Global financial risks

inSight

31 Jan 2002

Global financial risks

A confluence of risks, all of them placing unprecedented global pressures on the global financial system, require a high degree of alertness.

I mentioned last week that the global financial system is facing an unprecedented confluence of risks. The management of risks to the stability of the monetary and banking systems of Hong Kong is very much the responsibility of the HKMA as well as the financial community. I wish therefore to share with readers some aspects of the international risk profile we now face, as I see it.

Readers are familiar with the collapse of the tech bubble and the after-effects. My Heavenking.com Viewpoint article of 16 March 2000, despite its deliberate lack of seriousness, predicted that collapse. Even so, the extent of the erosion of wealth and the sharpness of the subsequent global slowdown associated with it were beyond my expectation. This is yet another manifestation of the surprising extent of economic contagion that is possible with globalisation. I fear that these after-effects are still working their way through the global financial system and it may take a long time for them to be absorbed and for things to return to normal. Indeed, we are still observing, globally, quite a widespread deterioration of credit quality, posing considerable risks to financial stability and challenges to those involved in "workouts", both in the private and public sectors.

Jurisdictions with robust financial systems will, I am confident, have the capacity to absorb these after-effects, hopefully without government involvement, and individual failures will probably not lead to systemic problems. I would put Hong Kong in this category. But the same clearly cannot be said about weaker national financial systems, where the risk of eruption of problems of a systemic dimension in the monetary and banking sectors is quite high, particularly in the absence of clear signs of economic recovery. These problems are never easy to handle. The preferred, free market solution is often so debilitating for the community as to be politically unacceptable, necessitating government involvement. But often there is also a serious lack of official resources, reserves and resolve to tackle the problems and contain the damage.

We have already seen, in recent months, the biggest corporate bankruptcy in history, in the form of the collapse of Enron, and also the biggest sovereign default in history, in the form of the debt crisis in Argentina. Although they are not entirely the after-effects of the tech bubble, for there were other more specific contributory factors at work in these two record cases, they are illustrations of the severity of the risks and vulnerabilities now faced by the global economy, in particular, the global financial system. I hope that these records will take decades, if not centuries, to be broken again, and that the rather more benign contagion dynamics, reflecting lessons learnt from the financial turmoil of 1997-98, will not rear its head again. But there is clearly a need to stay very alert.

There is yet another record that has been broken in recent months and this is the biggest "man-made" claim on international insurance, arising from the tragic events of 11 September. I am not very familiar with the financial linkages between the insurance companies and the traditional financial intermediaries, or with those between the insurance sector and the global financial system. But these tragic events, and the consequential heightened concern about terrorist activities, occurring at a time when the global financial system had already been weakened by the burst of the tech bubble, may have the effect of undermining the latter's ability to absorb further shocks.

For the same reason, the appetite of the global financial system to take on additional risks may have become rather limited. This has adverse implications for the economic recovery that everybody is hoping to see materialise quickly. At the same time, it is possible that the tragic events of 11 September may have changed the behaviour of US consumers permanently in favour of some, rather than zero, savings, making a consumption-led economic recovery less likely than otherwise would be the case. Furthermore, there is considerable doubt about whether the economic recovery, when it eventually comes, will be underpinned and sustained by a resumption of the recent trend of increase in productivity. Indeed, notwithstanding quite heavy doses of policy stimuli in the United States, introduced after the burst of the tech bubble, the response in the economy and in financial conditions generally seems so far not remarkable, in terms of both speed and magnitude.

 

Joseph Yam

31 January 2002

 

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