After 2006 ...

Abundant of liquidity had turned 2006 to the most bullish year in the decade for most of the stock markets. But with the major economies tightening their liquidity, will 2007 become a year of recessions?

I just want to recalled this BT article from March 2006.

Beware the Ides of March - or of other months - 16/03/2006
By ANTHONY ROWLEYIN TOKYO

'BEWARE the Ides (fifteenth day) of March', as the soothsayer urged Julius Caesar in Shakespeare's play of the same name.

That fateful date has come and gone. But what we should perhaps beware of is a period, such as the present, when things seem too quiet and when it appears that we can afford to let our guard down.

This is not to turn from soothsayer to doomsayer. But it is not a bad idea to take stock of whether or not economic conditions are really as benign as they appear to be, or whether there could be nasty surprises lurking beyond our immediate field of vision. If there are threats on the horizon, they probably will arise in Japan and in China - but more of this later.

For the moment, the world seems to have absorbed the emergence of new economic powers such as China, India, Brazil and others with remarkable ease. There are no major trade wars currently being fought; unemployment is contained in most major economies; inflation seems to have been tamed; and there is no crisis in currency markets. Above all, global economic growth is progressing at solid and apparently sustainable levels.

'All', it would seem (to quote Rabelais) 'is for the best in the best of all possible worlds.' Yet, in the case of the global economy, all is being sustained upon a fundamentally unstable basis. The US economy is the chief source of this dubious period of prosperity and plenty. Borrowing and spending with abandon, the US consumer is creating massive import demand, thereby sustaining stunning growth in China and recovery in Japan.

This, together with domestic demand in these two countries (which itself is fed by the confidence generated from exports), has leveraged up world trade and investment growth to remarkable proportions. Fortunately - or so it appears - for the rest of the world, the Japanese, Chinese, Indians and other Asians are not consuming but rather saving. More fortunately still, it appears, they are not investing their savings at home but in the US instead.

This completes the circle and not only enables the US to sustain a massive current account deficit but also permits the government there to run a huge budget deficit which its own citizens are in no position to fund themselves.

Meanwhile, the dollar is saved from collapse by this circular flow of funds, and the US Federal Reserve is able to preserve interest rates at levels which do not damage a housing boom that, in turn, provides a basis for borrowing and consumption.

Thus the merry-go-round of global growth, trade and investment spins on, while stock markets ride gaily on the back of it and even overstretched government bond markets - which ought to be shaking on their axles - are able to grind along too. The keystone of what appears to be this splendid edifice of global prosperity (but is in reality a house built upon sand) is the huge cache of financial liquidity which central banks have injected into its foundations.

If once that liquidity should dry up, the sand is in danger of becoming unstable and crumbling away. This is why developments in Japan and China over the past week are of great potential significance. The Bank of Japan has decided drain 30 trillion yen (S$414 billion) of excess liquidity from the banking system - a development which could have global ramifications of earthquake proportions.

The Japanese government will be unable to finance its own colossal budget deficit so easily as this liquidity evaporates and may be compelled to liquidate part of its vast holdings (some US$850 billion) of foreign exchange reserves in order to make ends meet. In China, monetary authorities have suggested this week that they will allow the yuan to appreciate further, which means they will buy fewer dollars and that domestic liquidity will contract.

Just what the consequences will be for the global economy is not something that is easily read in the cards but what is clear is that one vital link in the chain of global pseudo prosperity is about to come under stress. And, if Asian governments heed the advice given to them this week by Asian Development Bank vice-president Liqun Jin and use some of their 'vast financial reserves for (infrastructure) investments at home', that link could snap.

All this is to say nothing of the secondary effects of the recent oil shock, being manifested now in US gasoline prices. Nothing damages confidence quicker in the gas-guzzling US economy than a rise in 'pump' prices. If that should put pressure on the spigot of US personal spending, then the wave of consumer liquidity washing up on Asia's shores will recede.

The Ides of March may be gone but the Roman calendar shows there are Ides in other months, too - and we have yet to survive those.