Keynote Address On US Financial Turmoil And The Future Prospects For ASEAN Economies

Speech by Anwar Ibrahim delivered at the CLSA Investor Forum in Hong Kong on Friday 26th September, 2008

From:Din Merican’s Site

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What do you do when a financial behemoth implodes?

What can you say about free market capitalism when the world’s leading liberal democracy dumps nearly a trillion dollars in private debt onto taxpayers? Are Freddie Mac and Fannie May along with Lehman Brothers, Merrill Lynch, and AIG totally unforeseen victims of systemic once in a lifetime financial meltdowns or are they not really victims of their own greed? When you allow the “mushrooming of weapons of financial mass destruction,” to borrow a phrase from Warren Buffet then isn’t it written that you shall reap what you sow?

The question is who should pay the price of Wall Street’s excesses. I learned in Economics 101 that those who live by the market must also die by the market. But with this gargantuan bailout it looks like the only thing that is dead is raw capitalism. Not that I’m complaining or that I ever subscribed to this thing called a totally free market. Some will recall that in my address in Bangkok last year I repeated my mantra that the free market is well and good but Adam Smith’s invisible hand may sometimes continue to be invisible if not altogether paralysed when the time for action draws nigh. Sometimes as it is in times like these, Uncle Sam’s hand may prove to be far quicker on the draw. Otherwise spontaneous order may well turn out to be spontaneous chaos.

Hayek is history, so they claimed.

Speaking of history, it would appear that the powers that be have learned some lessons. We know what happened in the 1930s when, adhering strictly to free market principles, the Federal Reserve folded its arms and did absolutely nothing even as the financial system was cracking under the weight of massive defaults that eventually caused the collapse of the American economy and the contagion spread to Europe. There would have been lessons learned too from the October 87 crash, and the savings and loans scandal. Then of course, there was the 1997 Asian financial crisis.

As for the latter, Asian countries having experienced the pains of the financial meltdown which saw their currencies plunging to the depths, are now having generally stronger balance sheets. Regardless whether or not they swallowed the bitter pill of IMF prescriptions, they now have better current accounts than they had ten years ago. But what exactly were the lessons learnt? Is it that we can snicker at the U.S. and tell ourselves that we don’t need to listen to you, because we are far better off now? Is it that we don’t need market economy and the related principles?

Why talk about the sanctity of free markets and the importance of non-interference by governments when the bastion of free market itself is now engaged in the biggest bail out exercise?

Some leaders are now gloating over their so called successes in resorting to bailouts even much earlier and retrospectively sanitising their remedies of capital controls and the policy of currency. This is a false premise. Bailouts cannot be used as a veneer for crony capitalism. It appears rather foolhardy for certain leaders in the region to start thumping their chests over their relatively wealthier positions and that they have strong fundamentals.

Are the fundamentals that strong?

To get the analogy of true strength let me relate some lines from Tu Fu (Du Foo) one of the greatest Chinese poets and contemporary of Confucius; also a well known sage of the Tang Dynasty:

And so firm is the deep root,

So established underground,

That its lone lofty boughs

Can dare the weight of winds,

Its only protection the Heavenly Power,

Its only endurance the art of its Creator

The convulsions that began the last summer arising from the subprime crisis have morphed into a full blown seizure the implications of which have left us still groping in the dark. Aggravated no doubt by record breaking inflationary pressure, the current crisis has reached such a level that the threat of a worldwide recession looms. The hysteria, irrational as it is, is real. We saw the run on the U.S. financial institutions and the consequences unleashed. And as we all know, even Hong Kong hasn’t been spared—this week two typhoons scored near misses on the city, one a torrent of rain that passed to the south, and the other entailed a long line of depositors lined up outside the Bank of East Asia. With emotions running tense, we could certainly benefit from a return to sanity.

Even though the locus of the slaughter is the United States, the bastion of free ‘market’ democracy, yet, in many ways the current upheaval bears some similarities to the Asian crisis. We would think that the lessons learnt from the Asian crisis, in particular the Asean region, could help us navigate the treacherous waters that we may be heading towards.

At the end of the day, we are looking at a credit fiasco gone haywire. Both concern loan defaults which trigger a chain of consequences ending in massive losses for financial institutions. Like the crisis in the Asean region, there are without a doubt serious issues of governance, transparency and accountability at stake.

As I said back in 1998 at a forum in New York chaired by Maurice Greenberg, who was the AIG chief, I had likened the Asian crisis to the sinking of the Titanic. (I am talking about the AIG then, the financial Rock of Gibraltar, solid and unshakable, not the fallen giant of today.) Prior to the meltdown, there was the euphoria among the Asian leaders about the so-called East Asian miracle and all skeptics were dismissed as naysayers and those calling for fiscal restraint, including myself, were branded as doomsday prophets. Then the crash came. But the question is who the real victims were. Undoubtedly they were the ordinary people while cronies and family members of political leaders were given the life boats and the first to be bailed out.

In this regard, social justice must remain one of the main purposes of government. The proponents of free market may not want to admit it let alone utter the dirty word because the mantra is that state intervention should be avoided like the plague. But it is once again all too apparent that, left unchecked and unregulated, the consequence of markets running amok is not just gross inequalities of income distribution but systemic failure altogether.

We are looking at foundational weaknesses. Apart from the obvious issue of risks management, I believe that the global financial architecture and the institutions need structural reform. Make no mistake. We are not here to advocate command economies of the Orwellian kind but we can no longer be in a state of denial as to efficacy of a common sense approach to managing the economy. This is also very much in line with the demands of social cohesion and political stability.

Though we believe in a well-regulated market, where contracts should be honoured and the principles of fair dealing applied, we also know that a heavily-regulated market, coupled with highly opaque government operations cripples the economy and discourages investment. And it would be a grave error to think that governments have a duty to bail out badly run institutions and companies. Moral hazard cannot be simply dismissed as just another Bretton Woods construct. Among the most important lessons appears to be if you keep on spending money which is not yours, sooner or later it will take its toll.

In this regard, we view with great consternation the path that Malaysia has been taking in the last five years. Public-sector spending rose to RM200 billion annually from RM160 billion in 2004. That of course doesn’t include the slush funds in excess of RM30 billion used at the discretion of the Prime Minister. The national debt has gone up by another RM100 billion and as more money is being spent, the fiscal deficit has risen to 4.8% of GDP this year.

With capital flight at a record high since the 1997 crisis, RM125 million in 2008 already, Malaysian investment abroad now exceeds inward foreign investment. We are facing a double barrel onslaught of our own doing with the Ringgit hitting all time lows since 2005 and inflation a record high of 8.5%, the worst in 27 years.

Issues of governance and corruption are yet unresolved. The latest corruption perception index from Transparency International speaks for itself. In almost a decade Malaysia has hardly improved its position in the ranking while our would-be peers are making substantial improvements.

Our agenda for Malaysia is clear. Revive the lagging economy by adopting market friendly policies and take decisive action to cure the festering sore of corruption and cronyism that has decimated the judiciary, rendered the anti-corruption impotent and leeched billions of dollars from the state coffers – by Morgan Stanley’s account in the amount of at least $10 billion per year. Restore faith in the institutions of governance both domestically and internationally so that investors will once again find the country an attractive destination for their long-term investments. Among other things, this means strict adherence to the rule of law and an immediate end to draconian statutes that would allow the powers that be to detain their adversaries willy-nilly and without due process.

The issue of regime change is central to the current political scenario. The ability to handle a transition is a measure of the strength of the country’s democratic institutions. It can, and ought to be done, peacefully and orderly. Stability cannot be sacrificed on the altar of freedom no matter how intense the desire for change has become.

Weathering the storm of its own internal strife, it is apparent that populist spending is the easy way out for governments hell bent on clinging to power. On the contrary we would introduce structural reforms in public procurement programmes and the management of State companies while ensuring that adequate social safety nets are in place.

With the political will to combat corruption, wastage and mismanagement an 8% per annum growth rate is not unrealistic. Petronas should be made accountable to Parliament and not remain the private piggy-bank of the Executive Branch. We will remove restrictions on foreign capital inflows and outflows and revamp government protection of monopolies in industries like telecommunications and banking.

If our markets are strong and unfettered, and if our laws are transparent and enforced by impartial judges, we will not need special development corridors or regions to attract investment. A stable and clean business environment is far more important than special tax breaks and quotas handed out by a corrupt and opaque government.

With compassionate policies in place, the rifts caused by unequal development will finally begin to heal. Just as importantly, poor bumiputeras will finally be able to access economic aid that trickles all the way down instead of disappearing long before it reaches them.

The central principle of these economic policies is that the right opportunities must be made available to every single Malaysian –to learn, to earn an honest living, and to realise their dreams.

Ladies and gentlemen,

When the Asian Crisis struck ten years ago, the decisions I made as Finance Minister were not populist nor were they popular. On principle, I felt they were the right moves even though it was at the expense of my personal freedom. Yet in my darkest hours of solitary confinement I had never given up hope that something good was to come of the ordeal. And now after more than a decade of struggle and profound challenges we are on the threshold of a new beginning.

Thank you.

Malaysia: This Is Only The Beginning

Written By Dr. Farish A. Noor

From: The Other Malaysia

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Recently I found myself in an open discussion with some of my students in the university I am based at in Indonesia. At the tender age of 18, this first-year student demonstrated both the intellectual acumen and political commitment I have come to expect from those twice his age, yet he was just one of the many students whom I am proud to say have come under my care and tutelage. After ten years of teaching experience, I have come to the simple conclusion that my Indonesian students are by far the smartest, gutsiest, honest and dedicated compared to the students I have taught in Malaysia, Singapore, Germany, France and Holland. Why?

That an 18 year old can begin his university life equipped with enough political knowledge and commitment is a testimony to the success of a primary and secondary educational system that got it right. This boy is the product of the post-Suharto educational system of Indonesia, and living proof that the reformasi (reform) movement of the 1990s in Indonesia has succeeded.

Yet the success of reformasi in Indonesia depended upon the quiet dedication of a legion of activist-academics who toiled day and night to dismantle the hegemonic structures of power and knowledge that were developed and consolidated during the three decades of Suharto’s rule. This meant that they had to confront not only the hegemony of the old regime, but also replace much of the human and ideological resources that had been put in place between 1970 to 1998. Ten years later, the results are only beginning to show and it has proven to be a worthwhile endeavor after all.

Malaysia today is at a similar crossroads where Indonesia was a decade ago. With the febrile grip of the Badawi government growing weaker by the day, there is much speculation that Malaysia’s former Deputy Prime Minister and now de facto leader of the opposition, Anwar Ibrahim, is poised to take over the reins of power. It is widely speculated that Anwar now has more than forty members of Parliament who are prepared to leave the ruling UMNO party and join his People’s Alliance to take over from the unpopular and discredited government of Badawi. Anwar has written to Badawi and called for a dialogue between the two to discuss a peaceful transition of power: something that has never happened in the course of Malaysia’s 51-year history.

Should such a transition happen, however, it would only mark the beginning of what must be a long and difficult process of reform and reconstruction. Like Indonesia, Malaysia has lived under half a century of hegemonic rule by one party – UMNO – and the ruling coalition it leads. Five decades of UMNO rule translates into five decades of pro-UMNO propaganda that has been normalised as news in the press, official history in school textbooks, official discourse in the workings of the state. This also means that the entire apparatus of the state – from the police and the armed forces to the bureaucracy, educational institutions, economic sector, etc. – have all been stamped with the lingering imprint of UMNO and UMNO’s brand of racialised ethno-nationalist politics.

Taking over the government of Malaysia is just the first step to reforming the country. What many Malaysians do not perhaps realise is how difficult and long the process of reconstruction will take. For instance, the task of re-writing the country’s official history, that has so long borne the bias and slant of UMNO’s ideologues, will be a herculean task in itself. Malaysia’s communally fragmented society will demand representation on all levels in the new curriculum of the national educational system. The Muslims, for instance, may insist on a re-writing of Malaysian history primarily from their Islamist perspective. Other ethnic and cultural minorities may likewise call for an equally sectarian interpretation of history as well. And even if such a comprehensive history could be written, would a new government have the will to see to it that it is taught in schools? Decades of UMNO hegemony has also ensured that a pro-UMNO bias remains in many institutions of the state and to some extent the official ideology of UMNO has been internalised by many members of the bureaucracy. One can anticipate many rounds of furious polemics, protests and counter-protests, and not to mention countless efforts to sabotage the reform process in Malaysia before it even gets off the ground.

Compared to the long road ahead and the obstacles that are bound to be put up in the face of reform, winning power and taking over the government will seem a relatively easy task. Much more difficult will be having to dismantle the structures of power and knowledge that have grown sedimented for so long, and overturning the dominant culture of racialised politics that has divided Malaysian society thus far.

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What is required therefore is a spirit of universal citizenship and a commitment to a non-racialised and non-communitarian Malaysia: a task that the present opposition alliance itself is not perhaps ready to take on considering its own communalist make-up, divided as it is between communitarian Islamists and left-leaning democrats. The first and enduring task therefore has to be the inculcation of the value of universal citizenship and civic commitment to Malaysia. Until today Malaysians see themselves as members of the Malay, Chinese or Indian races first, or place their religious identity before citizenship. Yet the creation of a democratic and equal Malaysia relies on that intangible quality known as Malaysian citizenship, a quality that is hard to quantify or define but crucial nonetheless for nation-building. Are there enough of such Malaysian-minded Malaysians who can build a new non-racialised non-sectarian Malaysia? Time alone will tell, but for now the prospect of an unprecedented change of government is the first of many long and difficult steps that has to be taken in the slow birth of a reformed Malaysia.

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Several Comments from the site:

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Delvi:

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Dr. Farish A. Noor,

I was 16 and present when the euphoria of reformasi took place in my beloved country, Indonesia. I witnessed the changes and be part of it. I also learn that it is us, the youth of the nation, who will bring changes for the better to our country. I feel lucky nobody denies me chances to inhale the air of reformasi until now.
I consider myself lucky as well as I am present here in Malaysia where changes are looming ( I do hope for the better). Yet, I am dumbfounded to find that the university students here seem to be politically autistic.
Despite I am just a mere foreigner I was so excited with the last Permatang Pauh by-election and keenly followed every news coming out from ground zero through mainstream media and of course blogs. I used to think that my fellow Malaysian students here will get as excited as I was. But I was disappointed. I was hoping to see at my university (here in Malaysia) groups of students talk about the by-election. I was anticipating hot debates amongst the pros and the cons. Yet I saw nothing. How come an event as important as permatang pauh by-election escapes their attention? Well, for us, Indonesian students this “ignorace” is so hilarious.

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Anda Djoehana Wiradikarta:

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Reading the French weekly “Courrier International” while sitting with my daughter at a café terrasse in Paris, I have just discovered today the existence of “The Other Malaysia”. If there were more people like Dr. Farish, Southeast Asia would be a beacon of humanism.

When he writes “What is required therefore is a spirit of universal citizenship and a commitment to a non-racialised and non-communitarian Malaysia”, he echoes what French historian Ernest Renan declared in a speech in 1882, i. e. a nation is based on two principles, “the possession in common of a rich bequest of memories” and “the desire to live together”.

Soekarno, one of the founders of the Indonesian nation, would quote Renan when explaining his conception of the nation.

Much can be criticised about France, the country where I live and was born. However, even some British and Dutch political leaders now begin to admit that “communitarianism” that prevails in the IK and the Netherlands may not be the right thing and that the French conception, “intolerant” as it may look at first sight, is a principle more in accordance with the “spirit of universal citizenship” Dr. Farish is promoting.

Malaysia has the ingredients to become an example of racial harmony and universal citizenship. I can only hope more and more Malaysians will join “The Other Malaysia” and build the “True Malaysia”!

Anda (university teacher and research worker in Paris, France)

What’s Behind the Financial Market Crisis?

Written By Anthony Mueller

From: Ludwig von Mises Institute

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The financial crisis is not over. Neither tax rebates nor low interest rates nor higher or lower exchange rates can do the job of reviving an economy that is burdened by debt loads that are too high. On the contrary: the policy measures that the US authorities have been applying will prolong the agony. Be prepared for the challenges of extended financial turmoil and economic stagnation.

Early this year, the US central bank decided to manage the debt crisis in the light-hearted belief that a few aggressive rate cuts would “unfreeze” the banking system. Yet as of the end of the third quarter of 2008, the arteries of the financial system are still cluttered, and the financial system has moved even closer to total collapse.

Those banks and brokerages that haven’t yet failed have been kept alive by emergency monetary transfusions from the US central bank. The Fed has cast away all restraints of economic rationality and is acting in a purely political way. The Board of Governors of the US Federal Reserve System is pursuing the goal of getting the financial system through the mess — at least until the end of the year, no matter how high the costs will be thereafter.

The American central bank has adopted the financial equivalent of the military strategy of scorched earth. The economic philosophy of the current chairman of the US Federal Reserve System can be summarized in the slogan, “No depression under my rule!” He resembles a military leader who stubbornly declares, “No defeat under my rule!” the more the chance of victory is slipping away, and defeat can be denied no longer.

The current economic disaster is the result of the combination of negligence, hubris, and wrong economic theory. For decades, an economic and monetary policy has been practiced based on the illusion of, “It doesn’t matter.” At first it was, “Deficits don’t matter.” From that, the policy of “it doesn’t matter” got extended to money creation, the credit expansion, the stock-market bubble, and the housing boom. Now, we’re being told that buying financial junk by the central bank to beef up banks and brokerages also doesn’t matter.

As a byproduct of this mindless economic and monetary policy, financial market operators, too, have lost their heads. Trusting the official cheerleaders, investors hold on in the trenches until they will have lost their last shirt. Economic weakness is spreading around the globe. There is no new spurt of economic growth in sight. Yet many investors stay put because they have been conditioned to believe that government will bail them out.

The current financial crisis is not of a cyclical nature. The financial turmoil is the symptom of the structural imbalances in the real economy. Over decades, expansive monetary policy has gone hand in hand with implicit and explicit bailout guarantees, and this has distorted the process of capital allocation. Under such perverted conditions, those investors will win most who cast away the restraints of prudence. It is a game that can go on for a long time — up to the point when the irrationality has become systemic.

The behavior of the investment community reflects the incentive structure that has been put in place by the authorities. Investors have learnt to dance to the tunes of the pied pipers at high places. After all, the individual market player could see from those who were ahead of him in the abandonment of prudence how money is being made. In the wake of this, financial companies have become overextended and are now in need of deleveraging. Yet the core problem lies in the imbalances of the real economy.

In the Austrian theory of the business cycle, the distinction is made between the “primary” and “secondary” depression. The secondary depression is what catches the eye: the turmoil in the financial markets. Yet the underlying cause is the distortion of the economy’s capital structure: the primary depression.

The simple fact is that the US economy is burdened with a highly lopsided capital structure as the consequence of a wide discrepancy between consumption and production, which, in turn, is the result of monetary policy. Persistent trade imbalances are the symptoms of this discrepancy. This means for the US economy that lower interest rates and government incentives aimed at boosting consumption work as pure poison. Instead of more consumption, more savings, less consumption and fewer imports are needed.

The current financial crisis reflects that many debtors have reached their debt limit and that creditors are lowering that limit. From now on, business and consumers, governments and investors must work under the restraints of lowered debt ceilings.

Economic policy as it is currently practiced is in a fix: lower interest rates may temporarily help to alleviate the financial crisis, but they exacerbate the fundamentals that are the cause of the financial crisis. Equally, a lower dollar would make imports costlier for the United States, while a strong dollar comes with lower import prices. But while a low dollar would help to expand exports, a strong dollar impedes export growth. Therefore, the United States will have high trade deficits as long as the economy does not fall deeper into recession.

Without an adaptation that would increase savings, decrease consumption, and reduce imports, the US economy can only go on in the old fashion with ever more debt accumulation. But the limit of debt expansion has been reached. The financial crisis has reduced the willingness of domestic and foreign creditors to extend loans.

Foreign creditors are getting ready to reduce their holding of US debt in a more drastic way. The governmental takeover of the mortgage agencies Fannie Mae and Freddie Mac bailed out the monetary authorities of China, Japan, Russia, and other foreign countries that hold agency debt. As a result of the socialization of the so-called government-sponsored enterprises, the Treasury opened a window of opportunity for these countries to unload their US assets at subsidized prices, all at the cost of the US taxpayer.

A profound restructuring of global capital has become unavoidable. Such a process is quite different from a recession in the traditional sense. In contrast to a sharp and typically short-lived recession, when, after the rupture, business as usual can go on, the restructuring of a distorted capital structure will require time to play out. Rebalancing the distorted capital structure of an economy requires enduring nitty-gritty entrepreneurial piecemeal work. This can only be done under the guidance of the discovery process of competition, as it is inherent in the workings of the price system of the unhampered market.

Anticyclical fiscal and monetary policies are of no help when it comes to the daily toil in business to work towards reestablishing a balanced capital structure. The so-called income multiplier won’t work, and lower interest rates won’t stimulate spending. On the contrary: these policy measures only make the task of the entrepreneur harder.

The difficulties ahead arise from the problem that business as usual cannot go on under conditions of a credit crunch, which has its roots in the distortions of the economy’s capital structure. Thus, even if the financial market turmoil were to settle, there won’t be the simple resumption of the old ways of doing business. The belief that, after the financial crisis is over, the real economy can reemerge unscathed, is probably the greatest error that many investors share with the policymakers.

As a result of the bailouts and the socialization of the mortgage agencies, the financial system is now fully infected with moral hazard. The disastrous effects of these government interventions will show up soon. The major task of bringing the capital structure in order is still ahead and more pain is in the waiting.

As long as governments and central banks continue to focus on the monetary symptoms of the “secondary depression” and continue to ignore the structural aspects of the “primary depression,” they act like quacks. Ignorant of the lessons of the AustrianSchool, the authorities will most likely continue with their disastrous policies.