Monday, January 19, 2015

Living In The Past

As we say in BM, “mamat ni ketinggalan zaman” (excerpt):

‘Time to slash projects involving usage of foreign reserves’

Malaysia is expected to experience two to three years of slower growth rate due to the current stifling economic conditions, says independent analyst Prof Dr Hoo Ke Ping.

Pointing out that Malaysia’s current foreign reserves had depleted significantly since the 2015 Budget was tabled, the government and its people must be prepared for the worst case scenario.

Just before the tabling of the 2015 Budget in October, Hoo said, the country’s reserves were estimated to be around US$130 billion (RM462 billion), but in four months’ time it had gone down to around US$100 billion (RM355.4 billion) due to the shortage of US dollars leading to “illiquidity crisis”.

This, he said, was due to the fact that Malaysia as an oil-commodity based nation was struggling to control the outflow of US dollars following the plunge in global crude oil prices.

Hoo said that as other analysts had predicted that crude oil prices could fall even further to a low of US$40 (RM142) per barrel in the next six months, national petroleum giant Petronas, which remains a key contributor to the government’s revenue, would contribute less to sustain economic growth.

“Malaysia’s foreign reserve earnings are through four main sources. The first is oil which is the main source, has suffered a huge loss. The second is palm oil, whose price has dropped to roughly RM2,600 per tonne, making earnings look stagnant and third is tourism....

This “analysis” might have been somewhat true under the Bretton Woods regime of fixed exchange rates, though it would be thoroughly mangling the transmission mechanism between trade in goods and services and foreign exchange reserves.

Only problem is, the Bretton Woods system broke down in 1972, and fixed exchange rate regimes have seen a steady decline since. For Malaysia, the USD peg that prevailed between 1998-2005 would also have made this somewhat true, but since we’ve been under a floating rate regime ever since, it is almost wholly wrong.

Under a floating rate regime, increasing foreign exchange reserves is an entirely discretionary decision of the central bank, irrespective of the volume of trade, or whether trade is in surplus or deficit. You can do it any time you please (or not), with the proviso that any such action will have consequences for the market exchange rate and domestic monetary conditions. Why? Because the flip side of increasing reserves is increasing the money supply i.e. printing money.

In fact, under a fully floating exchange rate regime, you don’t even need foreign exchange reserves. It’s simply not necessary. The market exchange rate just adjusts to clear demand and supply. FX reserves are only desirable, as in Malaysia’s case, when you want to have foreign exchange on standby if market conditions get wild, as they did over the past month. The link between FX reserves and economic growth is even more tenuous.

I’ve complained about this before – almost since this blog came into existence – but some of our “analysts” really need to keep up with the times.


  1. hi, can i ask if the plunge in the value of the RM vis-a-vis the USD is of any real concern? or isit a temporary blip in the long-term scheme of things?

    1. @anon 10.33

      I'd call it a wart. It'll last longer than a blip, but should still be temporary,

  2. "Maverickly interesting" and "esoterically delicious" springs to mind. But this is a world in chaos and in new age chaos theory, anything goes....hahahaha.

    Folks, the world economy is actually in deep shit. Whatever imagined growth since 2008 was just that .."imagined" achieved via an adroit shuffling of financial assets plays aided by cheap money that largely benefited the elites at the expense of the hapless proles. You wanna see what real growth is like..analyze nothing more than the Baltic Index, a reliable weather wane of productive economic activity, enough said.

    But I like this dude...he has got his mojo about him....a hell for leather approach to crisis and a bon vivre reflex to economic doomsday...But unfortunately he is riding a Honda Shadow to a true blue Harley while his fecund imagination says otherwise....hahahaha. Apa pun jadilah. Reason for his unrelenting optimism is that:

    "The free float exchange rate regime itself does not imply any specific restriction on monetary and fiscal policy."

    You fill in the rest up there.....but ah reckon...sometimes even the best of intentions can get chomped by the worst of circumstances:

    "UK experience indicates that a floating exchange rate probably does not automatically cure a balance of payments deficit. Much depends on the price elasticity of demand for imports and exports. The Marshall-Lerner condition says that a depreciation in the exchange rate will help improve the balance of payments if the sum of the price elasticities for imports and exports is greater than one."

    Any which way but loose, I like your guts dude. That's panache for the big orchestra while the Titanic.......hahahaha. A sure class act you are, man.Ok! time to jump on my Harley.

    The Ineluctable Phantom

    1. @Phantom

      1. I prefer to think to growth between 2004-2007 as a more likely candidate for imaginery:

      2. No, floating exchange rates on their own do not cure trade deficits or trade surpluses. Given global production chains, some surpluses/deficits are structural. But I don't see what that has to do with international reserves.

  3. For the oldies and geriatrics wondering what chappie here is up to, get a primer on what the laddie means via this primer, courtesy of none other than Alan Greenspan:

    I am sure Hayek would be smiling at yer gumption too, right dude...wink wink....

    The Ineluctable Phantom

    1. @Phantom

      To add to your excellent link:

    2. Oh BTW, I'm not really arguing for or against floating rate regimes in this blog post (though I would tend to favour monetary policy independence).

      Rather, what I'm ranting about is the pervasiveness of incorrect analysis based on the FX regime we actually have, as opposed to the one we used to have.

      Different regime, different rules of the game. If you're trying to manage a football team, but you think rugby rules apply...

  4. @Phantom

    Methinks whatever grains of salt he may have in his arguments, the blogger is actually floating an idea that may come to fruition and acceptance as early as tomorrow. And that dovetails with his earlierpost about them fiscal deficits.

    I think there is an economic policy tussle going on between the CB and the gov's economic policy wonks and in all likelihood the latter has triumphed vis-a-vis the necessity of protecting forex reserves.

    He has a point within a free float regime but how the financial marts interprets that is a different ball game altogether...

    So dont be surprised that amongst tomorrow's measures, effing the forex reserves may be one....

    Whatever the merits of their "maverick/novel/imaginative/innovative" (watch for these adjectives and the like in all formal dispatches), the economic pain has just started and is about to get worse...

    The Indomitable Skulls and Bones

    1. @Skull and Bones

      I can certainly attest to a degree of policy disagreement between BNM and MOF. Especially with that strange circular...

  5. Just passing through when @phantom and @skull and bones caught my eye as did your normal cogent responses. While your collective gunghoism, albeit @skull a bit more cautious, is a source of mirth, one wonders whether:

    a. Your subscription to Greenspan’s persuasive take implies something more sinister i.e., an outright embrace of the market is always right maxim. One cannot but make that assumption given Greenspan’s prattle about his beloved market mechanism:

    “All requirements for foreign exchange in this idealized system could be met in real time in the marketplace at whatever exchange rate prevails. No foreign exchange reserves would be needed. If markets are functioning effectively, exchange rates are merely another price to which both public and private decision makers need respond…………………….”

    Can almost hear Hayek’s ghost shrieking in delight there as so redolent was it with Austrian ethos and echoes…hahahaha!. Gee! the Austrian school and particularly Hayek must be smiling at your capitulation to reality ……hahahaha. So dude, being simply pragmatic in this case or is this a sea-change in your views/philosophy whatever?

    b. Your seemingly hell for leather gunghoism is justified or offputting. I don’t know about BNM vs policy wonks speculated by @Skull but your aside about the “strange circular” is mystifying…care to share the “dirt” or would rather leave it to our imaginations? Whatever, the IMF links you provided contained some excellent observations that gelled well with Greenspan's take.

    And in keeping with the stream of your consciousness mode, Dr Zeti must be a “minah ini ketinggalan zaman” variety since she is probably wedded to this, crafted some 30 years or so ago:

    though Broughton premised all that ‘effective sterilized intervention’ on a “regressive expectation” assumption. Eisenmenger’s comments in the discussion portion are pretty telling in that regard.

    Personally, I feel that the gov’ has got its work cut out in dealing with the unfolding mess but I suspect central to their considerations now is the retention of their deficit reduction targets as any further downgrade would be highly undesirable for lots of obvious reasons. And given that, removing GST from the table would be a disaster despite its one-off kick up inflation’s arse. But the immediate and medium term environs are not too rosy especially with China and Euro in a funk and the Japanese in pretty bad shape and oil plummets. Only the US seems to have shaken off the malaise thanks largely to dropping fuel prices but with the slow demise of the American middle class, I doubt consumption would return to its former glories anytime soon. So here’s to more doom and gloom from a world weary me….hahaha

    @Phantom : bon de vivres aside, you are right about actual economic growth globally particularly in trade:

    and actual growth:

    and yes, whatever growth there was has largely benefited the elites. Don’t expect sympathy or empathy though from errr..someone…wink wink …hahahaha

    Warrior 231

    1. @Warrior

      I almost choked with laughter with your reference to Greenspan and Hayek.

      Free market idealogues, and Austrians in particular, support fixed exchange rates, not floating ones, and especially not "dirty" floats.

      So sorry, I haven't gone to the dark side.

      As for the circular, I was referring to this one.

  6. So, Oxfam is correct?

  7. Thanks @Warrior 231, that has been an open shut case for sometime.

    But I doubt Dr Zeti will take kindly to your good natured (or was it ironic) minah" jibe :

    Yes @anon 7.06, Oxfam was more less spot on regarding inequality and growth:

    The Ineluctable Phantom

    1. @Phantom, Nope, I didn’t mean it either way. For the lady to come out with the rather indignant sounding statement as per your link above is a clue to her philosophy. But my hunch is that the good lady (and she is a class act, mind you) is wedded to the idea that forex accumulation are necessary buffers to something worse:

      “While intervention operations may precipitate a substantial decline in reserves, the costs of
      sharp discontinuous depreciations beyond which a free fall occurs would be much higher.
      At the same time, the underlying internal factors that contributed to the unstable conditions in the foreign exchange market, including a deteriorating current account deficit, or high levels of external indebtedness or the pursuit of unsustainable exchange rate policies also need to be addressed”

      The policy “disagreements” regarding such intervention could have been precipitated by a cost-benefit evaluation as to the “efficacy of such interventions” given a free float regime:

      by others with a “greenspanian perspective, spooked they may be, perhaps by what happened to the CBR:

      “In theory the central bank could use part of its foreign exchange reserves to make this adjustment more bearable. In October however, the CBR lost $30bn trying to smooth the fall of the rouble and has recognised that it cannot oppose the market. The CBR has therefore taken the correct move of announcing its acceptance of a free-floating regime.”

      But the lady’s position is somewhat bolstered by experiences elsewhere (in a managed float regime):

      Both sides have their respective philosophies/perspectives/arguments and despite the rather naughty rejoinder the blogger fired at me the last time around, I have immense respect for his perspectives and wish him well though he should do better to hide his rather odd Hayekian Freudian slips hahahahaha….(just banter, mate!! wink)

      Me? No, I have no vested interest in the outcome ‘xcept I do play the currency markets on a significant basis but have no significant MYR exposure to worry about….hahaha. J

      ust some extra cushions for the nest egg mah when I grow world weary of my actual profession. Ok …now for some grass….

      Interested folks may like this in passing regarding the contemporary perceived roles of CBs:

      Warrior 231

  8. Another misleading post. Prof. Dr. Ho merely "used the declining reserve" statement as a passing remark on the illiquidity (whether short term or long term).

    It may be the discretionary of the central bank to intervene, but they intervene for a reason! And a very good reason, for that matter.

    And your statement: In fact, under a fully floating exchange rate regime, you don’t even need foreign exchange reserves...

    All i can say, is, its easier said then done.

    1. @Misleading

      "Malaysia’s foreign reserve earnings are through four main sources. The first is oil which is the main source, has suffered a huge loss. The second is palm oil, whose price has dropped to roughly RM2,600 per tonne, making earnings look stagnant and third is tourism...."

      A direct quote no less. That implies far, far more than managing illiquidity.

  9. @Hisham, the term "earnings" may not be right, but the reserves' inflows, is indeed, derived from export receipts (crude oil, palm oil and tourism). When a bank/company receives these foreign currencies, they do indeed need to exchange that for ringgit. Where is that excess ringgit coming from and where is the excess foreign currency going to?

    And to be honest, I am, indeed, very surprised, by your lack of comprehension of how the public markets work (besides the usual rhetoric's), given your standing in a prominent public entity. I'm not sure such understanding commensurate the responsibilities that you shoulder.

    I hope this serves as some motivation for you to keep your feet on the ground and continue to expand your knowledge horizon.

    1. @Misleading

      Where does the excess ringgit and forex go to? To other banks and companies, of course. That's why there's a forex market at all. The difference between that supply and demand is what determines the exchange rate. BNM only has to step in if a bank is short in meeting short-term FX and Ringgit obligations that it can't get from the interbank system.

      Under a floating regime, FX reserves are used like an insurance fund. Intervention and changes in the reserve position are not automatic like it would be under a fixed regime, where the policy goal is a stable exchange rate.

      I look at the reserves position as a matter of course, but the critical data to look at is banking system FX assets and liabilities. That gives you a much better idea of FX liquidity and exchange rate stability than changes in the reserves would, as reserves would only change if BNM is increasing the reserve cover, or when the system is in extremis.

      If export receipts are the main factor behind changes in reserves, you'll have to explain to me why, despite running a consistent trade surplus over the past four years, reserves have fluctuated in a tight range.

      So while I'm more than willing to expand my horizons of knowledge, in this particular case...right back at you, mate.

    2. i'm speechless....

      The difference between that supply and demand is what determines the exchange rate. BNM only has to step in if a bank is short in meeting short-term FX and Ringgit obligations that it can't get from the interbank system.

      Have you checked that with the banks/BNM? And i'm really tired of your sheer arrogance.

    3. @Misleading

      Wow, talk about the pot calling the kettle black.

      But truce! You and I appear to have gotten off on the wrong foot and things have deteriorated. That was not my intent, and I'd rather you stick around to keep my head from getting too big.

      So no more snarky comments from me, promise.

      Now, to the matter at hand:

      I showed what I wrote yesterday to both BNM and our Treasury guy (he's an ex-banker, so I killed two birds with one stone).

      Apart from some quibbling on the details (e.g. short FX positions can actually be carried overnight), they both thought it was a reasonably accurate description of the current system, at least as much as a complex system can be put into two short paragraphs.

      I'm really curious what you believe actually happens in the FX market.