Global Trends by Martin Khor

Monday 28 January 2008

World markets on roller coaster ride

It was a roller-coaster time last week for the world stock markets as a bloody crash looked likely until a dramatic rescue by the US financial authorities. The world looks like on the brink of more financial turmoil ahead.


It was an extraordinary week for stock markets around the world.  It started with a big plunge for two heart-stopping days (Monday and Tuesday), then recovered in the last two days (Thursday, Friday).

With volatility the order of the present, it is impossible to predict what will happen next week or thereafter.

The Kuala Lumpur market followed the Asian and the world trend, with the KLSE composite index falling 2.1% and 3.8% on last Monday and Tuesday, and then improving by 2.1% and 1.6% on Thursday and Friday.  The index closed on Friday at 1405, slightly below the previous week’s close of 1439.

The rout began last Monday with Asian and European stocks falling sharply, with the US on holiday.  Facing a major rout, the US Federal Reserve on Tuesday morning announced a 0.75 point decrease in interest rates.

This was the major factor that turned the markets around, first in the US and Europe and then in Asia for the rest of the week.

A big debate is going on as to the wisdom of the Fed’s action.  It was done before its scheduled 30 January meeting.  Many are viewing the action as a sign of panic on the part of the US central bankers, and as a signal that it is willing to bail out investors.

This would perpetuate “moral hazard”, in that investors, companies and banks that take risks can expect to be rescued, and can therefore continue to make risky decisions in future.

Moreover the Fed, and especially its previous Chair, Alan Greenspan, is now on hindsight being criticized for all the time coming to the rescue of the markets, especially by reducing interest rates when the markets go down, for this has facilitated an artificial continuous boom that has led to “bubbles”, including in the stock and housing markets.

The bubbles got bigger year by year and now the chickens are coming home to roost as some day they will have to burst.  By many accounts, the day of reckoning has come, with the US sub-prime mortgage crisis leading to a larger financial crisis, to a credit crunch, the fall in house prices and house sales in the US and the beginnings of what looks like a recession.

On Thursday came news of a loss of over US$7 billion caused to the French bank Societe Generale by the activities of a “rogue trader”, and by the bank’s own attempt to rectify it.

The trader in the bank had bet on the European markets rising, at a time when they were in fact falling.  When his unauthorized dealings were found out, the loss had been 1.5 billion pounds sterling. 

The bank then went into action on Monday to unwind the trader’s position, and this massive sale contributed to the sharp falls in Europe’s stock markets on Monday and the first half of Tuesday, before the Fed’s announcement of an interest rate cut turning the markets around on Tuesday afternoon.

In the end the French bank ended up with a loss of 4.9 billion pounds sterling.  And there is now controversy whether the falls in Europe on Monday had been worsened by the French bank’s action, thus wrongly prompting the Fed to take its big 0.75 point interest-rate cut.

Meanwhile, the political and business leaders at last week’s Davos meeting of the World Economic Forum were in somber mood as they had to contemplate a world equities market that is swinging wildly, a financial crisis that is deepening with so many banks reporting losses, and a “real economy” problem of slowdown and possible recession.

Many analysts have pinpointed the wrong turning in financial policy taken years ago, with financial institutions being allowed to introduce new speculative instruments and funds, freely crossing borders, with regulators and investors unable to understand let alone control the increasingly “sophisticated” and non-transparent instruments and funds.

The hedge fund founder, George Soros, last week called the present situation the worst market crisis in 60 years.  The current crisis marks the end of an era of credit expansion based on the dollar as international reserve currency. 

The current crisis is the culmination of a super-boom lasting over 60 years, he says.  Each time the credit expansion ran into trouble, the financial authorities intervened, injecting liquidity to stimulate the economy.  And this created moral hazard encouraging further credit expansion, says Soros.  

The Soros analysis seems to have been played out again this week, with the Fed coming in to rescue the markets by its big cut in interest rates.  However there are limits to this, as interest rates are going lower and soon may be near to zero, and if the crisis continues, there is little left to cut.

Is this the end of the possibility of credit expansion, and is the house of cards made up of debts about to dismantle, in the major economies of the world? 

Or can there be just another bout of credit expansion, that will put these economies on the growth path, spurred on by steroids, setting up a situation in the near future with yet another crisis, bigger than this one?