Dr Mahathir's advise to Muslim nations in coping with the global financial crisis

Unknown to the public, Dr Mahathir made a visit to Djibouti, the capital of Somalia for several speaking engagements at the end of January. He delivered a significant speech for the Muslim nations in facing up to the global financial crisis on January 30th.

He started his speech by telling the audience that the wealth created in western countries are superficial. They have left the business of producing goods and services for quick rich gambling in financial market and derivatives.

The problems begin when the bubble burst on the financial markets. This caused banks that lend for financial market speculation activities to collapse. This in turn shut the tap of credit to businesses resulting in a significant shrinkage to the real economy. Consequently, the poorer countries that rely on production and exports to richer countries are affected.

Having explained the problems with the banks and financial markets, he said idea of free and self regulating market does not work. It was the unregulated market that created derivatives, short selling, hedge funds, high leverage product and currency trading. Government must play a supervisory role and if necessary, intervention.

Dr Mahathir cautioned them that the western countries are living in denial. They failed to acknowledge that the failure of their banking system is the cause of the problem. Thus, poorer countries should understand this problem and deal with it.

He told the oil-rich Somalia not to invest in the west and avoid banks. He suggested investment in the newly indutrialised country's market and companies. These investments will be most valued when economy recover, which is not expected to be soon.

On their domestic economic management, Dr Mahathir suggested a lean and efficient Government. He proposed a tight Government control on banks and price of essential foods and goods. Domestic economic activities and infrastructure spending should be encpourage to overcome unemployment and stimulate the economy. Domestic tourism and limiting imports be encouraged to prevent outflow of funds.

His speech in full below:

SPEECH BY TUN DR MAHATHIR BIN MOHAMAD

GLOBAL FINANCIAL CRISES: HOW SHOULD A DEVELOPING ISLAMIC COUNTRY COPE WITH THE CHALLENGES

DJIBOUTI ON 30 JANUARY 2009

---------------------------

Bismillahirahmanirohim

Assalamualaikum warahmatullahhi wabarakatuh

Distinguished Guests,

Ladies and Gentlemen;

1. When I flew out of the UK for Riyadh on 25th January, the press reported that the UK is officially in recession. Other developed ethnic European countries may not have acknowledged that they are in recession but the undeniable fact is that all are in deep financial trouble. The richer they are, the worse is their economy. We need to know why and how the crises developed if we want to cope with it. Why has this crises involved the rich countries so badly? Why has it happened so suddenly? Only a few years back they were sloshing about in almost unlimited money. Their per capita incomes were very high, and millionaires were dime a dozen. Even billionaires were plentiful.

2. Actually the wealth created was not real. They were just illusions, with no real money being made. The business of producing goods and services were neglected because the profit margins were small by comparison to the profits from using money to make money, from the so-called capital gains, from short selling, investing in hedge funds and derivatives, and trading in currencies.

3. No goods or services would result from these gambling schemes. Practically no jobs were created. Yet huge amounts of money could be raised and the yield from these borrowed funds, sometimes as much as 30 times the initial amount invested, would give very high returns. Even after the fund managers have fiddled with the accounts and taken their cuts, bonuses and stock options; even after the interest on the loans were paid, the earnings of the investors would be far more than the dividends from real business.

4. For the banks themselves, the bigger the amount of loans they give out, the bigger would be the returns in terms of interest. Their tendency is to lend as much as possible and to secure risky loans through insurance or second mortgages. Hence the willingness to lend as much as 20 times the amount held by the funds, and to lend high risk dubious housing loans, the principal cause of the sub-prime crisis.

5. Other forms of gambling has been invented and introduced to investors and to the banks. The huge amounts of money for investments available to the funds enabled them to manipulate the share market, increasing and decreasing the values of the shares at will. It was the same with currency trading. So big are the funds and so sure are they of making extraordinary profits that they became more and more arrogant. The currency traders, for example, would attack even the rich countries, devaluing their currencies and making them actually poorer.

6. Those who invested in these funds were happy with the high dividends that they felt no necessity to enquire as to how the profits were made. And so the funds grew and grew until they had at their disposal more money than most Governments and countries. It seems as if nothing can stop them. They would become financially more and more powerful that Governments, even of the rich countries fear them. The most powerful countries in the world must listen to them, must legislate in favour of them, and must formulate policies that will enable them to continue their operations unchecked. They persuaded Governments not to interfere as the markets must be completely free.

7. But then the banks collapsed. Since all these funds depend on bank borrowings, very big bank borrowings, when the collapsed bank recalled the loans, borrowers were unable to raise the huge amounts demanded by way of margin calls. Since their assets were mainly in the form of shares of the companies they had invested, selling off the shares to raise funds resulted in steep falls of share prices. Very quickly the shares they held depreciated in value and the stock market collapsed.

8. With the collapse of the banks, all the financial institutions including the insurance companies and the mortgage companies collapsed, dragging all businesses, big and small down. In other words the whole economy of the rich went into a tailspin or would do so very soon.

9. As I have pointed out, it is the rich countries which seem to be most affected in the present crisis. Why is this so? It is simply because they apparently have the money to gamble. Their monetary system enables them to create money out of nothing and they then use this money to gamble in the financial markets. They made a lot of money at first and appeared to be very rich. But actually their wealth is represented only in figures in bank books which they cannot gain access to after the banks went bankrupt.

10. In America and in Britain millions have been thrown out of work. They will seek to be on the dole for the unemployed provided by the Government. The weakness of the dole system is that it is when the economy is bad and Government revenue is low that the amounts to be expanded on the dole is big.

11. The poor countries appear to be less affected by the crisis. This is because they do not have the money to speculate or rather to gamble on. But the poor countries all depend on the markets of the rich countries to sell their products. With the rich countries in recession they will not be able to buy the products of the poor. These products will not fetch the high prices as before.

12. Malaysia, for example, exports more than 100 billion US dollars worth of manufactured goods and raw materials. The exports have shrunken as the rich countries of Europe and America, which normally takes 40% of our exports, reduce their imports. Already their bankrupt banks are not able to issue Letters of Credits for the importers.

13. Even the oil producing countries are now earning less income as oil prices go down.

14. Loans from the big foreign banks will not be available to the poor countries.

15. National reserves held in foreign currencies will fall in value just when the economy of the poor countries is declining and the reserves are needed for sustaining the economy. It is also likely that the currencies of the poor countries will depreciate, making them even poorer.

16. There would be less foreign investments and the tourism industry would suffer quite badly.

17. In the face of all of these, what can the developing Islamic countries do to lessen the impact of the global financial crises?

18. Like all countries facing any crisis whether economic or financial, political or social, the first thing to do would be to seek to understand what is going on and what is the cause of the crisis.

19. For this, all the data that can be gathered must be studied. In this case the crisis is not domestically generated. It is generated in the rich developed countries. Fortunately, the rich countries of the West being confident their systems as well as how they operate them are first class, do not completely hide the goings on in their economy. They publish a lot of data which can give some clue as to what had happened.

20. But having said that, I would hasten to point out that they are more sophisticated in hiding things in their cover-ups. They have come up with all kinds of confusing economic terms that cannot be understood by the average poor country’s experts. This is especially so when the poor countries do not indulge in the kind of dubious activities they have invented for their own benefit.

21. The economies of the West (ethnic European countries) are much controlled by the rich, who would push for schemes for making more money more quickly. Towards this end they came up with the idea of less Government, of the markets being regulated by the markets themselves.

22. The markets are all about making profits, making money. When investors in the markets make big profits, they are not going to question why they are making such good profits. They would rather support the quick profit schemes and continue to invest.

23. And so the idea of the market regulating itself has not worked. As an example, the pyramid investment scheme operated by Bernard Madoff paid high dividends regularly. That Madoff was possibly taking the money invested with him to pay the dividends was never raised. And so Madoff lost 50 billion US dollars of the investors money before he was discovered.

24. So the first cause of the present day crisis was the belief that markets should regulate itself, that Government should not interfere.

25. Without Government supervision the market players invented more schemes for making quick money. This included financial schemes such as derivatives, short selling, currency trading, high debt to capital ratios of up to 30:1, hedge funds etc etc. Helping with the inventions of more gambling in the financial markets are the brilliant mathematicians of the great universities who regularly win Nobel Prizes for their quick profits formulas.

26. I must admit that I cannot understand many of these get-rich-quick schemes. But they were actually approved and promoted by the people who were supposed to regulate the financial market. The Federal Reserve Bank of the US under Alan Greenspan actually facilitated these schemes.

27. Very quickly the American people in particular were living on borrowed money completely. They felt no necessity to save for the future as they believe they can always borrow even when they have no means of paying back the loans they have taken.

28. When the amounts of unpaid loans or non-performing loans reached astronomical levels, the lenders i.e. the banks must collapse. There would then be a credit crunch and without bank financing, business especially big businesses simply cannot carry on.

29. There are more things that contributed to the credit crunch and financial crisis. But the rich nations which caused this crisis are in denial. They refuse to acknowledge that their banking and financial system have failed. Because they refuse to admit the real cause their remedies have also failed. That is why their bail-outs have not worked.

30. They are not going to turn around the economy any time soon. So we and the rest of the world can safely conclude that the crisis will not end quickly. We will have to live with this crisis for a long time and if we want to cope with it we must be prepared for the long haul.

31. Firstly I would suggest developing countries deal with the direct effect of foreign factors on the country’s economy. As has been pointed out it is the need to have economic relations with these foreign economies which result in the crisis in these countries affecting the economies of the developing countries.

32. Almost invariably we use the US dollar in trade. When the US dollar depreciates we lose the value of our reserves and also our earnings from exports. When the US dollar appreciates we will have to pay more for our imports.

33. To reduce the effects of the fluctuations of the US dollar we should diversify our reserves. We should of course study the exchange rates of the principle trading currencies such as the Euro and the Yen in order to determine the currency we should use for trade at a given time. When we can we should link our currency to gold and use gold as a standard for determining export and import prices.

34. The chances are the US dollar would devalue faster against other currencies and against gold. That being so we should try not to use the US dollar in trade. If we earn US dollars from exports, it would be a good thing to immediately convert to another currency that is likely to appreciate against the US dollar.

35. It is now not the best time to invest in the rich countries especially in the funds operated by western countries.

36. Where possible new markets must be found. China will continue to be a good market for raw materials. To a lesser extent so will India and the newly industrialising countries of East Asia.

37. Cash rich countries should invest in shares of established companies and properties in the newly industrialising countries. However, purchasing property in the rich countries of Europe can also bring good returns in the long run. Sooner or later the countries would recover and so would the industries. Prices for shares and properties are very low now. Investments in banks and financial institutions should be avoided as many would not recover at all.

38. Domestically there is a need to be lean and efficient. Government control over banks needs to be tightened. In fact some kind of price control of essential foods and goods should be imposed.

39. Domestic economic activities which can contribute towards growth should be encouraged. Government spending on infrastructure would help overcome unemployment and stimulate the economy. Domestic tourism should be encouraged to prevent outflow of funds due to foreign travels.

40. Imports should be limited except for materials which goes into the production of goods for exports. Food production should be encouraged and where possible import substitute industries must be initiated or expanded. Taxes on imports should be increased especially on luxury items.

41. The Government must know at all times the performance of the economy in order to identify which sectors need to be given special incentives and which to regulate or restructure.

42. The finances of the Government must be strictly managed. By controlling prices the cost of living may be made to avoid high inflation.

43. These are some of the ways that developing Islamic countries can mitigate the effect of the crisis. There can be many more if we study each country’s case separately. Regional counter measures may also help.

44. But as mentioned above, this crisis will take a long time to be reversed. The world must work together to devise a new monetary and financial system so as to get rid of the weaknesses which had enabled gamblers to abuse the system. The developing countries must work together to make sure that they have a say in the formulation of the new monetary and financial systems. Otherwise, the rich will again come up with systems that will benefit them only.

45. I hope I have been able to answer some of the questions posed by the title of this talk.