Global financial markets have been in turmoil for much of 2008. The effects of this turmoil on the Pacific islands and their residents have been minimal thus far.
Will this change if the crisis deepens in the United States and the rest of the industrialised world?
Could distance and isolation from New York (and the US), the epicentre of the current crisis, be an advantage for the island-Pacific?
Answering the questions posed above requires some understanding of the origins of the ongoing financial crisis abroad and the likely channels via which the ensuing shocks are likely to be transmitted to the Pacific.
No one is completely immune from the current turmoil.
The best advice for now is to prepare as best as possible for a rough ride and hold tight in the meantime.
The extent of exposure of individuals, as that of nations, depends on their circumstances.
Here, I will provide reasons for the ongoing (and deepening) credit crunch in the US, discuss the channels via which the above is likely to affect the Pacific islands and offer some suggestions on what may be done to prepare for a likely rough ride ahead.

Why the credit crunch?
A credit crunch arises from a sudden contraction in the supply of credit.
The immediate consequence of the above is a sharp jump in interest rates and/or afcredit.
The above can happen as a result of a deliberate policy on monetary tightening or, as in the current case, from investor-panic.
The panic is invariably triggered by a sudden (and unexpected) deterioration in the balance sheet of financial intermediaries. This panic can trigger a ‘bank-run’ and lead to a currency and debt crisis.
The suddenness of these changes leaves policymakers playing catch-up.
Let me use an example to illustrate the problems faced in a financial crisis.
The closest to a bank-run that I have witnessed was in the immediate aftermath of the first coup, that of 1987, in Fiji.
Panicked depositors queued at the Suva city branch of the then National Bank of Fiji (now Colonial) to withdraw all their deposits. Bank staff, caught completely off guard, struggled to maintain calm.
This panic arose following a rumour that soldiers, seen at the bank hours earlier, had raided the bank.
This was far from the truth; but no one was going to check this out lest they lost their hard earned savings.
It so happens that senior staff at the bank had requested earlier that day for security from the military to transport cash from one branch to another.
This ‘service’ provided by the soldiers was witnessed by some at the bank and thus the source of the rumour.
The news spread like wildfire with the ensuing panic—pushing NBF close to a liquidity (cash) crisis.
Luckily, common sense prevailed in the end but only after considerable convincing by the authorities.
Lesson number 1: If you are a bank, don’t call soldiers to provide you security!
The source of the current (global) credit crunch is both genuine and very different to the NBF's ‘mishap’ of 1987.
The last decade has seen easy money, particularly in the US where banks and the like have extended large loans, mostly for purchase of homes, to ‘risky’ (borderline) clients.
These loans were then repackaged and sold off to investors—some from abroad—who were less than fully informed of the risks involved.
The rapidly rising property prices and an expectation of this trend continuing fueled this risky venture to unprecedented heights.
An end to the low interest rate policy of the US and the consequent deflation of the price bubble for real estate triggered investor-panic: culminating into a credit crunch.
Loan defaults began with ‘sub-prime’ mortgages and spread quickly to the rest of the market, both in the US and abroad.
The rapidly receding demand for financial products from investors has left many institutions ‘high and dry’!
By mid-September, some nine commercial banks had failed in the US. Another 117 were placed on a ‘watchlist’ by the authorities.
Three major investment banks—Bear Sterns, Lehman Brothers, and Merrill Lynch—had succumbed to the credit crunch.
On September 16, American Insurance Group, one of the largest insurers around, was extended a credit-lifeline from the US government to the tune of US$85 billion as part of a rescue package.
By late September when this article went to press, the US Congress was debating a rescue package of US$700 billion for its sick financial sector.
Unlike the run on the NBF following a false scare, investor-fright this time round was all for real and well-founded.
Most damning of all is the fact that no one knows the full extent of the problems within the financial markets.
It is close to impossible to separate those institutions that are genuinely in trouble versus others who are being dragged down due to the prevailing (and intensifying) panic.
Disturbingly, every attempt made to date to calm nerves with a view to restoring investor confidence has failed.
The tide will turn: when exactly, no one knows!
How will the credit
crunch affect the Pacific?
The answer to the above depends on the exposure, both direct and indirect, to economies buffeted by the ongoing crisis. Worst affected would be those with direct exposure to the global financial markets.
TRUST FUNDS
Trust Funds such as those of Nauru, Kiribati and Tuvalu will see their earnings and value drop in the immediate term.
SUPERANNUATION
Similarly, those of us with superannuation will see our earnings fall, but only to the extent of exposure to the volatile components of the global financial market.
Retirees may have to go back to their food gardens, if only to supplement their pensions.
The stock markets in Port Moresby and Suva have barely felt the shocks from New York.
Monetary authorities from the Pacific region have been quick to reassure the public that domestic banks and thus their deposits are secure.
Let’s believe this to be the case!
The indirect effects of the financial crisis on each one of us can be both significant and protracted.
TOURISM
Tourist dependent nations such as Cook Islands, Fiji, Palau, Samoa and Vanuatu will take a hit from economic slowdowns in their source nations.
REMITTANCE
Remittance dependent economies such as Niue, Tonga, Samoa and Fiji will once again be adversely affected from a global slowdown. Fortunately, merchandise exports from the region to Asia will be least affected: a fact likely to favour Papua New Guinea and (less so) Solomon Islands.
IMPORTS AND CREDIT
The rise in price of imports and credit will adversely affect each one of us. Many are already feeling the pains of rising fuel and food prices.
More of the same will lead to increased poverty in each Pacific islands community.
INTEREST RATES
A rise in foreign interest rates will raise cost of borrowing at home—the global financial market, after all, is deeply integrated.
Finance, moreover, is the ‘oil’ that fuels the market economy. Nations with large debts and those contemplating running further budget deficits will see costs of servicing this debt escalate.
Solomon Islands has gone through a debt crisis recently; let us hope others take early action to avoid such a predicament.

What can be done to
mitigate some of the
adverse consequences?
Note has to be made of the fact that this crisis originated abroad. Its resolution, therefore, rests abroad.
The best that can be done within the Pacific is to devise coping strategies to ride out the shock as best as possible.
A closer watch on the health of the domestic financial sector will help maintain confidence and thus mitigate some of the adverse effects from abroad.
Further shock-proving of the domestic financial sector is likely to yield dividends should the crisis intensify.
Fiscal prudence including some belt-tightening with public expenditures will help governments manage their finances in these difficult times.
Those contemplating budget deficits this year may need to think twice about how these will be financed. Some such as Papua New Guinea already have low levels of public debt and thus are already in a good position to ride out this crisis.
Marshall Islands foreshadowed measures to cut budgetary outlays; action, however, has lagged rhetoric. Federated States of Micronesia may need to act soon on this front too.
Foreign reserves would also need to be protected if currencies are to remain stable. PNG, once again, is in an enviable position having built up a healthy stock of foreign exchange reserves.
The risk, albeit small, to PNG is if its export market, Asia in particular, begins to implode. The rest of the Pacific is less secure. Fiji is looking particularly worrisome given its high dependence on tourism, its rapidly dwindling stocks of foreign exchange reserves, and the slow (and sure) withdrawal of donor support. Any further political problems in Fiji will only make matters worse.
Nauru, Kiribati and Tuvalu are already in the frontline given the direct exposure of their trust funds to stock markets abroad.Tonga, Samoa and Vanuatu are also likely to feel some of the heat from abroad.
Islanders are used to riding out rough storms: a skill that may be handy this time round. Close watch on stormy conditions and timely evasive action will be necessary if trouble is to be avoided.
It helps to prepare in advance for these conditions.
A leaky canoe is never safe and least so when the weather is not with you. Fix the leaks and ‘stay awake’!