GLOBAL FINANCIAL CRISIS
By Heng Siam Heng
IN THE midst of deepening crises in the world's major financial markets, some say we are hearing echoes of the Great Depression of the 1930s. The D-word has occurred with increasing frequency in the media. Even United States President George W. Bush said at the conclusion of the G-20 financial summit last weekend that it was conceivable that the US could suffer a depression worse than the Great Depression.
There is little doubt that the US and many other countries are in recession. But depression? Most likely not. There are many reasons why we should see the glass as half-full - and not shattered - and focus our minds on relieving the pain inflicted by the recession.
First, the post-World War II system of economic governance, in both the developed and developing world, is better equipped to deal with downturns than were the governments of the 1930s. John Maynard Keynes, most eminently, provided the theoretical tools for this system of governance - and fortunately, as Richard Nixon put it in the 1970s, we are all Keynesians now, whatever our other ideological preferences.
One policy instrument of Keynesianism is anti-cyclical government spending. The other is the central bank acting as the lender of last resort. Governments have brought both instruments into play in the current crisis.
The second reason for optimism has to do with the flow of credit. It has dropped dramatically, for sure, driving up costs of short-term loans, and threatening what The Economist has called 'a global financial heart attack'.
But the world is not short of liquidity. In fact, the opposite is true. Before the crisis, the market was awash with money. What is crucially in short supply now is not so much liquidity as trust in the financial system.
It is good that central banks have got together to coordinate measures to restore trust and confidence in the financial system. Though politically unpopular, governments have acted decisively to bail out crucial financial institutions so as to prevent a financial meltdown. And they can go further. The West for one should drop its ideologically-inspired objection to sovereign wealth funds acquiring Western assets.
For the first time, the West is conceding to emerging economies some of its primacy in the global economy. Emerging economies have been asked to play the role of white knights to rescue the global economy. And they can do so because, thanks to the lessons they learnt in the Asian Financial Crisis of 1997 to 1998, they are by and large in reasonable macro-economic health.
China, especially, has the potential to play a positive role in the current crisis. It has US$2 trillion (S$3.05 trillion) of foreign reserves, a current account surplus, and (thank goodness) has not been fully integrated into the international financial system. It can pump money to stimulate its domestic economy. Its growth will support commodity prices. Both India and Brazil also have plenty of foreign reserves to tide over this difficult period. Russia has US$550 billion of reserves.
Another reason for optimism can be found in the supply chain process pioneered by the electronic business. The relationship between inventories and the business cycles was once a complex one. It has become less so because supply chain management now supports a production schedule where goods are made to order. As a result, inventories are minimal, if not zero.
In the event of an economic downturn, firms need no longer be saddled with inventories of raw materials and finished products to trim. Though demand may be lower, they will continue buying raw materials from their suppliers in order to produce goods for their customers. Their suppliers would not suddenly lose a huge chunk of business; they would earn less profit, certainly, but they would have time to adjust.
Just-in-time production and consumption has lowered economic volatility. In the old economy, firms would drastically cut orders from their suppliers, preferring to use up their inventories first. The fact that that is no longer the case should provide a breather.
The final reason for optimism can be found in the longue duree of history. Economic crises were often the result of wars and natural disasters as well as political misrule. The good news is that most parts of the world today enjoy peace. We are far from the situation which existed in the late 1920s and 1930s. Europe was emerging then from the devastation of World War I and was driven by its unresolved problems into World War II.
The mess originating in Wall Street is a manifestation of deep-seated problems: budget deficits, current account deficits, and huge public and private debts. Until recently, these problems were explained away by market fundamentalists. In one fell stroke, the meltdown has reduced the economic power of the US and the intellectual influence of its free marketeers.
Many have spoken of an inevitable shift, from the West to the East, of the global economic centre of gravity. The year 2008 will go down in history as an important milestone in that shift. The mighty dollar looks set to share its role as a global currency with the euro. The powerful West would do well to accommodate the rise of the rest.
Like it or not, we are now in a multilateral world.
The writer is a Senior Research Fellow at the East Asian Institute, National University of Singapore