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Do not believe what our homespun economists predict about the domestic economy; in fact, don’t believe what any economists predict at all, period.
Consider this scenario. The biggest creditor in the entire world has never ever had a balanced budget before. This is because a central government will not risk stagnating a robust economy just to show that it is capable of balancing its budget. Neither will it risk turning a bullish market bearish. A small deficit is always good for the economy because it exhibits a potential for further growth, money well spent one would say.
Look at the US of A, the biggest importer of finished goods and raw material the world has ever seen. To finance this venture, the banks have to extend credit to the importers as one need to sell off its wares before showing a profit on the bottom line. We are not talking about a couple of billion greenbacks here. American import figures exceed the trillion mark every year. Now, having understood this, one would ask just where do these financial institutions get the money to loan it to these importers? The answer is the US Federal Reserve.
Money does not grow on trees and a government cannot just run it off the printing press as need be. There is after all such a thing called inflation. The more cash flooding the market, the higher the purchasing power and when demand outstrip supplies, the intrinsic value of goods escalates and henceforth inflation. So, in order to finance this endeavor without inflating the economy, the US Federal Reserve created Treasury Securities (TS), which are in fact governmental public debt financing instruments. There are four types of TS, namely Treasury Notes, Treasury Bills, Treasury Bonds and Treasury Inflation Protected Securities (TIPS). All in all, money is suddenly created from debt.
First, we look at T-Bills. Maximum one-year maturity zero-coupon bonds (no interest upon maturity) that are traded at a discount to create a positive yield. T-Notes and T-Bonds have a longer maturity period but these possess a market-controlled coupon payment twice a year. TIPS are basically inflation-indexed bonds whereby the constant coupon rate is adjusted to the Consumer Price Index.
So, who buys these TS to create the money for the US Federal Reserve to loan to the banks? In the US, it is these same banks that purchase them. The other major investment firms that acquire them also finance these purchases through their banks. All national central banks also invest in them to hedge their currencies against the US Dollar. Suddenly un-backed money is literally created from thin air. Not too bad a thing because these debts are created to expand the economy and to generate more income.
TS are also the means for the government to finance their budgetary deficits and here is the start of all our current troubles. When we mention US Budget Deficits, we are looking not at a few tens of billions US dollar but rather something like 800 billion greenbacks for 2008 alone. To provide a perspective of what USD800B is like, the entire Malaysian Budget for the last decade (2000-2009) is only worth RM1,290.3 billion or USD368.7 billion – less than half of what the US 2008 Budget Deficit is. Still cannot visualize it? Imagine winning the Big Sweep (RM3 million) every month without fail for the next 77,778 years. Get it now? Imagine just how big a hole the US Government had dug for themselves and in the same process, for the rest of the world as well.
Because of these baseless funds used to finance their imports, the exporters from all over the world enjoyed more profits. Trade surpluses are evident once a nation exports more to a country than it imports from. When a nation earns more than it spends, the monetary value of its currency grows stronger and inflation creeps up as well. To offset this, more new local money is introduced into the system to balance things up a bit and to ensure that the value of its exports remain low and stable. This mirrors exactly what the US is doing, albeit for different reasons, but with the same consequences.
Come one fine day and the US faces an Economic Tsunami because there is only so much “unwarranted” money that the system can withstand before it breaks down. Well, that day has arrived and henceforth the credit crunch, and when the US economy goes downhill, all global economies follow suit. Domestic economist might say that the Malaysian economy is decoupled from the US economy and henceforth the impact will be minimal. BS! During those years of trade surpluses and high growth, the Ringgit became stronger. Bank Negara Malaysia (like all other central banks in Asia) had to keep it low to sustain the growth rate that was primarily propelled by exports. This is achieved by the introduction of new money into the Malaysian market. Now that the exports are no longer there, this “new money” is still floating around, fiat money not backed by gold, an almost exact scenario replicating the US economy. Will it affect Malaysians the same way it affected the Americans? Definitely so because the Laws of Economics follow the same principles no matter where it is applied and doubly so because BNM would have also invested in these American TS instruments – the major factor because US Dollars are the defacto international trading currency.
The ultimate conclusion is that there is no avenue of escape from the impact of the US credit crunch and its thereafter consequences no matter what anybody tells you. It is akin to a domino effect whereby the first toppled domino will take out the next in line and so forth. Malaysia might be way down the line but the effects will be encountered here nonetheless. It is just a matter of time. Subsequently, what are the consequences?
Next stop, hyperinflation. - Hakim Joe
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