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Generational Dynamics Web Log for 20-Oct-2008
Pakistan nears bankruptcy, as China refuses aid

Web Log - October, 2008

Pakistan nears bankruptcy, as China refuses aid

Pakistan will forced to seek unpleasant help from the IMF, after failing to get a hoped-for bailout from China.

The country may need as much as $6 billion in foreign-currency reserves, in order to meet scheduled repayments in dollar-denominated bonds before February.

As recently as Thursday, the Financial Times was reporting that China had promised to save Pakistan from default. The promise was expected to become a commitment during Pakistan President Asif Ali Zardari's visit to Beijing at that time. But when he returned Friday night, he had a promise from China to build two nuclear power plants, but no commitment for the badly needed aid.

Next, Zardari will have to turn to the International Monetary Foundation (IMF) for a bailout, but this will be a bitter pill to swallow because the IMF will impose onerous controls on spending and governance in return for the money. These controls will be extremely unpopular, and will be blamed on the U.S. The Taliban, which have been conducting a series of terrorist acts throughout Pakistan, will be emboldened to do more.

China's failing economy

It's quite possible that China is refusing to provide financial aid to Pakistan because it cannot afford to. China's own economy may be failing, now that the massive building bubble from the Beijing Olympics has ended.

You never know in advance what event is going to trigger anxiety, fear and even panic in the markets, but such an event occurred earlier this week, when the CEO of Rio Tinto said that China's economy will "pause for breath" in the next quarter. The remark spooked markets throughout Asia, especially in the energy sector.

Commodity prices <font face=Arial size=-2>(Source: wsj.com)</font>

Commodity prices (Source: wsj.com)

Rio Tinto is a giant multinational firm, one of the largest mining companies in the world. It has seen sharp declines in prices for iron ore, aluminum and copper in recent months, throwing the company into financial distress.

It's attributing the fall in these commodities prices to the cooling of China's economy.

This would not be a surprise to thousands of employees of toy factories in southeast China.

Half of China's toy makers have declared bankruptcy recently, as it became clear that sales to the U.S. and Europe are going to be particularly slow this year. In one of the highest-profile examples, a toy maker that sold to US giants Mattel and Disney announced last week it had gone bust due to the global economic crisis, leaving up to 7,000 people jobless.

Some analysts see dire warning signs in China. Independent Shanghai-based economist Andy Xie says that a property crash is imminent because prices are too high and developers have borrowed heavily and built too much.

In fact, malaise is affecting the entire Chinese economy, and many analysts believe that the trouble goes deeper than just a post-Olympics pause.

Whether it's millions of tonnes of surplus coal stacked up in ports, or Swiss jewellers from Shanghai experiencing total despair, the signs of collapse are growing.

A collapse of China's economy would affect all of Asia. Vietnam, Cambodia, Thailand and other Asian countries supply materials and unfinished goods to the Chinese, who finish them and ship them off to the Americans and the Europeans. The knock-on effects have extended to South Korea, whose currency, the won, crashed earlier this week, and has to be bailed out. So the reluctance of Americans and Europeans to buy as many toys this year is having knock-on effects throughout Asia.

And, of course, it means that Pakistan won't get aid from China.

From Eastern Europe to Latin America

Pakistan is not the only country seeking aid from the IMF to weather the global credit crisis.

In Eastern Europe, Ukraine, Hungary, and Serbia are all in emergency talks with the IMF. The plunge in prices for commodities like grain and steel, their chief exports, along with the drying up of foreign investments, have brought these countries close to default as well.

"This is turning serious," said Hans Redeker, currency chief at BNP Paribas. "Countries in Eastern Europe have been living beyond means for years and now they face a full-blown credit crunch. They are going to have to cut back on imports and that will push the eurozone deeper into recession. We think the next phase will be an attack on the currency pegs in the Baltics and Bulgaria."

He points out that many other countries Argentina, Ecuador, the Baltic States (Estonia, Latvia and Lithuania), Romania, Bulgaria, and Turkey are all flashing warning signs that are much worse than they were a few months ago.

"The global credit crisis is spreading to the most leveraged economies in the world," says an East Europe bank expert. "Iceland was the canary. It was the first to need a helping hand from the IMF, but all countries that have had asset bubbles and rely on foreign funding are vulnerable."

Russia

Russia has had a major stock market crash in the last month, requiring frequent suspensions of trading.

This has been caused by the high-flying, big-spending Prime Minister Vladimir Putin, who was counting on high prices for oil exports to fund his projects. With the price of oil now down almost 50%, the country is in serious trouble.

Meanwhile, hedge funds around the world are collapsing, thanks to the fall in commodities prices, stock prices, and developing nations' currencies. This forced selling creates a vicious cycle, where stock prices fall, leading to more margin calls, leading to more forced selling.

According to one expert, hedge funds "are not the sole culprit" for the selling vortex that's going on. He says mutual funds, pension funds and sovereign wealth funds also have been pulling money out of the market.

It's this kind of forced selling cycle that caused the crash of 1929. Experts today are hoping that the forced selling cycle will burn itself out, and that things will return to "normal" (whatever that is). But after many years to create the credit bubble, worth hundreds of trillions of dollars, it's going to be a long time and a huge deflationary spiral before anyone can talk about "normal" again.

(Comments: For reader comments and response, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (20-Oct-2008) Permanent Link
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Generational Dynamics Web Log for 20-Oct-2008 Pakistan nears bankruptcy, as China refuses aid

China's failing economy

From Eastern Europe to Latin America

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Generational Dynamics Web Log for 20-Oct-2008
Pakistan nears bankruptcy, as China refuses aid