Wednesday, October 15, 2008

Flying Blind

Banks and financial insitutions in the US and Europe and even Japan are badly affected by overlending and loan non-performance resulting in the inability of banks to repay deposits in full and the loss of paper wealth in financial markets.

This could potentially undermine public confidence in the banking and financial system. When confidence is lost, everybody wants to keep hard cash under their beds. This threatens the economic system. So, the policymakers argued that the banking and financial system should be saved.

Saving the banking and financial system does not mean that everything is OK.

In the first place, the banking and financial system collapses because of the sharply deteriorating economic system. So the rescue package only tries to stop the financial collapse.

With no additional investment, the economic system should continue to deteriorate at the same rate as before. Hence, the fear of a global economic recession.

Bear in mind that US and Europe are in trouble because of a major structural change in the global economy - the rise of China. It is this inability to compete with China that the US under Greenspan sought to pour liquidity into the economy in order to shore it up. Exactly like Japan in 1985 - and Japan has since not recovered. Do not be surprised if the US economic deterioration should last for some time, say 15 years.

Whether the world will fall into a recession depends on China's ability to restructure from an export-oriented policy to domestic consumption.

This turnaround in economic policy requires a different set of working parameters:

(a) Instead of cheap labour, now better-pay packages are required so that consumption is sufficient to yield positive returns to investments; and

(b) The old export-oriented companies may go bust or go abroad, while a new set of industries producing for the domestic market has to arise. And these do not necessarily mean robustness in the stock market nor real estate.

We must be careful that we do not listen only to speculators for answers to real economic problems.

The narrow focus of policy on financial market as a performance indicator is one of the causes of the current global financial mess.

In the case of Malaysia,

(a) Yes, the local banking system should not be unsettled by the global financial crisis. Most banks are not allowed by the central bank to be overexposed to global markets. This is because the central bank has all the foreign exposure. If there should be concern, it should be over the central bank.

(b) Well, the local economy has continued to suffer from the 1997-98 financial crisis. Only that government spending had helped shore up the economy, with help from an easy money policy. The attempt to bring about productive change to the economic structure through regional development has not been well received - by people who are addicted to easy money from mega projects. There is a limit to how much one can keep the economy afloat by printing money, if the economy remain unproductive.

(c) The only way to live in a time of uncertainty is to reduce the uncertainty through better and more information feedback. Worse if information is being withheld from the public. Information is needed to anticipate change and prepare for it rather than be caught by surprises. At the moment, we are all flying blind.

1 comment:

ctchoo said...

Very informative and instructive.