Monday, December 27, 2010

China the world's largest economy

China’s GDP in 2009 is about $5 trillion whilst that of the US is $14 trillion – nearly 3 times larger. China overtook Japan to be the 2nd largest economy this year. So, when will China overtake the US to be the world’s largest economy?

The relative GDP figures of 2 countries depend not just on the growth rate. It is also impacted by things like inflation and currency exchange rate. China, which traditionally has a higher inflation rate, will get a boost on its GDP from inflation. Similarly, a strengthening Yuan will help bolster its value of goods and services produced.

In the last decade, the real GDP growth averaged 10.5% for China and 1.7% in America; inflation averaged 3.8% and 2.2% respectively. Since 2005, the Yuan has appreciated an average of 4.2% annually.

Extrapolating from the past, conservatively, we assume an average growth rate over the next decade of 7.5% for China and 2.5% for the US, inflation rate of 4% and 1.5% respectively and the Yuan gaining 3% per year, China should pass the US as the biggest economy in the world by 2020. If, however, China’s growth falters to 5%, then the overtaking date would be 2022 – a mere 2 years later.

So, it is no more a question of whether China will overtake the US as the world’s biggest economy. Rather, it is a matter of when only.

Wednesday, December 1, 2010

Stewed in the Irish juice

Up to the late 80s, Ireland was a backwater economy – with high unemployment & huge government debt. In 1987, the unemployment rate was 18 % and the government’s debt was 120 % of the GDP. It was largely an agricultural economy.

Then the government pushed through dramatic economic reforms. Corporate taxes and business regulations were lowered. This opened the economy to the rest of Europe and attracted a lot of biotechnology and high tech investments. The country prospered. Its per capita income growth rate shot to 6 % from the historical rate of 3.5 %. Similarly, its GDP growth touched a figure of 10 %.

Wages rose and with it prices. Housing became a good investment. The banks borrowed huge amounts from the international wholesale market and loaned it to the domestic housing market. The feed of easy liquidity engendered a huge housing boom and it snowballed. House prices, construction company stocks, land prices and all things related to construction skyrocketed. By late 2006, the average new house costs 10 times the average earnings.

The boom peaked in late 2006. By the middle of 2007, unsold housing units began to accumulate. Banks began to feel the heat. In late September 2008, a run started in the wholesale markets on Anglo Irish Bank. It was quite clear that the domino effect or contagion would take hold. The government took the unusual step of guaranteeing all deposits and senior debt in the six Irish banks, nationalized Anglo Irish and invested 3.5 billion Euros in two other banks. And that is the start of the Irish economic decline.

Sunday, November 28, 2010

Malaysia's household debt

Malaysia’s total household debt is a whopping RM 560 billion as at 31 August 2010 – 55 % of the banking system’s total loans. This is about 72 % of the GDP. The debt is made up of borrowings in residential property, passenger car, credit card, securities and personal use. Residential property and passenger car comprise the largest portions with value of RM 230 billion and RM 123 billion respectively. This is equivalent to 48 % and 26 % of the total debt. Credit card debt is fast rising and has a cumulative value of RM 29 billion – 6 % of the total loans.

Malaysia’s average income per capita is about RM 2000 per month. The household debt to personal disposable income is 140 % in 2009. This figure is higher than Singapore’s 105 % and US’ 123 %. As the disposable income is about 70 % of the gross income, Malaysians owe double the amount they earn.

Of particular concern is Malaysia’s passenger car debt of RM 123 billion. At a quarter of household debt, this is a world record. The reason for this is the high car price in Malaysia and our penchant for wheels. With a population of 28 million, we have 19.8 million registered vehicles as at August 2010. This is a depreciating asset as the value and usability of the car reduces over time.

The kimchi punch

Two significant news on South Korea caught my attention. First, it is the final medal tally for the just completed Asian Games. South Korea came in at number two – behind host nation China but ahead of Japan. SK, with a population of just 48.6 million, managed to gather a total of 76 gold medals. Japan, on the other hand, with a much bigger population of 127 million managed to collect only 48. How did the South Koreans do it?

The second is the results of the Car of the Year 2010 awards conducted by New Straits Times & Maybank. Of the 18 awards available, South Korean manufacturers picked up 5. They even beat Japan who managed to score only in 3 categories. Again, how did they do it?

South Korea is one of the most ethnically and linguistically homogenous society in the world. Technically, they are still at war with their brother state in the north. This makes them very united and competitive. Also, the humiliation suffered by the country in 1997 when it was bailed out by the IMF has made them resolved to better themselves. That is the new spirit of the South Koreans.

One other factor is the country’s emphasis on education and the development of its human capital. Its local universities produced a total of 10,322 Phd holders in 2009. In the same year, 82 % of its high school graduates are enrolled in tertiary educational institutions. A total of 19,847 doctoral positions were offered by their universities. All this has not taken into account the Phd degrees obtained from foreign universities.

They have become very strong in research and development. They are also very innovative. They have become world leaders for a host of electronic products. Watch them. They will become more prominent in the future.

Tuesday, November 23, 2010

Singapore vs Malaysia

Malaysia and Singapore separated 45 years ago. Back then, Singapore’s GDP per capita was $512 while Malaysia’s was $335. Fast forward 45 years, Singapore’s GDP per capita has leapfrog to $36,537 compared to Malaysia’s $6,975. In the same period, Singapore’s GDP has risen 189 times but Malaysia’s only managed about a third of that rate.

By the end of this year, Singapore’s GDP is expected to overtake that of its northern neighbor. The former should chalk up a figure of about $210 billion whilst the latter about $205 billion. This is despite Singapore being only 2.1 % the size of Malaysia and has no natural resources. They make up for the disadvantage by optimizing their human capital.

On the currency front, the currencies of the two nations were at par at the time of separation. 45 years later, the Singapore dollar is worth about RM 2.40. What a world of difference. Singapore’s foreign reserve is $220 billion whilst that for Malaysia is $100 billion. In addition, Singapore has two sovereign wealth funds with a combined asset value of about $480 billion. Khazanah Nasional, Malaysia’s sovereign fund, has a net worth of $25 billion.

Dr. Mahathir has an explanation for this contrasting growth rate. He reasoned that Malaysia lacked behind because it has a social restructuring goal to fulfill. By this, he meant the fair distribution of wealth among the races. Perhaps, its lost focus on growing the economic pie and instead concentrated on dividing the pie. What a pity.

Wednesday, November 3, 2010

China's trade surplus

The US trade deficit with China for June and July 2010 was $25.9 billion and $26.2 billion respectively. This represents 60% and 52.6% of the total US trade deficit of $42.8 billion and $49.8 billion for the same periods. The September 2010 figure was $16.9 billion. For 2004 & 2005, the US deficit was $160 billion and $201 billion respectively. That for 2006 was about $230 billion. China’s share of US imports was 14.6% in 2005.

This trade imbalance is making the US very angry with China. They see the Chinese export as a threat to some US industries and also its manufacturing employment. They alleged that China is dumping its exports at below cost and engages in currency manipulation to gain an advantage in the export market.

China is the world’s largest exporter. It exports earned a total revenue of $1.2 trillion in 2009. Its trade surplus for 2008 and 2009 are $297 billion and $198 billion respectively. For 2010, it is expected to net a surplus of about $160 billion. Exports of goods and services constitute about 40% of the GDP.

What does China exports? Its major exports are office machines and data processing equipment, telecommunications equipment, electrical machinery and apparel and clothing. But, many of these products are ‘value-added manufacturing’ where components are imported from several East Asian countries and assembled in China and then re-exported. China’s value add to the products is only 20%. In the mid 1990s, the value-added trade made up about 55% of total China exports. This means China’s net trade surplus should be only about 56% of its reported figure. Consequently, its trade surplus with the US should be correspondingly lower too.

Monday, November 1, 2010

The Chinese foreign reserve

The rival sovereignty claim over some uninhabited islands - known as Senkaku in Japan and Diaoyu in China – caused a diplomatic spat between the two Asian giants. A Chinese fishing boat captain was detained by the Japanese authorities. Demands and protests were made for the freeing of the captain. Other diplomatic channels were also deployed.

In the financial market, China applied pressure on Japan by buying substantial quantities of Japanese bond. It purchased a total of $25.5 billion in the first 7 months of this year. This purchase, made with Yen bought from the open market, drove up the value of the Yen. The Yen had appreciated by 15% against the dollar since April. What is most infuriating for the Japanese is that the Chinese can buy their bonds, but they are no means for a reciprocal action.

The Japanese eventually released the Chinese captain. Almost simultaneously, the Chinese sold down their holding on Japanese bonds. This episode illustrates the mightiness of the huge Chinese foreign-exchange reserve. You can expect to see more flexing of this muscle in the future.

Wednesday, October 27, 2010

The flying geese paradigm

The Flying Geese Paradigm (FGP) is the graphic presentation of the three time series curves of import, production and export of a product. It is a dynamic situation in which a follower, in pursuit of development, emulates the industries of advanced economies in a manner compatible with its own factor and technological endowments at a given specific time.

In simple terms, it means that an underdeveloped country starts to import foreign goods. Over time, the entrepreneurs in the country understand the function and benefits of making the product themselves. They set up plants to manufacture the product either on their own or in collaboration with foreigners. This undertaking is called import-substitution production. As the production process gets more familiar and streamlined, the output is increased. Also, more investment is made to set up more plants. Beyond the domestic consumption threshold, the output is exported, thereby making foreign exchange for the country. This whole cycle of evolution is known as the FGP.

The FGP doesn’t seem to work in this country especially in the case of Proton. After 27 years of operation, they are still unable to come up with their own product. What they are doing is literally rebadging foreign made cars. This means they are still stuck in the first phase of importing cars. Exporting their own cars remains a pipe dream.

Monday, October 25, 2010

Economic malaise

The 2008 mortgage credit crisis caused massive wealth destruction – especially in the developed nations. The people generally became poorer. Consumption diminished and the economies moved into lower gear. To revitalize the economies, the governments resorted to fiscal expansion, monetary loosening and quantitative easing.

Fiscal expansion is the action of the government to speed up the implementation of physical projects. The government pumps in more money to construct better infrastructure. As a result, jobs are created and this will give consumption a boost. Hopefully, the economy will improve. The flip side of fiscal expansion is that the government will run a budget deficit. The bigger the deficit, the more venerable is the currency to depreciate.

Monetary loosening is the lowering of interest rate in an economy. It is hoped that with a lower cost of funds, entrepreneurs will borrow more money to expand their business. This will create jobs and hopefully stimulate the economy. Again, ‘cheap’ money is weak money. There is no incentive for holding this currency. Hence, its tendency to depreciate.

If the above measures don’t work, then the last resort is quantitative easing. QE is the printing of new money and pumping it into the system. The intention is to make money easily available so that businesses will boom. However, with the economy still sluggish and job creation slow, this extra money is not helping much.

Instead, this money is finding its way to the developing economies. With interest rate at near zero at home, it is more profitable to invest in countries that have positive interest rates, such as the BRIC countries. The movement of this money has the effect of driving up the currency of the investee countries. Indirectly, this is driving down the currency of the countries that practiced QE.

So, willy-nilly, if you have huge budget deficits (especially those funded by foreign borrowings), low or no economic growth and high unemployment, you currency will be under pressure. That is market forces at work.

Thursday, October 21, 2010

Snippets on Japan

The Nikkei stock index hit an all time high of 38,915.87 on 29 Dec. 1989.

Nikkei 225 reached a 26-year low of 6994.9 in October 2008.

In Ginza district, choice property fetched US$1.0 million per sq. metre in 1989. By 2004, it had slumped to 1 % of its peak. Similarly, residential prices in Tokyo shed 90 % of its value during the period.

In 1990, Japan accounted for 14 % of the world economy. Today, it account for just 8 % of the pie.

The population of Japan is 127 million today. It is expected to fall to 100 m by 2050.

Japan’s debt to GDP is 200 %. USA’s is about 100 %.

Liquidity trap – interest rate is set at zero and aggregate demand consistently falls short of aggregate supply potential. In simple language, the money supply is increased and the interest rate kept near to zero to encourage borrowing and spending. However, the corporations preferred to pay down their debts with their earnings and consumers deferred their spending in the hope of cheaper goods in the future. Japan was in such a situation during the lost decade.

The lost decade – from 1991 to 2000 when the Japanese economy went into a recession as a result of the asset bubble bursting.

The Yuan conundrum

The US is accusing China of artificially depressing the value of the Yuan. They said that China uses this to gain a competitive advantage on the world market for its exports. The more hawkish congressmen even alleged that China’s cheap export is causing job losses at home. The US manufacturers are unable to match China on the price of their produce.

So, is the Yuan really undervalued? The answer is probably yes. By how much is anybody’s guess? But, one thing is clear. A revaluation of the Yuan will in no way solve any of the US economic woes.

For China, the constant pressure from the west on its exchange rate is a big bugbear. How can it engineer a strategy and will pacify the rest of the world and at the same time not cause civil strife and economic slowdown in the country.

China has a foreign reserve of about $2.65 trillion. Of this, about 65% is held in US dollars. If China were to revalue its Yuan, then it would suffer a huge loss on its dollar holdings. If it decides to sell dollar to buy Yen or Euro, it would depress the value of the greenback. This would again result in losses for China.

The only way out is for China to revalue its Yuan slowly. Agradual increase in the value of the Yuan will result in higher household consumption. Exports will be affected slightly. On balance, the lost of foreign consumption would be compensated by domestic ones. This would have minimum impact on employment.

China cannot act in haste because of the foreign pressure. If it revalues too quickly, exports would be badly affected. This would force exporters into bankruptcy or move abroad. Workers would lose their jobs and their aggregate household income would drop. This would result in reduced domestic consumption. That would be the dreaded double whammy for China.

Friday, August 6, 2010

Deflation in Japan

The Japanese asset price bubble of the eighties started in 1985 with the establishment of the Plaza Accord. Quickly, the Yen doubled in value. With it, the property values skyrocketed. Stock market valuations also became stretched. The bubble burst in early 1990 when interest rate was raised. Since then, asset prices have been falling.

Starting 1999, the price of general goods has been falling too. This phenomenon is termed as deflation. The government, in trying to reflate the economy, pumped $1 trillion-plus into the economy by way of public-works spending, tax cuts and rebates in the last decade. It is now saddled with a public debt of about US$10 trillion – twice the GDP. Luckily, 90% of this debt is sourced domestically. (Japan has a household saving of some $15 trillions.) Otherwise, Japan could well be bankrupt. As such, the same formula of fiscal stimulus cannot be used further.

On the monetary side, its interest rate is at near zero (0.1 %) for years now. The only option left for the BoJ is on quantitative easing – making ample funds available for business and the public. Even this does not seem to work as businesses are reluctant to invest in a deflationary scenario. This is because the return under such an environment is uncertain and the debts are harder to pay off. The consumers, on the other hand are not spending as they feel that any purchase is likely to be cheaper in the future.

Deflation is causing wages to turn downwards. Coupled with a shrinking workforce, there is ample spare capacity in the country. The strong currency is also working against the manufacturing sector. However, a good work ethic is beating all these odds. The high productivity of the workers is helping the country to still achieve a trade surplus.

It is this good value, fiscal reforms and a strong monetary stimulus which will probably pull Japan out of deflation. The measures could range from an overhaul of the tax code, deregulation of farming, opening up of protected areas of the economy like transport and energy to foreign competition, boosting the birthrate and allowing more immigration. There is also the flip side to the strong currency. A strong Yen will enable a stronger consumer which in turn will stimulate domestic demand and spur growth.

Tuesday, June 8, 2010

How the PIIGS have gone to the pigs

The Euro came into existence on 1 January 1999. Before that, the PIIGS – Portugal, Italy, Ireland, Portugal and Spain, had their own currencies. These countries were, in the past, the weaker of the European economies. They had higher inflation and interest rates. They regularly devalued their currencies to maintain competitive.

Under the Euro, interest rate was standardized across the EU. This presented the PIIGS a sudden lowering of the cost of borrowing. The effect was a domestic consumption boom and a real estate bubble. This caused the costs to go up, especially labour. The problem was exacerbated by the immobility of the labour forces in the EU. The end result was a lowering of competitiveness. Unlike before, they are unable to devalue their currencies to regain competitiveness now.

Like the business sector, the easy credit induced the governments to borrowed more money to develop the countries. This caused a ballooning of their debts. An increase in government revenue due to the consumption boom gave the governments more confidence to embark on the lavish spending.

When the EU raised rates to fight inflation, the real estate bubble burst and the tax revenue collapsed. This resulted in them finding difficulty to service their huge debts.

The only way forward for the PIIGS is to lower wages and endure years of deflation and high unemployment. They have to go on a real austerity drive.

Thursday, April 15, 2010

The rising Ringgit

The Ringgit is doing pretty well since the beginning of the year. Against the US$, it has appreciated 7% in the last 3 months. It reached a level below RM3.2 to 1 US$ recently and is almost at a two-year high. The main reason for this bullishness is the optimism of a robust economy. The economy is expected to grow by 5.7% this year. Foreigners are also moving more money into the country to acquire assets.

The Ringgit has risen by a hefty 16% versus the US$ since the liberalization of the peg on 21 July 2005. Expectations are that it will rise further. This is because the Asia region economies are all expected to be doing very well in the next two years. The Chinese economy in particular is forecast to grow at a rate of 12% in the first quarter of this year. As a result, there is great pressure for the Yuan to be revalued. A surging Yuan will lend strength to the Ringgit and they will rise together.

Friday, March 12, 2010

Net investment flow

Since the relaxation of the country’s foreign exchange administration in April 2005, there has been an increase in the outflow of funds from the country. This is mainly due to the aggressive investment of foreign assets by Malaysian companies. To make matters worst, foreign direct investment in Malaysia has shrunk in the same period. This has resulted in a net outflow of RM50.0 billions in the last 3 years.

The main areas of investment abroad by Malaysian companies are banking, telecommunications, power and properties. Between 2006 and now, local banks have invested a total of RM25.3 billion in overseas banking assets.

Partly due to the huge outflow, the healthy external trade balance of RM118.3 billion and RM141.8 billion surpluses for years 2009 and 2008 respectively did not lift the country’s foreign reserve much. It rose only RM17.0 billion in the whole of 2009.

A direct result of the outpouring of funds to buy foreign assets is the reduction of investment at home. To plug the gap, the government has to bump up public spending to keep the economy going. In the process, the government chalked up a huge budget deficit of 7.4% of GDP in 2009.

The world financial crisis hit in 2008. In that year, there was a net portfolio investment outflow of RM84.3 billion from Malaysia. This caused a total deficit of RM118.5 billion in the balance on financial account in the year.

The outflow of funds has diminished the demand for the Ringgit. Consequently, the currency has been weak for the whole of 2008 and 2009. Things seem to have improved this year. Hopefully, it will end the year better.