JAN 26 — How much are 200 US$1 bills worth?
Nearly US$44 million (RM150 million), apparently. And before you ask, yes, I can count (with a calculator at least). In November last year, at a time when we were supposed to be in the midst of the worst recession since even old people can remember, an investor in New York paid that eye-watering amount for a painting of 200 US$1 bills (I’m guessing to prove that old adage that it takes money to make money).
Admittedly, the artist was Andy Warhol (before you think it’s a good idea to flood eBay with your own ringgit-themed versions). Having been put on auction at a reserve price of US$12 million, the final sale price for the painting was seen by some art investors as a sign that the art market had awoken from its credit crunch induced slumber. In fact, everywhere I looked, it seemed as though silly money had made a comeback. We seem to have gone from financial armageddon to bull runs in the blink of an eye, almost as if nothing has changed. Has it?
The “crisis” is often said to have started on Aug 9, 2007, when the French bank BNP Paribas told the world that it could no longer put a value on some of its assets. These assets were largely credit securities which, to summarise crudely, are a form of sophisticated IOUs issued by banks. Understanding how these IOUs work is the key to understanding the crisis.
The banks start by lending money – in the form of mortgages, car loans, personal loans, etc. They then take a large number of similar loans, bundle them together and “sell” them to a specially created company (that it owns) called a “special purpose vehicle” or SPV. The SPV pays for this by issuing the IOUs (or bonds if you want to be geeky about it) that are secured by the pool of newly-acquired loans. Put simply, if you have a mortgage, the real lender is the person who bought the credit securities and not your bank.
Why do banks do this? One, the interest they (through the SPV) pay on the bond is less than the interest paid to them by the borrower of the loan. Two, having sold the “loans”, they now have fresh capital to lend out, and can repeat the process (creating a cycle). Three, selling the loan means selling the risk.
So what went wrong? The pace of lending and securitising kept going in ever faster cycles, helped in no small part by an environment of unprecedented global economic growth and historically low interest rates. Having borrowed at an unsustainable rate, people just couldn’t meet repayments — and soon started to default. House values also started falling as people realised prices were inflated by cheap credit. As default rates rose, investors realised that the collateral behind their IOUs were less reliable than they thought. By Aug 9, panic had set in and investors just stopped buying and selling. In short, there was a credit crunch.
The crisis in the credit securities market quickly spread to other debt instruments. The cost of borrowing in the form of bonds went up (as they were seen as more risky), the availability of debt went down (as no one wanted to lend).
Despite an attempt by monetary authorities and central banks across the world to stop the rot by injecting an unprecedented amount of money and providing a range of guarantees, the markets had stopped working. Banks that had come to use the debt markets as a key source of funding soon found that this had dried up.
As a result, banks stopped lending to businesses and individuals and spending everywhere slowed. Businesses large and small took to cutting costs, which meant laying off people and reducing stock, leading to high unemployment figures and a sharp fall in capital investment. By late 2008, the dreaded recession had set in.
To make up for the failure of the debt markets, central banks acted as lender of last resort and in some cases, effectively printed money to flush the system with cash. And to make up for the fall in consumption (spending), governments spent more.
Economically at least, these measures have had some impact. Many now think the worst is over, and that the good times are about to make a comeback. I hope so. But things have changed. Despite the headlines focussing on the fall of Wall Street titans and the trillions lost, the cause and impact of this episode are more subtle and more significant.
There has been, for some time now, a gradual shift of economic power from West to East. It started with a shift in industrial output as Western companies invested in factories and manufacturing facilities in East Asia. With the rise of Chinese production, that shift was cemented, and Asia now dominates world industrial output. The crisis will scarcely threaten this.
Next came the rebalancing of economic capital. This second change is even more significant because it was Asian led. It didn’t happen simply because Western money had followed its factories to the East. Instead, Asian families saved while Western households borrowed. As China became one of the largest holders of dollars and US government debt in the world, it became apparent that this new wealth was a function of Asian labour, not Western largesse.
The crisis will further entrench this shift. Western governments were forced to solve the crisis be spending vast amounts money they didn’t have. The debt markets have stabilised and confidence is returning, but national debt levels in the developed world are at all time highs and may take decades to repay.
With an ageing population base they will struggle to fix this problem. In contrast, having paid for their stimulus packages with surplus funds, or with deficits that are reasonable in light of growth rates and a growing population base, Asian economies will find themselves in the enviable position of relative capital superiority.
The final bastion of Western economic supremacy is its intellectual capital. The US continues to lead the world in scientific and technological advances even as European engineers continue to build the finest machines. The world financial capitals are all either in the West (New York, London) or dominated by Western expatriates (have you been to Hong Kong recently?).
The crisis will not put an immediate end to that — but Asia’s confidence in the West’s ability to be the source of reliable and pioneering intellectual capital have been irreparably damaged. Put simply, there has been a paradigm shift.
As Asia leads the world out of a recession not of its own making, it will gain the confidence to seize the intellectual initiative and recast the balance of intellectual capital in its favour. The Asia of the future may not necessarily be the natural frontrunner of knowledge in the same way it is with industry, but it will once again find in it itself the ability to stand shoulder to shoulder with the West.
Maybe that Warhol painting will one day serve as reminder of the days the dollar ruled supreme.
