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Monday, 8 August 2011

US downgrade spells more chaos; QE3 in the making; Time for US to stop blames, take responsibility!

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


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.

“This time, there are less resources available, hence probably smaller amounts under QE3. Also, the market itself may reject larger amounts,'' said Pong.

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.

 Other economists expect slower growth in the United States but not necessarily recession.

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


The White House on Saturday challenged the ruling by Standard & Poor's to downgrade U.S. long- term credit rating form top rank of AAA to AA+, citing the agency' s decision relied on faulty math and in haste.

Disappointingly, instead of reflecting on themselves and sitting down to fix problems in a cooperated way, the Democrats and Republicans in Washington are questioning the creditability of the downgrade ruling and blaming each other for the ever-first shame of slipping out top credit rating club.

During the angry finger-pointing, the U.S. politicians seemed to have forgotten Wall Street's severest losses in almost three years last week, forgotten mounting concerns about double-dip recession, and forgotten the criticism over their irresponsibility showed during the debt arm-twisting from all over the world.

The world has seen enough useless bipartisan debate. The bond- holders are losing confidence. The investors have started to escape markets to stay in cash, showing their fears of uncertainty.

S&P managing director John Chambers said "The political gridlock in Washington leads us to conclude that policymakers don' t have the ability to put the public finances of the U.S. on a sustainable footing ".

The alarm has rung. It is time for the naughty boys in Washington to stop chicken games before they cause more damages. It is time for the policy-makers in Washington to settle down, to show some sense of responsibility and fix their fiscal problems.

The United States is not only the biggest debtor, who must pay its large amount of obligations, but also the printer of international reserve currency, which has the responsibility to assure the value of other countries' foreign reserve assets.

If the country's governors kept wrangling for their own interest, ignoring the voices from domestic and aboard, how can their people trust them and where will the confidence for a better economic scenario come from?

If the world's largest debtor kept eating May's grain in April and kept robbing Peter to pay Paul without fiscal discipline, eagerness to balance budget or effective efforts to boost sluggish economy, how can the creditors keep lending without doubts?

According to analysts, risk of dollar devaluation increased after this downgrade, not to speak of the possibility to see more cuts in the next two years with a negative credit rating outlook.

Whether admitted or not, the U.S. central bank tended to maintain a cheap dollar for the export's sake aftermath the financial crisis, which already squeezed world foreign reserves.

Currently, the U.S. is facing a high unemployment rate of 9.1 percent and almost stalled economic growth. But the Federal Reserve's "silver bullets" have run out after two round of quantitative easing. For fiscal stimulus, there is only little room considering the excessive debt and austerity agreement. For the desperate policymakers, to boost export seems to be the last way to kick the U.S. economy. From this point, the U.S. has every motive to maintain a weak dollar.

Before the U.S. makes any move, please remind it: don't forget your responsibility as the issuer of reserve currency to maintain the stable value of the dollar. Don't become blind to the great risks that a fluctuated exchange rate could pose to international financial markets and a weak greenback could pose to the world fragile economic recovery by lifting dollar-denominated commodities prices.

The history is a guide. What we should learn from the financial crisis is to be selfish could only hurt yourself and drag others into water.

It is time for the U.S. to tighten belts and solve structural problems, in order to resume reputation and restore world confidence. 

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