As liquidity lives on…to kill

Asian policy makers have to balance out the imbalances or these shakeouts will continue to hit us

Believe it or not, this contagion arguably dwarfs any other known epidemic or danger looming over the globe like that of a virus attack on the global internet, global warming or even Osama bin Laden’s terror networks. From Tel-Aviv to Times Square, from Wall Street to Dalal Street from Australia to China; you name it and almost have it in the list of casualties of the recent global equity market shake out. And the solution doesn’t lie in installing firewalls or ‘going green’, or even carpet bombing countries to uproot terrorist masterminds from their hideouts. Trillions were lost in few days and tremors were felt world over and interestingly the end to all of it seems to be light years away. We definitely need a mass rising against our policy makers for the imbalances are equally excruciating for mankind than any other immediate crisis facing our planet.

Let’s figure out what has actually happened in the past few days. Credit crunch seems to have taken its toll on the global equity markets. Bond spreads across the globe have widened unprecedentedly and have triggered a sell off in equities. Bond spread, which is the difference between the yield of a safe sovereign bond and a corporate bond, signifies the risk associated with a bond. So, the wider the spread the riskier a bond is. Since mid-June in the US, the bond spreads having ‘B’ rated corporate bonds, have widened by a staggering 150 basis points (See figure 1). The sub-prime lending woes in the US have also played an integral part in stoking this phenomenon. The world has already seen hedge funds with exposure to sub-prime lending, cripple like a house of cards. Even investment banking giants have seen themselves downgraded to ‘Junk’.

But on the backdrop of this melt-down an interesting phenomenon took place. In the currency market, the Yen saw an appreciation against currencies which were on the other side of the carry trade, as investors ran for risk reduction and started buying Yen. This short phenomenon stoked by the equity market sell off fears, was the unwinding of the debilitating carry trade, which at the end of the day is a healthy activity for the global economy; as the longer the carry trade continues, the more lethal the unwinding is going to be. But then, the Yen appreciation is reversing as the equity markets have shown some strength with analysts starting to paint a rosy picture for equities. So, what makes everyone so optimistic??? Well, it’s nothing but the liquidity that stems from an ultra cheap Yen, the oil exporting countries and the massive reserves that has been built by the Asian economies. As Philippe d’Arvisenet, Group Chief Economist, BNP Paribas while talking to B&E exclaims “… there’s enough liquidity being supplied from Asian economies (Reserves) and oil exporting countries which will continue fuel the markets. There was some unwinding of the carry trade in the past few days which is clearly reflected in the Yen appreciation. But there is no change in the economic fundamentals of countries that are on the financing side of the Yen carry trade. So, I don’t see a major unwinding of the carry trade coming from their side.”

So, the news is that the world will continue to get flushed with unprecedented amount of liquidity fuelling asset bubbles and imbalances, holding the global financial system for ransom till the end.

So, it will happen once again!!! Well, perturbing, this might just become the order of the day till the time our policy maker religiously work towards mending the structural imbalances that they have created over a period of time. Till the liquidity glut that has assumed crisis proportions is washed off in Asia, these spasmodic shocks will continue to rock the global financial system, continuing scraping trillions of market capitalisation and leaving the investors in dire straits every now and then. Till the time Japan doesn’t allow its interest rates to hit normal levels, till the time China doesn’t stop subsidizing its exports and amassing up trade surpluses like there is no tomorrow by maintaining an artificial Yuan exchange rate, these shocks will only become a matter of how often???

For Complete IIPM Article, Click on IIPM Article

Source : IIPM Editorial, 2007

An IIPM and Professor Arindam Chaudhuri (Renowned Management Guru and Economist) Initiative

For More IIPM Info, Visit Below....
The Sunday Indian - India's Greatest News weekly
IIPM Mumbai Parables - Stories that change life
IIPM International Student Exchange Programme
IIPM, ADMISSIONS FOR NEW DELHI & GURGAON BRANCHES
IIPM, GURGAON
ARINDAM CHAUDHURI’S 4 REASONS WHY YOU SHOULD CHOOSE IIPM...
IIPM Economy Review
IIPM :- Cicero's Challenge is going global
The Indian Institute of Planning and Management (I...
Time for Awards at IIPM