Economics 2008: 10 lessons

Economics 2008: 10 lessons
What a tumultuous year it has been for economics. The 'dismal science' has not seen such a 12-month period before - the year started on a boom and is ending with theories overturned, conventions abandoned and economies worldwide simultaneously falling into recession. Fiona Chan recaps the top 10 economic trends in a year where uncertainty has been the only constant



-- PHOTO: REUTERS
1 Inflation, deflation and stagflation
BEFORE the financial crisis exploded in September, inflation was set to be the year's biggest economic story.

As fuel and food costs skyrocketed, consumer prices soared to record highs around the region, including in Japan, South Korea, Thailand and Indonesia.

In Singapore, inflation hit a 26-year high of 7.5 per cent in April and May, partly due to the rise in the Goods and Services Tax over the previous year. In response, the Monetary Authority of Singapore (MAS) gave the Singapore dollar an immediate boost to help offset more expensive imported goods.

But the spectre of recession was looming ever closer, prompting predictions of the dreaded stagflation: low economic growth coupled with high inflation.

Then the financial crisis arrived, jamming the brakes on consumption in developed nations, export demand and oil prices. Inflation worries transformed into warnings of deflation as asset prices started to plummet.

The MAS reversed its Singdollar position in October, adopting a neutral stance that signalled its change of priorities from targeting inflation to stimulating economic growth. Inflation here is now expected to dive to between 1 and 2 per cent next year, after clocking in at 6.7 per cent in the first 11 months of this year.

But while deflation seems likely in the near term, economists warn of higher inflation in the middle term due to massive government spending and the need to aggressively boost money supply in the face of tighter bank lending. This, in turn, could end up in stagflation if the downturn proves prolonged.

Only one thing is definite: we have not seen the end of the inflation story yet.

2 Oil: What goes up must come down

OIL prices dominated headlines for much of the year, whether they were shooting up to a record US$147 per barrel in July or crashing to below US$34 just two weeks ago.

In the first half of the year, high demand from India and China, combined with rampant speculation, pushed up prices, which peaked at the height of tensions between Iran and the West. Predictions of oil at US$200 a barrel seemed feasible - until the market turmoil in September caused prices to plunge.

Recent moves by the Organisation of Petroleum Exporting Countries to cut supply appear to have had little effect on falling prices, reflecting the extent of uncertainty in the market and the bleak outlook for global growth next year.

Other commodities also had a roller- coaster ride this year.

Gold, however, breached US$1,000 per troy ounce in March and stayed high through the year as risk-averse investors literally poured their money into gilt assets.

3 Nationalisation and bailouts

DECADES of privatisation and lobbying for the liberalisation of markets came to a dramatic end this year as banking titans and giant companies, tottering on the verge of collapse from the unravelling web of bad mortgage loans, went hat in hand to governments for assistance.

Bankers that turned beggars included Wall Street's five hallowed investment banks: Bear Stearns was subsumed by JPMorgan Chase in March, Lehman Brothers collapsed in September, Merrill Lynch sold itself to Bank of America, and Morgan Stanley and Goldman Sachs transformed themselves into traditional bank holding companies.

More buyouts, bailouts and mergers were cobbled together as huge organisations such as insurer AIG, mortgage behemoths Fannie Mae and Freddie Mac and savings and loan company Washington Mutual hovered at the cliff's edge.

After an intense round of political jockeying, the United States unveiled a US$700 billion (S$1 trillion) bailout plan in late September. Britain followed about a week later with a £500 billion (S$1 trillion) bank rescue package, while European nations also acted together to save their banks.

The auto industry is the latest to jump on the bailout bandwagon, sparking an uproar over how much government help is too much. General Motors and Chrysler have obtained more than US$13 billion in US taxpayer funds to stay in business after they warned earlier this month that they would run out of cash in a matter of weeks.

4 Zero interest rates

SINCE October, central banks have been cutting interest rates in a bid to encourage borrowing and spending.

None have been more aggressive than the US Federal Reserve, which has cut its rate by 325 basis points since January. It used up its last interest rate bullet earlier than expected when it slashed rates two weeks ago to between zero and 0.25 per cent, an unprecedented level.

Having exhausted its main ammunition with little effect on the economy, the Fed must now turn to more creative and drastic measures, such as quantitative easing, to spur confidence and jumpstart growth.

5 Quantitative easing

IF YOU had to choose just one economic catchphrase to take into next year, this would be a good one.

This extreme policy of printing money and force feeding it into the system is adopted by governments only after traditional tools have been used up - for instance, when interest rates are already lowered to zero and cannot go further.

The Bank of Japan adopted this measure in the early 2000s during the country's battle with deflation. It flooded banks with money by buying government and commercial securities and avoided a liquidity crunch.

The US Federal Reserve appears to be going down a similar path. It is extending credit to banks through a wide array of facilities, providing them with more liquidity than they need with the aim of increasing money supply.

The Fed hopes this will boost confidence in the banks, encourage lending and economic activity, and even lift inflation, preventing a deflationary spiral.

6 Fiscal stimulus and the revival of Keynes

AS INTEREST rates reach new lows and the outlook worsens, governments around the world have taken a leaf out of the book of famed economist John Maynard Keynes and rolled out aggressive spending plans to keep their economies going as consumers cut back.

The US has taken the lead, with President-elect Barack Obama planning a stimulus package that could reach US$1 trillion. Europe has announced a ¥200 billion (S$411 billion) spending scheme, while China, Japan, South Korea and Canada have also unveiled stimulus plans in recent weeks.

Singapore has offered S$2.3 billion in loan and credit facilities for companies and S$600 million to retrain workers. The Government has also indicated that it will bring back some of the S$4.7 billion construction projects it deferred over the past year.

But the biggest fiscal boost is expected in next month's Budget, where individuals, households and companies are likely to get help to survive the downturn.

7 Decoupling debunked

PERHAPS the biggest economic myth to be demolished this year was the assertion that emerging economies in Asia and Europe had sufficient steam of their own to continue growing even when the US was in a recession.

Until June, economists were still arguing in favour of decoupling, pointing to China's continued strong economic growth as evidence that the region was insulated from Western problems.

But the credit crunch finally put paid to that theory, as the US proved once again that it has the capacity to throw a spanner into the works of the world economy.

The synchronised economic slowdown since then has illustrated how dependent emerging economies still are on export demand, a trend that is unlikely to disappear for as long as trade flourishes.

8 Bank deposit guarantees

SOME economists say the one thing that kept this year's recession from spiralling into the Great Depression 2.0 was the absence of bank runs by the public.

Learning from the lessons of the 1930s, governments moved quickly to shore up confidence in the banking system, with extraordinary measures such as guaranteeing deposits in all banks.

The US Federal Deposit Insurance Corp increased its guarantee of bank deposits to US$250,000.

Many governments, including those in Ireland, Germany, Switzerland, Australia, New Zealand, the United Arab Emirates, Kuwait, Hong Kong and Malaysia, also moved to guarantee deposits.

In Singapore, the MAS set aside S$150 billion in October to guarantee all the bank deposits of individuals and companies here until the end of 2010.

9 Recessions, technical and real

SINGAPORE became the first Asian country to enter a technical recession - its first since the dot.com bust of 2001 - when growth contracted in the third quarter. It followed similar contractions in the second quarter.

Hong Kong, Japan and New Zealand followed swiftly into recession. Outside the region, the US has been in recession for a year while the Eurozone has slipped into the red as well.

A global recession next year is now on the cards, according to the World Bank.

10 Currency volatility

CURRENCY traders had a rough ride this year as the financial meltdown hit 'riskier' commodity currencies and pushed up 'safer' ones.

The Australian dollar lost a third of its value against the US dollar within three months, while fears of a wrenching UK recession pushed the pound down to a new low against the euro earlier this month.

But the US dollar gained despite the American-made crisis, as countries and investors around the world bought into 'safe' US government bonds.

The Japanese yen has also shot up amid waves of global deleveraging.

fiochan@sph.com.sg