Do price falls signal a glut of supply triggering reduced demand? Or could there be something else at play? Conventional economic theory suggests that price signals the imbalance between demand and supply.
However, economists like Hyman Minsky have long argued that in the era of fiat money, these signals get distorted when the underlying variable (money supply) may itself be in short supply. The converse in true when prices rise dramatically, suggesting that it is perhaps not the imbalance in demand-supply dynamics of the asset itself but that of money itself.
According to the debt/deflation theory of economics, when overall accumulated debt rises, the economy goes into a contractionary phase, sparking off price declines at both the consumer and the asset price level. It is not the superstructure of the economy that is called into question but rather its basic premises.
Extreme swings the norm
This theory implies that the economy goes through only very limited periods of “optimal” activity, with the vast majority of the time traversing through periods of either excessive credit expansion or contraction. During these times, the role of the regulator is to ease monetary conditions.
Not lending enough
In a pegged economy, the demand and supply of money is constrained to the currency that it is pegged to (in this case the US dollar). The dollar is indeed global, involved in 87 per cent of currency exchanges worldwide.
Despite the unparalleled quantitative easing programme of the Federal Reserve, global economies continue to perform at suboptimal levels, suggesting that banks have not lent as aggressively in this cycle as forecasted. This was not done because the available supply of collateral to back up the loans was not considered good enough, triggering an injection of money flows into assets rather than businesses.
The shortage of pristine collateral has led to the fall in global bond yields, as well as credit contraction that the world is experiencing. This is how the global credit system now works. The Fed has become the lender of the last resort for the global market place.
Ease repayment terms
So what should the authorities do? At the local level, perhaps the Dubai real estate committee should, in consonance with the central bank, ease up on lending parameters. One method that has been long suggested has been to reduce the down payment for mortgages.
Perhaps a better mechanism would be to ease up on existing repayment terms. This implies that the banks must understand the measurement function that triggers a corrective impulse.
In this case, the global shortage of dollar liquidity is flashing red indicators across the globe, from the rising phenomena of negative interest rates to the inverted yield curve and associated fall in price of risky assets. During this period of instability, it is natural that as dollar strength recedes, monetary conditions will loosen up.
Until such time, if collateral standards are made less stringent (which is already apparent in the “shadow finance” world with developers offering payment plans for as little as Dh120 per day), then the process of monetary flows (and capital formation) can function smoothly, ensuring that economic growth remains healthy.
Indeed, the rise of the shadow finance sector explains, more than any other variable, the dollar shortage across several different facets of the economy, including foreign exchange. It is not something that is easily identifiable by local regulators as it involves the global dollar system rather than just domestic pieces of it.
Shadow finance alleviates temporary shortages during times of stress, but today the collateral squeeze has returned on a much larger scale, requiring greater intervention, especially at the asset formation level.
This process of “demand management” by regulatory authorities will serve the economy well, ensuring that private sector credit pipelines remain well supplied and the flight-to-safety phenomena is quelled. For the private sector in particular, it will allow for capital to be accessible, allowing for expansion plans to remain unhindered.
For savers and holders of assets, it will allow for capital preservation, fighting the cycle of “contagious cynicism” mindset. In the end, recessions and expansions are about the state of mind.
Regulators have the power to stoke animal spirits. The announcement of the real estate committee has set the stage for addressing the basic foundation of the economy, thereby leading to structurally sustainable growth.
Eventually, easing the recurring shortage of collateral will be the only way to provide real economic stimulus, alongside the fiscal expansionary programmes (via infrastructure spending) that are already in place.
Sameer Lakhani is Managing Director at Global Capital Partners.