Editorial | Wednesday, 28 May 2008

Financial turmoil in international markets

It is appropriate that the Institute of Financial Services is organising its annual seminar on the theme of the financial turmoil in international markets.
What lessons can be learnt? The international financial situation has been worsening day after day, as alarming news emerges from the world financial markets and the general public is increasingly apprehensive about the unfolding economic downward spiral, which could possibly include a deterioration of the US recession.
It is worth our taking note of what is happening across the Atlantic, as a study of what is happening in the States carries repercussions also for us in Europe. Often, problems arise because of our inability to recognise the financial risks staring us in the face. If banks, investment houses and indeed even homeowners did a better job in diagnosing the dangers, many of our present difficulties could be avoided. Basically, we tend to underestimate the repercussions of the present financial crisis, because we are simply too short sighted to even imagine a future much different from the present. Even when we finally realise, the adjustment processes are far too slow to prevent a bad situation from getting worse.
According to economists there are currently a number of dangers facing international financial markets. Firstly, the mortgage crisis in the US has given rise to a liquidity problem in the international banking system, created by the uncertainty of who is to hold the losses. As a consequence banks are lending less to companies and to households alike. This is turn gives rise to a reduction in consumption and of course investment. As a fall out from the reduced sales of goods and services, stock market valuations go down and as a result the bank liquidity crisis intensifies.
A second danger arises from the way the US property market works. Since more and more people are finding themselves unable to meet their repayments, foreclosures are increasing and as a result more and more houses are being put up for sale on the market with the result that the prices of houses are falling even faster. This in turn leads to even more foreclosures and declines in the general value of people’s houses.
The third danger arises from the interaction between wealth, spending and employment. As the stock market falls and average family’s wealth declines by reduction in the value of their houses, the consumption of the family likewise decreases and as a result companies are registering a decline in their profits, which will lead to a decline in investment. As a result there will be a decline in employment, which will lead to a decline in income and as a result a decline in consumption.
The fourth danger concerns the latitude for monetary policy intervention, as once interest rates are reduced to combat the crisis, the dollar is falling at the same time, leading to higher US import prices and oil prices in America, placing an upward pressure on inflation.
As pressure increases it will be more difficult to reduce interest rates further without the danger of starting a wage-price spiral. As a result of little interest rate relief, consumption and investment will dampen. The importance of all these developments lies in the fact that the international crisis and the decline in the US economy will inevitably have an effect on the growth of the world economy, as neither Europe nor the emerging countries of Latin America and the Far East can fill in the gap that the US economy will leave. There is no economic mechanism whereby the drop in the US aggregate demand will be matched by a corresponding increase in aggregate demand elsewhere. As a result all European and other countries are bound to feel the pinch.
In the longer run the prospects for the world economy will take a turn for the better, but in the meantime we are best advised to bear a few home truths in mind. First and foremost Malta is not a country which lives in isolation, and is also subject to all the influences and shocks of the world economy. As a consequence immediate action needs to be taken lest we find ourselves lagging behind in the adjustment processes that we need to implement, and fast.
It must also be borne in mind that in a globalised world the power of the market is far superior to that of politicians, who are finding themselves less and less relevant as the prime motivators and catalysts for change. We must change and adapt to the market, as ultimately the market will dictate our capacity to resist the strong forces beating at our economy. The solution lies in our competitivity and capacity to compete in the international market. Accordingly the golden words of the governor of the Central Bank, highlighting the need to rein in public spending with increases in wages tied to productivity, with spending leading to income earnings, social welfare payments being means-tested, and with State subsidies being reined in. Wise words, which for many a year the political class has consistently ignored.
Whether ignoring the writing on the wall for much longer is wise, or indeed even an option in the present turbulent financial crisis, is another matter.