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Financial crises: True picture still to emerge

GLOBAL stock prices tumbled this week in North America and Europe as losses mounted at US banks. Meanwhile, oil and gold prices rose, indicating the jittery mood of international investors.

Of course, dips are not unusual: stock markets have suffered bigger single falls in the past. And yet, there is something highly unusual and potentially much more serious about the financial markets’ current behaviour.

The credit crunch is a good example. The turmoil hit two major US-based banks: Merrill Lynch and Citigroup.

Both fell victim to the so-called ‘sub-prime crisis’, initially limited to low-quality American mortgages advanced to people with bad credit records, but now assuming a more ominous dimension, overshadowing much of the global financial system.

The two banks admitted that their losses are much heavier than originally anticipated. Their top executives have resigned, and the provision for non-performing loans has been increased.

In theory, this should be the end of the story. Only that it isn’t, and for a simple reason: nobody knows how big the losses of other banks are, and, as regulators admitted this week, it may take a long time before the true picture emerges.

Adding to the air of uncertainty is the plight of the US dollar.

The currency has been pounded from all directions. It has dived to its lowest level against the euro. The last time the British pound stood at such a high level against the US dollar was more than a quarter of a century ago.

China, holder of no less than US$1.43 trillion (S$2.06 trillion) worth of foreign currency reserves, is already hinting that it may diversify its deposits away from the American currency.

So are other governments, particularly in the Middle East or Russia.

And it is hard to see what the US Federal Reserve can do to boost its currency. Raising interest rates could plunge America into an economic recession; not doing so, however, will keep the dollar weak.

Meanwhile, in order to defend the integrity of the banking system, the US central bank may have to pump extra dollars into the economy.

Some analysts have already rushed to the conclusion that the US dollar has finally been kicked off its perch as the world’s reserve currency, to be replaced by the euro or a basket of other currencies. This, after all, is what happened to the pound a century ago. And, once the process starts, it moves fast and is usually irreversible.

But this prediction is almost certainly off the mark. The pound’s global pre-eminence was destroyed by World War I, which shattered all European economies and led to the emergence of America as a superpower.

No such cataclysm is expected.

More importantly, the supposed alternative to the dollar – the euro – is still a young currency. It may be gaining in credibility but it has its own problems.

It is usually forgotten that the US dollar suffered from credibility problems in the early 1970s when America was hit by high inflation.

But its supremacy was quickly re-established, and there is no reason why this may not happen again.

Nevertheless, there is little doubt that the current market crisis is deep and troubling, mainly because it remains so unpredictable both in its extent and duration.

 

Source: The Straits Times 10 Nov 07

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