Say What? Redux

One of my aims with this blog is to approach the question of economic policy from the “wrong” side of the bed – in a manner of speaking. Instead of using the more usual way of applying theory to try to explain what’s happening in Malaysia and the world, I prefer to follow the opposite route which is to look at the stats and then see which theory really fits the numbers.

To be honest, you really need to use both approaches to arrive at appropriate policy decisions, but I think you make less egregious mistakes by looking at reality first.

Case in point: in an article today at the Malaysian Insider, Datuk Jema Khan is calling for a repeg of the Ringgit to preserve “economic competitiveness” (emphasis added):

Beware the ringgit

…Our ringgit is the best performing currency in Asia for 2010, having risen by more than nine per cent whereas China’s yuan has only appreciated by two per cent as a result of its central bank’s intervention.…

…The major economies of the US, Japan and the UK are flooding the world with liquidity and that liquidity is coming to Asia. For Asia, that is not necessarily a bad thing as it means more inward FDI inflows, but unfortunately it appears that Malaysia is not benefitting from it.

The ringgit has appreciated the most in the region whereas Malaysia’s foreign exchange reserves has risen the least…

…For more than a decade, Malaysia has been carried by its strong trade surpluses to grow its GDP. If this were to reverse too suddenly, we will be in dire straits…

…If the manufacturers and exporters can’t sell their products because of the strong ringgit, the private sector will become even weaker in the future. At the same time, the government wants a high-wage economy. How do we in the private sector do that when we are already struggling with our labour costs today?

…What I think Bank Negara should seriously look at, is to reintroduce the currency peg at about the US$1:RM3.40 level. The peg helps not only in making our products more competitive but allows everyone, be they exporters or even importers to plan and price their products more effectively for a longer period of time…

So much of the article is based on an imperfect understanding of what’s actually going on, I hardly know where to start.

First, to say that high liquidity leads to higher FDI flows is a little strange. FDI is generally driven by fundamental factors, not liquidity which generally drives portfolio capital flows instead. In which case, the torrid pace foreigners are buying into Malaysian equities and especially debt securities and MGS, seems to amply demonstrate that Malaysia and the MYR are receiving their fair share of the expanded monetary pie.

Second, Malaysia’s international reserves have generally fallen, not risen, mainly because unlike nearly every other central bank in the region, BNM is no longer actively intervening in the forex market to dampen the Ringgit. This is something I’ve had to point out so many times on this blog, I’m sounding like a broken record.

Third, the Ringgit’s rise has been general, but has primarily been against the USD and the EUR, and even then you have to consider the USD to be fundamentally weak while the EUR has lately started reversing course. Against the currencies of our three remaining major trade partners (Singapore, China and Japan), I’ll let the charts speak for themselves (value of foreign currency in local currency terms; up indicates appreciation):

Context is all-important. If all you saw was this year’s admittedly spectacular rise, you would conclude that the Ringgit is strengthening dangerously fast – but it also took a real hammering in late 2008 (despite massive BNM intervention), with only the Korean Won being worse hit. The MYR is only just returning to its 2007-2008 range against many other currencies e.g. the Thai Baht:

I’d also point out that from a trade-weighted perspective, the MYR is still below its 2001-2002 peak (when the Ringgit was in fact still pegged to the USD):

You’ll note that the peg didn’t exactly stop the MYR from varying considerably in value against other currencies, which throws the volatility argument out the window as well. And if you use the argument that the US is Malaysia’s most important trade partner, you’d lose again (US percent share of total Malaysian trade):

Fourth, to say that our GDP growth has been driven by “strong trade surpluses” is demonstrably wrong. Again, a picture says more than a thousand words (percent annual increase):

This chart shows the marginal contribution of trade to real GDP growth over the last twenty odd years – in other words, how much of the percentage growth in real GDP each year is due the trade balance. Apart from 1998 and 2009, when of course trade volumes actually crashed, it cannot be said that the trade surplus drove anything at all. Most of the growth in GDP over the past decade has come from private and public consumption.

Fifth, the composition of Malaysian trade has changed considerably in the last decade. Nothing shows this better than the relative decline of electronics exports as a share of total exports:

Malaysia’s exports are now more heavily weighted to commodities like crude oil and crude palm oil, not manufactures. The increase in commodity prices since 2006 has helped sustain net exports at a time when Malaysian manufactured exports have stagnated – we can’t compete with China’s low cost labour, and deliberately undervaluing our currency won’t change that fundamental fact. That is unless we’re willing to take on more cheap immigrant labour, which doesn’t do anything for local incomes.

Besides all the above, I again have to point out the Penn effect, which shows that high income economies have higher price levels and stronger exchange rates than developing countries. The one is characteristic of the other – deliberate undervaluation will delay Malaysia reaching high income status. In theory, an undervalued currency is driven by an over emphasis on the tradable sector, where labour market wages and incomes are driven by global competition e.g. China, Vietnam, India.

To become a high income economy, there has to be a shift to the non-tradable sector, where labour market incomes are more greatly determined by local demand and supply conditions. It’s possible to retain a high export focus while at the same time improving labour incomes, but this would only be possible by going up the value chain – something which will take a generation or more to achieve given the state of our education system, and which will only benefit those who are able to pick up the requisite skills. If a general rise in labour incomes is needed (and in Malaysia’s case there is), then the first strategy has to take precedence.