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The Background Of Oil Price Crisis 2008 Economics Essay

In the 3rd quarter of 2008, an oil prices crisis occurred and causes the economies fell into recession. In 2008, world oil markets experiences volatility on an unprecedented scale. This is because, the crude oil prices shot up to almost $150 per barrel by the middle of the year and they came plunging down where it close to $40 per barrel by the end of the 2008(Timo, 2009). It is mainly because there are triggered by the US sub-prime mortgage and credit crisis. In 2007, advanced economies fell into recession where the world GDP fell from 5.2% to 3.2%, however, in year 2008, the world GDP sharply decreased from 2.7% to 0.9% (Michael, M., 2009) . Further, in Japan, there is a contraction of 0.6% in 2008. The GDP in the emerging and developing economies also fell from 7.3% in previous year to 6.1%. This sharp downturn depressed global trade, investment and capital flows in 2008. Due to the oil crisis, there is increase in inflation, those prices of food and prices of crude oil tumbled to USD44.60 per barrel. In banking sector, there is a huge losses which amounted to USD50 trillion and has raising the unemployment rate in global economy which the global unemployment rate rose from 5.7% to 6.0% (Rosemary, A., & Winnie V. Mitullah., 2010). To conclude, oil prices crisis brings greater impact on the global economy.

The background of foreign currency exchange system

After World War II, the International Monetary Fund (IMF) was set up mainly to monitor the balance of payment and exchange rate activities. For example, one-ounce of gold is worth USD $35 which categorized as fixed exchange rate. So, these will automatically peg all the currencies to US Dollar. The fixed exchange rate system was served well before 1960. But, the inflation rate started to rise until 9% by 1968 in US. Due to negative relationship between inflation rate and exchange rate, US dollar depreciates against all the currencies. In addition, all these condition indirectly contributed to oil price crisis.

Besides, the foreign currency exchange rate, commonly known as FOREX is a process that the rate at which one currency can be exchanged for another. This process is necessary as long as different currencies have been doing business together. For example, it is always quoted in pairs like the EUR/USD (the Euro and the US Dollar) that mean buying the Euro and selling the US Dollar in the spot or future market in condition that Euro will gains value compared to the US Dollar in the future. Besides that, exchange rates fluctuate based on economic factors like inflation, industrial production and geopolitical events.

However, the exchange rate become volatile and difficult to predict the value started March 1973. This is because OPEC increased the price of oil since oil crisis 1971. As a result, increases in US inflation rate give the effect that further depreciated the value of US dollar. Besides, during the oil price crisis in 1979, OPEC increased the price again and it gives doubled harmful effect to US inflation rate and trade position. In addition, the higher oil price crisis that happened in year 2008 impose a greater impact for five major currencies that very active in trading activities in the foreign markets that is US Dollar, Euro, Japanese Yen, Swiss Franc and British Pound.

Impact of US dollar to Ringgit Malaysia

It all started with the subprime crisis in United States of America in 2007. The government had lowered down the interest rate and as a result, the US dollar depreciated. The subprime crisis brings to the global crisis and it slowed down the economy of developing countries by large (Goh & Lim, 2010).

As the currency of dollar used as transaction in most of the trading commodities, thus, the depreciated dollar increases the commodities price. However, it did not give large impact to Malaysia as Bank Negara Malaysia implements fiscal stimulus measures which is supported monetary policy and introduces comprehensive measures to finance and stabilize the risk aversion among banks (Impact of global crisis on Malaysia’s financial system, n.d). Malaysian currency had appreciated against the US dollar after the oil crisis in 2008. According to Goh & Lim, Ringgit was pegged to RM 3.80 to US 1$ in year 1998 and monetary policy shifted to maintain the fixed exchange rate by keeping the inflation and interest rate different. However, it had been switch to floated exchange rate in year 2005 after the government realized that the Malaysian ringgit had been traded undervalued and to give flexibility for Ringgit to adjust global economic and financial developments (Bank Negara Malaysia, 2008). The falling dollar due to subprime crisis reduces the deficits of United States current account and strengthening the Ringgit that attracted more local and foreigner investor to invest in Malaysia’s property and thus stabilize the Malaysian economy.

However, the continuous appreciation of Ringgit may hurt the export of Malaysia. As mentioned by Jamesesz (2008), by leaving the Malaysian Overnight Policy Rate (OPR) unchanged at 3.5%, it causes a drop in value of Ringgit against other foreign currencies.

Depreciated US dollar left the commodities price went high and as a result the global economy slowed down in 2009 (Bank Negara Malaysia, 2008). The high price of commodities makes the consumption and real GDP dropped (Bank Negara Malaysia, 2008). The slowdown of domestic economy, high inflation and depreciated value of Ringgit to US dollar and other currencies increases the risk of doing business in Malaysia (Goh & Lim, 2010). So, the Federal Government’s 2009 Budget announced in August 2008 was to mitigate the nation form rising inflation and increase uncertainty. The Economic Stimulus Packages was introduced under the fiscal policy to provide government spending on the nations. Besides, the monetary policy has been focused on the economic growth. The Bank has reduced the OPR between November 2008 and February 2008 to support the economic growth. SRR was lowered to reduce the cost of intermediation and encouraged the bank pass on the lower interest rates to borrowers. Furthermore, the Bank announced the issuance of Bon Simpanan Negara to mitigate the impact of lower interest rate to the proportion of population who depends on the income from savings (Bank Negara Malaysia, 2008).

Impact of British pound to Ringgit Malaysia after oil price crisis 2008

Fuel prices were at the peak in mid-July 2008 which is about US$151 per barrel of crude oil in the case of Malaysia, although its price has start to decline gradually during August. Whereas for British, crude oil price rises to about US$140 per barrel. This has posted a threat to both British and Malaysia, British imports more oil than Malaysia where US being the largest importer. Even though British was highly affected by its higher oil imports from other countries compare to Malaysia, it has a lower crude oil price in terms of US dollar compare to Malaysia during the oil price crisis because British pound (GBP) is stronger compare to Ringgit Malaysia (MYR). The exchange rate of GBP per MYR fluctuates around 0.154/MYR after the crisis strikes, before it reaches an appreciation to a 0.155/MYR at 31 of July. Then, MYR has a rapid increase in value in terms of GBP in August 2008, which is about an appreciation of 4.4%. This leads to an exchange rate of 0.162/MYR at the end of the month. After that, at mid of third quarter of September 2008, MYR experienced a slight devaluation in terms of GBP as a result of crisis in global financial institution. This is evidenced by a movement of exchange rate from 0.162/MYR to a 0.158/MYR and has a gradual increase to 0.163 at the end of September 2008. Our Malaysian Ringgit strengthened against British pound to 0.203/MYR in 17 February 2011, this is because Malaysia has a sound and strong foundation in financial system.

The exchange rate of GBP/MYR has only a slight decrease at some time after the crisis strikes while most of them increase steadily from exchange rate at around 0.154/MYR after the oil price crisis. This was because regional central banks have applied contractionary monetary policy to fight against inflation, the increase in interest rate resulting from this will help to strengthen Malaysia currencies (Yeow&Tan, 2008). This is important because Malaysia is net food importer from other countries, so it is important to secure Malaysia ringgit to fight against import inflation. Malaysia was less affected by the surging of oil price because Malaysia is net export country for oil for is surplus of exporting value over the importing value (U.S Energy Information Administration (EIA), n.d.). This shows that Malaysia actually explicitly gain from the rapid shooting up of the world oil price, thus causing its exchange rate to appreciate gradually against British pound. British become the net oil importer since year 2006, thus makes it to be negatively impacted by higher oil price, but the effect is less if compare to US which is the largest oil importer in the world. British pound has incurred a severe fall in value in terms of US dollar compare to Malaysian ringgit because at that time UK is incurring housing and banking crisis which many banks fail. The failing of interest rate by Bank of England cause the demand for British pound to decrease (British government bond is less attractive) and thus help to devalue the pound currency in a more serious way. To conclude, high oil price benefited net petrol exporter which include Malaysia.

On the other hand, we know that appreciation and devaluation in either of the country’s currency has feedback effect which is the effect on the world economy as a whole and the effect to the country itself. This is because of international trade between countries are throughout the world. High oil price will affect Malaysia economy in the sense that appreciation of Malaysian Ringgit in terms of British pound will cause Malaysia export to be more expensive and import to be cheaper (increase in purchasing power), this will encourage import, and discourage export. Although the GDP of Malaysia will decrease, but this seems good to Malaysia, because the Malaysian will now having more choice of goods and services from foreign. On another extreme case, an increase in oil price will decrease the purchasing power of Malaysian (reducing real income of households) and net profit of businesses. This is because a decrease in real come of household will trigger them to reduce consumption and thus causing total demand for goods and services to decline. Besides, total supply also decrease as a result of an increase in the production and distribution costs which then cause an increase in overall price level in the economy(McConnell&Brue, 2008). Total output production will also decline because cost of production in terms of higher wages and increase in input price such as raw material in too high and business faced a decrease in aggregate demand for goods and services in the economy(Frederic Mishkin, 2007). On the other hand, business will place the burden of an increase in cost of production to the price of their goods and services. This is due to an increase in world oil prices which trigger business to incur more expenses. Eventually, an increase in price index will cause inflation in Malaysia. Inflation has weakened Malaysia ringgit but this effect is considered less compare to effect on British. Standard of living in most of the countries including Malaysia drop and monetary wealth decline. Due to the income inequality in Malaysia, the group that is mostly affected by the increase in price level is the low income group. Our bank Negara has decided to maintain the OPR at 3.5%, this has trigger our stock market to boom up by 1.08% and depreciation of Malaysia Ringgit (Loong Tse Min, 2008). We maintain a constant OPR because an increase in interest rate to reduce to money supply to reduce inflation will post burden and make business to be more difficult to tackle their bad business condition. Besides, a decrease in interest rate will discourage foreign investment. Fiscal deficit of Malaysia government will rise because of declining in tax base (holding tax rate constant) and an increase in government spending as the results of increasing in subsidy bills.

Impact of Japanese Yen to Ringgit Malaysia

Logically, there are negative relationship between oil prices and economic growth. Besides, oil prices normally will be affecting the performance economics growth in long run. With economic growth, it will be directly and indirectly affect the currency of Japan.

When oil price increase, the currency Japanese Yen to 1 Ringgit Malaysia will be appreciate. That is because Japan is the third largest economy in the world but categorized as low oil production country which makes it as one of the major oil importing countries. So, Japan would be heavily affected by the international oil market conditions. According to Tokic(2010). When oil prices shocks happen, the currency Japanese Yen to US dollar will be unstable is to reflecting the unwinding of speculative Yen-carry-trades. Besides, Japan was one of the major trading partners for Malaysia. Based on the table (Appendix 1), Japanese Yen to 1 Ringgit Malaysia started on 2008Q3 that is Yen 32.2602667 but appreciate to Yen 27.06916667 on 2008Q4. The situation becomes better for Ringgit Malaysia on year 2009. The Japanese Yen to 1 Ringgit Malaysia appreciate again on year 2009. Based on the table (Appendix 2), Japanese Yen to 1 Ringgit Malaysia is Yen 25.798 on 2009Q1 but depreciate a bit to Yen 27.445 on 2009Q2. Because of the oil price crisis 2008, the ratio of currency Japanese Yen to 1 Ringgit Malaysia can’t be achieved as before oil price crisis 2008. So, the impact on currency for Japanese Yen to 1 Ringgit Malaysia was not much affected by oil price crisis 2008 since Japanese Yen to 1 Ringgit Malaysia remains between Yen 25 to Yen 29 until today.

In addition, during the year of 2008, an oil price crisis happens causing the global economic downturn. According to Martin Khor (2009) Malaysia GDP fell by 11% between the third and the fourth quarters of 2008. Besides, the real GDP in manufacturing also decline 12% from RM40.3 billion to RM35.3 billion, while agriculture fell from RM10.8 to 9.9 billion and the construction fell from RM4 to 3.9 billion. There was only a very slight growth from RM74 to $75 billion in the services sector. Malaysia total manufacturing exports dropped 20% from RM138 billion in third-quarter 2008 to RM110 billion in the fourth quarter, and in the same period the exports of the electronic and electrical sector fell 20% from RM78 billion to RM62 billion. Therefore, those declined has create a negative trend on our economy. In the case in Malaysia, high oil prices would benefit to the Malaysia economy because Malaysia is an oil exporting country, and it brings the positive gains from higher oil prices and it will offsetting to any negative impact to the economy.

 According to the Statistical Yearbook for Asia and the Pacific 2009, it shows that, from the year of 2007 to 2008, the interest rate in Japanese country decreased from 0.8% to 0.3%. This decreased interest rate became the lowest interest level among all major economies.

With the oil price shock happen, Japanese economy fell into recession. According to Jeffrey Hays (2010) the Japanese economy shrank 3.3% in fiscal 2008. In February 2009, there was a “deep recession” fall in to Japan. Through IMF, the Japan’s GDP shown that there has a big contraction where their GDP declined 12.1% during October to December quarter in 2008. Besides, there is also a steepest decline and crashed in GDP of 14.2% during January to March 2009 following a sharp decline in exports, and particularly automobiles and electronics. Because dropping of GDP, the unemployment rate increases to a high of 5.7% in August 2009. Next, there is a stock market fall in Japanese economic crisis in 2008. This is mainly because of the dramatically drop was the exodus of the foreign investment. This foreign investment has occupied for almost 60% of the trading volume on Japan’s stock market. Others, because of the oil price crisis happen, it slowed down the global economy and causes the high value of Yen, and this decreased the demand for Japanese products. The price of products become more expensive and the demand decreased further, so the consumer spending also declined. As a conclusion, oil price crisis 2008 brings the Japanese economy fell in to recession.

*exchange rate adapted from http://www.exchangerate.com

References

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