Tuesday, March 25, 2008
Multiplier Effect & Fed's Agony
Comments: So, to you, stock market is not that important. Well, it is the biggest reflector of global wealth. The stock market is not a fixed thing. It is valued largely in multiple of forward earnings, i.e. growth and margins outlook. Naturally, a 12x global valuation would be a lot less "wealth" than 15x - and that in itself is a lot of trillions. Even if you assume each person's wealth has 1/3 tied up in stocks, this valuation drop will affect their spending, plus the trickle down effect and the velocity of money impact. Each dollar you spend is thought to be worth about $6-$8 to the economy, i.e. you spend $100, that will have a multiplier effect as people and companies use the funds for other trade, service, investments or consumption. So, the stock markets are very important.
It is not as important in some countries than others. For example in most developed European nations, only 50% or less of their GDP is listed. There is still large components of wealth and assets being held privately. Malaysia, surprisingly, has one of the highest of our GDP being listed, more than 80%. That's why you'd find that a company that makes RM1m-2m in net profit will find bankers swarming them asking them to list. Only things left unlisted are your laundromats, mamak stalls (though many do make more than a million ringgit a year...easy), hairdressers, etc... you get the drift. Hence for countries like Malaysia and HK, the stockmarket has a very high beta multiplier effect (up and down) on the real economy. While most of developed Europe would not blink an eye even in the event of a major correction.
On the issue of currency, yes Fed's moves will literally weaken the dollar. The Fed knows that, and its a deliberate strategy even though they may not voice it out too often - its unpatriotic and depressing news to tell your fellow citizens that they will have to have a weaker currency to maintain competitiveness and load up more debts. Weak USD is the right recipe for the US. The country has been living off future receipts for far too long. The imbalances are just righting itself. You cannot just keep consuming and consuming with no dire effects. The rise of sovereign wealth funds is a reflection of too much trade surpluses for certain nations - the US deficits has to go somewhere.
You may criticise the Fed's move as being too nice to stock prices. The Fed's move may have stave off a confidence crisis in banks but at the same time it has injected fresh funds into dicey debts and assets - thus forestalling the proper implosion of the credit crunch. Things may stabilise for now but the pockets of "dicey debts" will resurface later on. It is difficult at times for the Fed to ensure the US economy weakens properly in an orderly manner, and at the same time not whipsaw on the downside that paralyses the economy (and the global economy) for an extended period. While theoretically, it is better to let the credit crisis work itself out, taking a few weak companies out of their misery - it is very hard to also realise that you don't want all funding and credit to stop functioning in a confidence crisis among banks (which was where US markets was headed over the last 2-3 weeks). Damn if you do, damn if you don't.
p/s photo: Michelle Ye