The global financial crisis

According to the Institute for Development and Econometric Analysis, Inc. (IDEA) Economic Trends, “to say that the global economy remains dependent on the US economy may be a clear understatement. With the US dollar serving as the world’s currency, whatever direction it takes—often affected by the Fed’s interest rate movements—have a ripple effect all over the world. And since the US federal funds rate also serves as the benchmark rate for many other interest rates, its current level and future direction is always considered by other central banks in policy decisions”.

IDEA further reported that “after the mild recession in 2000 and the 9/11 attacks, the Fed promoted easy money by lowering its key rates to help stimulate the economy. The plan worked since the low interest rate environment, plus easing credit requirements, propelled the growth of the property sector. Since US assets were offering lower yields, investors shifted their funds to the emerging economies in search of higher returns. The result of this asset movement is the US dollar’s depreciation against other currencies.

Looking back now, the Fed failed to raise the red flag when the property sector started showing signs of overheating. In a marked failure of self-regulation, mortgage companies lowered their lending standards to help raise their profits. This led to mortgage loans being extended to individuals with questionable capacity to pay. Borrowers who had the impression that housing prices would continue to rise availed themselves of more loans, using their properties as collateral. Once the housing bubble did burst, both lenders and borrowers saw their wealth dropping substantially as house prices plunge.”

Furthermore, the financial sector which had a big exposure to the sector took a hit eventually. The resulting global credit crunch caused interest rates to rise sharply (especially for emerging economies) while yields for US government securities went down as investors looked for safer havens for their funds. This partly explains why yields for the Treasury Inflation Protected Securities (TIPS) event went negative. Investors were willing to risk losing the value of investments in return for the guarantee that the money will be returned to them, according to the same published report.

Until the US economy starts showing signs of sustainable recovery, real interest rates are unlikely to rise anytime soon. The danger of another asset bubble brewing may be too farfetched, given that housing prices, the sector where the crisis started, have yet to bottom out. The same goes for the rest of the world economy. Unlike in the US and Japan, the Philippines’ policy rates—the ones set by the BS—are still high (relative to them) and can still be lowered, if needed. The need for more rate cuts is apparent given projections of lackluster export and remittance growth for 2009. The downward trend in inflation, which started decelerating in September 2008 gives the BSP room to lower its interest rates further. This decrease would hopefully spur domestic demand and support the country’s economic growth.

Given the negative growth projections for the export sector and the likely up tick in job losses, other sectors driven by consumer spending would have to step in, according to IDEA.

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