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Destruction of global wealth tops $20trn


By Karen Remo-Listana

Top international investment banks have confirmed that the world is now experiencing the worst global financial crisis since the Great Depression with the global wealth losses amounting to $20 trillion (Dh73.4trn).

Morgan Stanley, HSBC and The Bank of New York Mellon Corporation (BNYM) unanimously say that the credit crisis has led to the biggest shock to world wealth since the Second World War.

The Great Depression was the largest and most important economic depression in modern history and is used in the 21st century as an example of how far the world's economy can fall. And like the current financial crisis, the Great Depression originated in the United States.

Historians most often use as a starting date the stock market crash on October 29, 1929, known as Black Tuesday. The depression had devastating effects in virtually every country, rich or poor. International trade plunged by half to two-thirds, as did personal income, tax revenue, prices and profits. Cities all around the world were hit hard, especially those dependent on heavy industry. Construction was halted in many countries.

But the current crisis is more than just a depression, says Richard Hoey, chief economist of BNYM. "We expect a severe global recession rather than a depression," he said in a statement sent to Emirates Business.

"The global economy was in freefall in the fourth quarter of 2008 and this should continue in the early months of 2009.We agree with the view this is the greatest global financial crisis since the Great Depression," he added.

According to Morgan Stanley's estimates, the result of the current financial crisis has been a destruction of world wealth, which since mid 2007 has amounted to approximately $20trn (or down 16 per cent from its peak, which has been estimated at $125trn by the United Nations).

"This is the largest absolute and percentage decline in world wealth since the physical destruction of the Second World War," said the New York-based bank holding company.

It added that while the US has seen the biggest shock to housing wealth, most other countries now also have negative trends in this key element of global wealth.

In addition, the US dollar value of local equity indices fell by more than the S&P 500 in almost all cases in 2008. This shock to wealth is reinforcing the negative impact from the breakdown of the normal functioning of the financial system on household and corporate confidence. Estimates of the wealth effect on consumption in the US suggest an approximate three to five per cent decline in consumption for every $1 of wealth lost.

Morgan Stanley said that the $12.5trn loss of US household wealth is therefore generating an estimated $375bn-$625bn drain on consumption spending, or a shock to consumption of 2.6 per cent to 4.3 per cent of US GDP.

This is in addition to the business cycle effects on US GDP of loss of income due to rising unemployment and the weakness of global demand.

The problem, it added, is not only the destruction of wealth but also the leverage, which exists against key elements of that wealth – particularly housing – that retains its nominal value. This threatens to create debt and deleveraging spiral.

The leverage of the US household sector is at $14.6trn at the end of third quarter of 2008 compared to $14.1trn at the end of third quarter of 2007. As a ratio of net worth, Morgan Stanley estimates that leverage for the household sector by the end of fourth quarter was around 28 per cent, up almost 10 percentage points since the 2001-2002 recession.

Edward Marlow, Managing Director, Principal Investments, HSBC UK, said that unlike the recession in the mid-1970s and the early 1980s, which is associated with inflation, the problem is now associated with deflation largely because the supply of credit is drying up.

"HSBC's outlook is that global GDP will shrink in 2009 – making it the worst global downturn in the post war period," he told the Commonwealth in Dubai Summit. "The credit crunch is a global phenomena that started in the US and the UK and other over-borrowed countries and economies. All countries are now in trouble especially emerging markets, which have been dependent on foreign borrowing."

And while HSBC forecasts a 3.1 per cent growth in emerging markets especially in China and India, he said bank lending continues to drop, cross border capital continues to diminish, capital injection is now divert funds away from emerging markets. "Governments are now going to control capital allocation for the foreseeable future," Marlow added.

The problem, says Hoey, is not just concentrated on the supply of credit as the demand for borrowing for new spending (as opposed to refinancing) is also likely to be weak. He said the major erosion in consumer net worth should limit the demand for new consumer debt while in the corporate sector, excess capacity should tend to restrain capital spending.

Companies in the region have also seen the ripple effect of the credit crunch. According to RAKBank – one of the few in the UAE that continues to lend – liquidity shortage is just one of the faces of the story.

"There is liquidity shortage – it's a common knowledge," said Graham Honeybill, the bank's general manager. "The problem occurred last year when customers simply didn't want to borrow. What drives borrowing in this market is confidence and when you think that you are going to lose your job then you are not going to borrow. Because of that, a lot of banks experienced reduced demand."

Dubai Group – a conglomerate of banking, investments and insurance companies – on the other hand sees "a lot" of firms looking for money, particularly because the regional and international markets are in a credit contraction mode.

"I cannot give you an exact number but the number of companies looking for money is no different now than it was a year or two years ago. Just by then it was growth money now it is to replace credit contraction," Tom Volpe, CEO of Dubai Group.

Hoey of BNYM said it is critical that policy-makers have a correct diagnosis of the severity of the financial crisis and should continue to be proactive in responding aggressively to it.

This contrasts with the experience of the 1930s and the Japanese stagnation after the Nikkei bubble.

"The good news is that policy is powerful, policymakers have a correct diagnosis of the situation and their ability and willingness to be proactive in adopting stimulative monetary and fiscal policies is quite high," he said.

"The bad news is that economic declines linked to systemic banking crises and house price busts have a history of being prolonged, so a very aggressive policy response is required in order to achieve a long recession rather than a more prolonged decline."

BNYM thus expects an economic decline lasting roughly a year-and-a-half with economic activity lower in 2009 than in 2008 in nearly all developed countries and the overall global economy should be roughly flat in 2009, well below potential trend growth.

And the result is a substantial rise in unemployment rates worldwide and rising protectionist pressures. It expects the recession trough to occur close to mid-2009 in response to monetary ease, fiscal stimulus and an end to inventory liquidation.

However, the end of actual economic decline is unlikely to be regarded as the beginning of prosperity, Hoey said.

"Instead, we expect a 'post-recession pre-prosperity phase' in late 2009 and in 2010. Whereas recessions dominated mostly by the inventory cycle are likely to have a V-shaped bottom, recessions dominated by a burst bubble of asset prices and systemic financial crises are not," he added.

"The end of economic decline by mid-2009 is likely to be followed by several quarters of subpar recovery, and then by a somewhat better recovery in 2010."