TheStar
Even though the full extent of the impact of the subprime problem would only be known in 2008, i Capital maintains it is containable and will not develop into a global financial crisis.
THE subprime and related problems continue to haunt many financial institutions and markets, especially those in the developed countries.
This is due partly to the fact that many developed economies have been enjoying booming real estate prices for a prolonged period. The rise in property prices in countries like Ireland, Spain and Denmark has been more spectacular than those in the US. So, now is the time to pay the price.
As the full impact of the subprime problem and the contraction in the US housing industry continues to unfold, investors are continuing to invest and looking over their shoulders to see if they should sell and flee.
The impact so far, whether on the economies or the balance sheets of financial institutions, has been contained.
Although the full extent of the impact would only be known next year, i Capital maintains it is a containable problem, and is not and will not develop into a global financial crisis.
Even as Citigroup reported being hit by the losses in mortgages, Wells Fargo unveiled a decent set of earnings. While Nomura recorded its first quarterly loss in four years, JPMorgan announced earnings that beat estimates.
This is not what a crisis is made of. This sounds more like a business-as-usual situation. One possible reason investors remain spooked by the subprime problem and the housing contraction is that they continue to make media headlines.
As stock markets continue their upward paths, i Capital is constantly on the lookout for any negative catalyst that could cause a sharp correction or even turn the bullish mood bearish.
The still rising oil price is one possible factor.
A simple correlation of the price trend with the world’s gross domestic product would lead one to naively conclude that rising oil price is good for the world economy as oil price has moved in tandem with the expansion in the world economy.
The cause-effect relationship is such that it is the expanding world economy that led to the sustained rise in oil price and not the other way round.
However, when oil price reaches a certain level within a certain time frame, the cause-effect relationship goes into reverse. The world economy would be hit.
This leads to the most important question, what is the level of oil price that would cause the world economy to move into reverse gear?
Past experiences have not been useful in answering this tricky question. Based on the nasty experiences in the 1970s, when oil price hit US$40-$50 per barrel in 2004 and 2005, many alarm bells were raised.
Nothing adverse happened. Instead, the world economy expanded faster and inflation rose for a while and then fell back. Even for a fast-growing economy like China, it was the price of pork that caused inflation to spike up.
Oil price has surged from around US$11 per barrel in 1999 to a recent high of US$94-$96 per barrel. If this big move did not cause the world economy to spin out of control, why would higher oil price in future cause damage to global economic growth?
It is not just the percentage rise that has to be considered. The absolute price level is also important. A rise from US$20 to US$40 is a 100% move but this was not worrying as the economies were able to absorb such a rise.
Will a rise from US$80 to US$120, a 50% increase, be less innocuous? There will certainly be an absolute level where the price of oil will hurt the global economy. What is this level?
Nowadays, no one seems to have the answer any more. After being proven disastrously wrong in 2004, 2005 and 2006, there are no more smart alecks.
For most of 2007, crude oil price was surging and yet, if not for the subprime panic, investors were hardly concerned with the high oil price. Investors were keener to chase the many oil and gas-related stocks.
To answer what the level is, one has to realise that the global economic environment has changed in a structural manner. The best way for us to describe it is to call it the i Capital Long Boom.
Old relationships are no longer valid. The cause-effect linkages have been modified. As i Capital has advised repeatedly, the transformation of China would impact the global pricing environment in two ways – it is inflationary and deflationary at the same time.
On its own, China’s economic transformation would have been less impactful. However, with the aid of the computer and Internet revolution and globalisation, the impact of China’s transformation can be transmitted to the global pricing environment faster.
The ensuing effect on the rest of the world (like Brazil, Middle East, Russia, etc) in turn resulted in other countries magnifying the impact of China's historic transformation. Does this then mean there is no absolute level of oil price that matters?
This brings us to another crucial factor in the oil price-world economy equation. Speed. A rise from US$20 to US$40 per barrel spread over two to three years is no big deal. A rise from US$80 to US$120 per barrel spread over four to five years can, on a net basis, be beneficial to the world economy.
On the other hand, a rise from US$80 to US$120 per barrel in a matter of weeks or months is a different story altogether. The chart shows that the rate of price rise has gained momentum. At this rate of ascent, oil price would soon touch levels that would make even the most bullish turn cautious.
Having analysed world developments in this way provides us with a different perspective and hopefully leads us to ask the right questions. What or who can cause crude oil price to spike up in a way that frightens every one in the world?
In 1990, the US economy was slowing down gradually. Then, the Gulf War broke out. Oil price surged, a short military conflict broke out. Based on all the war propaganda by both sides and the fact that it was the first military conflict to be shown live on TV, everyone was scared to his bones.
Stock markets plunged. The US economy went into recession. Now, it may be déjà vu as the US, using all kinds of excuses, is threatening to invade Iran, which has vast energy resources. At the same time, Turkey is threatening to attack northern Iraq; again a country we all know has plenty of energy resources.
Any attack, whether by the US or Turkey would most certainly cause crude oil price to shoot up. It would bring oil price to a frightening level quickly. It would have all the ingredients necessary to cause panic in the global financial markets and the subprime problem would be mostly forgotten.
Will Bush be crazy enough to attack Iran? Will Turkey be forced to turn a small border disagreement into a global panic? Who knows? We live in a different world. Even the world’s climate is changing and still most people do not care.
Disclaimer: Reading materials in this site are obtained from its respective website and it is for information purposes only. It is not Malaysia Unit Trusts - administrator view and it is not to be used against Malaysia Unit Trusts - administrator.
