Donaldson, but you mention “the historical experience of the emerging markets pulling the world economy along will point the way forwad when recovery gets under way.”

What historical experiences are you referring to? How would the emerging economies “pull us out of global recession”? I did asked about this in previous reply. As Eaststopper was saying, can you explain in terms of Y = C + I + G + NX?
or simple marcoeconomics interdependence?

I think Eaststopper as did I, sense that you are a bit confused here.

As for my previous reply the question was, paraphrasing, to what effect PAP caused or fail to address the widening income gap. And yes I do not like the PAP.

However, I think the bail-out package in the US and Europe will prolong the market pain. I don’t think government officials actually know more than market participants about the true value of these illiquid assets. However, I think it is that government officials with access to taxpayers’ money have decided to ignore market forces to artificially support asset overvaluation, the original root cause of the problem. Instead of being the solution, the bail-out backed by the people’s money has become part of the problem.

Just like you said CDS functions like insurance, but it is not regulated in a similar manner to insurance. Hence, when CDS collapses, it definitely cause a huge worldwide fall-out.

To summarize, if I try connecting the dots together, I cannot see through which mechanism (consumption?, capital investments?) that emerging economies will pull the global economies out of this recession. – Eaststopper (#34)

I also make no mention what mechanism will enable the emerging economies will pull us out of global recession. I merely said that when the emerging markets actually start to pull us out of the global recession, that will be the indicator that global recession is coming to an end.

The world looks murky now. Your description of the state of emerging markets is no doubt accurate. I believe what is happening now is the global write-down of assets is inevitable, whether it is through market correction of toxic debt securities or falling asset prices such as properties and commodities. Once all the bad debt and over-valuation has been expelled out of the system, the market will start to function normally again.

Maybe to follow up that question, why or what do you think cause the increasing income gap? Both mirrored in the US and SG. – alphavilleSG (#33)

What does increasing income gap has to do with the global financial crisis? I am no conspiracy theorist, but I see this issue as a problem of wall street versus main street. Yes, no doubt when main street raises, wall street raises too. However, when wall street rises, it is not necessary that main street rises too. This has to do with the practice of how salary and compensation are valued. This is best described by Albert Einstein in his essay Why Socialism published in May 1949 on the Monthly Review:

The essential point about this process is the relation between what the worker produces and what he is paid, both measured in terms of real value. Insofar as the labor contract is “free,” what the worker receives is determined not by the real value of the goods he produces, but by his minimum needs and by the capitalists’ requirements for labor power in relation to the number of workers competing for jobs. It is important to understand that even in theory the payment of the worker is not determined by the value of his product

I have to re-iterate this: an editorial amendment to my article have modified the interpretation of my article. I never intend to put “Although the immediate outlook for the world economy looks grim, the historical experience of the emerging markets pulling the world economy along will point the way forward when recovery gets under way.” at the beginning. It is meant to be part of the last section. What I am actually saying is that when recovery is underway, then the emerging market economies might show the way out out of the global financial crisis.

I am not exactly sure how the emerging economies will pull the global economy forward?
The emerging economies of Europe (Hungary, Bulgaria, Estonia) are all suffering from a depreciating local currency and soaring foreign debt (EUR); much like the emerging economies of East Asia during the 1997 Asian financial crisis. There is little reason to see how these emerging European economies can help pull us out.
The commodities-dependent economies of South America and Russia have to live a lot less revenue given lower demand for commodities. These economies have over-spent in boom times and their financial budget was based on assumption of ever-higher commodity prices.
As for Asia emerging giants like India and China, their growth rate has sank to a mere 9% (both economies need to grow at minimum 8 to 10% just to stay afloat). Their economies are extremely export-reliant and unless they can boost domestic consumption, I cannot see how these two giants can lead us out of the current recession.
To summarize, if I try connecting the dots together, I cannot see through which mechanism (consumption?, capital investments?) that emerging economies will pull the global economies out of this recession.

Maybe to follow up that question, why or what do you think cause the increasing income gap? Both mirrored in the US and SG.

Why do you think the response to the minibond fiasco has been so lethargic?

On the other hand, Ben Heineman from Havard University’s Belfer Centre for Science & International Affairs ponders over the lack of leadership in the financial sector for the tackling the global financial crisis.

Where are we heading from today? Who will President Obama appoint as the new US Treasury Secretary?

My view is it doesn’t has to be a matter of fact. This is change we can believe in! Under the governance of the PAP, we have see those GDP number grow but wealth is increasingly concentrated, wage gap increasingly widen. – alphaville (#30)

How does this gotta do with PAP?

A reflection will show the contrast, back in 97′, the effect of a massive outflow of foreign capital combined with speculators descending on the frenzy, suddenly bankruptcy of governments was a possibility. When the IMF moved in to provide liquidity to nations hit by the crisis, by the terms dictated by them, banks were allowed to fold (hypocrisy?), a nation in poverty ended in poorer, food riots and a dictator was disposed (could there be a less tragic way?)

Taking side, one can be detached, taking an analytical view, the theory say so, these events do and will happen, it is inevitable.

On the other hand, we don’t usually account for these negative externality. Banks require public funds to bail them out, preventing the devastation on Main St. Here’s the alternative, would you rather not prevent (or minimised) the circumstances from occurring and allocate resource to better use?

A debate on regulating the financial system
http://www.economist.com/debate/days/view/230

My view is it doesn’t has to be a matter of fact. This is change we can believe in! Under the governance of the PAP, we have see those GDP number grow but wealth is increasingly concentrated, wage gap increasingly widen.

So those profits you were talking about? To whom did it benefit? More good years?

Do you agree or disagree that flourishing of systemic risk led to the cycle of financial crisis. It is a general sentiment that a financial crisis occurs every 5-10 years.

Systemic risk is inherent to the operation of a system, if any of its interconnected mechanism fails to function as it should, then there’s systemic risk.

Say your kidneys, integral to the blood circulatory system, fail, the impact is the slow poisoning of your body, follow by death.

Systematic risk points towards failure in a methodological procedure which can be avoided.

Say the method of tagging bonuses of RMs to the sale of financial products, with an emphasis on volume as a measure of performance leading to mis-selling.

That is the case for China, not every emerging market economy. I denounced decoupling over grounds on growing domestic demand. Instead of decoupling, diversification of trading partners for each emerging market economy actually occured. This materialised in the form of increased trading among emerging market economies, thus being less reliant on trading with OECD countries.

I actually did not attempt to explain how we arrived at the Global Financial Crisis in my article, but rather stating what it is, with respect to consumers, and how it will affect us. Then I explored how the Global Financial Crisis will evolve from now by asking if we are entering a global recession followed by pondering whether the Chinese economic growth will indeed limit damage to the world economy.

I do not dispute that capitalism works for the common good if the capitalists share a common political ideology, united against a common enemy, but that is an American-centric view point as a Corporatist. But ideologies do not necessary generate revenue, but market trading does. I stand by the view point that systemic risk flourishes during good economic times. Let me illustrate this through a portfolio of equities:

Say you manage a portfolio of 5 companies, and their risk is given as:
2000- (a) 1.2% (b) 0.9% (c) 1.3% (d) 0.8% (e) 1.1%
2001- (a) 1.3% (b) 1.1% (c) 1.3% (d) 1.0% (e) 1.2%
2002- (a) 1.4% (b) 1.1% (c) 1.2% (d) 1.2% (e) 1.2%
2003- (a) 1.5% (b) 1.2% (c) 1.1% (d) 1.1% (e) 1.3%
2004- (a) 1.4% (b) 1.3% (c) 1.2% (d) 1.2% (e) 1.3%
2005- (a) 1.3% (b) 1.4% (c) 1.4% (d) 1.3% (e) 1.3%
2007- (a) 1.3% (b) 1.4% (c) 1.2% (d) 1.5% (e) 1.5%

From 2000 to 2007, the world economy has been doing very well, so for each company, the senior management’s risk appetite has increased over the years, so that they can maximise return for their shareholders. They can do this by investing in risky projects or by adopting higher leverage ratio for their investment projects. Although the portfolio may have diversified into 5 companies, because each company suffers from the common adoption of increased risk appetite, your systematic risk increases anyway. Total risk also increases too.

Thanks for the article and I think it was very well written. you must either be a journalist or a writer by profession? – Gilbert Goh (#19)

I am neither a journalist nor a professional writer. I have been writing and debating on international issues relating to politics, economics and security for 3+ years as my extra-curricular activities at university. My background is engineering, but I have interned and worked part-time in corporate finance advisory, hedge fund management and energy consulting. I am fairly acquainted with economics and finance, but I am still no expert.

Islamic finance forbids profiting from debt, so it is really quite interesting how an Islamic loan works out. It is actually similar to a lease financing scheme repackaged. In the case of an Islamic mortgage, the bank purchases the property and leases it out over a fixed period. At the end of the fixed period (e.g. 15 years), the resident is expected to pay a token sum to purchase the property from the bank. In this case, the bank takes on the cyclical risk of property valuation. Unlike the US Sub-Prime Mortgage crisis, in which the interest went up as soon as the property price dipped below the original loan value, the resident takes on the cyclical risk of property valuation.

Thanks for the article and I think it was very well written. you must either be a journalist or a writer by profession? – Gilbert Goh (#19)

I am neither a journalist nor a professional writer. I have been writing and debating on international issues relating to politics, economics and security for 3+ years as my extra-curricular activities at university. My background is engineering, but I have interned and worked part-time in corporate finance advisory, hedge fund management and energy consulting. I am fairly acquainted with economics and finance, but I am still no expert.

Islamic finance forbids profiting from debt, so it is really quite interesting how an Islamic loan works out. It is actually similar to a lease financing scheme repackaged. In the case of an Islamic mortgage, the bank purchases the property and leases it out over a fixed period. At the end of the fixed period (e.g. 15 years), the resident is expected to pay a token sum to purchase the property from the bank. In this case, the bank takes on the cyclical risk of property valuation. Unlike the US Sub-Prime Mortgage crisis, in which the interest went up as soon as the property price dipped below the original loan value, the resident takes on the cyclical risk of property valuation.

i really have no confidence in these economists when their guess are as good as mine.

meanwhile, to bring back the index, maybe , IF ETHICAL, will TVs be using stock market experts to urge people to bring money back to the market? Please observe all TV channels to find out what is happening.

Allow me to elaborate my account…

The story begins with Reaganomics and Thatchrism and their allied ideological principle of the self regulating free market, reduction in the role of governments, opposition to labour unions as an arbiter of wages, privatisation of state-owned industries getting rid bureaucratic bloat . There had been the emphasis on direct tax-cuts (say capital gain tax), in hope the wealth would trickle down, tax revenue can growth via indirect taxation (say GST).

This was presented as the Laffer curve and supported by proponents of supply-side economics. On the other side of the Atlantic, the answer to that calling in the UK would be big bang event of 86′, freeing up the capital markets (basically allowing foreign competition, and being allowed to trade in anything) , where, as of today, the financial sector contribute roughly 1/5 of UK’s GDP.

The allure of this idea is that an exercise of free will and choice would triumph over government bureaucracy, reward the individual entrepreneurism, presenting greater efficiency, where an increased in wealth would float all boat, allowing people decide how and where to spend their money. This is the tenet of free market capitalism as popularise by Milton Friedman, the one with the quote “there’s no such thing as a free lunch”, and his book Capitalism and Freedom.

How did this seed the change? The dogma attached to this school of thought came to form the ‘Washington consensus’, with IMF being a shadow agency of its execution (although IMF have other contributors, their right to veto are never used), as the international lender of last resort, where access to funds dictate the adoption of these policies.

Now back to the deregulation of the market, on the backdrop is the introduction of new financial instruments that allow leveraging and increase risk management, where before a futures contract states the price of purchase, with Options, one would simply pay a premium to hedge the risk at no obligation to purchase. A time of optimism where risk could be calculated, volatility predicted, all you need is the next ‘Dutch tulip mania’ to fuel a speculative bubble.

Step forward the take off, the dotcom bubble, in the six years run-up to the burst (1995-2001), a period of sheer insanity with the participation of banks raking in profit from IPOs. The belief that an efficient market prescribe the price as an reflection of the information available, hence why would a bubble exist?

In the aftermath, it was Fed to the rescue, within a year (2001) the Fed funds rate went from 6% to 1.75%. This is the advent of cheap credits. The Fed has effectively replaced the dotcom bubble and seeded the housing bubble, Greenspan was conferred the title of ‘maestro’.

The next period (2001-2008) saw the Bush administration brought back adherence of the same principle established by Reagan, at the same time, financial markets were bundling up mortgage loans into securities, chopped up, repackaged, traded with the help of globalisation and free flow of capital, ended in the hands of minibond investors. Anyone who had gleam the prospectus can see how complex and opaque this has become. Bank business model that relied on cheap money are frog march to nationalisation. And so here we are sitting on a global recession.

But the story doesn’t end, currently unfolding is the unwinding of Credit Default Swap (CDS) and the contagion that comes with it. If you say to a bondholder, you could buy insurance to protect yourself against a company going bankrupt, he/she would likely answer, sounds like a good idea. This is the premise that sold CDS, as a method of risk management.

But what if CDS could be traded or manipulated, where investors infer the cost of CDS as a reflection of the health of a company? But how can this happen? Lack of regulation. This is the point where a new financial instrument is stress-tested.

The quote about emerging market being less reliant on export, buoyed by domestic demands is a myth that everyone brought, the decoupling that never occurred. The current resilience of the dollar in this crisis reinforces its role as the reserve currency. I wish that was not the case but it is apparent.

Now to interject to this state of affairs, I believe capitalism performs better when there’s an ideological challenge to its orthodoxy. Think back to the suspicion and fear when the Soviets were building a new world of socialism with hanging chandeliers in their Metro networks and the impending space race. Fast forward to its collapse, to a world dominated by a single superpower, with an ideological driven mindset where it has taken unilateral action to spread its version of liberal democracy.

Now to support my opinion, do this exercise yourself, go to Yahoo finance, plot the S&P500 (^GSPC) from 1978 to 2008, look at the extrapolated linear trendline (or simply use a ruler), you will clearly see two period of ‘irrational exuberance’ (the twin peaks) that coincide with my emphasis.