Limping Economist

Our new Finance Minister, who is refers as the Limp by one of us, was said to be a "British-trained economist! He is expected to be a better finance minister than the Flip-Flop PM, who has a degree in Malay studies/Islamic studies... Some people also insinuated that when the Limp came back in 1976, he hasn’t completed his degree then. Who knows! But the fact is that he has no experience in running the financial health of our country. If this were true, then we would be better off appointing Mustapha Mohammad as finance minister. After all he has a first class honours degree in economics.

This thing which people associate between having an economics degree and being finance minister is over-hyped and mostly baloney. One thing that I know and for sure, despite my degree in business management and with sound understanding of economic theoretical knowledge, I still have to refresh the basic economic philosophy that I have learned in my university days..

So let me recalled, for the sake of the Limp the economic though beginning from the the economic philosophy of Mercantilism as adopted by merchants and statesmen during the 16th and 17th centuries right to the current decade.

1.    Mercantilists believed that a nation's wealth came primarily from the accumulation of gold and silver. Nations without mines could obtain gold and silver only by selling more goods than they bought from abroad. Accordingly, the leaders of those nations intervened extensively in the market, imposing tariffs on foreign goods to restrict import trade, and granting subsidies to improve export prospects for domestic goods.

2.    By 1750’s, Physiocrats, i.e. a group of 18th century French philosophers led by Francois Quesnay, developed the idea of the economy as a circular flow of income and output. They opposed the Mercantilist policy of promoting trade at the expense of agriculture because they believed that agriculture was the sole source of wealth in an economy. As a reaction against the Mercantilists' copious trade regulations, the Physiocrats advocated a policy of laissez-faire, which called for minimal government interference in the economy.

3.   Then in 1776 Adam Smith wrote, The Wealth of Nations which begin The Classical School of economic theory. Adam Smith laid out the three factors of production; land, labor, and capital. He viewed that an ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace.

He described the market mechanism as an "invisible hand" that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive.

The second major contributor of classical economic though is David Ricardo. In his         book-Principles of  Political Economy and Taxation, he wrote about the distribution of     income among lowners, workers, and  capitalists. He saw a conflict between                     landowners on the one hand and labor and capital on the other.  He  posited that the       growth of population and capital, pressing against a fixed supply of land, pushes up         rents and holds down wages and profits.Then came Thomas Robert Malthus with his       book- Essay on the Principle of Population. He used the idea  of diminishing returns to   explain low living standards. Population, he argued, tended to increase geometrically,     outstripping the production of food, which increased arithmetically. The force of a           rapidly  growing population against a limited amount of land meant diminishing               returns to labor. The result, he  claimed, was chronically low wages, which prevented     the standard of living for most of the population from  rising above the subsistence level.

Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its     spending by saving too much, a theme  that  lay forgotten until John Maynard Keynes     revived it in the 1930s.

Coming at the end of the Classical tradition, John Stuart Mill parted company with the earlier classical  ecomists with his book- Principles of Political Economy,  on the predictability of the distribution of  income   produced by the market system. Mill pointed to a distinct difference between the market's two  roles: allocation of resources and  distribution of income. The market might be efficient in allocating  resources but not inistributing income, he wrote, making it necessary for society to   intervene.

 4.    By mid 19^th century, The Marxist School challenged the foundations of Classical theory. Whether  deserving  or not Karl Marx was perhaps unwittingly destined to play a major    role in economic though.Basically Karl Marx was of the opinion the inequality of   capitalism would inevitably lead to a revolution of  the oppressed  workers leading to the formation of a Communist state. In fact Karl Marx went to extraordinary length to explain   this principle. One of his principle works, Das Kapital could make claim to  be one of the most boring  books ever written. (Perhaps only beaten by Adam Smith’s Wealth of         Nations). However in F.Engels, Marx had a companion who was able to help romanticise the ideals of  communism. 

An advocate of a labor theory of value, Marx believed that all production belongs to labor because workers produce all value within society. He believed that the market system allows capitalists, the owners of machinery and factories, to exploit workers by denying them a fair share of what they produce. Marx predicted that capitalism would produce growing misery for workers as competition for profit led capitalists to adopt labor-saving machinery, creating a "reserve army of the unemployed" who would eventually rise up and seize the means of production.

5.   Marginalist:Classical economists theorized that prices are determined by the costs of production. Marginalist economists emphasized that prices also depend upon the level of demand, which in turn depends upon the amount of consumer satisfaction provided by individual goods and services.

Marginalists provided modern macroeconomics with the basic analytic tools of demand and supply, consumer utility, and a mathematical framework for using those tools. Marginalists also showed that in a free market economy, the factors of production -- land, labor, and capital -- receive returns equal to their contributions to production. This principle was sometimes used to justify the existing distribution of income: that people earned exactly what they or their property contributed to production. Contributors to the marginalist thought are:

Leon Walras-He revolutionized economics with his rigorous mathematical formulation of the mechanics of the price system.

Alfred Marshall-He demonstrated the tremendous theoretical power of demand and supply curves, and bequeathed to economics the critical distinction between the short run and the long run.

6.   Institutionalist economists regard individual economic behavior as part of a larger social pattern influenced by current ways of living and modes of thought. They rejected the narrow Classical view that people are primarily motivated by economic self-interest. Opposing the laissez-faire attitude towards government's role in the economy, the Institutionalists called for government controls and social reform to bring about a more equal distribution of income. Thorstein Veblen, one of the leading Institutionalists, is best remembered for his theory of "conspicuous consumption" which parodied the ostentation of the Gilded Age.

7.    Keynesian School

      Reacting to the severity of the worldwide depression, John Maynard Keynes in 1936 broke from the  Classical tradition with the publication of the General Theory of Employment, Interest, and Money.  The Classical view assumed that in a recession, wages and prices would decline to restore full  employment. Keynes held that the opposite was true. Falling prices and wages, by depressing people's  incomes, would prevent a revival of spending. He insisted that direct government intervention was necessary to increase total spending. 

      Keynes' arguments proved the modern rationale for the use of government spending and taxing to stabilize  the economy. Government would spend and decrease taxes when private spending was insufficient and  threatened a recession; it would reduce spending and increase taxes when private spending was too great  and threatened inflation. His analytic framework, focusing on the factors that determine total spending,  remains the core of modern macroeconomic analysis.

      Most western countries adopted the principles of Keynesian but by late 1960’s, troubling inflation and  lagging productivity prodded economists to look for new solutions. From this search, new theories emerged: 

      Monetarism updates the Quantity Theory, the basis for macroeconomic analysis before   Keynes. It  reemphasizes the critical role of monetary growth in determining inflation.  

Rational Expectations Theory provides a contemporary rationale for the pre-Keynesian tradition of limited government involvement in the economy. It argues that the market's     ability to anticipate government policy  actions limits their effectiveness.

Supply-side Economics recalls the Classical School's concern with economic growth as   a  fundamental  prerequisite for improving society's material well-being. It emphasizes     the need for incentives to save and invest if the nation's economy is to grow.

These theories and others will resurfaced and be debated and tested. Some will be           accepted, some modified, and others rejected as we search to answer these basic         economic questions:

1. How do we decide what to produce with our limited resources?

2. How do we ensure stable prices and full employment of resources?

3. How do we provide a rising standard of living both for now and the future?

So, Mr. Limp there is a hell lots of theory and economic philosophical knowledge to be grasped within a short time. Economic understanding is not just coining the word….. “glokal” or professing himself to be the campaigner of Islamic banking in Malaysia but still adhering to the cronyism and corruption practice of the dimwits ( Second Finance Minister).

The Dimwits Petrol Gift

The chart above i.e the topmost showed the crude oil price restated in Ringgit from 2004 to current year, while the bottom chart is our petrol price for similar time frame.

 The upward trajectory of crude  oil prices from 2004 has three distinctive characters;

(a)    From 2004 to July 2006 prices move in moderation and subsequently our petrol price at the pump was increase in tandem with crude oil price.

(b)   From August 2006 to January 2007 crude prices descend while our Riggit ascend vis-à-vis the US Dollar. The strength of the ringgit caused the prices of crude in ringgit to touch the bottom by March 2007as compared to crude in US dollar was at the lowest in January 2007. Unfortunately the good fortune was not passed to the rakyat by the dimwits.

(c)    From February 2007 to  July 2008 there was a long sustaining linearly upward movement in prices and ended with a record high price of crude prices in July, before a reversal or maybe a retracement in August. Despite the expansion in prices, the petrol price was kept at bay due to the election year. After the election in March and with the dimwits lossing the 2/3  majority and, 5 states and Wilayah Perseketuan….the dimwits showed their true colors…we were hit by a 40% increase in petrol prices in July.

(d)   The fall of crude oil in late August and September gave a breathing space for the dimwits to reduce petrol price. However, the reduction is not reflective of a caring government since it was more of the dimwits political strategic maneuver …the reduction of  5.6% was done in 23^rd August before the Permatang Pauh by-election and further reduction of  3.9%  on the 25^th of this month is to appease us before Hari Raya.

The 40% hike in petrol in July has done the damage as reflected by the inflation rate which has jumped to a 27-year high of 8.5 percent in August, driven by the escalating cost of food and fuel, according to official data. Any reduction of petrol prices will not be aligned with a reduction in food prices since sellers of foodstuff are a bit sticky about price reduction.

 Graphically, the increase in crude prices and petrol prices can be clearly seen in the chart below where prices is compared  to a base of constant price of January 2004.

Crude prices have moved astronomically high in the past six months and US dollar also been moving upward from March to July. The double whammy is reported to be the works of hedge funds and also the Central banks of industrial nations (that will be another story).

The meltdown of financial industry in USA will be a big question to ponder for our economic planners. Where does the US Dollar and crude prices heading?

But anyway…..an increase in crude oil prices will increase Petronas profitability.

I just don’t trust the imbecilic dimwits to manage the subsidies and loyalties forwarded by Petronas…….”Seperti tikus baiki Labu”.

Investment Bank

“We're asking the American taxpayers to sacrifice and put $700 billion out there when other people have been lining their pockets,'' Illinois Representative Luis Gutierrez, a Democrat, said on 23^rd September on bailout plan by The Treasury Secretary Paulson and Fed Chairman Bernanke using taxpayer funds to be used to purchase assets that will in all likelihood be worth considerably less in the future. “I want to make sure it doesn't happen tomorrow.''

According to proxy statements outlining their salaries, bonuses and stock options: those  mandarins  from some of the major investment and commercial banks involved in the financial upheaval and bailout earned hefty paychecks last year.

§                Lehman Brothers Chairman and CEO Richard Fuld Jr. made $34 million in 2007. Lehman  filed for Chapter 11 bankruptcy protection earlier this month.

§                Goldman Sachs , which Sunday gained Federal Reserve Bank approval to become a bank holding company, paid its Chairman and CEO Lloyd Blankfein $70 million last year. Co-Chief Operating Officers Gary Cohn and Jon Winkereid were paid $72.5 million and $71 million, respectively.

§                Morgan Stanley Chairman John Mack earned $1.6 million. Chief Financial Officer Colin Kelleher got a $21 million paycheck in 2007. Morgan Stanley  also received approval to become a bank holding company, a shift that allows Morgan and Goldman to bring in bank deposit assets which offer more solid financial footing.

§                Merrill Lynch CEO John Thain was paid $17 million in salary, bonuses and stock options in 2007. Merrill is being acquired by Bank of America . BofA CEO Kenneth Lewis earned $25 million in 2007.

§                JP Morgan Chase & Co. Chairman and CEO James Dimon earned $28 million in 2007. Chase  acquired troubled investment house Bear Stearns earlier this year with the federal government promising to take on as much as $30 billion in Bear assets to help get the deal done.

§                Fannie Mae CEO Daniel Mudd received $11.6 million in 2007. His counterpart at Freddie Mac, Richard Syron, brought in $18 million. The federal government announced earlier this month it was taking over the mortgage backers with Herbert Allison to serve as Fannie CEO and David Moffett the new CEO at Freddie.

As stated above, the last two standing investment bank, Goldman Sachs and Morgan Stanley are abandoning their investment banking models. The Federal Reserve has approved the applications of the two investment banks to become Bank Holding Companies.I personally think that the whole reason the Investment Banks needed to partner up with established banks (who have deep retail deposits) was to get stable funding.

 With the current scenario that befall the investment bank industry in US, maybe down here we should rethink back the investment bank model especially those without a banking license in their group holdings. No doubt those executives running the local investment banks are not that creative as the American counterparts, but  they might acquire certain ideas from the Americans since all the highly confidential and secretive dealings of those American Investment banks become public due to the bailout.

Bailout....ours and them

In US, the great land of capitalist lately been reduced to a  land of selective socialism….socialized financial industry. What has happened over there?

The greed of behemoth financial institution caused their downfall and the misdirection of the political leaders lead them be a  capitalist greed. Just reflect back to the fall of AIG, once the biggest insurance company in the world. 

A decade ago, Sen. John McCain, a Republican President aspirant, embraced legislation to broadly deregulate the banking and insurance industries that proponents said would result in greater economic growth.

In 2002, McCain introduced a bill to deregulate the broadband Internet market, warning that "the potential for government interference with market forces is not limited to federal regulation."

Three years earlier, McCain had joined with other Republicans to push through landmark legislation sponsored by then-Sen. Phil Gramm (Tex.), who is now an economic adviser to his campaign. The Gramm-Leach-Bliley Act aimed to make the country's financial institutions competitive by removing the Depression-era walls between banking, investment and insurance companies

That bill allowed AIG to participate in the gold rush of a rapidly expanding global banking and investment market. But the legislation also helped pave the way for companies such as AIG and Lehman Brothers to become behemoths laden with bad loans and investments. 

It is ironic that now McCain condemns the executives at those companies for pursuing the ambitions that the Gramm-Leach-Bliley Act made possible, saying that "in an endless quest for easy money, they dreamed up investment schemes that they themselves don't even understand." 

Anyway, credits (ahem…) have to be given to AIG.  The insurance company been in the forefront of the industry.  Whether introducing new insurance products to  finding new and exciting ways to mistated their reserve levels through phony reinsurance deals (see Gen Re/AIG case earlier in the decade), to selling protection on billions of subprime residential CDSs (Credit Default Swaps).  The company has written down about $20 billion in subprime related transactions. Note: AIG also participated in CDS of corporate bonds. 

Credit default swaps (CDS) function much like insurance on another party’s debt. So, for example, investors that purchased a mortgage-backed security issued by, say, Lehman Brothers may also have purchased a credit default swap issued by AIG that would pay if Lehman defaulted on its bonds (e.g., by going into bankruptcy).

Credit default swaps are essentially unregulated insurance contracts. Not technically securities, they do not have to be registered with the SEC. Not technically insurance, their issuance by AIG was not overseen by state insurance regulators.

This meant that AIG was apparently not required to disclose the full extent of its liability, or to hold reserves against these contingent liabilities, as they would for the life insurance policies their (currently) healthy subsidiaries write. So, when the rating agencies threatened to downgrade AIG, it is not surprising that the counterparties to these contracts would have required AIG to pony up more collateral.

This, AIG could not do.

Thus, a liquidity crisis.

AIG initially went to the Fed asking for $40 billion, they got $20 billion from their subsidiaries, and before the Fed bailout, based on the news, Goldman and JP Morgan were tasked with trying to raise $70 billion of bridge financing for the company.

 In this a bailout?

 Based on the bit and pieces that I gathered from the report. The bailout contained: 

1. The Fed is giving AIG a credit line of  US$85 billion limit, with interest rate at current level 12% (It is indexed to market interest rates). AIG will use this to ensure they can continue making payments on their other liabilities in the short term.
2. The Fed line of credit is collateralized by AIG’s full assets. This means that if AIG is forced into bankruptcy despite the bailout, the Fed will get paid before AIG’s bondholders.
3. The Fed does not own any AIG stock, but has warrants (similar to stock options) on just under 80%, meaning that the Fed not can buy 80% of AIG at a fixed price. There is no mentioning of the price.

 Who get bailed?

AIG’s shareholders are not getting bailed out.  At best, they just lost 80% of their assets to the Fed.

AIG may or may not be fundamentally solvent. AIG has huge assets and huge liabilities which currently nobody is quite sure what the correct price. They needed the bailout because they have liabilities coming due today which they weren’t able to raise cash to cover. The Fed line of credit lets them pay their current liabilities and gives them time to rearrange their finances in hopes of being able to cover future rounds of liabilities with their assets.

If AIG is fundamentally solvent in near future, AIG has a chance to pay bondholders back in full. If it isn’t, then bondholders will be taking a bigger haircut than without the bailout because  they now  are subsidiary to Fed US$85 billion loan. Therefore AIG bondholders are getting bailed out somewhat.

The real beneficiaries of the bailout are AIG’s counterparties — companies and investors to whom AIG has contractual obligations (most significantly credit default swaps — essentially insurance for bondholders against the possibility that their creditors won’t pay their debts). These are the people that to be bail out, because they behaved responsibly by buying insurance for their risky assets from an apparently solid insurer, and because it is the possibility of AIG defaulting on its counterparties which holds the biggest risk of a cascading failure wrecking a big chunk of the financial system.

 Now just compared the bailout done  in  Malaysia’s  bolehland by the dimwits BN/UMNO. Just perused through some of the bailout that cost money from the taxpayer pockets.

1. IWK: The dimwit (i.e. the former PM) raised  RM200 million for bailout of Indah Water Konsortium (IWK), the financially hobbled concessionaire managing the national sewerage system. But that was not all that the country lost. According to DAP national chairman, Lim Kit Siang, the soft loans granted by the government to IWK amounted to about RM1.4 billion and they were ‘clearly irrecoverable losses’. 

2. KPB: Remember the former dimwit’s rescue of Konsortium Perkapalan Bhd (KPB) (then owned by his son Mirzan), which was submerged in debts of about RM1.7 billion, using funds from Petroleum Nasional Bhd (Petronas)? The Petronas-controlled national shipping carrier Malaysian International Shipping Corporation Berhad (MISC) was used to acquire KPB’s shipping assets with cash said to be as much as RM1 billion. 

3. MAS: The diwits bought back a controlling stake in the Malaysia Airlines System Bhd. (MAS) at the same price for which it sold it in 1994. But the carrier, which had a light debt load then, was grounded by its RM9.5 billion debt and was headed for a fourth straight year of losses.  Bankruptcy was imminent. 

The national carrier was first sold to then chairman, Tajudin Ramli,  without an open bidding process. In the bailout, the government used the tax payers money to pay RM8 a share when the shares of the ailing airline were trading at only RM3.6. It was believed that the government paid close to RM1 billion more than the market value for the stake held by the airline’s former chairman – who had no experience in the airline business before he took over the company and was widely blamed for running the airlines into the ground. 

4. Time dotcom: The manner in which the government rescued Time dotCom, a subsidiary of Time Engineering (then saddled with a RM5 billion debt), itself a publicly-listed company of the dimwit’s UMNO-linked Renong Group, added yet another ugly dot to its integrity. 

In a land where anything is possible, Bolehlanders watched in disbelief when:

• Kumpulan Wang Amanah Pencen (KWAP) or the Pensions Trust Fund coughed up RM904 million to buy 273.9 million unwanted Time dotCom shares, incurring an instant loss of RM280 million. 

• Employees Provident Fund (EPF) spent RM269.28 million on 81.6 million (unsubscribed public portion of the initial public offering (IPO)) of Time dotCom Bhd shares at RM3.30 – when the share was hovering between RM1.96 to RM2.10 and even less -  eventually suffering a loss of over RM100 million belonging to the rakyat. 

• Danaharta (the agency tasked with removing bad loans from the banking system) and  Khazanah (the Government’s investment arm) got involved in the bailout, when it was clearly not their mission to be a vehicle to bail out failed IPOs of companies. (Khazanah acquired 30 per cent of Time dotCom for some RM2.1 billion.).