Friday, July 30, 2010

A Matter of Principle

(I’ve been drafting this for a few days, and then Tun Mahathir has to go and steal my thunder!)

There are a few unspoken rules and principles I have followed since I started this blog. But since the readership has expanded, and I’ve gotten a few queries about writing outside the blogosphere, I thought I’d make these explicit, so there’ll be no misunderstandings. This post should also explain why I try not to write on certain subjects, even if they fall within the general ambit of the Malaysian economy.

Since I work in a public company that works for and services the financial needs of many Malaysians, there’s always a risk that my thoughts and opinions might be construed as representing the policies of who I work for. Even on an anonymous basis as I’ve tried to maintain on this blog, enough people know who I am and where I work, for this to become a potential issue.

The Miti Blog On The FDI Issue

It reads like a FAQ (you can read it here). You may or may not believe the answers, but for a précis about the whole situation, it’s a good place to start.

Thursday, July 29, 2010

An Absence Of Markets: IKEA Edition

It sometimes fun to apply economic principles to everyday matters, and the way people interact with each other. And sometimes, it’s a little depressing. This post outlines a case of the latter.

I was at the IKEA store at IKANO Power Centre in Kota Damansara last Saturday, having dinner with my family and my sister. It being the start of the IKEA sale, the place was of course packed to the gills. The in-store restaurant was no exception, with fairly long queues into the cafeteria area.

JP Morgan Chase Says Malaysia Is A Safe Refuge

And they’re sorta right, though I wouldn’t put too much credence in the idea of a “weak correlation”. Correlations have a way of reversing just when you least expect them to, and when you can least afford it. To turn that old chestnut on its head, the absence of correlation does not necessarily imply a lack of causality. Correlations are also highly sensitive to the sample you choose – relying on them isn’t a great idea:

Malaysian Stocks Offer Foreigners ‘Safe Refuge,’ JPMorgan Says

July 28 (Bloomberg) -- Malaysia’s stock market is a “safe refuge” for foreign investors seeking shelter from volatility in other Asian markets because of its domestic economy and defensive qualities, JPMorgan Chase & Co said…

…The Malaysian market has “defensive characteristics such as low volatility and weak correlation with major indexes,” he said. “The market is back on a high; we see evidence of foreign monies trickling in based on foreign incremental buying and ownership levels.”

Foreign ownership in Malaysia’s market rose to 20.6 percent at the end of June from 20.3 percent in February, signaling a pickup in net buying by foreigners, Oh said.

Wednesday, July 28, 2010

How Effective Are Retraining/Reskilling Programs?

One of the big concerns under the NEM is that with a structural shift away from low-value added export industries towards higher value-added activities and towards services, existing workers will be poorly equipped to handle the transition and find jobs under the new paradigm. With that in mind, the NEAC has suggested a transformation fund to pay for job retraining and reskilling of displaced workers to better fit the requirements of the new growth sectors.

But going by some new research, this is going to be a tough proposition. Although it focuses on youth education, this paper covers optimum investment in education across a person’s lifecycle and comes to some pretty strong conclusions (excerpts; emphasis mine):

Investing in Our Young People – Flavio Cunha and James J. Heckman

This paper reviews the recent literature on the production of skills of young persons. The literature features the multiplicity of skills that explain success in a variety of life outcomes. Noncognitive skills play a fundamental role in successful lives. The dynamics of skill formation reveal the interplay of cognitive and noncognitive skills, and the presence of critical and sensitive periods in the life-cycle. We discuss the optimal timing of investment over the life-cycle...

The Future of Economic Models

One of the key issues that has bedeviled the economics profession in the last three years has been the almost complete failure to predict the financial crisis and its contributing factors. Apart from a prescient few like White, Roubini, Shiller and Roach (among others), regulators, policymakers and pundits were caught off guard by the near collapse of an over leveraged financial sector in the Western nations, and the speed and depth of the downturn.

Part of that failure has been the poor performance of standard econometric models of both New Classical and New Keynesian varieties to adequately explain what’s going on. There’s a great critique of the current state of macro-models at the Macro Advisors Blog – well worth an investment of time, if you have some basic econometric knowledge.

An article in last week’s Economist magazine points a potential way out of this mess (quoted in full):

Tuesday, July 27, 2010

What’s Behind The Drop In FDI?

You may have heard that inward FDI to Malaysia crashed in 2009 – Tony Pua has a nice roundup on his blog. You can read the full report from UNCTAD here.

As far as knowing the cause, I haven’t a clue…yet. There is of course the general drop in FDI across the globe in 2009 due to the global recession, but that doesn’t explain why Malaysia’s inward FDI dropped more than most. There’s also some interesting anomalies with the data that I really would want to know about before commenting on the situation, such as the massive increase (like, 100%+ a year) in both inward and outward FDI stocks from 2007-2009. This isn’t something that is confined to Malaysia – it runs across the global database.

As far as suspecting why inward FDI has been so poor lately, however, I have a few ideas.

Thursday, July 22, 2010

June 2010 CPI: Prices Still Under Trend

June’s Consumer Price Index report shows inflation slowly picking up (log annual and monthly changes;2000=100;click for a bigger pic):

01_inflation Note that I’m incorporating my pain index now as part of the coverage (see details on this index in my post on May CPI).

Opportunity Knocking

From a forthcoming paper, Malaysia is ranked in terms of its opportunities and capabilities for future growth:

Development and accumulation of new capabilities: The Index of Opportunities

This column introduces the Index of Opportunities – a ranking of countries by their capacity to undergo structural transformation and develop. It suggests countries at the bottom are in urgent need of implementing policies that lead to higher diversification and sophistication of exports.

International Reserves And The Balance Of Payments

From the comments:

Wenger J Khairy said...

Dear HishamH,

Appreciate your response. Perhaps would like to comment further on the link between reserves and the BOP. The argument was presented in the book the "Dollar Crisis".

The author presented the case for the link between reserve build up and a growth in the money supply. He cited Thailand and Japan and as the example.

The thrust of the story

(a) From strict correlation point of view, reserve and credit growth was correlated for the case of Japan, Malaysia and Thailand. The lag maybe between 1-2 years.

(b) Build up of reserves act as high powered money entering into the domestic banking system.

(c) One can draw a simple flow chart how lets say surplus US dollars earned by Sime Darby gets deposited as Ringgit in Maybank, and at the same time increases Bank Negara reserves.

In the case of Thailand, their reserve build up was due to surplus on the Capital and Financial account

(d) Build up of reserves act as exogenous source of credit creation in the domestic banking system. If there was a build up of credit due to solely endogenous factors, wouldn't it be highly inflationary?

My wife told me that I’m barely comprehensible to readers who aren’t that knowledgeable about the inner workings of economics or finance, so I’m going to answer Wenger’s query in some detail – though this post will feature a little bit of double-entry accounting.

Wednesday, July 21, 2010

Khazanah Is In The Market

…for an economist. Check out the advert here.

I’m going to take this opportunity to clarify my comments regarding the job openings at Public Bank and Public Investment Bank that I posted on before. What you’re seeing here is the difference in emphasis between the “sell” side and the “buy” side in the financial sector.

Monday, July 19, 2010

The NEM In Numbers: Nominal Versus Real

I’ve been meaning to cover this issue for some time now, but haven’t had the time. It’s very late to be talking about this, but I suppose better late than never.

One of the things that has been bothering me about the New Economic Model is that the public discourse revolves around trying to reach over 6% real growth. That’s largely false, or to be more precise, largely misleading.

Market Completeness and Financial Regulation

Adair Turner on economic ideology:

The Uses and Abuses of Economic Ideology

...Indeed, at least in the arena of financial economics, a vulgar version of equilibrium theory rose to dominance in the years before the financial crisis, portraying market completion as the cure to all problems, and mathematical sophistication decoupled from philosophical understanding as the key to effective risk management. Institutions such as the International Monetary Fund, in its Global Financial Stability Reviews (GFSR), set out a confident story of a self-equilibrating system...

...So risk managers in banks applied the techniques of probability analysis to “value at risk” calculations, without asking whether samples of recent events really carried strong inferences for the probable distribution of future events. And at regulatory agencies like Britain’s Financial Services Authority (which I lead), the belief that financial innovation and increased market liquidity were valuable because they complete markets and improve price discovery was not just accepted; it was part of the institutional DNA.

Schools of Thought and a Crisis of Conscience Part II

[2nd in a series of posts on economic schools of thought]

Following on from my first post in this series, I’m covering today thoughts on this audiobook:

  1. "Struggle Over the Keynesian Heritage: Neoclassical Synthesists vs. the Post Keynesians"

Bear in mind that a 2hr plus audiobook isn’t going to delve very deeply into doctrinaire differences; nor is my understanding of it going to be very complete or meaningful. I’d also point out that the script for this audio was written by Paul Davidson, who is one of the leading figures in Post-Keynesian thought, i.e. you can’t discount bias in the treatment (the Austrian book I listened to was noticeably one-sided). So bear these caveats in mind when reading through the rest of this post.


There’s a language to economics and government finance, just like in any other field. It’s one thing for an outsider to make a mistake in terminology, but it’s quite another when government ministers (or the journalists covering them), make the same mistakes.

Friday, July 16, 2010

Schools of Thought and a Crisis of Conscience Part I

This was a difficult post to write, because I’m really in the process of exploring my basic beliefs of how economics and economic agents interact and operate – you could say this is an examination of my faith. So what will follow is a series of posts on schools of economic thought, from orthodox to heterodox, and I’m going to see where it takes me.

For starters I’ve been listening to a series of audiobooks, partly in an effort to expand my horizons, and partly because as Sun Tzu said:

Hence the saying: If you know the enemy and know yourself, you need not fear the result of a hundred battles.

If you know yourself but not the enemy, for every victory gained you will also suffer a defeat.

If you know neither the enemy nor yourself, you will succumb in every battle.

In this case, I am trying to find answers to the question (about economics): What do I believe? And why is that belief better, or worse, than what others believe? There are a number of distinct schools of thought in economics, with more or less highly divided views on how economies are organised and function, and in what the role should be of various institutions such as government and money.

Have PhD, Will Travel

On today:

Introducing a free database of nearly all jobs for PhD economists

To help grow the next generation of economists, has teamed with to form the world’s largest database of job openings for PhD economists. In addition to this comprehensive database of nearly all job openings for PhDs in economics and related fields, our partner also offers a free online application system allowing the exchange of all application documents and reference letters.

VoxEU are based on Europe, but I doubt they’ll restrict entries to just that region as they also host articles from economists around the globe.

So if you have a PhD in economics or working towards one, feel free to visit (and don’t forget to share your experiences!).

Lovely, Lovely Post On The State Of Macro-modelling

I stumbled on this post this morning, via The Economist magazine’s Free Exchange blog:

The Emperor has no Clothes: MA on the state of "modern" macro

Much has been made of the failure of modern macroeconomics to predict or understand the Great Recession of 2007–2009. In this MACRO FOCUS, our resident time-series econometrician, James Morley, explains what is currently meant by “modern” macroeconomics, what is behind its failure, and what can be done to rehabilitate its reputation.

This should be required reading for undergraduate and graduate economics students interested in applied work. It’s highly wonkish for everybody else (lots of jargon and math), but if you’re interested in the mechanics of macro-modelling, it’s well worth a read.

Thursday, July 15, 2010

It’s Begun…

Subsidies on sugar have been slashed by 25sen, LPG by 10sen, diesel and RON95 petrol by 5sen, and RON97 petrol subsidies will be abolished. Total estimated annual savings will be RM750million – or about approximately 1 week’s average government borrowing.

Read the full news and press statement here (BM version here).

All I can say is…it’s about time. There’s both a fiscal issue here (which is frankly comparatively minor, based on the scale of the savings) and a political credibility issue. Nice to see things finally moving.

Wednesday, July 14, 2010

Why Am I Blogging?

[This is a long post, so feel free to jump to the end. You’ll miss a lot of fun stuff if you do though]

A few weeks ago, Kartik Athreya of the Federal Reserve Bank of Richmond delivered a harsh attack on the economics blogosphere:

Economics is Hard. Don’t Let Bloggers Tell You Otherwise

The following is a letter to open-minded consumers of the economics blogosphere. In the wake of the recent financial crisis, bloggers seem unable to resist commentating routinely about economic events. It may always have been thus, but in recent times, the manifold dimensions of the financial crisis and associated recession have given fillip to something bigger than a cottage industry. Examples include Matt Yglesias, John Stossel, Robert Samuelson, and Robert Reich. In what follows I will argue that it is exceedingly unlikely that these authors have anything interesting to say about economic policy. This sounds mean-spirited, but it’s not meant to be, and I’ll explain why.

Saturday, July 10, 2010

Economist Job II

It’s Public Investment Bank this time, but for the higher position of Head Economist. I’m till wrapping my head around the idea that having an MBA qualifies you as an economist (look up this post and the comments).

But given the job description, maybe an MBA is appropriate – your job is to sell, not to accurately describe the economy and the markets. I’ll leave you to imagine what that means for the public discourse, and what that means for customers on the other side of the table.

Morgan Stanley Is Arguing That We Don’t Need Further Global Policy Stimulus – Because The Market Is Already Delivering It

Now this is a contrarian argument if I ever heard one (excerpt):

Global: How I Stopped Worrying and Learned to Love the Double-Dip Scare - Manoj Pradhan

...policy-type stimulus is already under way - without central banks having to lift a finger or utter a word. How? Markets are doing the job for the monetary policymakers, and very efficiently at that. For one thing, asset price inflation far outstripping growth and accelerating inflation expectations could have tempted central banks to hike, but recession fears and sovereign risks from Europe have led to a moderation in both. Further, the rally in Treasury bond markets (except in the euro area periphery) is exactly the kind of reaction that one would expect if policy rates were cut and /or central banks had ramped up QE programs to buy more government securities. As long as a recession doesn't materialise, this prevailing combination of softer risky asset prices and moderating inflation expectations has set the stage for AAA (ample, abundant and augmenting) liquidity to be provided for longer. Delayed tightening along with the rally in bond markets will support economic growth going forward.

It’s an interesting perspective of what’s going on, and on the same level as the argument advocated by Scott Sumner that low interest rates are indicating tight money, not loose (and vice versa).

Also in the same issue of the Global Economic Forum is an analysis of optimal policy options for ASEAN (excerpts):

ASEAN: The Leverage Lesson, Double Dip and the Rebalancing Game - Deyi Tan, Chetan Ahya & Shweta Singh

...In conventional lingo, the Chinese-style macro rebalancing means reducing savings (read: current account surplus) and increasing consumption. However, in ASEAN, we think rebalancing is more likely to come via investment. Gross domestic savings in 2004-07 had actually fell (with the exception of Malaysia) compared to the pre-Asia crisis period of 1994-97, and total consumption ratios (private plus public) mostly rose even as ASEAN economies adapted to Asia's new exporter status...

...Indeed, rather than poorer consumption, ASEAN's export surpluses had came primarily at the expense of weaker capex. Put another way, ASEAN economies were simply not channeling their savings into investment, but were exporting it abroad...

...Is there room for more consumption? Comparing ASEAN economies with countries of similar income levels indicates that ASEAN's gross domestic savings rates are much higher compared to the average. Prima facie, this would suggest scope for consumption as a rebalancing tool, too. We think it depends. In our view, the scope is bigger for economies such as Singapore, which have already achieved high-income status, rather than for upper middle-income economies such as Malaysia or lower-middle income economies such as Indonesia and Thailand. Typically, savings rates tend to have a positive relationship with the economy's income level. This is why lower-income economies suffer from the dilemma of needing investment to ‘take off', but lacking the savings to finance it. Hence, rather than increasing consumption, we think Malaysia, Indonesia and Thailand are better placed, tapping on their high savings rates to increase investment and raise potential growth trajectory...

...However, smaller economies like Singapore will still be able to maintain an export-oriented strategy. Singapore faces a theoretically infinite export demand market by virtue of its small size and can ‘free-ride' on the positive externalities from macro rebalancing efforts in other economies...

...We think economies like Indonesia and Singapore are slightly ahead in the rebalancing process compared to Thailand and Malaysia. To begin with, Indonesia's economy is relatively more balanced as its current account surplus is smaller than other economies...

...However, in Thailand, fixed capex ratios fell further to 23.8% of GDP in 4Q09-1Q10 from 27.3% in 2004-07, and in Malaysia, it fell to 18.6% from 20.9%. In our view, the political climate will likely have to improve in Thailand to spur further investment. In Malaysia, policymakers will have to execute on their plans. Policymakers will have to shift their focus from physical to non-physical infrastructure such as education. A suitably qualified labour force will have to be built to unleash growth potential and drive government transformation. The subsidy systems, which have impeded progress on the competitiveness front, will have to be rolled back. A structural inflexion point in these areas will help to jump-start private investment momentum, both local and foreign.

In other words, we have to implement the NEM – in full. On a side note, I’ll add that only Indonesia and Malaysia of the countries covered have yet to undergo a demographic transition coming from falling birth rates and a lower dependency ratio – this factor will also boost consumption and growth over the long term, but will require considerable investment in education to fully leverage on.

All That Is Gold Does Not Glitter…

I’ve been a Tolkein fan since childhood, and I get steamed at how often people misquote the line that is the title of this post (“All that glitters is gold…”, yeech). The line comes from the beginning of the poem that describes Aragon/Strider, and essentially says that appearances can be deceiving. I’m using it here in both its metaphorical as well as literal meaning.

Yesterday’s Economist magazine had a long report on Gold (quoting in full):

Gold: Store of value
Low returns on other investments and fears about the world economy have caused the price of gold to soar. Don’t count on its continued rise
Jul 8th 2010 | Delhi and London

ON THE kind of hot, sultry day in which the brutal Delhi summer specialises, the attractions of lingering languidly over gold jewellery in air-conditioned comfort are easily understood. Yet customers are thin on the ground in the jewellery section of the Central Market, an unruly hive of commerce in the middle-class district of Lajpat Nagar. “Business has never been this slow in the 14 years that I’ve run this place,” complains Mrs Anand, owner of Hans Jewellers. Lajpat Nagar’s jewellers estimate that sales are down by 40% or more on a year ago.

In a typical year India soaks up perhaps a quarter of all the gold mined in the world. Now, however, not only are people not buying; more and more of them want to swap their gold jewellery for cash. Jyoti Pal, a shop assistant, reckons that these days about as many people come in to sell as to buy. Suresh Hundia, president of the Bombay Bullion Association, goes further: “There are only sellers in the market at these prices and most jewellers are buying back only old jewellery.”

Middle-class Indians have been turned from buyers to sellers by the rapid increase in the price of gold in the past couple of years. The seemingly insatiable demand of mainly Western investors, drawn to gold as a store of value rather than as an adornment, has driven the price from less than $700 an ounce in 2007 to more than $1,200 since May this year. Last month it reached its highest-ever point in nominal terms, $1,264.90. It has eased a little since, sliding below $1,200 this week. After adjusting for inflation (measured using American consumer prices), in recent weeks the gold price has been at its highest for 30 years—although only just over half its all-time high (see chart 1).

In both the Central Market and the international financial markets, there is no shortage of people who believe that the price will resume its ascent. Ronald Stöferle, an analyst at Austria’s Erste Group, points out that the value of American gold holdings amounts to about 1.85% of the country’s GDP. In 1940 it was above 20% and in 1980 close to 7%. This, he argues, points to continued demand for gold from investors. He expects the gold price to hit $2,300 by 2012.

The appetite for gold arises partly from the paltry, uncertain returns from more conventional investments. Gold’s main drawback is that it pays neither a dividend, like a share, nor a coupon, like a bond, nor a rent, like property. But monetary policy has been keeping official interest rates, and thus the opportunity cost of holding gold, low and seems set to do so for a while. The yields on the government bonds investors regard as safest, notably America’s and Germany’s, are also thin. Equity markets are weighed down by worries about economic growth. Investing in property, which lay at the root of the financial crisis, requires a boldness that many still lack.

At the same time, the looseness of monetary policy has made many investors fear the eventual resurgence of inflation. The wretched state of many governments’ finances makes some worry about states’ ability to repay their debts—or about the temptation to inflate them away. Banks’ exposure to sovereign debt and to a still-fragile world economy adds another layer of concerns. And when all governments would like their currencies to be weaker rather than stronger, whose paper money do you trust? Hussein Allidina, head of commodities research at Morgan Stanley, reckons: “Gold looks better every day with growing sovereign risks.”

Some gold bulls argue that the long-term prospect for gold prices is bright even if these fears subside. Income per person in China and India, the biggest markets for jewellery, is racing along, the reasoning goes, and this should support the market.

But the price surge has had others shaking their heads. As an investment that does not produce income, its attraction lies solely in the hope that its value will rise or at least be maintained. As a metal, its main use is in jewellery. It defies logic, say the bears, that its price should remain so high without any fundamental change in the sources of demand or constraints on supply. Willem Buiter, a former professor at the London School of Economics who is now the chief economist of Citigroup, has called gold the subject of “the longest-lasting bubble in human history”. He says that he would not invest more than a sliver of his wealth “into something without intrinsic value, something whose positive value is based on nothing more than a set of self-confirming beliefs.”

At the root of this debate about the durability of the gold-price rally are different beliefs about the future path of demand and supply. There have been notable shifts on both sides of the market, serving to push up the price of gold. These predate the global financial crisis: between 2003 and 2007, when some investors were already beginning to doubt the sustainability of the boom in property and share markets (as well as the wisdom of monetary policy and the prospects for global growth), the price more than doubled. But since the crisis these doubts have intensified, generating the recent leap in the price.

Start with the demand side (see chart 2, top panel), which has two main parts: demand for gold as jewellery, and demand for gold as an investment. (Some is also used in industry and dentistry.) Jewellery has conventionally accounted for the lion’s share, but it has been declining in both absolute and proportional terms. Between 2000 and 2007 global gold-jewellery demand slid from 3,205 tonnes to 2,417 tonnes; as a share of the total demand for gold, it declined from nearly 80% to just over 60%. The fall was precipitate in the Western world. Demand in India, the biggest jewellery market, was little affected until last year. Demand in China, the next biggest, has continued to rise.

As jewellery demand went down, investment demand went up: for gold in the form of coins or bars, for gold exchange-traded funds (ETFs) and for the services of online companies that allow investors to buy small amounts of pure bullion, stored in underground vaults. Buyers of jewellery might be put off by a rising price; investors are more likely to see it as a sign that the price will increase further still. Annual “identifiable investment”, as the World Gold Council puts it, was 611 tonnes in 2004-07, a little more than twice the average for the four previous years. That just about offset the fall in jewellery demand.

Since then, however, investment demand has accelerated and jewellery demand has collapsed. Last year, indeed, was the first in which investment demand exceeded jewellery demand. Purchases of gold for jewellery dropped to 2,193 tonnes in 2008 and then to 1,758 tonnes in 2009. Meanwhile, the signs of surging investment have been everywhere. This has more than made up for the slump in the jewellery trade: total demand in 2009 was the highest since at least 2000.

Investment in gold ETFs and similar products reached a record high in 2008, of 321 tonnes—and then almost doubled, to 617 tonnes, last year. The stock of gold held by such funds more than doubled to 1,839 tonnes in the two years to the end of 2009. John Paulson, a New York hedge-fund manager best known for making handsome sums betting on the collapse of the American subprime-mortgage market, holds $3 billion-worth of gold ETFs, the largest part of his $35 billion portfolio.

The 229 tonnes of gold sold in the form of official coins last year was the most since 1986, thanks to demand from retail investors in America and Europe. In November demand for one-ounce American Eagle coins was so strong that the American mint ran out of supplies. Rand Refinery, producer of the blank coins which the South African mint turns into Krugerrands, raised its output to 30,000 ounces in the first week of June, the highest rate of production since 1985. In Abu Dhabi those seized by an urge to buy bullion can now head to the lobby of the Emirates Palace hotel, where the Gold-to-Go machine dispenses bars.

Adrian Ash, head of research at BullionVault, one of a number of web-based bullion dealers which allow customers to buy titles to gold bars stored in vaults deep beneath the ground in London, New York and Zurich, reports that business is booming. The sources of Mr Ash’s business are a guide to the sentiment driving many investors into gold, some of them for the first time. In the first half of May the crisis in the euro area was uppermost. Worries that the burden of some countries’ sovereign debt might precipitate a collapse in the euro were stemmed only by the extraordinary measures taken by the European Union, the IMF and the European Central Bank (ECB). At that time, 41% of BullionVault’s new customer deposits came from euro-zone banks, about twice the average since January 2009.

The other big worry is inflation, even though economies in the rich world surely still have more to fear from deflation. Some investors fret that the huge amounts of money created as central banks have rolled out bond-buying programmes or lent to banks will eventually create inflation on a grand scale. At least some of BullionVault’s customers are probably Germans unconvinced by the ECB’s “sterilisation” to offset the monetary effects of its bond purchases.

For investors in gold who think of it as an alternative to paper currencies, its attractiveness is intimately linked to their fears about the capacity of these other currencies to retain their value. Unlike gold, they argue, the value of paper currencies depends on the whims of governments, which can fuel inflation by printing it at runaway rates. Paul van Eeden, a veteran Canadian investor and a student for many years of the gold price and its relation to monetary aggregates, says he suspects that “what’s driving the gold price higher is the sentiment within the market that European and US central banks will eventually be forced to do more quantitative easing.”

Some worry that the crisis has eroded the intellectual consensus that has kept inflation in check in the rich world for the past 20-30 years. For example, a few months ago Olivier Blanchard, the chief economist of the IMF, suggested that central banks might do well to raise their inflation targets from 2% to 4%. The fear is that governments might inflate away their enormous debts: whereas medieval kings adulterated their coins with base metal, today’s rulers may debase their money simply by creating more of it.

On the supply side (chart 2, bottom panel), the main source of new gold—what is dug out of the world’s goldmines—has been flat or declining. Mine production peaked in 2001 at 2,646 tonnes and has been a little less than that ever since. A combination of rising production and exploration costs, dwindling output from long-established mines in North America and South Africa, and political and economic instability in other parts of Africa means that mine supplies cannot be ramped up at will.

Another potential source of supply is sitting in the vaults of central banks. In June national central banks, the ECB and the IMF held more than 30,000 tonnes in all. On average, they sold 520 tonnes a year between 2000 and 2007. Last year the flow of central-bank gold almost dried up, even as the price soared. Only 41 tonnes made it to market. Some bulls argue that central banks will at some point become net buyers. However, this week China’s foreign-exchange agency said gold would not become an important element of the country’s official reserves.

The third main source of supply is scrap: jewellery sold to dealers for the value of the metal. While the price was rising steadily in the first few years of the century, scrap sales did not respond: in 2003, when the price averaged $300, 986 tonnes were sold; in 2007, when the price was $700, the amount was four tonnes smaller. But as the price has climbed steeply since, record quantities have been sold for scrap—1,674 tonnes last year.

The sellers include middle-class Indian housewives, who habitually put their savings into gold jewellery. Last year Indians sold 115 tonnes from their private collections, a third more than in 2008. In Turkey, where 217 tonnes were sold back to jewellers, the deputy head of the Istanbul Gold Exchange says that “a widespread belief that gold is overpriced” is leading some to sell “anything they have”. Some sellers may also be feeling the pinch. Last year scrap sales leapt by nearly a third in America, where companies that allow people to mail jewellery in have helped drive up supply. “Cash For Gold paid me $829 for gold jewellery I never even wear!” screams one firm’s website.

Where the gold price heads in the future depends on the answers to three questions. First, for how long will investors keep piling into gold? Second, if and when they quit the market, will the demand for jewellery revive enough to support the price near recent levels? Third, how will supply respond if the price stays high?

The answer to the first question lies largely in the state of the world economy. Western investors’ new interest in gold has coincided with the rich world’s deepest period of economic turmoil since the 1930s. Harold James, a historian at Princeton University, argues in his latest book, “The Creation and Destruction of Value”, that crises lead to a fundamental uncertainty about what things are worth. In a world of unpredictable currencies, riven by fears of massive inflation and with enormous doubts about the true value of many other financial instruments, gold becomes an attractive option.

Yet at some point either the worst fears of the gold bugs must be realised—in which case, heaven help us—or the world will become a less nervous place. When interest rates eventually rise, the opportunity cost of holding gold will go up, taking off the shine. When the overall economic climate improves so that uncertainty about the prospects of companies is no longer so pervasive, that will provide another reason for some investors to retreat from gold. And even if inflation rates do increase, argues Mr van Eeden, they are unlikely to be high enough to justify the prices at which gold has been trading. These things suggest that the swelling in investment demand in 2009 and the first half of 2010 cannot last indefinitely.

At that point, the second and third questions will become pertinent: will demand for jewellery be strong enough at today’s prices to compensate for the falling away of interest from investors in the West, and how will supply respond? The gold industry would hope for vigorous jewellery demand in its traditional markets, mainly India and China. Indian demand, especially, has long been reliable. In the early 1770s Alexander Dow, a veteran of the East India Company, marvelled at the country’s thirst for precious metals, calling it “the sink where gold and silver disappeared, without the least prospect of return.”

Nevertheless, the experience of the past year suggests that accounts of India’s eternal attachment to gold are somewhat overplayed. Although Indians have continued to buy at high prices, they have done so in ever smaller quantities: purchases last year, at 480 tonnes, were more than 200 tonnes lower than in 2008. Jewellers in Lajpat Nagar see a clear trend towards buying less gold than was earlier considered socially acceptable. “Where three sets were mandatory for a wedding,” one says, “two are now fine. Maybe even one.” Mr Hundia reckons that India’s gold imports will probably fall by 40% in 2010 from 343 tonnes last year. In any case, India and China would have to more than triple their annual purchases just to soak up the world’s newly mined gold.

All this suggests that the traditional markets for gold cannot be expected to pick up the slack if rich-world investors’ appetite should pall. And if prices remain high, more of the world’s existing stock will augment supply. In theory, there is a lot more that could be sold for scrap. Gold’s boosters are fond of pointing both to the roughly 4,000 tonnes traded every year and emphasising that “all the gold that’s ever been mined is still around”—glossing over the contradiction in emphasising both limited flow and abundant stocks. Some reckon the world’s total stock of gold to be about 160,000 tonnes. Only a fall in the price can hope to restore balance to the market, by boosting demand and restricting scrap supplies.

As the world economy returns to business as usual, the gold market may also return to some semblance of normality. Only when the price retreats will the housewives of Delhi go back to being net buyers. Over the years, as they get richer, their demand may increase. Or they may find other kinds of financial instruments increasingly attractive as the Indian financial market deepens. As long as the world economy remains uncertain and investors fear inflation and sovereign default, gold will keep its allure. Eventually, however, the price will weaken: it is even possible that the recent slide to below $1,200 marks the turn. And investors may look back on the bull run of 2009-10—or 2009-11—with the sort of wonder that humanity has too often reserved for the yellow metal itself.

This report covers much the same reservations that I have regarding gold as an investment – and reinforces my conviction that a return to gold as a currency reserve, as some are advocating, is a truly stupid idea. The article’s data shows the supply situation is actually somewhat worse than I thought (see these posts for details).

In the absence of an increase in output and new mining reserves, full gold reserve backing for world currencies would doom the world to a permanent state of currency deflation, with all that implies in falling investment and employment, and eventually depression.

I don’t doubt the gold price bubble still has legs – you might even manage a profit buying at these (to me) insane levels. But when hacks start touting gold, and legitimate buyers are scared away, that tells me that we’re probably entering the terminal phase of the bubble. It might continue for years before coming down – it might crash tomorrow. But I don’t see how prices can remain elevated at these levels permanently for something that has essentially no intrinsic value beyond its limited use in industry and as jewelry.

Friday, July 9, 2010

Research Roundup

Highlighting some interesting research that I’ve come across recently, and worth a read (excerpts/abstracts):

  1. Dealing with Volatile Capital Flows - “How have emerging-market countries dealt with capital flow volatility in the current crisis? What is the appropriate level of reserves for emerging-market countries? How can international crisis-lending and liquidity-provision arrangements be improved? What role can financial regulation and capital controls play in dealing with volatile capital flows? Olivier Jeanne discusses these and other important questions that are useful to keep in mind when thinking about the reform of international liquidity provision for emerging-market countries to deal with volatile capital flows.”

    I’ve talked about the dangers of unregulated capital flows before (here and more extensively here), and this new article just reinforces my view that open capital accounts aren’t necessarily beneficial for economic development.

    Jeanne, Olivier, "Dealing with Volatile Capital Flows", Peterson Institute for International Economics, Policy Brief 10-18, July 2010

  2. Estimates of Fundamental Equilibrium Exchange Rates, May 2010 - "The fundamental question explored is what pattern of exchange rates is consistent with satisfactory medium-term evolution of the world economy, interpreted as achieving those objectives while maintaining internal balance in each country...The big disequilibrium in the pattern of exchange rates remains the undervaluation of the renminbi and the overvaluation of the dollar. The size of this disequilibrium is, however, less than previously estimated (now 15 percent on an effective basis and 24 percent bilaterally with respect to the dollar), due to the decline in the IMF's estimate of China's prospective current account surplus."

    Cline and Williamson update their estimates of the real effective exchange rate against the USD for a range of countries, and find some pretty significant changes from last year. Their methodology suggests that the MYR should be at RM2.52 to the USD, up from 2.63 last year. I covered their previous research, and what I think is wrong with it, here. Read this post for an alternative view.

    Cline, William R., and John Williamson, "Estimates of Fundamental Equilibrium Exchange Rates, May 2010", Peterson Institute for International Economics, Policy Brief 10-15, June 2010

  3. Do Consumer Price Subsidies Really Improve Nutrition? - Many developing countries use food-price subsidies or price controls to improve the nutrition of the poor. However, subsidizing goods on which households spend a high proportion of their budget can create large wealth effects. Consumers may then substitute towards foods with higher non-nutritional attributes (e.g., taste), but lower nutritional content per unit of currency, weakening or perhaps even reversing the intended impact of the subsidy. We analyze data from a randomized program of large price subsidies for poor households in two provinces of China and find no evidence that the subsidies improved nutrition. In fact, it may have had a negative impact for some households.

    Another example of subsidies and market distortions creating perverse incentives, though with a different approach (and implications) than that which I tried to show.

    Jensen, Robert T., and Nolan H. Miller, "Do Consumer Price Subsidies Really Improve Nutrition?", NBER Working Paper No. 16102, June 2010

  4. Calling Recessions in Real Time - "This paper surveys efforts to automate the dating of business cycle turning points. Doing this on a real time, out-of-sample basis is a bigger challenge than many academics might presume due to factors such as data revisions and changes in economic relationships over time. The paper stresses the value of both simulated real-time analysis-- looking at what the inference of a proposed model would have been using data as they were actually released at the time-- and actual real-time analysis, in which a researcher stakes his or her reputation on publicly using the model to generate out-of-sample, real-time predictions. The immediate publication capabilities of the internet make the latter a realistic option for researchers today, and many are taking advantage of it. The paper reviews a number of approaches to dating business cycle turning points and emphasizes the fundamental trade-off between parsimony-- trying to keep the model as simple and robust as possible-- and making full use of available information. Different approaches have different advantages, and the paper concludes that there may be gains from combining the best features of several different approaches."

    Prof Hamilton is one of the two bloggers behind Econbrowser, which is one of my favourite reads. And he isn’t afraid to put his research to the test either – you can find his recession indicator index on the Econbrowser frontpage, complete with emoticon (details here and here).

    James D. Hamilton, "Calling Recessions in Real Time", NBER Working Paper No. 16162, July 2010

  5. Moving Holiday Effects Adjustment for Malaysian Economic Time Series - The dates of holidays such as Eid-ul Fitr, Eid-ul Adha, Chinese New Year and Deepavali vary from one year to the next and non-fixed date can affect time series data. The moving holidays need to be taken into consideration in the seasonal adjustment process to avoid misleading interpretations on the seasonally adjusted and trend estimates. Hence, by removing the moving holiday effect, the important features of economic series, such as the turning points can be easily identified. Seasonally adjusted data also allows meaningful comparisons to be made over a shorter time frame and it also reflects real economic movements. Currently, there are various methods applied for seasonal adjustment such as the X-12 ARIMA. However, these methods can only be used to adjust for the North American Easter effect and there is no such method which can deal with holiday effects in Malaysia such as Eid-ul Fitr, Eid-ul Adha, Chinese New Year and Deepavali. Due to these limitations, this paper proposes a procedure for seasonal adjustment of moving holiday effects in Malaysian economic time series data called SEAM (Seasonal Adjustment for Malaysia). The procedure involves estimating the irregular components using the X-12 ARIMA program and subsequently removing the moving holiday effects using a regression method. Three types of regressors namely, REG1 (using one weight variable), REG2 (using two weight variables) and REG3 (using three weight variables) are proposed in this study to measure the Eid-ul Fitr, Chinese New Year and Deepavali effects. Overall, it is found that SEAM is an effective method in removing the Malaysian moving holiday effects.

    Data in most advanced economies is seasonally adjusted i.e. smoothened to take out seasonal effects from holidays, structural peaks and troughs in consumption and production (and thus demand and supply), and other "regular" shocks to data. But Malaysian data is not seasonally adjusted, which is a failing I've tried to remedy in part through this blog. While doing some research on the subject, I stumbled on this paper, which explains how to account for Malaysian specific holidays that aren't included in standard statistical seasonal adjustment programs – since these holidays aren’t specific to any date in the standard Georgian calendar, you can introduce bias into seasonally adjusted series. The procedure outlined isn't earth-shatteringly new from my reading, but since it is known and available, I'm somewhat nonplussed that DOS still hasn't applied seasonal adjustment to Malaysian data. So what about it, DOS?

    Update: Hah! Seems I spoke too soon. I just checked the revised external trade data for May which has just come out on the DOS website, and Table 17 includes seasonally adjusted data for exports and imports. I await with bated breath for seasonal adjustment to be applied to the rest of Malaysian time series.

    Norhayati Shuja, Mohd Alias Lazim and Yap Bee Wah, "Moving Holiday Effects Adjustment for Malaysian Economic Time Series", Journal of the Department of Statistics Malaysia, Volume 1 2007 (Warning: pdf link)

Economist Job

If you’re in the job market looking for a position as an economist, Public Bank is advertising.

And, no, I’m not affiliated with them.

May 2010 Industrial Production: A Pleasant Surprise

So much for the expectations that GDP growth will slow in the second quarter. Export growth numbers weren’t very encouraging, but it appears domestic production has more than offset slowing external demand (log annual and monthly changes; seasonally adjusted; 2000=100):


Both mining and electricity production were flat in May relative to April, but manufacturing output has ticked up (for now). But growth is certainly not coming from the export-oriented subsectors like electronics (log annual and monthly changes; seasonally adjusted; 2000=100):

03_eeI’m still working on the detailed numbers but it certainly seems as if we’re seeing a structural shift towards domestic-oriented manufacturing – and not before time, considering the external outlook.

I’ve also checked the relationship between IPI and exports (single-equation, VAR etc) and while it’s possible to forecast exports and IPI through lags of each variable, it’s an iffy proposition – lots of statistical problems like serial correlation and heteroscedasticity. A cointegration test reveals no long term relationship between the two variables, and Granger causality tests turned up negative. In short, exports are not a good guide for values of IPI nor vice versa, and any regression based on these two variables will be spurious.

So, what does the IPI imply for 2Q 2010 GDP? No cointegration problem here, so there is a long term relationship, although causality tests are negative. So it’s possible to forecast GDP using IPI values, as long as you recognise that we’re not talking about an increase in IPI “causing” GDP to rise, and you don’t mind using a forecasting regression rather than a full-featured, theoretically-correct structural model. Also bear in mind that we’re only looking here at two month’s worth of IPI numbers (April-May) for the second quarter, so June IPI numbers may materially change the forecast.

With those caveats in mind, I got a point forecast of RM139.5 billion and a range forecast at the 95% level of RM142.2-136.8 billion, which imply a y-o-y annual growth rate of 9.6% (range: 11.8%-7.5%), and a q-o-q seasonally adjusted annualised growth rate of 8.9%. The former implies a slight slowdown over 1Q 2010, while the latter suggests economic growth accelerated instead:

04_forecastOne further implication is that all this talk of further fiscal stimulus may be premature. If the domestic economy is still picking up, despite expectations of an external slowdown in the second half off this year, then there’s not much call for additional public support for the economy.

Technical Notes:

May 2010 Industrial Production Report from DOS

Thursday, July 8, 2010

Oops!…They Did It Again

As expected, but not necessarily as desired (at least in my mind), BNM have raised the OPR another 25bp. Read the statement here.

But BNM are also signalling that this will be it for a while (emphasis mine):

The MPC considers the new level of the OPR to be appropriate and consistent with the current assessment of the growth and inflation prospects. The stance of monetary policy continues to remain accommodative and supportive of economic growth.

Unless something drastically changes to the economic outlook, I’d expect the OPR to stay at this level until the end of the year.

Deficits or Austerity?

If you're not quite clear on the theoretical basis for deficit spending in recessions, this is a must read (excerpt):

Fiscal austerity – the newest fallacy of composition

Prior to the 1930s, there was no separate study called macroeconomics. The mainstream theory – which dominates still today – considered macroeconomics to be an aggregation of the individual. So the representative firm and household were just made bigger but the underlying behavioural principles that were brought to bear on the analysis were those that applied at the individual level.

So the economy is seen as being just like a household or single firm. Accordingly, changes in behaviour or circumstances that might benefit the individual or the firm are automatically claimed to be of benefit to the economy as a whole.

The general reasoning failure that occurs when one tries to apply logic that might operate at a micro level to the macro level is called the fallacy of composition. In fact, it is what led to the establishment of macroeconomics as a separate discipline. As indicated, prior to the Great Depression, macroeconomics was thought of as an aggregation of microeconomics. The neo-classical economists (who are the precursors to the modern neo-liberals) didn’t understand the fallacy of composition trap and advocated spending cuts and wage cuts at the height of the Depression.

The question here is whether the same conditions apply here in Malaysia – the examples used in the post best fit a "closed" economy with no external sector. In our case, we're facing a shortfall in external demand, not domestic demand, where consumers in developed countries are trying to save more. But in that case, what we should be arguing about is not whether the government should intervene to maintain aggregate demand, but what form that intervention should take (note: one more reason why BNM should not raise the OPR today).

I’m in two minds about the rather vague reports in the papers of “major projects”, as the problem with that is the empirical support for high multiplier effects of spending on construction is in developed economies with relatively small external sectors. Given the high import content of our construction materials, I’m not sure that import leakage might not completely offset the long term gains from infrastructure investment.

There hasn’t been much research done on fiscal multipliers in developing countries, so while the general theoretical basis is there, the empirical evidence in support is not. We are in some ways flying blind here – hopefully there isn't a mountain in the way.

Wednesday, July 7, 2010

A New (Old) Way To Launder Money

This isn’t exactly on economics or even on Malaysia, but I couldn’t resist posting this:

Zimbabweans wash dirty US dollars with soap, water

By ANGUS SHAW, Associated Press Writer Angus Shaw, Associated Press Writer – Tue Jul 6, 10:19 am ET

HARARE, Zimbabwe – The washing machine cycle takes about 45 minutes — and George Washington comes out much cleaner in the Zimbabwe-style laundering of dirty money.

Low-denomination U.S bank notes change hands until they fall apart here in Africa, and the bills are routinely carried in underwear and shoes through crime-ridden slums.

Some have become almost too smelly to handle, so Zimbabweans have taken to putting their $1 bills through the spin cycle and hanging them up to dry with clothes pins alongside sheets and items of clothing.

It's the best solution — apart from rubber gloves or disinfectant wipes — in a continent where the U.S. dollar has long been the currency of choice and where the lifespan of a dollar far exceeds what the U.S. Federal Reserve intends.

Zimbabwe's coalition government officially declared the U.S. dollar legal tender last year to eradicate world record inflation of billions of percent in the local Zimbabwe dollar as the economy collapsed.

The U.S. Federal Reserve destroys about 7,000 tons of worn-out money every year. It says the average $1 bill circulates in the United States for about 20 months — nowhere near its African life span of many years.

Larger denominations coming in through banks and formal import and export trade are less soiled.

But among Africa's poor, the $1, $2, $5 and $10 bills are the most sought after. Dirty $1 bills can remain in circulation at rural markets, bus parks and beer halls almost indefinitely, or at least until they finally disintegrate.

Still, banks and most businesses in Zimbabwe do not accept torn, Scotch-taped, scorched, defaced, exceptionally dirty or otherwise damaged U.S. notes.

Zimbabweans say the U.S. notes do best with gentle hand-washing in warm water. But at a laundry and dry cleaner in eastern Harare, a machine cycle does little harm either to the cotton-weave type of paper. Locals say chemical "dry cleaning" is not recommended — it fades the color of the famed greenback.

Laundry worker Alex Mupondi said customers asked him to try machine-washing a selection of bills and the result impressed him.

But storekeeper Jackie Dube hasn't yet taken up advice of friends to cleanse the often damp and stinking U.S. dollars she receives for the garments and cheap Chinese consumer goods she sells in Harare. It's time-consuming, she says, adding that stinky, unhygienic bills are a problem.

"I get rid of the worst of the notes as soon as I can in change," she said.

APTOPIX Zimbabwe Money LaunderingAlex Mupondi, hangs one dollar notes on a drying line after washing them in Harare, Zimbabwe, Tuesday, July 6, 2010. The washing machine cycle takes about 45 minutes — and George Washington comes out much cleaner than before in Zimbabwe-style laundering of dirty money. Zimbabweans trading in the American currency since their own hyperinflationary notes were abandoned last year say washing their dirtiest cash works. (AP Photo/Tsvangirayi Mukwazhi)

Census 2010 Begins Today!

…and will go on for the next six weeks:

Population census on for next six weeks

KUALA LUMPUR: The fifth national population census has begun with enumerators making a special effort last night to seek out homeless people in several cities.

During the six-week period (July 6 to Aug 22), 29,000 enumerators will visit an estimated 7.5 million homes to collect data that is vital for the planning and implementation of government policies.

Other developments:

> CHIEF Statistician Datuk Wan Ramlah Wan Abdul Raof said under normal circumstances only one enumerator would visit a residence at a time. If there is more than one officer approaching the household, residents can call the department hotline at 1-800-88-7828 for verification; and

> RESPONDENTS can also opt to provide their particulars using the e-Census form by visiting Chief Secretary to the Govern­ment Tan Sri Sidek Hassan, who took only 10 minutes to fill the e-Census form, calls on the public to utilise the Govern­ment’s e-services.

Remember: safety first – there should not be more than one enumerator visiting, so keep your local police station number handy.

Also if you’re working and don’t have the time to fill out the survey form, you can also participate online here.

Tuesday, July 6, 2010

Recent Imposition Of Capital Controls In East Asia

An interesting piece of research has turned up on VoxEU (excerpt):

Emerging markets consider capital controls to regulate speculative capital flows
Kavaljit Singh

Despite recovering faster than developed countries, many emerging markets are struggling to cope with large capital inflows. This column discusses the recent capital controls imposed by Indonesia and South Korea. It argues that while the international community is warming to these policies, it would be wrong to view capital controls as a panacea...

...Just days before the G20 summit in Toronto, South Korea and Indonesia announced several policy measures to regulate potentially destabilising capital flows which could pose a threat to their economies and financial systems...

...Despite recovering faster than developed countries, many emerging markets are finding it difficult to cope with large capital inflows. There is a growing concern that the loose monetary and fiscal policies currently adopted by many developed countries are promoting a large dollar “carry trade” to buy assets in emerging markets.

Apart from currency appreciation pressures, the fears of inflation and asset bubbles are very strong in many emerging markets. Since mid-2009, stock markets in emerging economies have witnessed a spectacular rally due to strong capital inflows. In particular, Brazil, Russia, India and China are the major recipient of capital inflows.

The signs of asset price bubbles are more pronounced in Asia as the region’s economic growth will continue to outperform the rest of the world. As a result, the authorities are adopting a cautious approach towards hot money flows and considering a variety of policy measures (from taxing specific sectors to capital controls) to regulate such flows. In May 2010, for instance, Hong Kong and China imposed new measures in an attempt to curb soaring real estate prices and prevent a property bubble.

In emerging markets, strong capital inflows are likely to persist due to favourable growth prospects but the real challenge is to how to control and channel such inflows into productive economy.

Contrary to the popular perception, capital controls have been extensively used by both the developed and developing countries in the past. There is a paradox between the use of capital controls in theory and in practice (Nembhard 1996). Although mainstream theory suggests that controls are distortionary and ineffective, several successful economies have used them in the past (Nembhard 1996). China and India, two major Asian economies and “success stories” of economic globalisation, still use capital controls today...

...Yet it would be incorrect to view capital controls as a panacea to all the ills plaguing the present-day global financial system. It needs to be underscored that capital controls must be an integral part of regulatory and supervisory measures to maintain financial and macroeconomic stability (Singh 2000). Any wisdom that considers capital controls as short-term and isolated measures is unlikely to succeed in the long run.

The theoretical (or should I say theological) basis for an open capital account, where capital of any sort is allowed to enter and leave freely, is that capital will flow to where it can be used most productively (i.e. where capital is relatively scarce, and would then attract higher returns). An open capital account should therefore result in lower cost of capital for the recipient, which will result in an increase in investment in productive capital which then raises incomes and social welfare. That’s the free-market, neo-classical story anyway.

The problem here is that there is an underlying assumption that the country involved is big enough that capital inflows/outflows won’t have a significant impact on monetary conditions – that’s simply not true of many developing economies in the context of a relatively more massive global financial system. (I’m leaving out here the empirical “puzzle” that capital doesn’t in fact flow to capital-scarce nations – quite the opposite actually occurs. Otherwise, Africa would be the number one destination of foreign capital and investment).

There are a number of ways a country can manage outsized capital inflows and outflows – reserve accumulation as an insurance policy, as is common in East Asia and the oil-rich Middle East; sterilisation through issuance of central bank liabilities, which can get expensive; and of course capital controls.

The general practice has been that if the domestic financial sector and capital markets don’t have the capacity, breadth or depth to absorb large-scale short-term capital, then capital controls are the instrument of choice, never mind investor opprobrium. Malaysia has had more than a few brushes with capital controls, of which 1998 was just the latest.

At the moment, capital flows aren’t an overriding concern here (we’re not as “exciting” an investment story as Indonesia, China or India), but that may change if interest rates and yields in developing countries remain ultra-low for an extended period.

Technical Notes:

Singh, Kavaljit, “Emerging markets consider capital controls to regulate speculative capital flows”,, July 5 2010

2009 International Investment Position

The Department of Statistics last week issued Malaysia’s IIP report for 2009, which shows the level of Malaysian ownership of foreign assets matched against foreign ownership of Malaysian-domiciled assets. If you want a simpler business-type analogy, the balance of payments is our external cash flow report while the IIP is our external balance sheet report.

I’ve noted before that Malaysia has become a net creditor nation in 2008 – we own more foreign assets than foreigners own our assets – and for the first time since independence. The 2009 data more than confirms this trend (RM millions):

01_iipWe’re now RM120 billion to the good, compared with around negative RM140 billion in the early part of this decade, and worlds away from the more than RM700 billion in the red in 1986 (source: see note 2).

Now whether this is good or bad depends on your point of view. The rapid increase in foreign asset accumulation in the last 5-6 years has largely been driven by direct investment (and reinvestment of earnings) abroad by Malaysian companies (RM millions):


…compared with relative stability in foreign accumulation of Malaysian assets (RM millions):

03_liab…apart from portfolio capital which remains highly volatile (RM millions):


The problem here is that Malaysian companies are investing abroad corporate savings that might have been invested domestically – one reason why private investment growth has been so poor since the 1997-98 crisis, and why we have not been able to match the growth rates in GDP that we saw pre-1997. The outflow of funds (we’re talking about half a trillion Ringgit over the last ten years) has also played a role in dampening appreciation of the Ringgit.

The flip side of this is of course, that our income account in the balance of payments is going to improve over time as investments (hopefully) bear fruit – a source of foreign exchange which will be non-trade related, and thus reduce our external vulnerability.

One further side effect of this is that it reduces the incentive for massive accumulation of foreign exchange as an insurance policy against capital outflows, which can be expensive. Luckily, BNM has more or less ceased forex intervention (with some notable exceptions) since the float of the Ringgit in 2005, but there are still structural factors which will inhibit reducing our reserves over the short run – liquidity of foreign portfolio assets for starters, as well as the relatively higher proportion of foreign ownership of Malaysian equities and debt.

But this development does mean that one of the underpinnings of the Ringgit’s valuation is long term positive.

Technical Notes:

  1. 2009 International Investment Position from the Department of Statistics
  2. Lane, Philip R. & Milesi-Ferretti, Gian Maria, “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004”, International Monetary Fund Working Paper 06/69, March 2006

Countdown to MPC Meeting

The consensus is leaning towards another 25bp OPR hike (excerpt):

Economists expect rate hike next week

PETALING JAYA: Although Malaysia’s year-on-year (yoy) export growth of 21.9% to RM52.3bil in May fell below market expectations, economists are still positive on an interest rate increase next week…

…Bank Negara raised its key rate by 25 basis points to 2.5% in May – a normalisation process after rate cuts during the global downturn.

AmResearch senior economist Manokaran Mottain told StarBizWeek that although the numbers showed slower-than-expected-growth, it was still at respectable rate…

…Thus, Manokaran said the interest rate hike next week would likely to go on.

“But after July 8, I think there will be a pause pending on the development then,” he said.

Standard Chartered Bank economist Alvin Liew was quoted by Reuters as saying despite the slower exports growth in April and May trade data, these two months of data still pointed to a decent second-quarter economic performance…

…“As our expectations for a healthy recovery in first half of this year remains intact, we reiterate our view that the central bank is likely to continue normalising interest rates further to suit current economic conditions.

“We expect Bank Negara to hike rates by another 25 basis points at its July 8 policy meeting and thereafter keep the overnight policy rate on hold at 2.75% for the rest of the year, which is the normal rate for the OPR in 2010, in our view,” he said.

Like any good economist, I’m in two minds (or two hands) on whether continued “normalisation” of interest rates is called for. With growth likely to slow and external demand likely to fall off, we’re still faced with a substantial output gap, i.e. there’s still unutilised capacity in the economy, which means there won’t be much pressure on consumer prices in the near term. The relative strength of the MYR also means less inflationary pressure from imported inflation.

So what’s the case for continuing to raise interest rates? BNM’s concerns will be centred, to their credit, on asset markets, which has not been a particular focus of central banks until this past financial crisis. But before getting into that, what other indicators would matter?

First, inflation is pretty tame, so raising interest rates effectively mean also a rise in real interest rates:


…which is what BNM is aiming for. By raising the cost of borrowing, BNM is hoping to limit a build up of leverage and consumption that would raise consumer and asset-price inflation. Consumption indicators are up this year, such as loans (log monthly changes):


…but not to any great extent. Housing loans are a fairly big chunk of the increase (defying the increases in interest rates: more on this later), but other loans for asset purchases aren’t too troubling (log monthly changes):03_loans_assets

…and working capital loans are growing at least as fast.

Turning to the asset markets, the FBM-KLCI has almost fully recovered to its 2007-2008 peaks, and you could argue that at these levels, the stock market is overvalued:

05_klci …which is supported by the market’s historical PE-ratio:

06_pe Price has outrun earnings, and the market needs a period of consolidation (i.e. companies need to start registering profits, not prospective profits). But I’d note that the stock market was well into its current sideways trading phase before BNM started raising rates, so this isn’t an obvious immediate concern.

More solidly, house prices have started to pick up at the end of 2009 (log annual changes; 2000:100):


…but 3% per annum doesn’t exactly qualify us as an overheating property market. The only thing that stands out is prices of high-rises, which rose 8% in 4Q 2009, and apparently primarily in Penang. So what we’re looking at here is a potential limited market bubble confined to a small (but volatile) segment of property. Tightening monetary policy to keep a lid on this strikes me as using a hammer to swat a fly. The other aspect of this is that based on the limited data available to me, interest rates have a very limited impact on property sales – population and income growth matter much, much more.

In short, there doesn’t seem to be much of anything going on right now to justify a rapid increase in interest rates. What BNM is really doing is trying to peer through a half-obscured crystal ball and trying to head off potential asset price bubbles, but with the trade-off of slowing growth in the interest rate-sensitive parts of the economy despite an economic recovery that still isn’t fully settled.

I’ll leave this post with one further nugget – money velocity (read this post for fuller details) still hasn’t recovered to pre-crisis levels:


In fact, the rate of change in the velocity of monetary aggregates is still negative (log annual changes):


Juxtaposing this with money supply and economic growth suggests that far from being expansionary, monetary policy is in reality still too tight:

10_m3M3 adjusted for inflation and velocity is signalling a real interest rate level of nearly 10%, far above the approximately 1% difference between the OPR and CPI/Core inflation measures. So I don’t think an interest rate hike is fully justified right now.

On the other hand (you knew that was coming, right?) here’s an alternative viewpoint, from a highly respected economist who was one of the very few to foresee the financial crisis in the US:

Monetary Policy or Fiscal Policy

...Perhaps more worrisome is the view that the main problem is aggregate demand is too low. In response to ultra-low interest rates, the thinking goes, households will cut back on savings while firms will invest more, demand will revive, and the workers who have been laid off will be rehired.

But this recession is not a “usual” recession. It followed a period of ultra-low interest rates when interest sensitive segments of the economy got a tremendous boost. The United States had far too much productive capacity devoted to durable goods and houses, because consumers could obtain financing for them easily. With households recovering slowly from the overhang of debt resulting from the binge, and with lenders extremely risk averse, it is unrealistic to expect households to spend beyond their means again, and unwise to try to tempt them to do so...

...Put differently, the productive capacity of the economy has shrunk. Resources have to be reallocated into new sectors so that any recovery is robust, and not simply a resumption of the old unsustainable binge. The United States economy has to find new pathways for growth. And this will not necessarily be facilitated by ultra-low interest rates.

What many people forget is that interest rates are also a price, and shape not only the level of economic activity but also the allocation of resources and the relative wealth of buyers and sellers of financial savings. A sustained period of ultra-low interest rates will favor the segments of the economy that took us into the crisis – housing, durable goods like cars, and finance. And it will encourage households to borrow and spend rather than save. With policies focused on reviving the patterns of behavior that proved so costly the last time around, it is ironic that President Obama wants the rest of the world to change and spend more to displace the United States as spender of first resort, even while the United States is unwilling to make any changes itself.

Put differently, aggregate demand is indeed insufficient to restore the economy to old patterns of production. But that production was absorbed only through an unsustainable debt-fueled, asset-price-boom-supported consumer binge. And even if we think U.S. consumers have become excessively cautious (it is hard to see a savings rate of 5 percent as excessive caution, except in relation to the extravagant past), moving them back down the same path seems unwise.

More important, the United States also has a problem of distorted supply. Prices in the economy should reflect the past misallocation of resources and move resources away from areas like housing and finance. A lot of people have to be retrained for the jobs that will be created in the future, not left lamenting for the jobs they had in the past. A Fed that keeps real interest rates at a sustained negative level will stand in the way of the needed reallocation.

None of this is to say that the Fed should jack up interest rates quickly without adequate warning, or to extremely high levels. There are trade-offs here, between short-term growth and long-term misallocation of resources, between reducing risk aversion and inducing excessive risk taking, between reviving hard-hit sectors and encouraging repeated bad behavior. On balance though, if and when the jitters about Europe recede, it would be prudent for the Federal Reserve to start paving the way towards positive real interest rates.

Interesting, no?

Saturday, July 3, 2010

May 2010 External Trade

In my last trade post, I said that I thought that trade would continue to contract based on my forecasting models, but inventory adjustments would cause exports to marginally increase – why, oh why, don’t I believe my own models (log annual and monthly changes; seasonally adjusted):

01_trade Exports contracted by 5.9% while imports improved 1.4% (m-o-m, seasonally adjusted, log terms), although the annual growth rates still look good for both. The main culprit was a continued contraction in electronics exports (log monthly changes; seasonally adjusted):

02_compBased on the tentative improvement in imports, I’d expect a slight rebound next month, though with China’s growth visibly slowing, there’s not much prospect for further trade growth over the next few months.

Based on the uptick in imports, there should be a rebound in June exports (fingers crossed):

Seasonally adjusted model


Point forecast:RM54,158m, Range forecast:RM60,930m-47,386

Seasonal difference model


Point forecast:RM53,434m, Range forecast:RM60,966m-45,902m

A word of caution however – the fact that monthly exports are now 10.8% off their recent peak (in seasonally adjusted terms), is more than a little worrying and evidence that faltering external demand is starting to dampen our recovery. Again, we’re looking at more signs that 2Q GDP growth will be well below the first quarter’s.

Technical Notes:

May 2010 External Trade Report from MATRADE.

2Q 2010 National Debt Update

Having just watched Brazil crash out of the World Cup, I’m in need of some cheering up (all kudos to the Dutch for persevering though). Not that there’s much to cheer about in terms of government finances. 2Q numbers aren’t in yet, and won’t be for another couple of months, but the numbers don’t look terribly encouraging (RM billions):

01_govtYear-on-year seasonally adjusted revenue fell 22.1% in log terms, which was only partially offset by an 8.8% drop in expenditure. The deficit hit RM10.2 billion in 1Q 2010 – of course that ends up as being a positive for GDP, though that’s not a big fillip for a RM700 billion economy.

On the other hand, the Treasury hasn’t been all that aggressive in borrowing over the last three months, largely going to market only to rollover maturing debt. As a result, outstanding Government debt has barely budged from 1Q 2010, at approximately RM378.4 billion.

Instead, most of the action has been in the money market with BNM issuing a startling net RM37 billion in bills in April and May (typically for 3-6 month maturities) to keep the interbank money on track with the OPR. But since BNM’s open market transactions are financed (or paid off) by the issuing of currency, it doesn’t count towards the government’s debt level.

In any case, with the population increasing by approximately 150,000 every quarter, and as nominal GDP has increased in 1Q 2010, the national debt ratios have levelled off:

03_debt_gdp04_debt_cap (Note: my Debt/GDP ratio is calculated on the basis of a rolling 4 quarter summation of nominal GDP, so it might not correspond exactly with the official figure).

Estimated debt to GDP now stands at approximately 53.6% as of last month, which puts Malaysia below the 60% alarm-bells-are-ringing level, while debt per capita retreated slightly to RM13,227 from RM13,292 in 1Q. I’m actually expecting government revenue to show slightly positive growth this year, as against the government’s projection of an 8.1% drop – which means that they’ll probably hit below the 2010 target of 5.6% of GDP easily (the increase in revenue will be offset by an off budget increase in expenditure, but I’m also expecting 2010 GDP to surprise on the upside).

So from my perspective, we’ll probably see some improvement on the debt front this year, but with growth prospects increasingly uncertain, I’m not putting any bets on 2011-2012.