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.
Monday, October 25, 2010
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.
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.
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.
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.
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.
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.
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.
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