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What does ‘no money circulation in the market’ mean?
Last Tuesday we said "Let go the empty talks and see what we should do." In this context, we first focused on the corporate sector. It seems that the current conditions will first affect the corporate sector regardless of what we want. Until today, we in a polite and technical manner said "It is critical to prevent any obstruction in the credit channel"; but no one understood anything. Therefore, today it is time to explain what is going to happen concretely. Do you remember the first example? The question we asked was quite simple: What happens if banks tell companies 'The collateral you supplied for the credit you received is not sufficient anymore. Either supply additional collateral or return the part of the credit not covered by the collateral'? The answer was that bad things happened. The economy contracted. Today, let us evaluate the "There is neither money circulation, nor any exchanges in the market" thesis. I guess you have been hearing such statements a lot nowadays, so do we. If you wonder what is going on, continue reading.
All exchanges in the market are not done with cash. Retailers purchasing commodities from the wholesalers or wholesalers purchasing commodities from the producer do not make the payment in cash. If the economy is operating under normal conditions, the payment is forwarded a few months. In the last period, this forward term was around six months. Now, we are at a point where the forward term has completely disappeared. Sellers want to receive the money right away after the commodities are delivered. And as it is not easy to do for all cases, the exchanges in the market almost stop. Liquidity does not disappear, but no one wants to extend credit.
The first question shall be asked at this point: Why does no one want to make 6-month forwarded sale to anyone? Why does the contract term shorten? The reason is quite simple: No one is sure whether the company he made a forwarded sale to will survive to the first quarter of 2009 or not. Even if the company survives, it s not definite whether it will consider paying its debt with the money I holds.
So, what is the issue? As the forwarded sale option has disappeared, there is no money circulation and exchange in the market. This is the first point. And the reason behind the disappearance of the forward sale option is that the sellers do not trust in the payment commitment of the buyer. Therefore, "there is no money circulation in the market" means that "no one trusts in promises." And this is the second point.
So, does the issue end here? No, it does not. This obstruction in the credit channel is also related to the banking system. Basically, forward payment in exchanges means provision of a check undertaking the forward payment. In the past, this contract term expanded up to six months. Because client checks with payment commitment could have been deposited to the bank and credit could have been received in return. However, this does not seem possible anymore; because, the fact that whether the company will survive to the credit repayment date is not definite forces the banks to be more cautious. This tendency altering the attitude of the banks shortens the forward sale maturity and stops exchanges. And this is the third point.
At the end, the issue again comes to the banking sector. Saying "there is no money circulation or exchanges in the market" in fact means "Banks are not extending credits as easily as before." This might not be apparent to you and you might not have received any credit from any bank; but the money circulation in the market is actually ensured by the banking sector. And if the operation of that channel is obstructed, we all suffer from the results.
According to the recent news, the share of credits in banks' balance sheets was decreasing while that of government debt securities (GDS) was increasing. So, we can state the fourth point: "There is no money circulation in the market" as the banks rather than extending credits prefer to purchase GDSs.
Such is life. Things you enjoyed yesterday can upset you today. Yesterday, the fall in GDS interest rate was a good development. However it is a bed development today. Yesterday, interest rate cut by the Central Bank was a good development for the corporate sector; however, today it has no meaning for the corporate sector.
So, what is the challenge? The challenge is how to transfer resources to the corporate sector so that exchanges continue and this is impossible for now due to the confidence crisis.
This commentary was published in Referans daily on 25.12.2008