Will the world bail out US?

Other countries will worry about solving their own problems first

THE world today is indeed a different place than say, a year, or even six months ago.

It was only recently that the National Bureau of Economic Research (NBER) declared that the US was in fact in recession since December 2007. But measured against the technical definition of a recession, i.e. two consecutive quarters of negative growth, the US is yet to be in recession.

However, with the market expecting fourth quarter growth in the US to be decisively negative, at as much as negative 6.5%, the US will be in technical recession once it releases its current quarter GDP data by the end of next month.

Recession or no recession, the US is in trouble, what with the massive global writedowns and credit losses todate amounting to a little over US$1 trillion, of which two-thirds originated from the US.

On top of the above losses, the US economy is in dire straits with rising unemployment, all-time low readings on the Consumer Confidence Index and ISM indices for both the manufacturing and services sector.

It is also facing a depressed retail sector and diminishing values for homes as well as the threat of deflation.

To address these challenges, the Fed has been aggressive in cutting interest rates with its latest move of lowering the target rate to between zero and 0.25%, the lowest ever on record.

At the rate the Fed is going, it has effectively used up all of its monetary tools to fire up the US economy.

The Fed has been busy in recent months, providing liquidity or buying up toxic assets to the extent that its own balance sheet has ballooned to more than US$2.2 trillion, almost triple compared to a year ago.

The Fed is effectively printing money but by doing so, the world too is drawn to the US problem as the rest of the world has been the biggest buyer of US Treasuries, despite the current extremely low interest rate environment.

Indeed, some nations have been cutting their exposure to the US economy and debt papers and rightly so.

With the current yield on US Treasuries at only 2.13% and 2.56% for the 10- and 30-year papers, does it make sense for the rest of world to continue to buy US debt papers?

More importantly, through the current low interest rate environment, the Fed is indeed getting cheap funding for its efforts to rescue the US economy but the end result may be even more damaging, especially in the supply of money, which at one point will turn inflationary.

US Treasuries have been among the best asset class performers in 2008, returning more than 15% this year.

With market expectations that the US economy will remain in the doldrums for at least another year, US Treasuries are set to return more than 10% if yields continue to dip due to their “safe haven” status and buying from the rest of the world.

Some may argue that the rest of the world cannot afford not to buy these debt papers now for fear that the US dollar itself may become a victim, resulting in nations recognising huge translation losses.

While this argument has a valid point, I must say that it too can be argued further.

For instance, if the rest of the world were to buy these papers now, would it be logical to think that the risk-reward ratio is indeed negative as chances of US interest rates climbing back up are definitely higher, maybe not in one or two years, but some time during the tenure of these long-dated papers.

Investing in government papers too can be risky in terms of mark-to-market losses, as when yields rise, prices fall.

Hence, even by buying these papers now and achieving short-term aims, i.e., supporting your own interest in US dollar assets, it too can backfire when things return to normal.

The other point of argument is that the rest of the world, including the European Union, Japan and China, is either experiencing its own respective problems at home and hence, I believe it is logical that they will take care of themselves first before acting on helping the US.

Uncle Sam can’t simply issue us “IOUs” and expect us to believe that it will not turn sour at some time in the future, either in forex losses or in the form of capital losses.

Pankaj Kumar is the chief investment officer at Kurnia Insurans Bhd.