After the ‘greed’ period, fear now drives markets to rationalization

Miranda Xafa, a deputy executive director of the International Monetary Fund (IMF) and chief economic adviser to former Greek Prime Minister Constantine Mitsotakis from 1991-93, thinks everyone should stay calm amid the current upheaval on world capital markets. The state of the global economy remains in good shape and problems will have no lasting impact, she told Kathimerini in an interview, excerpts of which follow. How likely is it that we are at the beginning of a world economic crisis at a time when global growth is progressing well? This is indeed the hot question of the day, but no one can answer it with certainty. What we are seeing is the upheaval that started with US subprime mortgage loans and spread. These loans are securitized and are sold on secondary markets as bonds. They are asset-backed securities and we now know that part of them is no longer serviced. Because they have been spread far and wide in the international market, finding their true valuation is difficult and time-consuming. For this reason, we are seeing that the pressure on markets these days comes in waves, increasing and falling depending on changing valuations. In any case, it is a fact that the international economy remains strong. The global rate of economic growth has not been this high for quite some time and the upheaval on the markets has not impacted the real economy. However, we may just have seen the tip of the iceberg… What risks do you see from this upheaval on capital and financial markets? The problem itself has not been assessed yet. For some investment funds that own bonds corresponding to non-serviced loans, the loss in value is known and specific. For others, where an evaluation has not been made, payments have been «frozen.» BNP Paribas’s three hedge funds that provided the signal for the strong stock market pressures last Thursday and Friday belong to this category. But the issue now is that lack of confidence is now spreading in a domino-like effect to all banks and investment funds. No one knows precisely the economic situation of the others and the resulting caution impacts both share prices and the volume of transactions among the various economic organizations. The dominant trend now in the market is «flight to quality.» So, when bond prices fall, yields rise, for they are the price of the higher risk. In turn, rising interest rates put pressure on corporate profits and share prices; in other words, conditions arise that lead the economy to recession. This is where the danger lies, that the pressure may spread throughout, although so far such a development is not discernible. Are there any mechanisms that could prevent the real economy from being hit? This is precisely the mechanism that we are seeing being activated. Central banks are keeping interest rates down and injecting money into the market. Thus, companies keep borrowing cheap money, productive investment continues to pay and growth continues. On the other hand, there is the danger of inflationary pressures from falling interest rates. The quest is for the ideal balance. US Federal Reserve Chairman Ben Bernanke’s recent statement that his basic target remains the control of inflation rather than the economy’s growth shows that central bankers are not yet greatly concerned. In the end, do these sudden market upheavals function as relief valves for pressures, or do they signal a deeper crisis which will erupt at some point? No, they are relief valves, as you said. Upheavals correct excesses. For instance, it is just not on for countries such as Brazil or Turkey to borrow at rates lower than those that Greece did a few months before it entered the European Economic and Monetary Union. This is a sign of excess and this is why bonds are now coming under pressure. Corrections such as the current one are in the right direction. Stock market valuations, you will recall, had risen substantially. Now, they are evening out. Let me put this way: Markets always seek a balance between greed and fear. We have been through the avarice period, now we living through the period of fear. Is liquidity not a risk factor? Let us make it clear that there is no lack of liquidity. It remains abundant. The latest injections by central banks are being made for purely conjectural reasons. The increase in liquidity in recent months originated in the currency reserves of a number of countries, such as China and some Arab nations that are seeking higher-yielding investments, and, naturally, by assuming higher risk. But this is no threat to the global economy. The message is, «Stay cool.»