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Downgrade spells more chaos
Global Trends By MARTIN KHOR
The US credit downgrade – coming after a weak solution to its debt ceiling crisis and signs of a new recession – is signalling greater turmoil ahead in the global economy.LAST week was a tumultuous time for the global economy as stock markets plummeted on a series of bad news in the United States and Europe. But this may only be the start.
This week is likely to usher in even more turmoil as the prospects for recovery have suddenly turned negative.
After several other dramatic events, last week ended with the US’ credit rating losing its AAA status to AA+.
It was only one notch down, this downgrade was by only one (Standard and Poor’s) out of three rating agencies, and it had been half expected.
Nevertheless, it marks the end of an era. For the first time since 1917, the US does not enjoy an AAA rating.
It has long been assumed that the US dollar and its Treasury bills are the safest of havens.
There may be some practical effects of the downgrade as some funds which prefer or are allowed to only invest in AAA investments may have to find alternatives.
The US dollar is also expected to depreciate further, thus raising fresh questions about the role of the dollar in global trade and as the world’s reserve currency.
Manufacturers and traders are asking whether they should trade their goods in currencies other than the US dollar to avoid making losses.
This was shown in yesterday’s Sunday Star report on the reactions of Malaysian businessmen to the news of the downgrade.
The Federation of Malaysian Manufacturers’ president Tan Sri Mustafa Mansur urged Malaysians to consider trading in Chinese renminbi (as China is poised to be the world’s largest economy and a lot of Malaysia’s trade is with China) and in other currencies to avoid losses in export earnings from the continuing use of the US dollar.
Besides the use of the dollar as the main medium of exchange (the currency for global trade), it is also, by far, the world’s most important reserve currency, thus making it the global store of value.
Since almost all countries hold a major portion of their foreign reserves in US dollar assets (especially US Treasury bills), there has been increasing fears worldwide over the safety and value of their US investments.
First, there was the scare of possible default by the US Government in debt servicing, because of the White House-Democrats-Republican wrangling on the government’s debt ceiling.
On Aug 1, just a day before the deadline, a deal was struck in which the debt ceiling would be raised by US$2.1 trillion (RM6.32 trillion), provided the government slashes the same amount in its budget deficit over 10 years, with the bulk of how to do so to be decided by a bipartisan committee later.
This gives temporary respite, and the world will likely witness a repeat of the messy Washington budget conflict when the committee starts work.
As a caustic commentary in Xinhua news agency put it, the higher debt ceiling “failed to defuse Washington’s debt bomb for good, only delaying an immediate detonation by making the fuse an inch longer”.
Second, the S&P’s credit downgrade has articulated the fears of the investment and policy-making circles.
The confused and confusing atmosphere surrounding Washington politics has seriously eroded confidence in the ability of the US to handle its budget, debt, fiscal, financial and economic policy issues.
Only political analysts who specialise in US politics can fully explain and anticipate the intricacies and implications of the views and tendencies of the various branches of the Republican Party (especially its Tea Party component and its effects on the Party’s congressional positions), the Democratic Party and the Administration.
But even non-specialists comprehend that there is a serious governance problem in the US which is affecting the rest of the world.
Its political system is experiencing a gridlock which will affect the US dollar, the US economy and the world economy’s prospects for what seems to be a long time to come.
Third, the US economy shows increasing signs of stalling leading to a new recession.
Last week’s indicators for consumer spending, manufacturing and services output were negative, and some prominent economists gave a 50:50 chance of a double dip recession.
Recession is made more likely by the inability of the Obama administration to take effective recession-busting measures.
Congress will block any new significant fiscal stimulus (as the debt ceiling crisis and solution show), while a new round of printing and injecting money through quantitative easing, which is being considered, may only have limited positive effects.
All these point to a further weakening of the US economy and the US currency, at least in the short term.
These three developments, all in one week, have galvanised those in business, trade, finance and policy making to re-think the role of the dollar and the US economy in the global economy.
In the short run, it is difficult to find alternatives to the dollar as a unit of exchange or as a store of value, mainly because the euro is in a crisis of its own, the Japanese economy faces its own difficulties and the Chinese currency is not convertible enough.
But many agree that in the long run, a solution or solutions must be found. Otherwise, the global trading and monetary systems could be in a disarray.
There is nothing like a crisis or an emergency to collapse a long run into a short run.
If the US and European crises continue to unfold without respite, the world is in for financial and economic turmoil similar to or even worse than the recent 2008-2009 great recession.
Solutions will therefore have to be urgently sought.
Smaller QE3 may be necessary to prevent US double dip recession
By YAP LENG KUEN lengkuen@thestar.com.my
PETALING JAYA: With the US economy possibly sliding into a double dip recession soon, there are expectations of a third round of quantitative easing (QE3), which may involve smaller amounts.“It is not a popular decision but may be the only reaction from the US Fed to keep the economy going,'' said Pong Teng Siew, head of research at Jupiter Securities.
“The Fed has limited options especially with no more government spending to stimulate the economy. Fiscal policy that involves government spending is out in the wake of arguments related to the US debt ceiling where the only acceptable solution to the Republicans is to cut spending, and not raise revenue.
“QE3 may involve smaller purchases of Treasury instruments at the longer end of the yield curve. This may help to drive down the yield where the medium term rates may also move down in tandem. In this way, interest costs may also be reduced.
There may be a resultant boost to the stock markets on a smaller scale. However, the European debt problem especially in Italy represents a situation that is likened to an elephant in a room.''
“As long as there are upward pressures in the Italian government bond yields, there will be downward pressure on the stock markets in Europe,'' said Pong, adding that investors should stay light on selected plantation, oil and gas and consumer-related companies.
Bloomberg reported on Friday that the difference in yield, or spread, between Italy's 10-year bond and German bunds widened to 389 basis points on Thursday, after closing at 368 basis points the previous day.
Lee: ‘This time round, headline and core inflation have been creeping up.’It said Spain's 10-year spread also rose six basis points to 398, as European Central Bank debt purchases failed to reassure investors that officials in the region would solve the sovereign crisis.
QE refers to the Fed's decision to buy US Treasury bonds in an attempt to inject liquidity into the market.
The previous rounds of QE1 and QE2 had not produced a lasting impact on the US economy which is holding the weight of inflation and higher debt levels.
CIMB Investment Bank head of economics Lee Heng Guie said full-year growth estimate for the US economy had been revised from 2%-3% to 1.5%-2%, raising the odds of a double dip recession by 30%.
Moreover, the cut in the US credit rating by Standard & Poor's would have a double whammy impact on the lethargic economic recovery in the US, Lee added.
In a recent update, Lee noted that the US second quarter real gross domestic product growth came in at a tepid annualised rate of 1.3%, short of the 1.8% consensus forecast.
Consumer spending in the United States, hurt by higher gasoline prices and auto chain supply disruptions, rose by only 0.1% (2.1% in Q1), the slowest in two years.
“We expect the Fed to take more actions, such as buying of bonds, if the economy appears in danger of stalling,'' said Lee.
However, he does not think that inflation and inflation expectations are heading towards the point which would prompt the Fed to consider further large asset purchases.
Lee recalled that before the second phase of quantitative easing (QE2) was implemented, the trend of disinflation and deflationary risk formed a strong case for the Fed to pump in extra liquidity.
“This time round, headline and core inflation have been creeping up,'' he said. “With inflation and unemployment rising at the same time, the Fed will find it difficult to justify yet another cash injection.''
Should the Fed detect firmer signs that the US economy is faltering, it may:
- Adjust forward guidance to push back timing expectations on the first rate hike.
- Shift back market expectations on when it will shrink its balance sheet. (In April, Fed chairman Ben Bernanke had signalled that the Fed may reinvest the proceeds from its bond purchase when they mature).
- Intervene in the credit market through direct loans or adjust interest rates payable on bank reserves to spur bank lending.
A banker told StarBiz that banks in general were adopting a cautious stance in view of the world and eurozone economic conditions.
“The US leaders have mainly taken temporary measures but the real issues like debt are not addressed,'' he said. “The debt problem remains while their agreements have to be bipartisan.
“From their behaviour, there seems to be a lot of politicking in the US especially on the economy. As a world leader, that does not give a good picture to the whole world.
Their decision to cut US$2.4 trillion or more in spending in ten years will have an impact on the world economy. Hopefully, for Malaysia, the economic transformation projects and its own economic growth will provide the momentum forward.
“The business is there but banks have turned cautious on lending and are diversifying into services, fee-based income, niche areas and wealth management,'' said the banker.
Commentary: It's time for U.S. to stop blames, take responsibility
