come apart, a tidal wave of
liquidity generated by rising commodity prices and
derivatives has swamped financial markets, not
only in Europe but emerging markets as well. Even
a country as disastrously managed as the
Philippines has experienced a stock-market surge
to record peaks. Markets in Australia, South Korea
and Hong Kong have hit equally giddy heights as
hot money has washed in from a global economy in
which far too much money is chasing far too few
financial instruments.
This liquidity has
charged into commodities, emerging-market debt and
equities, Asian currencies and particularly
Chinese assets. Cross Border Capital, a financial
advisory service, estimates total global financial
assets now at US$74 trillion - $36 trillion in
equities, $18 trillion in bonds and $20 trillion
in liquid assets, looking for places to park on
low interest rates.
Sean Darby, Asia
strategist for Nomura, depicted one aspect of the
phenomenon in April - a Sotheby's art and ceramic
auction in which a painting of a pink lotus by
Chang Yu sold for HK$28.12 million (US$3.62
million), more than five times the HK$5 million
offer price. "Ironically, Chang Yu spent most of
his life inventing games rather than painting,
believing the former would make him rich and
famous," Darby wrote. "We think the auction
represents further anecdotal evidence that the
financial economy is still flush with money."
Darby described what he called a "cocktail
of global demand and excess liquidity ... helped
by low real short interest rates and a lack of
desire by corporates to replace inventory or
reinvest in [capital expenditures]". He warned
that central banks had left monetary policy too
relaxed for too long, that the market
underestimated growth, and that inflation signals
that had emerged so far from the long bond market
were misleading.
Alan Greenspan,
previously everybody's favorite central banker,
may have exited the stage just in time, leaving
his successor, Ben Bernanke, with a series of
seemingly intractable problems. Investors,
particularly concerned about rising inflation, are
watching anxiously to see how the Fed will react
at the next Federal Open Market Committee meeting
in late June (the FOMC is the Federal Reserve body
that sets monetary policy). The consensus is
increasingly that interest rates must go higher.
They have reached neutral in the United States,
and in Japan the central bank is steadily
withdrawing excess liquidity - printing less money
- in preparation for a rate rise.
But
raising interest rates in the United States would
have several consequences, none of them
appetizing. At a time when the US - and world
markets - are seemingly welcoming a cheaper dollar
to try to control the country's huge and growing
current-account deficit, a rise in interest rates
means a flood of new money into US Treasuries to
take advantage of the higher rates and adds to the
deficit. Just on the growing belief that the Fed
would have to raise interest rates, the US dollar
rose overnight against the euro, the won, the New
Taiwan dollar and the yen, among other currencies.
Second, rising interest rates in the US
mean an automatic rise in mortgage rates as well.
The average American family's debt load, which
would be further exacerbated by any interest-rate
rise, risks lower income growth and outright
declines in home prices, Geoffrey Barker says. In
a word, a rise in mortgage rates risks puncturing
the already precarious US housing bubble, which is
keeping the country's economy afloat. Millions of
Americans have refinanced their homes and taken
out the equity to spend for other possessions.
The average American now carries $10,000
worth of credit-card debt. Nor is the US alone.
Mortgage rates, particularly in Hong Kong and
other areas, parallel what happens in the United
States, and homeowners - or in Hong Kong's case,
apartment owners - are going to have to get used
to sharply rising mortgage payments. Without a
steady income stream and stability in the price of
their largest asset - their homes - debt may
become unbearable. Foreclosures once again will be
a bank headache.
"Stagflation" is a word
that came into the English language during the
final years of president Jimmy Carter's
administration in the US. The term refers to a
period when rising commodity prices and previously
lax monetary policy cost central bankers the
ability to control inflation through interest-rate
rises, and economies start to stagnate. A new
nightmare for the US may be a new bout of
stagflation - the combination of a stagnating
economy and soaring interest rates that undid the
markets in the final years of the Carter
administration. It also undid the Carter
administration itself. Puru Saxena Ltd, a Hong
Kong-based wealth manager, in a press release this
week predicted oil would hit US$200 a barrel and
gold would rise to $2,000 an ounce. It remains to
be seen how long the current downturn in commodity
prices will last. Demand in China and India and
other newly industrializing economies does not
appear to be about to abate. US President George W
Bush may have a long two and a half years before
he leaves office.
(Copyright 2006 Asia
Times Online Ltd. All rights reserved. Please
contact us about sales, syndication and republishing
.)
