Why on earth should the Rupiah in our pockets lose value
because someone in America has defaulted on his home loan?
A few years ago this could not have happened. Today, the world’s
financial markets are inextricably intertwined. This can be
seen most visibly by watching global stock markets. If the
main US indexes, the Dow and the S&P 500 fall, it is almost
certain that Asian markets and then European markets will
follow. But why should events such as the home loan market
in the US affect the Rupiah? Perhaps we should first look
at the cause of recent market volatility.
The main culprit – the ‘sub-prime’ market
It would be pretty difficult to find a bank in Indonesia –
or in most countries for that matter – that would lend
you money to buy a house if you had no job or regular income.
For a foreigner it’s pretty well impossible even with
an income. Yet in the US, aggressive lenders have been happy
to lend money to people who can ill afford the loans. The
rationale of the lenders has been that even if borrowers defaulted,
the collateral of spiralling house prices would ensure they
get their money back. But predictably, the good times came
to an end. Borrowers started to default in their thousands
and as more and more homes were vacated prices invariably
started to fall.
Now in the old days, lenders would have been left ‘holding
the baby’. But in today’s more sophisticated markets
they had already ‘passed the baby’ on by packaging
the mortgages and selling them in bulk to other institutions
such as hedge funds. In some cases these would use the collateral
to raise more capital. But as thousands of home owners started
to default on loans they should never have taken out the situation
became grim. Several hedge funds that had gone heavily into
the sub-prime market collapsed, not just in the US, but as
far afield as Europe and Australia. A number of banks who
were left with bad debts had to make provision for substantial
losses.
How come world markets were affected?
What should have been a problem restricted to one segment
of the mortgage market provoked a sharp fall in stock markets
around the world. The main US Dow Jones index fell 10% from
its high of just a few weeks previously, which technically
constituted a ‘correction’. The reason? Fear of
a credit crunch resulting from a general tightening of the
granting of loans. This in turn would result in lower profits
for businesses and a reduction in spending by consumers. If
Americans would be spending less this would result in exporters
around the world seeing their profits drop, hence the global
contagion.
But why should this affect the Rupiah?
Whenever there is turmoil or uncertainty in the markets investors
seek secure havens such as gold, cash deposits or US government
bonds and tend to pull away from any ‘higher risk’
investments. The latter include emerging market stocks, bonds
and currencies. Further pressure came from the ‘unwinding’
of the ‘carry trade’ in which traders borrow in
a low interest currency such as the Yen and profit from the
higher rates in other currencies such as the New Zealand Dollar
or the Rupiah. But when a currency starts to fall, the gains
from a rate differential can be rapidly wiped out, so as soon
as there is a hint of volatility, everyone makes for the exit
and the high interest currencies fall further.
Is the worst over?
Possibly, but far from certain. The US Federal Reserve moved
very quickly to reduce the interbank lending rate to ease
credit and improve liquidity. This resulted in an immediate
partial rebound in the markets. However, as news broke of
more institutional losses the markets fell again. Then, at
the end of August the US Fed hinted that a base rate cut was
on the cards for September. This resulted in another short
rally. Since then markets have been bobbing up and down and
no-one knows which direction they will finally take. The fact
is it is a tussle between the still healthy economic growth
that most of the world is enjoying and the fear of a severe
credit crunch which could result in a global recession. It
is almost like a Balinese drama depicting the battle between
good and evil. Usually good prevails but evil is always present.
Yes, the markets are a bit like that. Perhaps just as well.
If they weren’t I’d have to look for something
else to do!
Should long term investors be worried?
Not in the least. Market movements and cycles are perfectly
normal and have been around since the capital markets were
created. If you have followed sound financial planning principles
you will have adequate cash reserves to see you through the
near term. Your long term investments may fall in value but
they will remain in place and intact for the next recovery,
unless you were misfortunate enough to invest in a high risk
fund that goes under. The best insurance against that is not
to put too many eggs in any one basket. As always, we never
know precisely when to expect the next recovery, hence the
importance of being invested in the markets. A downturn is
also the time to be ploughing in more cash, not wait until
the next peak and ‘feel good’ time. If you have
a regular savings plan it is important not to lose faith when
the valuation sags because now is the time you can buy more
shares or units for the same amount of regular premium. The
rewards will come later, as those who kept their plans going
through the bear market of 2000 to 2003 discovered.
The moral of the story? Stop worrying about the markets and
use the opportunity to build up your wealth!
Colin Bloodworth is a senior adviser with Financial Partners
International. The opinions expressed are his own. If you
have any questions relating to personal finance you may contact
him at 021 520 8099 or colin.bloodworth@financial-partners.biz
