FOR more than a week, from February 26 to March 6, global financial markets were shaken by extreme volatility. It all started with the stock exchanges in China with the news that the authorities in that country may attempt to curb the irrational exuberance of their investing community.The Chinese investors had taken the markets in the country to unimaginable heights and the fear that the government may move resulted in panic-selling.

Exuberance melted away and investors withdrew the moneys they had pledged. Valuation of most stocks listed on the boards of Shanghai and Shenzhen declined precipitously. Overall, the markets saw a fall of nine per cent.

The Chinese markets are not well linked with the large markets in North America, Europe and Japan. Government regulations don’t permit foreigners easy access to the Chinese stocks traded in the country’s exchanges. Chinese investors cannot readily invest in foreign markets. And yet what happened in China on February 26 produced quick results in other parts of the world. On February 27, the Standard and Poor’s 500 index that traces the value of the 500 largest companies in the United States, suffered its biggest one-day fall in almost four years. The fall ended the longest run in the index without a significant drop since 1950.

Other markets in the West suffered the same kind of decline. Stock market volatility, which had been incredibly low, jumped by more than 60 per cent. In the week that saw the markets tumbling, American stocks lost about $900 billion in value, or almost five per cent.

The markets rested for a week but on March 12, they began to decline again. Dow Jones index lost another 242 points on that day, the second largest drop in several years in terms of the points given up. This time it was not contagion from China that produced the fall.

A market that had become nervous noted with concern that a number of American financial institutions were being hurt by the lending they had done in the real estate markets to “sub-prime” borrowers. These borrowers don’t have the economic wherewithal to sustain any significant increases in the cost to them to service the loans they have taken out.

Hundreds of thousands of such borrowers were attracted to the banks by the low interest rates charged by them over the last several years.

The banks had developed the “adjustable rate mortgage” (ARM) lending product to entice these borrowers with relatively poor credit ratings. The rates were kept very low for a few years, then were raised significantly after the lapse of five to seven years. A very large number of such loans were now subject to these adjustments.

It had become clear that a significant number of borrowers would not be able to service the loans they had taken out. Widespread bankruptcies were feared. This would also hurt the banking sector. Consequently, the tumble on March 12 was led by the commercial banks.

What do these gyrations in the global market imply for the world’s financial system? How would the developing world be affected by these developments?

Is globalisation the main reason for the arrival of volatility in the financial markets? Are there reasons for policymakers in Pakistan to worry about the fast-moving changes occurring in the large financial markets?

I will begin by discussing the influence of China on the global financial system. Many analysts have suggested that the initial sell-off demonstrates China’s growing financial significance. China’s emergence as a player can be seen from several different perspectives. It can be argued that the country’s market is too small to matter significantly.

At the end of 2006, the value of all China’s stocks was $1.4 trillion, equivalent to 10 per cent of US market capitalisation. It had gone up much faster than would have been the case had the investors been watching the economy’s fundamentals. It was clearly a market that had soared on the basis of pure speculation. In 2006, the market rose by 130 per cent; it was ready for a drop.

Also the government was worried about the breakneck speed with which the economy was growing. That growth could not be sustained for long. That was another reason why the stock market was ready for a large correction.

It is true that relative to the western markets, the Chinese markets are small. It was also true that the return of rationality to Shanghai and Shenzhen was overdue. Notwithstanding these factors, it is also true that the stampede began with the initial push from China. It was the skittish behaviour on the part of China’s investment community that returned volatility to the world’s financial markets.

Contagion began with Shanghai and Shenzhen. The Chinese markets may be small and relatively insulated from the world’s financial market but the country’s economy and its economic fortunes were linked with the global system in several different ways. China had parked a significant proportion of its reserves – now valued at more than one trillion dollars – in the West, particularly in the United States. By sending so much cash to America, it was able to help that country pay for its very large trade deficit.

This infusion of Chinese money into America also helped to keep low that country’s interest rates which in turn helped the US citizens remain active in the housing and other markets.

Given these links, it was possible to imagine a scenario that a precipitous fall in the values of the companies listed on the Chinese stock markets may produce a wave of bankruptcies including those in the public sector. The government may then need to step in by providing liquidity to the companies in stress and to do it may reduce the flow of money to the United States. This would affect the US economy negatively. Contagion from China could be communicated to other economies in several different ways.

The word “contagion” in the context of financial systems gained currency in 1997 when investors initially lost confidence in the economy of Thailand and then punished most economies of East Asia. What came to be called the Asian financial crisis eventually gripped South Korea, Malaysia, Indonesia and then affected some emerging economies in Latin America. Three developments concerning these economies made them contagious.

One, they had opened themselves to capital flows from the outside. Foreign money was welcomed not only for investment in productive assets but also to play in the stock markets.

Two, a number of countries allowed domestic investors to borrow abroad and invest at home in real estate. These created many real estate booms in these markets.

Three, while the banks that got involved in these transactions borrowed in foreign exchange, lending was done in domestic currency. In other words, these institutions took the exchange risk on their books.

Once the foreign players in these markets were made aware of some weaknesses in the Thai economy, they panicked and withdrew money from many other countries. This led to a large outflow of foreign exchange which weakened domestic currencies and resulted in the collapse of several banks that had incurred large foreign obligations.

This time around the nature of the contagion is very different. While the process began in an emerging market – China – it quickly spread to the developed countries. There is now considerable nervousness about the state of the American economy. The rate of GDP growth is slowing down; trade deficits continue to increase; the housing market has weakened to the point that Alan Greenspan, the former chairman of the Federal Reserve Bank, fears that the economy may be heading towards a recession; and, as already discussed, the banking sector has come under great stress.

One consequence of these developments is the return of volatility to the financial markets. Is that a bad development? What happened in late February and early March in the world’s capital markets was out of the normal, if normal is defined as the way in which the markets had behaved for four to five years. Most of them had been extraordinarily stable. That changed in the few days following the sharp decline in stock prices in China.

For several days following the China slump, most major markets saw extreme gyrations, sometimes during the course of trading in one day. What does the return of volatility suggest?

Some volatility is not necessarily bad. Lack of it produces complacency and that results in the lowering of the price investors assign to risk. In the very stable markets that prevailed in the early years of 2000s, risk premiums – the difference of what investors pay for risky and non-risky assets – had narrowed considerably. This, economic theory tells us, is not a good thing since the narrowing of risk premiums lowers the rewards for innovation and entrepreneurship.

Joseph Schumpter, the Austrian economist who wrote about these matters several decades ago, put a lot of emphasis on what is sometimes described as “creative destruction”, progress that occurs by replacing old and less productive processes and products with those that are more productive. This happens with a combination of innovation and entrepreneurship. Those who spend time and money in innovating and those who bring in new businesses – the entrepreneurs – do so in the belief that their endeavours will be suitably rewarded.

That does not happen when the markets don’t draw enough distinction between risky assets and risky moves compared to those that promise stable returns. The reason for this is that the reverse of risk premiums is the margin of profit. If an investor is paid a certain amount above the market norm that gets reflected on what the entrepreneur who takes the risk can hope to receive.

One asset class on which risk premium had narrowed over the last several years is investing in emerging markets. Had this persisted for a while, the quantum of flows made available to the emerging markets would have grown at a rate slower than would be the case if risks and rewards remained high.

Why should an investor place money in the developing world if the return is not much higher compared to those available for investing in assets closer at home? Risk perception by the market and the volatility it produces are, therefore, not bad for the developing world as long as they remain within reasonable bounds.

Let me now turn to the capital markets in Pakistan. As indicated by the movements in the KSE-100 Index, there was some volatility in Karachi as well. At the time of this writing (Thursday, March 15), the market was down by two per cent compared to the level reached before the declines in other major bourses. There was some volatility but not as pronounced as in several large emerging markets. What do these movements suggest?

They suggest that Pakistan is relatively less integrated in the global financial system than other large developing countries. What moves this market are more domestic developments than the events taking place beyond the country’s borders.

This relative protection from external influences will abate once the country gets closer to external finance, a process that has begun. It would, therefore, be wise from the regulators and policymakers in Islamabad to watch how other markets are coping with the current situation and draw some lessons from it for themselves.

DURING sixteen years of violent anarchy, most of Mogadishu's population stayed put, but in the past few weeks tens of thousands have fled.

Since Ethiopian troops installed the Transitional Federal Government (TFG) in the city in late December, the Somali capital's brief interval of peace and security has given way to renewed fighting, with the Ethiopian invaders replying to mortar attacks on their bases with indiscriminate artillery fire in the middle of the city.

Almost all Somalis see Ethiopia as their country's main enemy, and behind the Ethiopians they see the United States. So when the Union of Islamic Courts that restored peace to the ruined city last June was forced to flee in late December, and US aircraft attacked retreating UIC fighters (targeting suspected Al Qaeda members, they claimed), resistance was inevitable.

The attacks on the Ethiopians by various Somali factions, some linked to the Islamic Courts and some to local warlords who returned to the city after the UIC was chased out, have grown so frequent that most of the TFG's members have withdrawn from Mogadishu back to Baidoa, their former "provisional capital."

The plan was to replace Ethiopian troops with a multi-national African Union force as soon as possible, but the first Ugandan soldiers to arrive in Mogadishu on March 6 immediately came under fire as well.

Like his father before him, President George W. Bush has authorised a military intervention in Somalia, and once again it will end in tears. But there are two differences this time: the younger Bush is committing no American troops, and there are none of the genuinely humanitarian intentions that motivated the 1992 intervention. It's just a question of making sure that "our guy" runs Somalia.

"Our guy," in this case, is Abdullahi Yusuf, one of the many warlords to rise out of the chaos that has been Somalia for the past sixteen years. He has long been close to the Ethiopians, the only US ally in the Horn of Africa, and in 2004 he was chosen as president of the TFG by a Somali "parliament" meeting in Kenya and composed mainly of other warlords or their representatives.

While Washington approved of the choice, at that point it did not put much effort into helping Abdullahi Yusuf take control of Somalia. That all changed after June, 2006, when a US-backed operation by two warlords in Mogadishu, intended to capture three men suspected of planning the attacks on US embassies in East Africa in 1998, went badly wrong.

The men were not captured — and the incident triggered a non-violent popular uprising that chased all the warlords and their troops from the city.

The organising force behind the popular uprising was the Union of Islamic Courts. Funded by local merchants in the hope that they could reduce the constant robberies and kidnaps that made it almost impossible to do business, the Islamic Courts quickly grew into a mass movement that embodied the longing of ordinary Somalis for an end to the violence. The peace they brought to Mogadishu soon spread over most of southern Somalia.

It was Somalis settling their own problems -- just what all the foreigners had been urging them to do for so long -- but unfortunately they had come up with the wrong answer: the courts were "Islamic", and they wanted to enforce Sharia law. How else you might persuade Somalis to rise above their divisive clan loyalties, apart from appealing to their shared religious values, was not explained, but this solution was clearly unacceptable to the United States.

As an amorphous popular movement, the UIC had no control over its more loud-mouthed supporters, some of whom prattled freely about unifying all Somali-inhabited areas (which would mean invading Djibouti, northern Kenya, and much of eastern Ethiopia). Some very stupid UIC members even insisted on sheltering the three (non-Somali) men whom the United States wanted in connection with the 1998 embassy attacks. But the UIC was not a "terrorist organisation," and it gave southern Somalia six months of peace.

That's over now. Since the Ethiopians took Mogadishu, the violence has returned worse than ever, with warlords fighting each other to re-establish their turf and everybody having a crack at the hated Ethiopians -- who respond with artillery fire. The peace is a memory, and the notion that a few thousand African Union peacekeepers are going to recreate it is a fantasy. (Besides, half of the promised 8,000 AU troops have yet to be volunteered.)

If Abdullahi Yusuf could bring peace to Somalia, with or without the collaboration of his fellow warlords, it would be a lot better than the chaos that prevailed a year ago. But it is very unlikely that he can do that whether the Ethiopian troops go home or not. And it is quite likely that they will go home soon, precisely because that would maximise the chaos. Ethiopia doesn't want to occupy Somalia permanently; it just wants to cripple it.

The Islamic Courts will go on fighting the Ethiopians, Abdullahi Yusuf, and the other warlords, but they risk becoming just one more contender in the unending, multi-sided battle for control of Somalia. They were the country's best chance for an end to the killing, but their moment has probably passed.—Copyright

ALTHOUGH the Constitution envisages the judiciary as an organ of the state that is separate from the executive and the legislature, successive rulers in Pakistan have considered it as an arm of the government – one that can always be expected to extend blanket legitimacy to unconstitutional and illegal steps taken by the government.

The current crisis is the result of the present government’s continuous effort to browbeat it and to make it subservient to its interests, even if this means the use of force.

After being continuously undermined by several governments, the judiciary under Chief Justice Iftikhar Chaudhry had taken a number of brave steps to restore the confidence of the people in this august institution. The present regime, instead of seeing the wisdom of these measures and establishing the rule of law, embarked upon a course of confrontation which portends ill for the government and the country. The manner in which the chief justice was removed has incurred the wrath of not only the legal fraternity, as evident in their violent protests, but also of the public This has raised serious questions about the true intentions of the government.

The fundamental reason behind this whole saga is that the present government, even after defacing the Constitution through the Seventeenth Amendment, does not intend to adhere to it and persists in acting against its principles. When the Seventeenth Amendment became part of the Constitution, political parties and civil society, resigned to their fate, hoped that the government would at least act upon its own amended Constitution. But it soon dawned on them that even this new social contract, tilted heavily in favour of the government, would only be observed by it in the breach.

Soon the president of the country, under an amended Constitution, reneged on his promise to shed his army uniform by December 2004 and the ruling party passed the “President to Hold Another Office” act in clear disregard of the Constitution, giving artificial protection to the president. It is childish to think that a clear constitutional provision can be amended by an act of parliament. The matter did not end there. It was said by the ruling Pakistan Muslim League that the president could be elected by the present assemblies and that there was also a provision in the Constitution to the effect that general elections could be postponed for a year.

This was indication enough that neither the ruling party nor the president had any intention of adhering to the provisions of the Constitution which they had amended to suit their interests. In the event of any likely violation of the Constitution, the judiciary headed by Justice Chaudhry was the only institution which could check their onslaught and hold them to their promise to the nation.

However, the desire of the rulers to remain in power by hook or by crook has plunged the whole country in crisis and tarnished its image. Already, there was a feeling that the judiciary was subservient to the government. Prior to the incumbency of Chief Justice Iftikhar Chaudhry, the lawyers’ bodies had decided that they would not file any petition before the apex court on any constitutional issue. This trust deficit was ably filled by the chief justice who restored the image of the judiciary as a separate organ of the state rather than as an extension of the government. This was not liked by the establishment.

The high functionaries of the government continuously issued statements that either the president would be elected by the present assemblies or that elections would be postponed for a year. The president himself canvassed everywhere in favour of the ruling Muslim League appealing to the people to vote for the ruling party whenever he got an opportunity. This type of conduct on the part of the highest functionary of the government has incensed the nation.

The Supreme Court’s landmark judgments in the Steel Mills case and the Gwadar land scam and its bold stand on the issue of the disappearances of political workers abruptly lessened the expectations of the government from the judiciary. It is widely believed that the executive planned to get rid of the chief justice before the tenure of the parliament or president expired and hoped that others would learn a lesson.

While filing a reference against the chief justice, the government did not even bother to observe the rules of propriety and civil conduct and humiliated the office of the chief justice to such an extent that its after-affects will be felt for a long time to come.

Had the president simply forwarded the reference to the Supreme Judicial Council, the chief justice would, in all probability, have stayed away from the functions of his office until its result. But the reference’s timing – when the next senior-most judge, Rana Bhagwandas, was out of the country and the oath of the office of acting chief justice was administered to a judge third in seniority – speaks volumes for the true intentions of the government.

The government did not restrict itself to these acts. It prevented the chief justice from coming to the Supreme Court and virtually made him a prisoner at his official residence. It also allowed the police to manhandle him. This again infuriated the nation. What could it expect from a government that treated its chief justice in this manner? In any true democracy, such an action would have brought down the mightiest of governments.

The action against the chief justice was mala fide from the very beginning. It is the considered view of all leading constitutional experts that there is no provision for the appointment of an acting chief justice in case a reference is sent against the chief justice. A bare reading of Articles 180 and 209 will make this clear even to a lay person. The events subsequent to March 9 have made the government realise this and it now says that Justice Iftikhar Chaudhry continues to be chief justice.

The basis of the tussle between the chief justice and the government is not related to the alleged misconduct on the part of the chief justice but goes deeper. There is a well-orchestrated government plan to violate the Constitution before or on the eve of the expiry of the term of the present parliament and president.

The unrestrained greed of the government to retain power through illegal methods has led to this crisis. It will not abate unless the government takes some sensible steps. For this, it must allay the fears of the legal fraternity and the people at large by sending the reference to a legally constituted Supreme Judicial Council which must not be interested in the outcome of the reference and should be acceptable at a national level.

It is necessary that justice should not only be done but seen to be done. This is not so in the present case. The problem is that governments of this country do not consider themselves as an organ of the state and consider themselves a state within a state arrogating to themselves powers of the judiciary and parliament. They must realise that there are two other equally important organs of the state – the judiciary and parliament.

This crisis brews quite often in Pakistan involving various organs of the state. The Constitution envisages separate powers for each organ of the state. This is the reason that the chief justice can only be removed by the judiciary itself.

It is now time for the bar and bench to close their ranks and refuse to be cowed down by the executive which is bent upon violating the Constitution and putting at stake the honour and dignity of the nation.

The writer is a Barrister-at-law
Email: barrister_zamir@hotmail.com