Beware of heading into a crisis

Ichsanuddin Noorsy

IO – On Wednesday, 5 September 2018, I sent data to nearly 150 journalists from various media, comparing economic and political conditions in 1997/1998, 2008, 2011, and 2018. This data also included a graph of the fluctuating Rupiah exchange rate against the US Dollar in a series database from 1964 to 5 September 2018. I did not draw any conclusions about the data set that I sent.

I would like to stress that the data in question does not manifest a single variable. I therefore refer to an earlier credit rating agency rate, one which elevated Indonesia’s credit rating to a more advantageous position. Their review was followed by praises of Sri Mulyani, who was awarded the title of “Asia Pacific’s Best Financial Minister”. Debates about foreign debt also referred to a safe position, since the debt ratio against GDP per June 2018 stood at 35.3%.

Next were reviews from foreign consultants who had been enjoying the plumminess of the Indonesian market. They predicted that Indonesia will be the fourth-biggest country in the world by 2050. When we check the Competitiveness Index, we note that Indonesia has risen to 36th from 41st. However, President Joko Widodo conceded that while the economic climate is still uncertain, we do not need to be alarmed about the free market – an admission similar to one Soeharto made in the 1990’s.

In interviews with ElShinta radio and Trans7 TV, I referred to external situations in response to this statement, particularly the position occupied by the United States, which is currently pushing a protectionist economic policy through trade wars which it wages – even with its partners. I have confirmed US President Donald Trump’s policies with Financial Minister Sri Mulyani and BI Governor Agus D. Martowardoyo during an RI Police Chiefs and High Officials School’s Seminar held in Jakarta on 19 October 2017. I asked this renowned Financial Minister “Isn’t ‘Make America Great Again’ a protectionist policy that may trigger deglobalization?”

This question is actually closely related to the crisis faced by the US in 2008. Several journalists who received my data asked me about the “one-crisis-every-10-years” theory. Some Indonesians are even uneasy, looking back to the 1998 crisis, as they fear that a similar calamity could repeat itself in 2018. Against this, consider that the data I sent has demonstrated that while a crisis like that of 1997/1998 is unlikely, price rises are unavoidable. A review of the crisis path is necessary in order to view this issue clearly.

An academic thesis on a crisis path would reveal that it is comprised of a financial (or monetary) path and a trade path. The 1997/1998 crisis Indonesia suffered could be attributed to the financial/monetary path: it was better known as the “exchange rate crisis”, and the culprit was fingered as uncontrolled liberalization and bad monitoring – both in the banking sector. I term these two conditions the “banking moral hazard”, because bankers actually stole liquidity banking assistance by means of loopholes in underwriting policies. This resulted in the near-collapse of the national banking industry, which necessitated Rp 670 trillion simply for recovery.

This crisis was “overcome” by selling off strategic Indonesian national assets at discount prices, followed by liberalization of various sectors. This strengthened the domination of domestic and foreign private corporations over the Indonesian economy. IMF, as the “quack doctor” faced charges all the way to international tribunals. The backlash against the IMF and the “Berkeley Mafia” as economic lords since 1966 forced the IMF to admit that they had decreed a mistaken prescription, and they apologized. However, the Berkeley Mafia itself remains in power until now, whereas Thailand, which was the first country attacked by the exchange rate crisis, is now more prosperous than ever.

What about the US? The 2008 crisis in the US was triggered by two things: first, oil prices skyrocketed to USD 147.00 per barrel, and second, a USD 323 billion American trade deficit with China. This deficit has been swelling since G. W. Bush became President, and it continued to balloon until it reached a peak in trade wars, indicated by the huge amount deficit. In consequence, many corporations in the US were forced to dismiss employees, or even to shut down.

The impact spread all the way to the US credit rating, especially to Fannie Mae and Freddy Mac, as the financial agencies that provide cheap housing credits to workers as well as issuing bonds; these instruments collapsed in value, and their holders, Sub-Prime Mortgages (SPM), suffered from a financial crash. As SPM also issued bonds, the failed repayments set off a massive chain reaction known to the world as a “Sub-prime Mortgage Crisis”; this signified that the public was distracted from a necessity to face the crisis, instead focusing on the consequences. The main cause was actually US losses in the balance of trade, which resulted in a trade deficit.

In June 2007, a mere year before the deficit hit, the Economist stated that the US was still a leader due to its military power, its defense expenditures having reached 45.7% of the total budget; it was a world leader in industry, oil & gas, information technology, communication, and technology (ICT) industries. By 2018, US military expenditures, at USD 4.1 trillion, took 50% of its total budget.

Obama and Janet Yellen attempted to cure the crisis through financial and monetary policies. Even though Obama keep on urging the public to “Buy Americas”, the impact was actually the result of the world taking advantage of cheap money, i.e. the Fed issuing both government and private bonds at interest rates nearing 0%, resulting in the US Dollar flooding the world.

The Obama and Yellen prescription was afterwards appraised as ineffective, and the US Government stopped issuing such a volume of bonds. Trump went directly to the root of the problem: he mitigated the US trade deficit, especially with China (up to USD 376 billion as of the end of 2017), by increasing import tariffs on specific commodities, and manipulating energy prices as a weapon, since the US is able to satisfy its own energy requirements. Trump also rejected the policy proposed by the Fed’s Chairman, Jerome Powell (Yellen’s replacement), who wanted to bump up interest rates 4 times, reasoning that it all depended on US inflation and unemployment rates: if interest rates increased again, the US Dollar would return home and American business would once again be stimulated, thus cutting unemployment rates. However, even this increase should not exceed a limit that would cause inflation to rise. Trump stuck to his guns and refused. The trade deficit crisis was thus “cured” for a short period.

In other words, the exchange rate is closely related to interest rates. Any increase in interest rates will be followed by an increased exchange rate. On the other hand, interest rates are also strongly associated with rising inflation which will balance out as interest rates also go up. The Fed believes that high inflation will impair buying power, which in turn will corrode the purchasing manager index, an indicator of business activities; this in turn will hurt trade volume and transaction values.

This description shows that the US suffered a crisis in 2008 because of trade, which affected finance or monetary conditions. As a real estate developer, Trump was aware of the importance of dealing with the root cause of the crisis. In economics, we call this a “fiscal and monetary policy mix”. These two conditions are cumulative and limitative, because they contribute towards each other and practically cannot reduce each other. If mutual reduction occurs, i.e. a high interest rate with low public expenditures, uncertain situations such as the one as present will occur.

In Indonesia, as seen in the data that I have distributed, inflation is low. The BI interest rate tracks a weakening Rupiah (if at a slower rate), and the current transaction deficit (for both trade in goods and services) is 3.04% of the GDP, as foreign reserves continue to drain away, from USD 130 billion to a current USD 118 billion. The ratio of foreign debt against the GPP is climbing steadily, and primary balance in the State Budget continues. The percentage of foreign-owned shares at 40%, continues to decline.

This reveals how we are heading down a “double-crisis path”, both trade and financial. Luckily, our foreign reserves are still enough to finance imports for the next 6 months. I would say that a further downfall of the Indonesian Rupiah, sliding to Rp 15,500.00-16,000.00 per USD 1.00, depends on Fed’s policy and Trump’s tariff moves. As our macro fundamentals are really fragile, only time will tell.