Emptying the Tool Box
After a relatively slow response to the gravity of the credit crisis in September, central bankers around the world are utilizing some serious fire-power to counter a global slowdown.
The U.S. Federal Reserve led the way with a sizable half percentage point cut, bringing the discount rate down to just one percent. U.S. Fed Chairman Ben Bernanke noted the bank is prepared to bring rates even lower to unlock lending to consumers and businesses.
Three regional central banks -- Kuwait and Bahrain -- followed suit cutting their key rates to help rekindle confidence, while a handful of Asian central banks, most notably China, did the same.
The timing is crucial. Countries are quickly trying to sing from the same hymn sheet before they gather in Washington on November 15th for an emergency summit, shortly after a new president has been elected in the United States. The meeting will be held under the auspices of the G20, which includes emerging markets countries from Asia to Latin America, with two Middle Eastern members, Saudi Arabia and Turkey.
Leading up to the U.S. elections, John McCain’s campaign used Joe Wurzelbacher, affectionately labelled “Joe the Plumber,” to contend that Barack Obama’s tax policy would hinder small business. The Toledo-based plumber was worried that he will have fewer options in his tool box to expand.
The tool box is an apt analogy for the world’s central bankers. They have used outright capital injections and share purchases of banks, cut interest rates on multiple occasions and now are looking to construct a new financial architecture to monitor and govern financial markets. They will have very few tools to reach for if commercial banks don’t start loosening up lending.
Seeing there is the same liquidity shortage in other countries, the U.S. central bank will provide $30 billion each to Brazil, Mexico, Singapore and South Korea. Hard money is being supported by a great deal of high profile diplomacy.
Robert Kimmitt, Deputy U.S. Treasury Secretary, concluded a four country Gulf tour to Saudi Arabia, the United Arab Emirates, Qatar and Kuwait in an effort to enhance dialogue with those who manage sizable sovereign wealth funds. Kimmitt said that these fund managers are “actively looking at U.S. opportunities.”
In this climate, there is less emphasis in Washington on who owns the Chrysler Building in New York (Abu Dhabi) and the debate over Dubai World and its attempted ports purchase seems a distant memory.
Not to be outdone, U.K. Prime Minster Gordon Brown crossed paths in the air with Kimmitt for his own tour. It is pretty smart business. Middle East sovereign funds have an estimated $2 trillion under management and can serve as key players as both equity and bond investors when it is needed most.
It is a bit too early to tell which way the funds are leaning today. On our programme we have been exploring the high profile investments into China and Southeast Asia over the past year by sovereign funds and Middle Eastern companies.
Saeed Ahmed Saeed Chief Executive of Dubai based property group Limitless said Asia provides “all the opportunities that would be expected as a return on investment.” Four out of ten of his international investments this year have gone to Southeast Asia. I used the example of Limitless, because it will be fascinating to see where the money will gravitate in the future which depends on how this financial drama will unfold in the coming months.
According to Morgan Stanley, their benchmark emerging market index has dropped more than 40 percent in the past month alone, but over the last decade the markets that make up the index far outpaced their peers in the U.S. and Europe. The reason is quite simple; many of these governments had to learn a difficult lesson ten years ago during the financial crisis which swept through Asia, Russia and Latin America. They are better prepared today than ever before.
Let’s hope that in a post-election environment and after pulling out a lot of arsenal to combat the slowdown that the Group of 20 can offer concrete solutions that work for all the members to move forward.
Two groups, one that already has 13 members, the other which looks poised to comprise 13 members, could potentially help stabilize and redesign the global architecture for the 21st Century. This all sounds quite grand, but the truth is the world is in need of some rebuilding in the aftermath of the tornado which swept through global markets in the past month.
Let’s start with the group that is under construction. The G7 plus Russia seems horribly outdated. In the words of French President Nicolas Sarkozy after his meeting with George W. Bush at Camp David the world cannot “continue to run the economy of the 21st Century with instruments of the economy of the 20th Century.”
Sarkozy is referring to the so-called Bretton Woods institutions, named after the city in New Hampshire where they were created before the end of World War II. I was surprised that neither of those institutions -- the International Monetary Fund and the World Bank -- was given a mandate at their autumn meetings to re-engineer their structures to be the streamlined home for dialogue, financial regulation and monetary policy.
Sometimes it takes a crisis to prompt action and that is where we are today. At the Gleneagles Summit in 2005 Tony Blair formally invited leaders from the G5: Brazil, China, India, Mexico and South Africa to begin outlining the blueprint for the new G13. According to many who attended that meeting, the new emerging economic powers thought the rule book was already written before they showed up in Scotland. That blew over like a cold wind off the Atlantic and talks have stalled ever since.
The French President, who cut his teeth in the Ministry of Finance, is sensing a window of opportunity to move into action. While the current occupant of the White House may not be keen on building a new institution (and some may argue more bureaucracy) the future occupant just might be. And if a President Obama or President McCain doesn’t like the idea, come January there may be enough coal in this engine to leave the station anyway.
As it now stands, the G13 will meet sometime after the U.S. election. UN Secretary General Ban Ki-moon has offered to host this gathering at the organization’s headquarters, perhaps as a bid to eventually put the remit for this fortified group under the United Nations umbrella. That certainly needs to be decided over time. But it seems clear that the G7 (G8 with Russia) needs to design something concrete, and stand ready to build in a regulatory framework to take decisions on capital flows and new financial instruments (like mortgage backed securities) and the role of sovereign funds.
On the latter subject, it seems that if President Sarkozy and others are getting positioned to bring the developed and developing powers together it might make sense to consider a seat for the Middle East, representing both the sovereign funds and the oil producers. I never thought the number 13 was lucky; in fact I, like many in the world, remain superstitious about it. G14 has a nicer ring to it anyway.
This week U.S. Treasury officials will tour the major economies of the Gulf in an effort to enhance the dialogue between Washington and the major sovereign investors. Riyadh, Doha, Abu Dhabi, Dubai and Kuwait are all on the itinerary. Rather quietly at the IMF meeting in Washington, 24 so-called Santiago Principles under the International Working Group of Sovereign Wealth Funds were presented at the gathering. The timing is fortunate. In a period where markets are swinging five percent in either direction, it is always good to have a pool of $3 trillion available in the shape of potential emergency lenders and long term investors. The Santiago Principles can provide the political cover for those still worried about their intentions.
While the grand design of the G13 remains on the horizon, that other group of 13, OPEC, is trying to speak with one voice to recoup some dramatic losses. In a span of only 14 weeks, prices have dropped 50 percent. Three digit oil ($100 and above) seems long forgotten and the President of OPEC Chakib Khelil, has talked about protecting a price band of $70-$90 a barrel.
The secretary general of OPEC, Abdalla Salem El-Badri, during a speech in Moscow this past week outlined the cartel’s plan to expand production by five million barrels in 2012. That, he says, will require $160 billion of investment. If prices go back below $70 and stay there, I would not bank on all that coming on-line.
While the G7 is not eager in principle to have an official dialogue with a cartel, a G14 with a seat for the Middle East included in the mix, most likely would. That would not only be lucky, but prudent as well.
That Slippery Feeling
A fifty percent correction in four months! At first glance you probably think I am referring to regional equity markets. Think again.
Before one can say West Texas Intermediate, crude prices have gone from a hefty record of $147 a barrel way down to the $70 range. It may have taken too long for the G7 countries and their new partners to come together with a defined rescue package. That is on the books. The world has now decided to focus on a new chapter titled "Recession 101".
The gathering of 185 countries at the International Monetary Fund and World Bank meetings in Washington provided the outline for this new chapter. Take note of the tone by Olivier Blanchard, Director of Research for the IMF.
"Growth in advanced countries will be very close to zero or even negative until at least the middle of 2009," says Blanchard, "We predict that even the fast developing countries will grow at a substantially lower rate than they have in the recent past, 7 percent in 2008, and 6 percent in 2009."
Slower growth is not the surprise; the speed of the fall and depth of the drop are. Blanchard’s ultimate boss at the IMF, Dominique Strauss-Khan, says the institution was quick to dispel the concept of de-coupling, that no part of the world was immune to the downturn. I think most would admit today in fairness, that no one really thought that this banking crisis would be so horrific.
It has Middle Eastern central bankers cutting interest rates. Saudi Arabia lowered its benchmark rate by a half percentage point after the likes of the UAE, Bahrain and Kuwait pulled the trigger the week before. Enemy number one was inflation at the peak of summer, which was replaced by slower growth. Both surely have been substituted by lower oil revenues.
Let’s take the largest producer; Saudi Arabia. At $147 a barrel, the Kingdom brought in oil revenues of more than $1.3 billion. At $70, that quickly becomes $637 million. That is a lot of money; more than a population of 28 million can spend of course, but a great deal less than a quarter ago.
According to Saeb Eigner, founder of investment group Lonworld and author of "Sand to Silicon", most Middle Eastern oil producers have been prudent with their revenue targets. In five short years they wiped out budget deficits accumulated, in part, by financing the first Gulf War. In most cases, $40-$50 has been the yardstick. It would be more interesting to discover what targets they penciled in on the margins after seeing prices trade well over $100 for a half year.
Oil ministers representing13 members of the OPEC cartel will hold what they call an extraordinary meeting in Vienna this Friday. They already agreed in September to trim production by a half million barrels a day. Not long before that, swing producer Saudi Arabia agreed to boost production in June to cap prices that were on their way to $147 in July. Back then, oil minister Ali al-Naimi said there was not an oil shortage, but the market was not factoring in a slowdown in demand. Not surprisingly, he was correct.
This leads us to the old debate within OPEC between the price hawks and doves. Saudi Arabia has always tried to counter balance members Iran and Venezuela, who have sought maximum revenues per barrel. The Kingdom has taken the view there is a breaking point where price undercuts demand. After we have witnessed the first hint of recession, one sees what the slippery slope looks like. OPEC has already cut its 2009 forecast for daily demand by a half million barrels a day.
This crisis did start in America. It has crossed the Atlantic hitting Britain and the European Union with full force. Export driven markets from China to Southeast Asia are feeling the pinch, with growth off one to two percentage points depending on the economy.
The real fear it seems is not $70, but what many privately say could be just around the corner. If one can see prices tumble by 50 percent, then another 20 percent is not outside the realm of possibility with investors still climbing a wall of worry.
Swept out into a Sea of Red
Who says we are not connected? What clearly is a banking crisis in the United States and Europe has spread like a bad virus throughout the emerging markets of this world, the Middle East being no exception.
In a span of a week, the Morgan Stanley’s emerging market index was down 23 percent. Equity markets from Shanghai to Sao Paolo fell in lock step. It is a pretty nasty tally in the region. Prior to the concerted effort to cut interest rates, Cairo, Saudi Arabia, Dubai and Doha were all down 50 percent or more from their peaks in 2008. Hot money flooded the region to tap into growth, but left local traders and investors stone cold on the way out.
The economies of the Middle East are growing nicely, regionally about seven percent this year. Oil revenues with prices between $85 and $90 a barrel are still strong by historical standards. So why are the major markets of the region drowning in a Sea of Red?
The simple answer is these economies cannot stand alone in isolation with all the chaos around them. They surged in part because investors are enthusiastic about the future. There was a double-whammy if you will since many of investment funds put money in thinking that the Gulf economies would soon abandon their pegs to the dollar. When leaders in the Gulf decided not to scrap that dollar peg, even after a fall of nearly 30 percent over the past few years, foreign investors looked for the exit.
All together now
It took too long for the central bankers of the world to grasp the enormity of the problem. After much delay, the major G-7 central banks cut interest rates by a half percentage point to send a signal of unity. A handful of the region’s central banks followed suit, with rate cuts of different proportions, due to the formal link with the dollar. At this juncture, it is the fear of a liquidity crunch, not inflation that is driving sentiment.
I am old enough to remember the power of speaking with one voice. That art, crafted in large part by Alan Greenspan, has been lost when it has been needed most. The February, 1987 Louvre Accord is a prime example. The G-7 gathered to send a signal that the dollar had fallen too far and they backed it up with coordinated intervention to make the point. A similar response came after the October, 1987 crash. In today’s much larger economy, intervention packs a softer punch, but unity is essential. Market traders usually lose a lot of money betting against central banks.
The recent meeting of leaders from Germany, France, Britain and Italy to discuss the banking crisis was a perfect illustration where coordination was in short supply. They met, went their separate ways and all had a different view of the meeting and their own individual plans to move forward. This does not bode well for the European Union or the future of the single currency. This trend also does not say a great deal about enhancing the roles of the International Monetary Fund and the World Bank. One of the two institutions could serve as the global unifier, where a set of rules for 21st century trading and capital flows can be not only debated, but agreed to and most importantly enforced. This could be the new home for an expanded G-7 that includes: Brazil, Russia, India, China and a seat for the Middle East – especially with all its liquidity.
All told there is an estimated $1 trillion dollars of development projects throughout the region. Sovereign funds in the Middle East have a reported $1.5 trillion dollars under management. That is a lot of capital. While some of that money was used in the past two weeks to inject money into their local markets and banks, it could serve as a great source of funds for Wall Street and for European markets.
This major market correction, if we want to limit the description to that, is a big test for the central bankers of the Middle East. They have been working to expand their tool kit to control money supplies, battle record inflation and keep a lid on borrowing for all real estate projects which sprout up like mushrooms in the desert.
At Cityscape in Dubai, the Middle East developers showed off the latest wares with stands costing up to a reported $8 million dollars each. One new planned development outside of Dubai called Jumeria Gardens has a price tag of some $95 billion dollars spread out over a dozen years. Think about it, that is more than the $87 billion dollar bailout by the British government of their banking system.
But there is a problem in the Middle East that is similar to the challenge throughout the world – there is a lack of confidence in western banks. The sovereign funds came on strong at the end of last year with some high profile investments. After falls of 50 percent or more, they too are in no rush to jump back into this market. Until the expanded G-7 can come together, Middle East investors and sovereign funds seem content to deploy assets closer to home.
Uncle Sam on the line
It was a surreal experience, standing outside a brand new conference center in the spruced up port city of Tianjin, China preparing for live cut-in.
In my earpiece I could hear what many people around the world were watching. U.S. Congressional leaders lined up in front of a "political scrum" to tell everyone that they were making progress on a $700 billion rescue package. They wanted to both illustrate their unity while at the same time declare their disdain for having to go to their constituents for money. This interplay came before the first bill was voted down in the U.S. House of Representatives.
My eavesdropping followed a thirty minute plenary speech and Q&A session with Chinese Premier, Wen Jiabao at a gathering of the so-called New Champions of the World Economic Forum. If one wanted to find a starker contrast of ascent and decline, you saw it in person and heard it through the earpiece. Washington legislators were crunching together a package to restore confidence while at the same time the next president with massive debt burden.
Mind the growth gap
These are the new realities of today’s economy. The Chinese Premier hosted a meeting in his hometown, while the U.S. begins a hard road back after years of borrowed time after bankers sold products few understood. In the halls of the vast conference center, many were talking about the "tilt to the east."
CNN cameraman Charlie Miller and I travelled from Tianjin to Beijing to capture the post-Olympic mood and reaction to the banking legislation that was stalling on Capitol Hill. We went to Tiananmen Square on Chinese National Day to tape a segment. Visually the energy of the economic expansion underway hits you.
The U.S. is still growing a respectable 2.8 percent; Europe a less respectable 1.5 percent and the Middle East to Asia 7 percent. China is worried about slowing down to 9 percent. This growth is the primary reason business leaders from this new belt of growth are looking to each other for opportunities. It is why Airbus, for example, which unveiled its assembly plant in Tianjin during the meeting, has an operational support hub in Dubai and is building a plant in Tunisia.
While this is the future, the New Champions cannot divorce themselves from the past. In a panel that I chaired, business leaders talked about financing infrastructure in the Gulf, while raising the sensitive issue of co-dependency with the United States. All told, foreign investors and governments have an estimated $3 trillion invested in U.S. assets -- bonds, buildings and banks. As the dollar has sunk over the past three years, so too did their portfolios.
These investors want the rescue package to help restore confidence, but at the same time, they are not eager to jump bank into the U.S. market in pursuit of value. In an interview, Sameer Al Ansari, Executive Chairman of Dubai International Capital said he has held reservations about the financial sector in the U.S. for months. In his words, “It just feels to us that things are going to get even worse, so it is time to be careful.”
The bottom line? Many who do not need to add political considerations into their investment decision making are keeping their powder dry.
This leads us to the role of the sovereign funds. They have an estimated $2.5 trillion to invest. That is a vast liquidity pool that could buffer the downturn coming on both sides of the Atlantic. Victor Chu of First Eastern Investment Bank called them the super-nationals, government funds that have to look well beyond their borders to, in some cases, serve as lenders of last resort.
“They are the people with the capacity. They can act with speed and they can act with financial and strategic returns,” Chu said, “Sovereign wealth funds have a super-national interest to try to make sure that international markets are back on the right track otherwise we will see a domino effect of major failures,” he continued.
We all know the worn out phrase, "money makes the world go around." It is fitting today as we witness how interconnected everyone is at this level.
As one Gulf banker concluded in our session, if Uncle Sam calls, they will have to pick up the phone.
ABOUT THIS BLOGJohn Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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