Confidence could be a fragile thing especially when what is at stake is the world’s entire financial market. And when huge sums can move across the globe at the click of a mouse, the time span between tipping point and financial Armageddon can be very short indeed. It is therefore no surprise that the White House and Capitol Hill are working flat out to find an urgent solution after the unexpected rejection by Congress of the US$700 billion ‘bailout’ package initially worked out with bipartisan support.
It’s the Main Street turning up its nose at Wall Street. Why should the ordinary taxpayer fund this mother-of-all-bailouts for the ‘fat cats’ on Wall Street who have brought the country to this pass in the first place? There is also doubt whether this hastily assembled package puts too much discretion in the hands of a few unelected officials without adequate safeguards for the ordinary taxpayer, and above all, whether it is sufficient to stem the tide.
What is at stake is not just the clear and present danger of a meltdown of Wall Street and the American financial system. Nor is it the immediate prospects of occupying the White House for its two main contenders. There are far-ranging dimensions that are set to reverberate beyond Wall Street and the United States.
The question must be asked whether the current global crisis is merely lack of access to liquidity. The Fed and a host of other major central banks have pumped gigantic sums of taxpayers’ money into the system but the market continues to seize up. Banks remain nervous of lending to one another for fear of unknown credit-worthiness of their opposite numbers. The injection of public funds into the system is needed to keep some banks afloat but does not appear to unlock the capital-market lock jam. In these circumstances, there may well be a temporary need for major central banks, like the Fed, to restore confidence in inter-bank lending by acting as a guarantor on a case by case basis. But it has become apparent that the world's financial market is built on a mountain of innovative debt. Credit Defaut Swaps (CDS) alone, for example, are estimated to total some US$55 trillion. This mountain is collapsing like a house of cards in a casino. To strengthen long-term confidence in the world’s financial system, the problems will need to be vigorously addressed of how to better regulate mortgage-backed securitization, leveraged derivatives, short-selling, mark-to-market practices in a free-falling market, and the role of rating agencies. In flooding the market with taxpayers’ money, care must also be taken not to fan inflation at a time when the Main Street is worried about costs of living fueled by rising food and energy prices.
The Treasury’s bailouts so far have weakened rather than strengthened confidence in Wall Street and in the entire US financial and banking system. An even more worrying scenario is that, if not handled carefully, this crisis could undermine the perceived infallibility of the US Dollar. There are beginning doubts whether the Fed’s balance sheet is being over-stretched. A Congressional Research Service Report of 12 March 2008 shows that the top ten foreign country holders of federal debt, including Japan, China and the oil-exporting countries, account for 1.803 trillion worth of US treasuries. Even if these holdings are unlikely to be withdrawn all at once, a significant reduction by way of diversification will lead to higher interest rates and exacerbate the already weakening US economy. Marc Faber, of ‘Dr Doom’ fame, predicts that when the US budget deficit reaches 1 trillion dollars, US bonds will be downgraded. The drop of the UD Dollar value by 2% and the largest-ever one-day rise in oil futures by $25 a barrel on 23 September could well turn out to be the canary in the coalmine.
The crisis has also exposed the vulnerability of the US debt-and-consumption-driven economic and financial system. The over-leveraged investment banking model has now collapsed. The sudden abandonment by Goldman Sachs and Morgan Stanley of their status as stand-alone investment banks questions the future role, business model and definition of investment banking worldwide. Professor Kenneth Rogoff, a leading Harvard academic and former IMF chief economist, spoke of too much debt in the system at a live interview with CNBC (23 September) and has warned that the worst has yet to come. But the habit for consumer debt dies hard as Main Street seldom thinks twice in spending to the hilt with consumer credit. More prudence or the old adage of how to ‘cut one’s coat’ begs to be vindicated. Much of the US economy so far has thus depended on easy credit with historically low interest rates and relatively cheap energy. Low interest rates have been underpinned by foreign capital invested in US treasuries. Energy is not only getting more expensive but energy security has also come up to the top of the national agenda. All these are clarion calls for a timely re-examination of the sustainability of the US economic and financial model.
How the citadel of Western capitalism has nationalized the market raises some interesting questions when emerging economies are extolled to do the opposite. State Owned Enterprises are no longer the monopoly of ‘non-democratic’ countries as they are now evident on Wall Street. It is high time to re-visit the role of the state in capitalism in the light of recent experiences of dynamic emerging economies such as China. Moreover, as some of these emerging economies are building huge foreign currency reserves and are setting up gigantic Sovereign Wealth Funds, the current global credit crisis should hasten a much-needed reappraisal of how these rising mountains of gold can and should play a more constructive role in the global financial and investment markets, subject to sensible safeguards. This is particularly opportune as the stage for investing in the US banking industry is set to open to private equity and corporate investors, with the minority ceiling being raised from 25% to 33%. Additionally, as the threat of financial meltdown is cutting across national boundaries and continents, key central bankers not only inside but outside the G7, especially emerging economies holding massive foreign currency reserves, should be actively involved in helping to devise a more stable global banking and financial architecture.
The implosion of so many Wall Street icons and the perceived doubt of the US’s ability to influence global events in the Middle East and in the Caucasus reinforce the anxiety that a tectonic shift of gravity is taking place from the West to the East, in particular, to the ‘CRIMB' countries: China, Russia, India, the Middle East and Brazil. While China, for example, cannot isolate herself from the global slowdown, she can still expect a much lower but still enviable growth rate of 8 % or higher. This should guarantee the generation of broadly sufficient jobs for her masses while internal inflation has moderated from 8.7% in February to 4.9 % in August. Offsetting her declining export earnings is her burgeoning internal consumption with retail growth registering 23% over the past two months, supported in no small measure by an unprecedented urbanization drive set to continue into the coming decades (Preparing for China’s Urban Billion, Mckinsey Global Institute, March 2008).
The US remains a beacon of democratic ideals and economic liberalism with leadership in many fields including science and technology, innovation, media and business savvy. She is also by far the world’s largest economy. Nevertheless, the global landscape is rapidly shifting with more asymmetrical inter-dependence amongst different countries. Against this background, the waning of Amercian exceptionalism has augured well for a global order where a host of emerging players are poised to play an increasingly more important role. But while the world is becoming more multi-polar, it still looks to the US for true global leadership. It is to be hoped that the US presidential election will rise to the many challenges and opportunities of this new era.
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