Tuesday, March 25, 2008

Multiplier Effect & Fed's Agony
Blogger SP said...

Today THE STAR (21/3/08) posted the global measures to stem credit crisis from 10 August last year til 3 days ago where fed cuts 75 basis point.

Question: Are there any effect of any "help" given by any central bank or goverment institution on US slowdown?

From stock market point of view, the answer is certainly no! Here are some of the main indices of the world performance from 10 August 07 to 21 march 08:

Dow -6.6%
Nasdaq -11.27%
S/P 500 -8.54%
FTSE -9%
CAC -16.79%
DAX -13.9%
KLCI -7.8%
FSSTI -14.33%
HSI -3.14%
NKY -26.25%
TWSE -5.14%
KOSPI -10.54%
S/P ASX -13.62%
SHG COMP -19.5%
SENSEX +0.85%
SET -0.836%

However, the US Dollar index traded on ICE futures drop heavily from 80.59 on 10 August 07 to 72.8 on 20 March 08. Thats more than 9.6% drop on USD against 6 major currency in the world. That's mean if anybody longs all the futures of all indiaces in the world, and also longs the USD to hedge against the risk of indices long,then this person will lose big in USD and all indices except SENSEX. So after all the aid given by central banks of major countries, after FED cut 300 basis point, after numerous talk by so called 'big guns' like george bush, ben bernanke,donald kohn,warren buffet,jim cramer,henry paulson etc,

wat there able to do is weaken the USD and drag down the major indices of the world (except for Mumbai,of course).

Blogger Salvatore_Dali said...


i think there is a grave fallacy in yr argument... yes 99% of stock indices have fallen despite all the measures n big speeches by the big wigs...

Can u appreciate the probable fact that if they didn't that the indices may have DOUBLED their losses? Just because indices are negative does not mean anything? We r talking of a credit implosion, I really think without the measures most mkts would have lost 50% in value...

Blogger SP said...

Actually, what i mean is that there is almost no "good" effect for the fed 2 do all those "smart" move. Yes the market may have corrected more if notin have been done...
but did it reallt matter?! 20% drop vs possible 50% drop in indices matter?

dont forget what's the opportunity cost behind these move: it really hurt the currency and eventually economy. Economy is not juz about stock market or bond market.these are just part of the economy. By doing all the "smart move", more ppl will be out of job,purchasing power wil reduce and consumer confidence will lost.

300 years ago,adam smith intruduce laissez faire,invinsible hand and all that idea to the world and look like fed still haven learn bout it.

u still think these move wise??

oh yeah, almost forgot the inflationary effect it cost by doing all that. if not because fed cut less than 100 basis point last week, we may have new all time high for commodities around the globe and all time low of dollar index! how is that gonna hurt the US econ?
stock market really that important?

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


brotherlone said...


there is an ommision variable bias in both the analysis, there is no mention of the velocity of money supply, the multiplier is dependant on more than one factor.

Salvatore_Dali said...


In the post: "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."

Yes you are correct that money supply would be one of the greater determinants of velocity of money. I am only using the stock market as one indicator as I was only trying to reply specifically to reader's queries on stock market. Cheers.

brotherlone said...

apologies, may have missed that out while reading.

do appreciate your thorough and succint anaylsis within the local and international context. was suprised to see one of your articles appearing on the star.

btw, with the new layout you are using, is there a link to access your archives?

Salvatore_Dali said...

there is an archive link on the left, or u can scroll down the end for older posts, or u can search for posts under certain headlines/companies/issues

SP said...

thx 4 d info given.appreciate it and hope 2 chat with u next time