Monday, November 19, 2007

Global Capital 1: Why Market Turbulence are Necessary

Market turbulence shakes and shocks many people. It is those painful financial adjustments, sometimes approaching crisis situation, where stock markets swing wildly if not tumble, currencies significantly depreciate or appreciate, values of assets and properties often head downward while prices of major commodities head upwards, and big debt write-offs are reported along with announcements of resignation or sacking of CEOs of some very big banks and companies. Hence, fear of such turbulence is understandable because at the end of the day, incomes, savings and jobs are in danger.

But what people often refer to as "turbulence" are only those periods of economic downturn such as those described above. When new innovations and products come on stream, or new discoveries (petroleum and mineral deposits, attractive real estate development, etc.) are announced, they are also part of turbulence where old technologies and processes are discarded in favor of new ones. So that many people make money, and many new jobs are created. Thus, people are scared only of negative turbulence but applaud positive turbulence.

Increasing globalization should result in more turbulence across all countries and economies around the world. This is because in theory, mobility and migration of capital, technology, labor and commodities should result in equalization of their prices (other factors held in constant) across the world. And for many decades, the world has known only very expensive countries and dirt-cheap countries, so that "price equalization" over the long-term is a far-out possibility.

But markets can also follow natural laws. The law of gravity says that objects will fall down the earth or low-lying areas when the force that hold them up high is spent up. Capital can follow countries or territories where skilled (or trainable) labor, land and office rental, and other factors of production are lower, so that profits can be maximized. Thus, poorer countries that are capital-deficient suddenly becomes capital-surplus, and this creates positive turbulence there. Whereas countries that used to be capital-surplus suddenly find a growing portion of their capital migrating elsewhere, and this creates negative turbulence for them. In short, market turbulence is as natural as sunrise and sunset, as natural as the Newtonian laws of gravity, inertia and action-reaction. Market turbulence therefore, is necessary, so that countries will be forced to adjust, to liberalize their trade and investment rules, to encourage and respect innovation, and to abandon complacency, if not laziness.

The current market turbulence in the US subprime and house mortgage markets, the bigger than expected losses of big US banks, the continued depreciation of the US dollar relative to all major currencies and many currencies of developing economies, and the slowly-but-surely inching of world oil prices towards the symbolic 3-digits $100 a barrel or more, is causing headaches to many people, both economic policy makers and ordinary citizens alike. In the case of high world oil prices, it is unlike in the 70s, the 80s and the early 90s where the spike was driven by supply disruptions, both actual and anticipated. These days, the spike is due mainly to sustained high world demand as millions of people from emerging markets become richer and buy more cars or travel more often via public transportation (land, sea and air). Which is a case of positive turbulence creating some negative turbulence elsewhere.

Should governments step in to introduce new regulations, or upgrade existing regulations to stricter ones? There is no logic in doing this except to show that the state is "doing something". As argued earlier, turbulence like these allow markets and people to adjust to changing situations. Some people bought expensive houses though their current and future incomes cannot support the high amortization needed, so loan default should happen along the way. You multiply this a thousand times, or a million times, and you have an economy-wide, or world-wide financial turbulence. If we allow individual responsibility to take its course, to allow individuals learn lessons from their earlier decisions and actions made, then more government regulations will be unnecessary, if not counter-productive over the long-run. Because more state regulations often encourage complacency among individuals, not to mention financial costs in terms of taxes and fees, to sustain a new army of bureaucracies and regulators being created.

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