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Today’s announcement of quantitative easing  – lowering UK’s interest rates to 0.5% accompanied by the decision to print more money – is widely acknowledged to be a total untried gamble and an admission of failure of all previously announced rescue-the-economy measures by the present UK government. It appears it’s the first time this is being tried in the UK, so we don’t know whether this will be successful or a total disaster.

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The global financial crisis is threatening to engulf yet another state. This time we are talking about Pakistan.

Background: It’s a very different story from Iceland – and has a heavy political spin to it. Pakistan has had 9 years of military rule headed by Pervez Musharraf. He recently stepped down to avoid being impeached. Pakistan’s new civilian government is just 5 months old and is now headed by the widower of Benazir Bhutto, Asif Ali Zardari.

The challenge the new government faces is dealing with the aftermath of Pervez Musharraf’s outdated economic and security policies, and changing these policies to rescue the country from its current brink of default.

During Musharraf’s rule, Pakistan has been propped by aid from the USA. Now these loans have stopped, the country started rapidly running out of money.

As Reuters reports, “Pakistan has been running unsustainable fiscal and balance of payments deficits”. In the last few months, Pakistan’s foreign currency reserves have fallen sharply to just under $9bn (compared to $16bn in Nov 07), as the country is spending a lot of money on importing increasinly expensive oil, whilst also maintaining a large army and supporting programmes to fight militant extremists.

Impact of the crisis: As the result, Pakistan’s currency rupee has dropped in value by 19% in 2008. The country’s stock index the KSE (Karachi Stock Exchange) has slumped 41% from the April’s peak.

The inflation is running at 25%, and although the government has stated that it will aim to cut central bank’s borrowing, tightening the monetary policy, there is fear that heavy government borrowing (a much looser fiscal policy) will actually fuel inflation further.

Security fears: Pakistan’s people are living in poverty and many cannot now afford fuel and food staples. There have been protests where people expressed their anger at the situation. Strong popular discontent is fuelling support for militant extremist groups. This creates a big problem for the new government as it has vowed to deal with militant groups near the Afgan border. Pakistan have a large army to support at present, and lack of money will make it difficult to finance existing planned programmes.

Trouble is near: It is forecast that if the country carries on as is, it will need $10bn to prevent going bankrupt in February 2009. Government bonds traded internationally have already dropped down in value implying the market fears the government will default upon its debt.

Whilst the government has been denying it is facing a crisis of balance of payments, it has been reaching out to China for a large loan instead of the IMF.  

China is set to benefit: China presently has $2 trillion in foreign exchange reserves, and although it cannot be seen as totally immune from the ravages of the global financial crisis, it certainly seems well insulated at present. In fact, China might do quite well out of the Global meltdown, strenghening ties with other countries in trouble and acquiring new allies. Its prospects are presently far better than for many other states. Watch this space – China is set to grow and grow and grow…

 

Copyright 2008 by CuriouslyInspired

I don’t have any answers. And today, I feel the weight of fear and uncertainty over the impact of the Global Meltdown on people closest to me. The government measures do not seem to be working to stop the systemic panic that has taken hold of everyone. Markets are in freefall across the globe.

Lehman’s CDS settlement: Part of the reason’s for today stock market crash is the fear surrounding the need to settle Credit Default swap (CDS) protection on Lehman Brothers’ debt. This is due to happen today. The size of financial contracts under settlement is $400bn.

CDSs are a type of financial insurance policy (loosely speaking) written by a financial institution to protect the holder against the risk of a specified party (in this case, Lehman Brothers) going bust. Now that Lehmans is bankrupt, the holder will want this policy paying out. If the payout does not happen, the holder of the policy is at massive risk as it does not get the money it was counting on. The payout might also not happen if the writers of the policy do not have enough cash to pay all obligations. If things go sour, this will impact banks which have so far not been in the spotlight being the writers of these contracts, or the holders of these contracts – such as JPMorganChase.

There is uncertainty that this settlement can take place today, given the state of world’s markets and absence of liquidity. If it goes wrong, this might kick off a further chain reaction of negative events. 

Gloomy thoughts of the day: Going back to the economy, here is what I fear might happen – and I do feel quite negative today – we can check how close or far off the mark I was later this year:

  • Lower limit of indices: Only 2 days ago I speculated (at home) that FTSE 100 will stop before crashing through the 4000 psychological barrier. This has already taken place – it’s trading below 4000 – so the reality is worse than my fears. So should FTSE 1000 at 3000 be the limit?
  • Markets shut down for weeks: We have already seen Iceland and Russian markets closed. Will US and UK and other major stock markets follow suit in an effort to curb panic?
  • Sweeping reforms: There might be major reforms taking place in the economy and finance. I cannot discount the possibility of drastic steps such as freezing all savings as reforms are carried out. Your money might not be safe wherever it’s held. Our Governments have guaranteed savings so far – but will they be able to stand by that guarantee? I fear they could abandon it if they really had to.
  • Pensions and Investments: Any stock-market reliant savings held in funds, have already lost a massive chunk of their value. My own savings held in funds are down 25%. People close to retirement are going to struggle to live on what is left. Savings are not safe wherever they are. If there is something akin to a currency reform, then all savings can be taken away anyway as part of that. How much faith do we have in the Government’s guarantee on existing deposits? I would not trust it 100%.
  • More bank failures: I am sure we’ll see a few more of these, causing problems with existing savings lost or frozen
  • Recession: Fears deepen about entering a major recession akin to the Great Depression of the 1930ies. The IMF is speculating this might last until the end of 2009. Could it be longer? Could it be years of hardship for people who worked for decades on end to secure their future?
  • People take to the streets: Wouldn’t you – if things got very bad? It’s the likes of you and I who can topple governments, if we are truly p*ssed off.

Because at this stage, no-one seems to really know what to do next.

 

Copyright 2008 by CuriouslyInspired

Yesterday was a very, very bad day on European stock exchanges, with key indices sliding down massively. To give some examples – UK’s FTSE 100 down 7.8% (the largest fall since 1987’s crisis), France’s CAC 40 down 9%, Germany’s DAX down over 7%, Russia’s RTS down over 19% resulting in Russian stock markets being shut down today again. Asian markets were also sharply down. There are more market casualties – Fortis (a Dutch-Belgian bank) and Hypo Real Estate (a German bank) – and seeking urgent rescue either through cash injections or a quick merger.

Iceland continues to struggle under the weight of its massive banking crisis, trying to avoid national bankruptcy, with the second largest bank Landsbanki now being nationalised – this is in addition to Glitnir about which I wrote recently. Thus, this week the US economic calamities have been demonstrated to well and truly impact global markets – not that we have doubted this earlier.

Cause of the panic: The European stock market slide is attributed to the lack of a coordinated economic front amongst EU’s governments which does nothing to restore confidence in the system at the time when emerging economic data is implying that US is entering a recession. US’s recession will impact the world’s economy due to its global nature. European governments are pursuing their goals in isolation and cannot have seen the depth of the crisis we are about to enter. According to this article, we are staring into the abyss of a systemic collapse, with markets at risk of closure. One recommendation is for the European central bank to lower its interest rate immediately and start acting like the lender of last resort to companies in trouble. Lowering the rate of interest should kick off inflation, one side effect of which will be to reduce the real value of outstanding debt, making debt obligations easier to bear.

UK is also showing deteriorating economic figures, prompting statements that it too is now technically in recession. Meanwhile, European countries are introducing their own measures to address the credit crisis and resulting stock market plunges, but there is no overall agreed policy. This must be reflective of a panic that set in amongst governments, each trying to protect their own skin in the eyes of the very concerned electorate by introducing quick measures. Divided, they stand. Read the rest of this entry »

I stumbled across a great article this morning which explains very well how Central banks (the Fed, the Bank of England, etc) operate on the money markets to inject liquidity into the system in order to stabilise it. This prompted me to consider the bigger question why money and credit is important in an economy.

Central banks and monetary policy: Typically Central banks aspire to maintain a certain target interest rate, and tighten credit (reduce it) when rates are too low, or increase the money supply when the rate is too high when rates are too high. This does not mean printing money: purely issuing notes and coins without reference to economic conditions can and does lead to inflation which, when excessive, is very damaging to the economy (it is outside the scope of this note to consider what is deemed “excessive” or what drives inflation in the first place, although some degree of inflation seems inevitable and healthy). Instead Central banks buy or sell short term Treasury bonds to primary banks (the likes of Goldman Sachs) to manipulate liquidity.

Central banks thus influence available credit through its dealings with primary banks and not small regional banks. If primary banks ceased to exist, e.g. if they went bust, Central banks would lose this existing tool of influencing available total money in the economy.   Read the rest of this entry »

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