Is 'China crisis' disproportionately overblown?

RAINY DAYS AHEAD. Chinese leaders Xi Jinping and Li Keqiang are now bracing a stormy weather as the economy is growing at its slowest pace in more than 25 years, a situation that has incited serious concerns among international observers.

(Photo courtesy of Andy Wong / Associated Press)

China is on top of minds of international media and economic policymakers recently as its equity markets nosedived and its currency fluctuated wildly. The world's second-largest economy is estimated to record only 6.9 percent of gross domestic product (GDP) growth throughout 2015, the slowest annual expansion in more than twenty years, and investors' major fear factor is that China could record another deeper-than-expected slowdown this year. 

Stock indices around the world saw massive sell-offs on fears the collapse of China may take the whole world with it. Market speculator George Soros cautioned that recent China-triggered volatility might mean the 2008 global financial crisis is bound to repeat. 

But, as the world is on edge over possible crash in China, citizens living in the Mainland now might be wondering perplexingly: Where's the crisis? 

Here in Beijing, consumer spending is as strong as ever as people are still flocking into shopping centers. malls and supermarkets remain crowded despite the recent boom of e-commerce businesses, which encouraged more people to turn to internet startups such as Taobao (China's version of Amazon) to buy online their necessities from food, clothes, to detergent.

My friend who is working in a global consumer goods company admitted that her company noticed declining sales throughout China, but noted that it was caused by fiercer competition due to strong growth of local Chinese brands, not by weaker demand. 

Outside the capital, local tourists still passionately flocked into sightseeing spots. The last time I traveled outside the city with a high-speed train, whose tickets are considered generally expensive for the standards of Chinese locals, it was full and there wasn't any single vacant seat as far as my eyes could see.

Unlike in 2008. when the stock and housing market crash in the US rippled to its real sector through rampant layoffs and morgage closures in a zap, optimism among the Chinese people remains intact despite the slowdown and the constant, worrying drop in stock markets in Shanghai and Shenzhen since mid-2015.

Most importantly, the phases of "economic crisis" or "market crash" were never mentioned by my economics professors in Peking University, a campus that is known for a culture of being critical towards the Chinese government. They just showed no gestures of worry at all. 

One of my professors cooly explained that Chinese policymakers might have decelerated growth by purpose, as the too fast economic growth predisposed the country into overheating. This is why, despite the lingering slowdown, China's fiscal and monetary policy stances were still set in a rather "tight" setting, not expansionary. 

The no-big deal viewpoint of my professors is shared by most Chinese: Their country is growing slower, but it is far from falling into an economic destruction. In short, the nation is just experiencing a rational slowdown needed to steer the economy into a healthier and sustainable growth path, which would mean more efficient utilization of resources and less pollution. 

Over the two decades, annual GDP growth in China has averaged around an impressive 10 percent, underpinned by mostly investments, as well as exports. 

As China's reliance over investments grows, its efficiency also falls, hence the long-run unsustainability of this growth model. As capital accumulates, the output-capital will trend lower, meaning that China would need higher and higher level of capital if it wants to record the same level of growth. 

For China to stubbornly rely on investments will only lead to piling up of debts, inefficient usage of resources and overexploitation of environment. This is why China wants to shift its growth driver away from investments, which now account for 46 percent of its GDP, to household consumption, which fills 36 percent of GDP (that's a meager level of consumption for the world's most populous country with 1.3 billion of population). 

Some of China's leading economic indicators, such as manufacturing index and factory output, are indeed slowing. However, those readings are sensible in a country where its government is now aggressively shutting down many factories and enacting various regulations to force industries to adopt cleaner, more efficient technology, in response to China's serious pollution problem. 

Chinese underperforming provinces that became the biggest laggards to national growth, for example, are either exposed to dirty commodities, or are known for their inefficient and polluting factories that make them soft targets of the government's environmental crackdowns.

For example, annual GDP growth fell to 2.7 percent in the first half this year in Shanxi, which is the country's top coal producer. Other Chinese provinces that also experienced sharp growth slowdowns were Inner Mongolia, which provides around one-third of China's coal supply; Hebei, a leading steel producer; and Heilongjiang, a manufacturing base with substantial oil production. 

Meanwhile, in the capital or other China's emerging provinces, growth remained robust, thanks to the booming service sector. GDP growth in Beijing, which has a population of 22 million, or twice Jakarta's, is expected to hit at least 7 percent throughout last year. Where in the world a crisis-threatened country still sees its capital growing by 7 percent?

Another possible reason why some provinces have reported lower growth than in recent years could also be related to the clampdown performed by the Chinese central government to regional leaders who are suspected to "inflate" their statistics (I've read reports saying output or investment figures in some provinces could be inflated by more than 20 percent).

This is because in China, regional leaders are appointed by the central government, not elected, and promotion or demotion will depend largely on their performance of managing their areas, which is indicated by economics statistics. Now, they might have to settle with reporting lower, but more credible, growth figures. 

China's economy has its defects, namely the lack of policy oversight, rampant corruption and the underdevelopment of its financial sector, among others. However, I see many fears about China were overblown as foreign media and economists take a too simplistic view by labeling its policy implementation inefficient, its economic future risky; just because China is a non-democratic country with an idiosyncratic policymaking approach. 

Quite the reverse, China's centrally planned economy, where all economic organs could be flawlessly steered to a specific direction, actually made it extremely efficient. The well-coordinated, communist-style implementation of fiscal stimulus in the aftermath of the 2008 global financial crisis was the reason why China could return to 10 percent growth only two years after the crisis - an economic recovery that is faster than any countries in the world.

For Indonesia, China is its largest trading partner and every economic developments in the Mainland would have a significant impact outlook for Indonesia's exports, economic growth and even its rupiah. The two countries were so heavily linked that the International Monetary Fund (IMF) has estimated that every 1 percent of slowdown in China could trim down Indonesia's growth up to 0.5 percent. 

Nevertheless, the situation in China might not be as scary as global policymakers imagine. Indonesia and the rest of the emerging markets world just have to deal with the "new normal" of global growth as the Asian giant seeks a slower, but more sustainable, economic expansion. 

The article was published in The Jakarta Post on Friday, January 15 2016  

China-US Relations: Why China Can't Bluff

BIG PLAYER. With US$ 1.6 trillion dollar of US treasury bonds in possession, China's Hu Jintao is betting big in United States and is being held hostage by Barack Obama and his economic policies.

The game of Poker expects the player with the strongest hand to raise the bet, control the opponents’ moves, and dictate the flow of the game.

So why could not China –as the biggest United States’ creditor with 1.5 trillion of US treasury bonds in hand– just dictate United States and tell Washington what to do? The riddle here is why China succumbed to the pressure from the United States in some of its economic policies –like appreciating its currency– whereas they supposedly have the power to direct Washington to conduct economic policies for Beijing’s benefit.

Onviously, China is anticipated to be acting something more like this: “You do what I say,” said Hu Jintao to Barack Obama, “or I’ll stop lending you money, I’ll stop buying your assets, and I’ll sell all these 1.6 trillion treasury bonds in instant.”

In fact, such conversation is not happening –because the situation is more complicated and some things are definitely easier to be said than done.

Holding 1.6 trillion of the US treasury bonds does not mean China is holding United States hostage –it could be, in some ways, the other way around. Instead of having a strong hand that allows its player to bluff and dictate the game, it turns out that the 1.6 trillion dollar US assets that China is holding right now is a devilish bug that limits Chinese policymakers from doing what they deem necessary for their economy.

In its effort to boost export and increase trade competitiveness, it is well known that People’s Bank of China –China’s central bank– has been continuously interfering the market by purchasing US dollars every time they deem the situation as necessary.

This policy ultimately leads to two outcomes. The first is the world’s economy is overwhelmed with Chinese currency, the renminbi, whose rate is excessively undervalued since there is way too much supply of the currency in the market.

The second is China hold too many foreign exchange reserves in their possession. Because China continuously purchase US dollars –and other currencies as well– and fill the market with renminbi, at the end of March 2011 China’s foreign reserves has accumulated to a astounding level of US$ 3.05 trillion; 60% of which (about US$ 1.6 trillion) composed of US dollar that comes mostly in the form of US treasury bonds.

The latter outcome is a condition that prompts a big-scale headache for Chinese policymakers at present.

If something happens to United States and their economy, China could not simply sell their US treasury bonds. Holding US$ 1.6 trillion of US dollar-denominated assets makes China the big player, hence if China sell its assets, other countries are more likely to follow suit. Eventually, this will drive down the value of China’s own assets and put their multi-billion investment at stake.

With an investment worth of more than a trillion dollar in United States treasury and institutional bonds –and some in the form of stocks–, it makes a lot of sense if the officials from Beijing are watching United States’ economic policies in vigilant state.

For example, a few months ago Chinese policymakers were infuriated to see their US dollar-denominated assets to decline in value because of the quantitative easing policy implemented by the officials of The Federal Reserve, United States central bank, who craftily depreciated US dollar to boost the United States export sector.

Just recently, the Republicans are losing their marbles as they are putting the world’s economy at bay by trying to push the United States economy into default in the protracted debt-ceiling negotiation against Barack Obama. The situation is serious: If a new bar of debt-ceiling is not set and United States goes into default, the US dollar will surely freefall and the Chinese, with its US$ 1.6 trillion of dollar-denominated assets in their stash, would be among the party that suffers the biggest economic losses.

The situation could go from bad to worse due to the fact that rating agencies like Moody's and Standard & Poor's have considered the possibility of downgrading the United States credit rating from its current rating (AAA) this year.

But, where to invest besides in US treasury bonds? No matter how worse the situation that engulfs US economy at present, the US treasury bonds remains the largest and the most liquid investment in the world. Moreover, amidst the deteriorating euro and the volatile yen, the fact that the US dollar is still considered as the world’s reserve currency should not be ignored.

At the moment, China does not really have better solution and alternative in this game. Eventually this makes any bluff from China to the United States meaningless –because the opponent, apparently, knows that China is betting loads of money in the pot with a very, very weak hand.

The Renminbi Blame-Game

I BOW TO YOU. As United States is running massive deficit on its trade balance at the moment, Barack Obama seeks help from his new foe Hu Jintao while crossing his fingers that China would be willing to help United States by letting the renminbi to appreciate.

It’s interesting to see that for the last few years the centre of gravity of the world’s economy has shifted radically from the west to the east.

In United States, the 2008 financial crisis that was caused by irresponsible bankers in Wall Street has led many countries to stop worshipping United States’ economy as their deity. In Europe, the failure of euro and the collapse of its adopters such as Greece, Ireland, and Portugal make the Europe’s economy no longer relevant to be seen as benchmark.

Countries such as China, India, Vietnam, and Indonesia look more powerful than ever. China, particularly, managed to reach a double-digit economic growth in 2010 and overtook Japan as the second-largest economy in the world. If China’s trend continues, it is even predicted that in 20 or 30 years time United States’s position as the world’s largest economy could be in peril.

And such stellar achievement does not go unnoticed: China’s growing force in its economy has left many western leaders –who have always had histories of looking down to their Asian counterparts– to put more strict attention on the country.

United States now deemed China as an important player in global stage. Hu Jintao’s diplomatic visit to United States in January 2011, for example, was met with more coverage from the United States media than ever.

What exactly is the major factor behind China’s rise today? Of all the far-sighted tactics and strategies of Chinese leaders, economists, and policymakers that have bolstered China’s economy until present; how Chinese central bankers peg the renminbi and keep the currency low has always been considered as China’s most brilliant –and controversial– economic gambit.

Currency devaluation leads to what some economic analysts call as unfair advantage for China. They claim that China is allegedly controlling its renminbi in its own favor at the expense of other countries’ economies, as the downpour of Chinese goods today is increasing their import numbers as well as hurting their domestic industries.

Of course, China’s strategy in keeping its currency low does not matter in the past when Chinese goods only held a small fraction of the world’s economy.

But in a situation like today when Chinese goods could be found in almost every corners in the world, it prompts massive headache for many policymakers in many countries: Citizens are becoming more dependent to Chinese goods, and thus many countries see a massive surge in import in that leads to trade deficit in their balance book.

Is China really the evil here? Criticisms regarding China’s international economics policy could be heard mostly from Americans: Both US President Barack Obama and his Treasury Secretary Tim Geithner has repeatedly launched searing attacks against China’s undervalued currency, while Nobel prize-winning economist Paul Krugman even described China as ‘bad guy in currency war who is to blame for the currency tensions as the cheap renminbi is contributing to global trade inbalances’.

This renders complicated problems for economic policymakers in many countries that import goods from China, especially United States, simply because their domestic industries could not compete with cheaper Chinese goods that are more preferable among the customers.

What deteriorates the problem is today many Chinese goods come in the same quality as American, therefore pushing some western goods in the sidelines, with almost no competitive advantage against exported goods from China.

In addition to hurting many countries’ domestic industries, the maelstrom of imported Chinese goods causes many countries to run deficits in their trade balances, as their import exceed exports number. It is reasonable if many world leaders massively denounce China’s act of depreciating the renminbi far beyond its real value, as this is simply not the right time for China to become so inconsiderate.

The world is still recuperating from the United States financial crisis in 2008; arguably one of the worst economic crises the world has ever seen. In fact, today not all countries have returned to their pre-crisis economic growth, yet China seemingly acts as the real villain whose undervalued currency and massive export numbers are causing global trade imbalances and rendering trade deficits among its trade partners.

But apparently, the argument of deeming China as the real evil here is a little bit too unfair.

The first question we ought to ask is: Why does China, after all the sweltering attacks from various countries, keep insisting in maintaining the renminbi undervalued? While many countries blast China’s acts as immoral during these tough times, it’s difficult to judge their actions as wrong or against the law however.

Keeping an eye on currency’s valuation is necessary if a country’s economy depends very much on its export industry; which is precisely the situation that China is currently in. China’s economy depends much on its export industry –so much that it was reported that in 2007 export in China accounts at a staggering level of US$ 1.22 trillion, or close to 40% of its total GDP.

China’s exports also shows a striking development, as China’s export alone have grown at 25% annual rate in the last decade, over the twice of growth of China’s GDP.

An economy that depends on export sector like China means its citizens also depend on the export industry –or mostly employed in factories or companies that focus on exporting items abroad. For China, it means that adjusting policies regarding its export industry –such as letting the renminbi afloat– is the same as playing with the fates of the Chinese citizens.

It is clear that by devaluating the renminbi, China is trying to make jobs and save its own citizens. For example, a research shows that total employment in China significantly increased by 7.5 million per year over 1997-2005, with export growth contributed at most 2.5 million jobs per year. The researchers also concluded that exports have become ‘increasingly important’ in stimulating employment in China.

Chinese policymakers, after all, are just doing what they have to do: Implement the best policy for their own citizens.

Of course, it is not to say that what China has done is morally justified in this post-crisis period; but it is also unfair to put a verdict that what Chinese policymakers have been doing is completely wrong. Today, the soaring economic growth of China has successfully dragged millions of Chinese out of poverty, and policymakers in China are merely implementing a policy to support its export sector, which provides jobs for million of Chinese and makes them better off.

Yet an economic superpower like United States is acting like a street beggar these days, pleading Chinese policymakers to pity them and help the country to overcome its massive trade deficit.

Why United States is acting so shameful like that goes beyond my comprehension. Well, China’s response regarding this US-China currency fallout is predictable, and it is represented at its best by the words from Yu Jianhua, a Director at China’s Ministry of Commerce, who said:

“Don’t make other people take the medicine for your disease.”

It's the Global Economy, Stupid

PUBLIC ENEMY. Barack Obama might not be popular during the G-20 summit following the decision of The Federal Reserve to pump US$ 600 billion to the US economy; a policy which will weaken the US dollar and propel more hot money inflows, inflation, and asset bubbles to the developing world.

As the United States President, Mr. Barack Obama surely has too many thoughts in his mind, doesn’t he?

The major overhaul in US healthcare system reflected Obama’s responsiveness in domestic policies and fulfilled his campaign promise, while the way he handled the British Petroleum fiasco in Gulf of Mexico indeed had satisfied the environmentalists.

In foreign policy matters there’s an urgent need to embrace the Muslim world after George W. Bush responded the 9/11 attack with waging wars here and there. The relationship has never been bitter: In Iraq, the US enraged many Muslim communities by demolishing the country because of the Weapon of Mass Destruction that never exists. In Afghanistan people still cry for more American troops to be deployed, arguing it is the US’s responsibility to fix the chaos that Bush once initiated.

But it seems Obama’s mind is being crammed with too many foreign issues that the US has to deal with –and the economy is not being put as his major precedence. Perhaps we could recall one of the most famous remarks in the history of United States politics, which was coined by Bill Clinton during the 1992 presidential campaign against George H. W. Bush.

That phase of Clinton’s emphasized the need to put economic issues as the most important priority among others. As Bush at that time gained fame among his voters because of his foreign policy developments, Bill Clinton, impressively, become the eventual winner the election thanks to his audacious –and effectual– campaign slogan: It’s the economy, stupid.

That’s what Obama should know, because the dreadful economy at present is definitely the reason why his Democratic party conceded a defeat against the Republican recently. Obama’s report card in the economy is a complete mess: In US currently unemployment rate soars higher than ever, and the multi-trillion dollar bailout is not actually effective to fix the situation or jumpstart the domestic economy either.

Also, Americans are not too interested with the revamp on regulations of Wall Street, as they urge Obama to put more attention to the jobless people who desperately look for dollars to feed their family on Main Street.

While Obama is not popular home, The Federal Reserve’s decision to boost the US economy by purchasing treasury bonds worth of US$ 600 billion and keep the interest rates at a historically low level may make him a more unpopular figure overseas.

Yes, Obama may be welcomed with ecstasy by Indonesians as he gave his speech in fully-packed hall of University of Indonesia’s. But surely unhappy leaders of G20 economies would not be that kind to shake his hand with such warmth as the Indonesians did –and they surely greeted him with sinister smiles on their faces knowing what the US had done to the global economy.

The US is the major perpetrator behind the recent currency wars, depreciating its dollar in order to make its exported goods more competitive abroad, as well as continually keeping its interest rates low to boost its economy. As if the historically low interest rates are not enough to cultivate hot money inflow and prompt headache among developing countries, now The Fed is looking to print US$ 600 billion more to the economy –a move that will surely increase the US dollar supply in the market, press the US dollar to depreciate further, and ultimately bring the new chapter of currency wars.

The United States is playing dangerous game here in implementing such self-centered policies like those because the consequences of the policy are likely to put the stability of global economy at bay. Depreciation in US dollar currently leads to a considerable corrosion in many countries trade balances, while a near-zero interest rate already stimulates a significant surge in capital inflow among developing countries.

And regarding the US$ 600 billion injection to the US economy: Is this a trade protectionism in disguise? Weaker dollar will eventually make US goods more competitive abroad; stabbing many US trade partners in the process. Countries around the world would not be so happy with this. “You blame me as the global economy’s hitman and now look what you’ve done,” says China.

Does Obama really need to come to G20 meeting anyway? While the global economy is still recovering from an economic mess which the US started, the G20 economy members are supposed to implement integrated and joint efforts to fix the global economy together, not the other way around.

Yes, the G20 group should work in cooperation; and that’s why it was formed at the first place. But now such commitment is in question because currently the group’s de-facto leader seems to be more interested in pursuing egotistic policies to save the his economy alone, not the world.

380 Billion Dollar vs. 13000 Billion Dollar

If 380 billion dollar debt burden could smash Greece's economy into pieces, then will the United States -with 13 trillion dollar debt under its belt- share the same fate in the future?

Barack Obama could not sleep tight these days. The words of one of his economic advisers echo in his mind as he puts his head on his spongy pillow at night, “Alarming news, Mr. President: unemployment rate still relatively high, the threat of deflation still persists, and our economic recovery in overall is limping slowly in the path where China is running riot.”

That economic adviser pauses a while and finish his round of words with a massive blow, “I know that you have spent lots of money these days –but we really need to spend more.”

Spend more? Add more debts? Deep inside Obama’s heart he is surely yearning for the end of massive spending. He knows it, the Americans know it: it’s too much budget deficit already these days and the US debt has gone to a lethal number.

What a doom that Obama inherits. Bill Clinton may have long-sufferingly amassed the money in the mid 1990s, but two Texas cowboys with 'Bush' pedigree splurged it wildly –so wild that if there is anything left for Obama, the massive debt from Bush’s previous fondness of wars is all he’s got.

In Greece, the consequence of piling up debt proved to be fatal. And if even mercurial Gods in Olympus were unable to thwart the crisis; then should anyone remind the mortal Obama that this could be the right moment to stop spending and cut the budget deficit?

No, he should not and will not stop spending. During these hard times, flatlined economy like US need government spending more than anything else to galvanize the economy until it is completely back on the right track –even if that means lots of money poured in to the market with 13 trillion debt daunting behind as the consequences.

Hence if you are embroiled in a financial crisis where the threat of recession or depression is imminent, spending money or running a budget deficit policy is absolute necessity.

After all, maybe one should stop calling US as a liberal and lassez-faire nation from now on, as it is walking the path where the principles of free market and invisible hand are forgotten, and government intervention –such as government spending– matters more than ever.

Here are several lessons we can draw from Greece’s case-in-study and its discrepancy to US. First and foremost, comparing the 380 billion dollar Greece’s debt and 13 trillion dollar debt of the US is somewhat misleading. The United States may possess 40 times bigger debt than Greece, but you simply cannot compare the economy of superpower like US and what they have in Greece. The economy of US is big, and so big that you can have ten countries like Greece combined and in you will still have a smaller economy than the US.

Second, during the last few years Greece is like a zombie waiting his name to be called by angel of death; in 2010 its debt stood at the highest level of 113% of its own GDP and thus it was no surprise when it eventually went bankrupt. But United States is not a dead man walking –at least not yet. Even though its current debt is tenfold compared to Greece’s, that 13-trillion-debt is actually ‘still’ around 90% of its GDP and at least Barack Obama can still breathe for several years before its GDP-to-debt ratio indicator flashes red.

And the third party to blame for Greece’s crisis is Euro. Because of the single currency policy, which Greece shared with other 15 European countries, the country did not have the independency of its economic policies and could not implement essential monetary actions to jolt its economy during the turmoil. The US dollar, by contrast, is a widely accepted currency around the world and becomes an enormous advantage for US who prints it.

Yet no matter how different the US to Greece at the moment; debt is still debt. The bigger your debt is, the higher the interest you will have to pay in the future; which literally means more and more burden your child and grandchild will share. It very much resembles nurturing a time bomb whose blast is just in the offing.

Obama’s spending spree is likely to continue as major solution to salvage the economy. But the question is: how long can he pour the money before the pump eventually runs dry?

It’s 93% of GDP-to-debt ratio which United States has at the moment. The future looks bleak for the Chicago kid.

Indonesia's Capital Inflow and the Downside Risks that Follow

WARNING SIGNS. Soaring stock prices and rising Rupiah are outwitting you now; in fact an economic bubble is stealthy lurking behind the shadows because of the overcrowding capital inflows which have flooded Indonesia in recent weeks.

You are simply not a savvy foreign investor if, given current global economic situation, you overlook Indonesia as a place to invest your money.

Back then you used to have well-developed and industrialized countries in the table as your priority to invest because they, in reality, tended to be more secure compared to developing countries.

But while United States economic recovery is still beset with various obscurities, and European’s economic stability is disrupted by the debt-troubled PIGS economies (Portugal, Ireland / Italy, Greece, Spain), currently you may want to wait a little longer before you can be finally sure to invest your money there again.

This is the moment when you should start to notice that in the east, several Asian emerging economies can be considered as less risky places to invest as they are trouble-free and actually withstand the global financial crisis better than developed economies.

Indonesia is one of those economies, recording an impressive 4.5% economic growth during the crisis and has seen significant upgrading in its investment grade rating because of its imposing economic performance.

Besides, its economy is bolstered with political stability, violence-free democracy, and huge domestic market. In the midst of the financial storm which has left most economic frameworks in the world shattered, what Indonesia’s economy boasts in its disposal would surely make you and your fellow investor friends to turn heads.

Indeed, money is flowing in. The rise of demand for one country’s investments theoretically would lead to a higher demand for the currency of the country itself, and the unusually strong Rupiah these days, which surges to 30-month-high level to almost Rp. 9,000 per US Dollar, is a clear reflection of the rising number of foreign investors who have crammed the Indonesia’s market.

The problem is: when someone has too much money in his hands, sometimes it will engender more convoluted quandaries than he previously expects.

While many will perceive the improvement of Indonesia’s image in the eyes of the foreign investors is a good thing for Indonesia, actually policymakers should be wary about the long-run corollaries that can possibly occur when Indonesia is inundated with too much capital inflows.

The most important thing to bear in mind is that the stronger-than-ever Rupiah at the moment, unfortunately, may not make all Indonesians better-off.

For instance, just ask Indonesian exporters who surely have been monitoring the rapid rise of Rupiah in recent weeks with deep anxiety.

In fact, the too-strong Rupiah –whose rate moves in an unpredictable fashion, appreciating swiftly in such a short-period like what we have seen in recent weeks– will be a huge blow for them as Indonesian goods will be more expensive overseas and could eventually damage Indonesia’s exports as a whole.

Yet because of the excess amount of capital outflows, another problem like inflationary pressure is also lurking behind the shadow.

Too much capital inflow can stimulate a considerable rise in money supply and, eventually, inflation. The government could welcome capital inflow to the country, but if inflation’s presence on the economy goes unnoticed and largely ignored, inflation could nibble our economic growth and disrupt our economic development.

If it is already too little and too late and the inflation has soared, Paul Volcker, the former Federal Reserve chair, can be asked about how hard and costly it was he tried to trim down the inflation rate during his tenure.

In addition to the spat over the unusually strong Rupiah and the looming threat of inflation, it is also worth noting that the increasing demand for Indonesia’s investment has lead to yet another problem: the current swell of the price for Indonesian shares and assets to such abnormally level, which emerges concern whether an economic bubble is just around the corner.

For many economists, the most feared weapon that an economic bubble possesses inside its arsenal is its ability to swell and burst almost any time and in such an impulsive way –and very often when it truly bursts, it generates a devastating repercussion. The burst of the housing bubble in the mid-2008 in the United States, in fact, was deemed by many as the key trigger to the worst financial crisis that Americans have ever seen in almost a century.

And economists hate to deal with economic bubble very much: knowing the fact that the term that economists keen to pay heed the most is always ‘stability’; economic bubble, in contrast, has always been notorious for its ‘volatility’.

Economic bubble can possibly emerge because of the fact that the largest share of Indonesia’s massive capital inflow these days, unfortunately, is dominated by short-term investment or hot money.

It is an ‘easy-come, easy-go’ investment: when those investors with their hot-money find more attractive countries to invest, they will simply cash in their chips, pulling their investments out from Indonesia which will cause the once-soaring price of investments and assets to freefall all of a sudden.

With such ominous threat from the burst of the investments and assets bubble, economists’ fear about Indonesia’s excessive number of capital inflows is indeed understandable.

Some may rejoice current news about the massive number of new investors which deluge the country, the insurgence of Rupiah, or the soaring stocks prices in recent weeks; but when we look through the other side of the prism, they actually also leave economists and policymakers in conundrum.

This is basically because failing to solve this excessive capital inflows problem in the short-run may likely lead to bigger problems in the economy, which will require a higher sterilization costs in the future and impede the long-term plan of Indonesia’s economic expansion.

What seems to be a good thing, in actual fact, can also mean exactly the opposite –just like the dilemma faced by Indonesia because of its excessive amount of capital inflows which is seemingly good for Indonesia’s economy, but in actual fact hides perilous threats underneath.

This article was published in The Jakarta Post on Tuesday, April 27 2010

Bank Century Bailout: a Necessity or Not?

PUT THE MONEY IN. Feared by the likelihood of a systemic failure caused by Bank Century's bankruptcy, the government sparked controversy by injecting a massive amount of US$ 670 million bailout money into the bank to thwart it from collapsing.

When US Congress passed Hank Paulson‘s US$ 800 billion bailout bill in October 2008 to prevent the economy from slumping any further, several US citizens’ initial response was very much the treasury chief had expected, “Are you nuts? We’re the taxpayers and that’s the money we’ve been paying to you for years. Now you just hand over that massive amount to those Wall Street financial institutions?”

But as US treasury chief, surely Mr. Paulson was smarter than the average US taxpayers and knew that the money was put in good use. Shaded with the trauma of the Great Depression of 1929, where many banks in United States went bust that lead to the severest economic downturn the world has ever witnessed, he did numerous efforts to prevent the history from repeating itself –and as an economist, he definitely knows that the bailout plan was one of the most compulsory endeavors.

Yet he was not mistaken and now look at how his bailout plan swerved United States from encountering what they have had in 1929. It may be too soon to conclude that the bailout plan has succeed, but without doubt the US treasury under Paulson performed really well in handling the 2008 financial crisis and deserved a better score than their compatriots in 1929.

And thanks to the bailout now the dust has settled –while the US economy in the Great Depression took about 10 years to fully recover, the US economy (now headed by the new treasury secretary Tim Geithner) starts to show several encouraging signs of recovery at the moment and many economists believe it won’t take that long for the whole nation to finally convalesce.

Funny, here in Indonesia we are dealing with a similar situation. Many people are in disagreement regarding the $670 million Bank Century bailout and argue that it would be better if such amount of money is allocated in other sectors.

For many Keynesians economists, who are educated in throwing money during bad times through aggressive spending to prevent the economy from dreadful downward spiral, an insolvent bank’s bailout is among the list of where the money should be thrown.

There is no doubt that if we do not want to be bumped into another financial fiasco, we should be all Keynesians by now. And basically in Keynesian economics throwing bailout money in this kind of circumstance proved to be necessary –in other words, if government really wants to prevent a systemic failure, giving bailout for an insolvent bank whose collapse can severely damage the economy is never a question.

And this left people in Indonesia treasury in a tight spot; if they don’t lend Bank Century that huge amount of money and let the bank fold, the domino effect from the collapse will be immense and will bring other 23 banks into bankruptcy as well and trigger the crisis of confidence among the market–and eventually the impact for Indonesia’s economy will definitely be much bigger than only $670 million money which the treasury proposed to bail the bank out.

As our economy is performing really well at the moment and various economic indicators signify a brighter future for this country, we cannot allow the havoc to happen and surely we don’t want to return again to the gloom that we experienced during the 1998 financial crisis.

Here in economics we face trade-off; when things don’t work according to the original plan, sometimes you have to sacrifice something in order to achieve a more desired ending.

It is hard being government officials like Sri Mulyani and Hank Paulson these days; things don’t really work according to their plans as a catastrophe named global financial crisis has hit many countries really hard and put many treasury chiefs, including them, in the eye of the storm.

It never rains but it pours for our treasury chief; in her attempt to fix the situation, political dispute regarding the bailout proposal is rising. People question whether there is a political background behind the plan or not and do not believe that such massive amount of bailout is really necessary.

But instead of wrangling over the political dispute of the bailout ahead of the necessity of the bailout to the economy itself, we should realize that Sri Mulyani is the one who raised Indonesia as the unlikely winner in this global financial crisis as she helped Indonesia to record a positive 4% economic growth amid the current turmoil.

She has proven to us that she has the capacity to usher us through the storm, so by putting the $670 million Bank Century bailout proposal forward, certainly she is not that dumb to throw her entire hard work to waste and put Indonesia’s economy at stake by prioritizing few politicians’ self interest above the country’s.

Or if you were her, would you do that with the risk of losing all of your flawless credibility and previous achievements as treasury secretary?

If your answer is negative, then it should clean your mind regarding whether there is a political motive or not behind the bailout plan as well as unfolding the importance of the money for her to rescue the economy and keep it firmly on the right track.

Appointed as a treasury secretary, in economics undeniably Sri Mulyani is smarter than the average of us and comprehends the problem better than we do –and she will not bet that huge amount of money if she thinks it is not really necessary.

Hence let’s halt this hassle and simply put our faith in her like what the Americans did to Hank Paulson. Still have doubts about the money’s huge amount? Think in the long-run and consider it as a trade-off for saving more in the future.

This article was published in The Jakarta Post on Wednesday, September 9 2009

The Wall Street's Catastrophe

STRESSED UP. The crash of Wall Street mounts pressure on United States Treasury Secretary Hank Paulson, as he faces challange to get rid of what is dubbed as one of the greatest economic disasters ever happens in United States

The New York Wall Street, as is recognized as the most prominent stock market worldwide in which stock markets like NASDAQ and Dow Jones reside, is in turmoil. It is, in fact, the main pointer of all stock markets as well as financial systems all over the world. Now analyze this: September 30, 2008 Wall Street was hammered when the Dow industrial average index fell 778 points –a record for one-day decline. Then, the record was surpassed a week later, it fell 800 points, leaving investors, bankers, and economists conjecture, “How dire this crisis will turn out to be?”

This financial meltdown comes out of the blue, unforeseen, and highly unexpected. When Alan Greenspan left his post as the Federal Reserve’s chairman in 2006, at that time no one would ever believe that what awaited his next successor is this huge economic mess, with great responsibility to fix it. During Greenspan’s period in office, for years United States experienced terrific times on its economy like a relatively low inflation rate, boosting house prices, escalating firms’ profit, and so forth. But suddenly, coming out from nowhere, here goes the downturn.

And so emerged his heir, Ben Bernanke, to whom many people throw these words at present, “Wrong time to be a governor of The Fed, Sir”, the words that may also resound in a similar way within the mind of Henry M. Paulson Jr., an ex Goldman Sachs’s CEO who took the chair of US Treasury Secretary in 2006. Both Bernanke and Paulson share the same task: they did not shatter the economic framework, but they have to mend it nevertheless.

The words that were delivered by Mark Gertler, a New York University economist, regarding current financial crisis in United States are absolutely terrifying: This is the worst financial crisis since the Great Depression, no doubt about it. As we recall the Great Depression of 1929, it is no exaggeration to say that those times are the nastiest of all economic breakdowns ever happened in any part of the world, where many banks in United States collapsed and then followed by the crash on the world’s stock markets. As a matter of fact, what we experience today look a lot like it. Currently we are witnessing the event that will be remembered by next generation’s economists and written in all economic textbooks; the story about how United States blew its economy up and failed to save its citizens from the outburst.

The derivations: what rocks Wall Street, and why it happens

The saga started with the bankruptcy of Bear Sterns, followed by Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae), then the story reached its climax; the collapse of Lehman Brothers. As is well-known, Bear Sterns is the fifth biggest investment bank in United States, Freddie Mac and Fannie Mae are huge financial companies working on mortgage-lending business, and Lehman Brothers is the foremost among them: the nation’s fourth-biggest financial institutions with over 25,000 employees and the sum of its assets calculated more than US$ 600 billion.

In the Wall Street, there are several renowned financial institutions that are considered as big players on the floor, whose stocks are traded at towering price because of their reputation and eminence. When we mention names like Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Sterns, we are talking about quality and excellence they have built through long-time affiliation with their clients. These financial institutions became a dream workplace for students in famous business school like Harvard or Wharton –before this disaster happens.

And there is this word: sub-prime mortgage, the nucleus of all of these problems. In reality, there are two types of mortgage. The first one is prime mortgage, credit given to large firms and institutions which usually use it as source of capital. A prime mortgage tends to have low risks; the lenders will likely be able to fulfill the obligation to return the money and the debt has small possibility of being unpaid. The second one –well, this word is getting famous nowadays–, is the sub-prime mortgage, the one that banks give to people in common or small businesses. It is defined easy, suppose you go to the bank to borrow some money, then the money that the bank gives you is the sub-prime. Of course, because we, as normal people, borrow money because we urgently need it, we will not do careful calculations and estimations –as large firms and institutions do when they borrow money– regarding can we really return the money we borrow. Even sometimes, because of pressing circumstances, we just borrow the money and speculate on our ability to return it. So if banks know that sub-prime mortgage tends to have high risk, then why give people sub-prime instead of prime mortgage? And how does this simple problem emerge chaos in one big financial system like United States’?

The Financial Accelerator Model is the answer of the question number one. This theory argues that financial condition and credit condition largely interrelated with economy, and both sides support each other. In fact, the condition of these three variables could be the main factors to generate economic booms, or conversely, economic failures. Economic booms cause firms and family units have higher income –and higher value of their assets as well. With higher value of assets, banks will likely be more generous to lending credits to them. Easy lending promotes easier lending requirements, therefore, produces more money to the market and accelerates economic growth, vice versa. However, the sub-prime mortgage controls the market for money lending, and most of the demand for credits given by the banks is usually on the type of sub-prime, very few is prime mortgage. That's why sub-prime mortgage holds an important role in the economy. It is, in fact, a fundamental variable in one country’s economy.

Laissez-Faire is the answer of the question number two. Yesterdays, there was too much freedom given to Americans who want to borrow money from banks. No collateral, no need to guarantee, and no further supervision to the borrower; it was even said that an American who borrow the money and had not returned it for years got no words of warning from the bank at all. As a result, Americans felt free to borrow money as the requirements from banks made borrowings seem easy. Also, United States is a liberal country which supports the invisible hand ideology; the less government intervenes, the better financial system and economy works. But, here is the correction. If truth be told, that lack of supervisions and regulations has actually worsened the situation. That Laissez-Faire thing has emerged greed among the market –financial institutions work as they please as there is no regulation to prevent them to do so.

Here is how greed is defined. Imagine yourself as Richard Fuld, a failed CEO of Lehman Brothers, a bank that works on mortgage and credit lending business. During period 2001-2005, United States experienced a bubble in housing market, where demand for houses largely increased that caused the price to accelerate. As we normal people assume that house price will continue to go up and up and never plunge, then there goes the bandwagon effect; investing money in house will become trend among American people and creates a larger boom in house demand. So as the demand for houses increased, so does the credit and the mortgage –people ran to the banks to get credit to buy houses. Therefore, the demand for credit –the subprime– also increased. The demand for credit boosted significantly, but unfortunately, Lehman Brothers do not have enough money to supply the credit’s demand. What would you do as a CEO?

In actual fact, Richard Fuld is a very ambitious person. What he did as Lehman’s CEO was he tried to match the credit’s demand by piling up debt; he continued to borrow and borrow money and made sure that Lehman was still able to supply the money into the market. Well, huge investment? Wrong. It was one hell of a risky business. Soon as the housing bubble burst and house price fall, Lehman Brothers took a punishment because of its greediness: it went broke. Lehman could not recover most of its assets because many borrowers found that their houses were worth far less than their mortgages, thus, they could not afford to reimburse the credit.

The illustration for the derivations of this financial crisis can also be described in a more simple way. It began with the housing bubble. Second, the housing bubble led to a massive increase in credit –the sub-prime mortgage– demand. Then due to the increase in sub-prime mortgage demand, financial institutions burdened themselves; they piled up their debts by borrowing before lending it again for the sub-prime borrowers who used the credit to buy houses. When the housing bubble burst, the house price fell, and many borrowers were not able to pay back the money, those financial institutions took the upshot: they got busted. And that’s the way it is done.

The present time: daunted by the domino

The fall of Lehman Brothers is not the last part of the story and it is important to study its collapse to analyze the roots of the crisis, as well as the forthcoming effects in the future. In fact, the repercussion of Lehman’s fall is still there and even broadens; many financial institutions also went bust, and it encompasses names like American International Group (AIG) and Merrill Lynch. Those names are recognized as giant financial institutions in United States whose stocks conquer Wall Street, and the tumbling of the giants, which previously seems impossible, gives signal to the world that United States’ economy is in a real hazard.

In extraordinary circumstances, a central bank can act as the lender of the last resort, which is lending money -a bailout- to insolvent banks or financial institutions, if it thinks such action is necessary. That is what United States’ central bank, the Federal Reserve, did to Bear Sterns, Freddie Mac, and Fannie Mae; the Fed lend them some money so they can avoid bankruptcy. Unfortunate for Lehman Brothers, it is a different story since the Fed has made an absolutely clear statement: there will be no bailout this time.

Why no bailout? “Too many bailouts”, said the Fed. After the bailouts on Bear Sterns, Freddie Mac, and Fannie Mae, the fed thinks that giving bailouts over and over again will affect the morale of financial institutions in United States. If it gives bailout so easily, concerns are mounting regarding the morale hazard effect; other big financial institutions will go bankrupt effortlessly knowing the Fed will give them bailouts if they go bust. The Fed also forecasted that the effect of the Lehman’s bankruptcy would not be noteworthy for United States, since most of the Lehman’s creditors come from Asia and comprise only a small number of American creditors.

It seems mistaken, yet the Fed changes its mind. After Lehman Brothers had failed, the debacle went to the next level; an insurance giant named American International Group (AIG) followed Lehman Brothers and went broke. Worried by the huge impact of the collapse of AIG, the Fed saved AIG and decided to give bailout once more to repress greater damage to the economy. End of the story? Far from it, then there is Merrill Lynch which went broke and had to be sold to Bank of America –thanks to Merrill’s CEO John Thain who succeeded the deal right before it were about to tumble. The collapse of AIG and Merrill Lynch may not be the last to bring the crisis to an end, as United States’ preeminent banks like Goldman Sachs and Morgan Stanley wait in the line to be the next cadavers.

What will the future be without Lehman? Lehman’s fall, undoubtedly, has established the crisis of confidence in the economy. Confidence is the engine of the financial system; investors and banks work together since they trust each other –they believe the cooperation will offer symbiosis that benefits both of them. Meanwhile, Lehman Brothers is a huge investment bank with 158 years of history, an impossible-to-fail bank; even the Great Depression of 1929 could not take it down. Letting Lehman Brothers to fail is a bold gamble by US Secretary Treasury Hank Paulson, risky bet as well, because the domino effect of the collapse of Lehman Brothers –that crisis of confidence– is so high that they affect financial sector not only in the United States, but also many countries all over the world.

The fall of a huge bank like Lehman Brothers makes people believe that “the economy is in crisis”. Therefore, it establishes huge concerns among investors and bankers; causing market’s confidence to fade and people to lost trust to the economy. People pull their money out from banks’ vaults and banks all over the world hold themselves to give credits. As a result, it impedes capital flow in the market; forcing many central banks like Bank of England and European Central Bank to inject short-term liquidity funds. Keep in mind, credit is the grease of the economy on which businesses and firms rely as their source of capital. A contraction of credit leads to a lack of capital in the market, a lack of capital causes a slowdown in economic growth, and finally, an economic slowdown guides the economy towards a recession. Also, due to the volatility of the global economy caused by the collapse of one huge bank like Lehman Brothers, investors are on a hostile and risky environment to invest their money or run business. Concerning that situation, many investors decide to withdraw or delay their investments. Things like these are the domino effects of the fall of Lehman and, regrettably, have caused more upset in the global economy.

The worse is yet to appear. For Americans, the situation is getting really dreadful currently as the domino effect enlarges and has taken financial institutions like Merrill Lynch, AIG, Washington Mutual, and Wachovia into the same part as Lehman’s. People, however, have sunk deeply in this crisis of confidence. Yet despite the US government has tried to tranquilize this situation by delivering a US$ 700 billion rescue package into the financial system, doubts still arise whether the bailout will succeed or not. Yes, it seems that Americans’ confidence has plunged to the lowest level –and that is not an easy problem to crack.

One question remains left unanswered. So, how dire this crisis will turn out to be? Truthfully, it is still unknown how deep the global economy will sink. Let’s be optimistic: people there at the Fed and Treasury, who are nothing but smart, are doing whatever they can to prevent the US economy –and the global economy as well– from plummeting any further. Instead, the right thing to ask now is, what can be learned from this crisis? Here in economics, we do study the history; we analyze cases like the post-world war hyperinflation in Germany, the great depression of 1929 in United States, the Asia’s financial crisis in 1998, and so on. Indeed, this financial crisis turns a new page in the history of economy, and presents a lesson to be learned.