Down but not out

PUBLISHED : Monday, 29 August, 2011, 12:00am
UPDATED : Monday, 29 August, 2011, 12:00am


It's not exactly pretty out there. Financial markets have traded in such violent fashion of late that even hardened investors wonder whether we are heading into another major bust. The memory of 2008, when the collapse of Lehman Brothers caused a global deep freeze, is still fresh. Hong Kong, too, received a heavy blow at the time. After three short years, could this possibly happen again?

There are plenty of worries to go around. In the United States, the economy is looking wobbly, with especially the manufacturing sector decelerating. Recent wrangling over America's debt ceiling, and the subsequent credit downgrade, only added to uncertainty. There is also the lingering fear that US officials are out of ammunition to counter weaker growth.

Europe, too, is not out of the woods yet. More reforms, and further financial support for the continent's periphery, are probably needed to put to rest market worries. Politics prevents swifter action, so policy uncertainties are bound to linger.

What's more, even Europe's economic engine - Germany and the Nordic countries - has sputtered of late.

The picture, in short, looks challenging. But a repeat of the events of 2008 still appears unlikely. Think of what precipitated the crisis. When it became clear Lehman Brothers was in trouble, after a brief debate, it was decided that it should receive no official support.

Central banks have new instruments in place

At the time, this appeared like a wise decision: in order to forestall moral hazard - the tendency of borrowers to act foolishly if they have no reason to fear the consequences of their actions - the US financial system was thought to require a lesson in risk, and the collapse of a major investment bank was seen as just such a teaching opportunity.

In hindsight, presumably everyone wished a different path had been struck. As desirable as it might be to prevent moral hazard, the costs of financial collapse proved in the end too large. Therefore, policymakers will act swiftly to shore up major financial institutions should liquidity again dry up.

Major central banks now have in place a whole range of new instruments to inject liquidity into the market to prevent a full credit crunch from spreading. They will not hesitate to use these.

The European Central Bank, for example, currently offers unlimited euro liquidity to local banks and has the means to provide dollars as well, as it did once again in recent weeks.

In the US, the type of institutions with access to Federal Reserve liquidity support has been vastly extended, covering now nearly all major institutions. Globally, the International Monetary Fund, with its richer coffer, has expanded lending powers to help countries in need, and swap lines have been institutionalised among major central banks to quickly address any potential shortage in hard currency.

To be sure, all of these measures are useful only in the event liquidity dries up. Solvency problems, such as the funding challenges of some European nations, cannot be solved by simply providing emergency central bank support. As such, major problems remain.

However, there is a key difference between a liquidity and a solvency crisis: as long as the former can be avoided, the latter will evolve only slowly, and not calamitously, more likely leading to weak growth over a long time rather than a sharp plunge in output.

For Hong Kong, this means that another recession, on the scale of the one in late 2008, is not on the cards.

Financial volatility, of course, may weigh on local consumer sentiment and spending. Trade, too, is bound to cool further as Western shoppers cut back further. But a similar collapse in global supply chains, as happened during the global financial crisis, appears unlikely at this stage.

Moreover, as the integrity of the global financial system is being maintained, Hong Kong's capital markets should continue to function without major interruption, even if returns fall short of expectations for a while.

Frederic Neumann is managing director and co-head of Asian economics research at HSBC