| Yawning
Bread. 14 November 2008
Scary ride down the economic roller coaster
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This is much gloomier than what the government and the Monetary Authority of Singapore (MAS), our central bank, have been prepared to say. As recently as 27 October 2008, MAS was reported to have indicated that "GDP growth is expected to be around 3.0 percent in 2008, and the economy will continue to grow below its potential rate into 2009." [1] It still said "grow", not "shrink". That all this is not mere statistics can be seen from other news: DBS Bank is retrenching 900 staff from its Singapore and Hong Kong operations. We're in for a very rough ride in the next 12 – 18 months. * * * * * DHL has announced that it is cutting 9.500 jobs in its US operations [2]. American electronics retailer Circuit City filed for Chapter 11 bankruptcy protection, putting 43,000 jobs at risk. Another major electronics retailer in the US is also suffering:
That doesn't even begin to compare to General Motors' sales. "GM posted a massive 45% drop in October US sales earlier this month, leading a barrage of brutal results that added up to the industry's worst monthly tally in 25 years," reported Market Watch [3]. The automaker reported that it burned through US$14 billion in the third quarter, and at this rate, analysts figure it will run out of cash within a few months.
Ford, the other major US car-maker, is not doing much better. Car news website AutoCar predicts its pockets will be empty within 7 months. [4] If the Detroit car-makers were to go bust, about 3 million jobs would be lost in the plants, the companies that supply components and the communities beyond. [5] Given the way that supply chains stretch globally, just about every country around the world will be affected with the snowballing economic downturn. We're seeing mass layoffs in China, for example. * * * * * We seem to think that economies should behave as if they are on some linear growth path, creeping up so many percentage points year on year. Singaporeans, especially, are prone to this rather mechanical view of the universe. (Is it our education system, I sometimes wonder?)
The truth is, we never got off the roller coaster, and given human nature, we never will. The part of human nature that is the source of such trouble is that we have a fundamental asymmetry: Humans tend to be more credulous about the upside than the downside; we tend to act on the hope of good news than on the possibility of bad news. We don't integrate bad news into our behaviour until it is plain to see. This asymmetry is at the very root of gambling behaviour. Even when it is a known fact that in the long run the house always wins, people will still place bets in the hope that they will beat the average. Asset bubbles arise from similar behaviour patterns. We buy into assets when we see them rising in price, usually underestimating the risks. Economic history is a sorry tale of one asset bubble after another. This downturn is a particularly nasty one. Its direct genesis is from the steady rise in property prices in the United States over the last decade. People either borrowed heavily to fund their property purchases in the belief that there is certainty in the valuations and a very good chance of further rises in prices, or they took out mortgages on their property to fund their consumerism. There was an illusion of wealth while the roller coaster was on its way up.
The only-too-happy-to-spend American consumer spread his effects globally. Chinese, Vietnamese and Mexican factories produced furiously to meet demand. To expand production, these factories placed new machinery orders on Japanese and German engineering firms. Or they built new factories altogether, raising demand for steel worldwide, and energy. Meanwhile, the banks hit on a new way to immediately realise the value of all the property loans they were writing, rather than wait for the home buyers to pay up over 20 years. They packaged loans into investment products and sold them to other banks, who resold them onwards. Over the same period of time, there was some realisation that these financial products were devilishly complicated, and that it would be impossible to ascertain their true worth, but these worries were salved by a new financial invention: the credit default swaps (CDS), which was basically a kind of insurance policy. Financial institutions began to underwrite each other against the possible default on any of these structured paper. In the end, I think it's fair to say: everybody insured everybody else. So you can imagine how vicious things would get when troubles surfaced. The network effect would paralyse banks. Since the financial system is the chief lubricant of commerce and investment, it is hardly any surprise that the real economy is now gumming up too. * * * * * For an example, consider how, in October, major banks got together under the aegis of the US Treasury Department to settle the multiple and overlapping CDS involving the bankrupt Lehman Brothers. They had to pay each other for the undertakings they had given. Apparently, the swaps were successfully unwound, but I have yet to see any definitive account of how much had to be written off in total. Estimates varied from US$6 billion to US$400 billion.
If banks do not know, figuratively, how much money they have in their back room safes, how are they going to do business? Which is why US Treasury Secretary Henry Paulson and members of the US Congress have expressed a little frustration that despite putting US$250 billion into banks' balance sheets, they haven't done much lending to support businesses. Anne Finucane, Bank of America Corp.'s highest ranking executive in Massachusetts, however, told Congress that there is a limit to what banks can do in a slowing economy. "The American public really isn't borrowing to the degree that it was before, because of the credit crunch, because of concerns about unemployment," Finucane said. [6] And so we're to the subject of lay-offs. What a vicious cycle. © Yawning Bread
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Footnotes
Addenda None
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On the home front, the economic news looks grimmer by the day. A forecast
recently issued by Morgan Stanley said that the Singapore economy could
shrink by 2 percent in 2009.
