Is the world to witness another looming crisis?

by Charmele Ayadurai

The European debt front and the worsening US economic growth tremor is increasingly being felt by the rest of the world as the world composite index continues to close on the low on most days.

Investors’ desperate attempts to resort to their own devises to make some quick profits from the deteriorating market is causing volatility and setting off a ticking time bomb.

The recent move by Eurozone countries to ban investors from short-selling their stocks has successfully managed to defuse the ticking bomb of debt and moral hazard.

Investors forecast the world economy to remain down in the doldrums for some time, which is a good indication to short sell. However, as the economy fluctuates, inflation rates will rise, thus moving prices up. Adding inflation to short squeeze is all that is needed for a snowball effect of default to take place and banks to take a tumble.

As history has revealed, the aftermath of the 1999 dotcom crisis was felt only 3 years later in 2002 when the NASDAQ showed signs of the effect. In 1999, Nasdaq was up 86% although two-thirds of the stocks declined.

Germany’s wise decision to ban naked short-selling is a prudent move. The free market economy is free to react to changes in the natural working of the economy, but as soon as the market becomes aloof and too dangerous for its own good, regulators are expected to quickly put a leash on it. This was the case in 2008 when short-selling was banned after the collapse of Lehman Brothers.

The industry was hiding heavy losses and, indeed, the shorters were right. Therefore, whether the move to short-sell is a wise one can only be determined by whether the market is currently dysfunctional and expected to get worse.

Greece has been bailed out twice by the EU and member countries are running out of both the patience and money to rescue the ‘damsel in distress’. The Euro is a shared currency among the EU countries, and stronger countries like Germany and France are expected to prop up weaker countries such as Greece, Portugal, Spain and Italy. Germany and France will suffer higher inflation and weaker economies if they continue handing out cash to Greece and other ‘damsels in distress’.

Financial institutions across the globe hold substantial Italian and Spanish government and corporate bonds. Their recent loss of faith in Italy and Spain in honouring their contracts has led them to sell off their shares, driving up the borrowing cost.

As these banks rely on billions of American dollars from mutual fund providers in the United States, there seems to be a gigantic storm gaining momentum as matters are made worse by the US debt downgrade, US high unemployment rate, and forecasted global recession looming.

Experts believe the sovereign debt crisis could get much uglier than the subprime mortgage crisis. Even the world’s most neutral economy, Switzerland, is feeling the pinch. The Swiss Franc, which was moving head to head with gold, has reached the status of massive overvaluation.

The world is calling out for desperate measures to shift the burden of growth onto the shoulders of developing nations. Never before have developing countries been in the limelight for being St Bernards. Sadly, their economies are not robust enough to turn the world economy around. On the contrary, their economies are somewhat dependent on the wealthier nations.

Although China is seen as the biggest developing economy in the world, its economy is still dependent on rich countries to purchase up to 40 percent of its exports. The world economy is at its most dysfunctional state as of now. The ban on short-selling is affecting the equilibrium of the market and causing unwanted volatility.

Therefore, the burden to make the right decision now rests on the shoulders of the EU and US. If it does not happen soon enough, the world will witness yet another financial crisis very soon.

Charmele Ayadurai is a Banking and Finance lecturer at Curtin Sarawak. Prior to joining Curtin Sarawak, she worked at Barclays Bank and Natwest Bank in the United Kingdom as a trainee associate, and having obtained her Masters degree, ventured out to work with UNISYS, an American insurance company as a lead verifier, and later on as a business development manager cum entrepreneur with TC Autos. In Malaysia, she has worked as a business development associate with OSK Investment Bank Berhad.