Quis Custodiet Ipsos Custodes

I’ve always had mixed feelings about criticising news report and editorials. On the one hand, I realise that it could take away the focus of this blog from the purpose I intended for it, which is to cover developments in the Malaysian economy. I ‘m also fairly sure that such posts could make me come off as petty (I plead not guilty) or intellectually arrogant (maybe guilty as charged).

Against that, there’s the role of the press in reporting and commenting on national policies (which has an impact on political accountability), and its role as opinion leaders. If there are mistakes in this arena, whether by omission or commission, then there is some value in pointing those out even if I don’t have the reach that they have.

Of course, whether you consider a particular viewpoint a “mistake” really depends on one’s point of view and educational background.

I think I’ll continue to have ambivalent feelings about this issue, but will proceed nonetheless.

BTW, if it seems I pick on The Star too much, it’s because out of the major English dailies I find that, right or wrong, they actually do have something to say about the economy. The News Straits Times appears to be interested only in human interest stories and sports. Ok, that was exaggeration, but justified exaggeration IMHO.

To round up some the articles that caught my interest this weekend:

1. Managing Editor P Gunasegaram thinks marketing Bursa Malaysia is putting the cart before the horse, and we should put our economic house in order first. For once, I fully agree with him.
2. Raymond Roy Tiruchelvam asks to consider purchasing power parity when comparing incomes in other countries, if you’re considering immigrating. I only ask that you don’t try using it for comparing the level of exchange rates unless you want another scathing editorial on this blog! BTW, instead of using the Big Mac Index (what, again?), I would use the World Bank’s International Comparison Program, or the Penn World Tables. Either would give a better multi-product idea of the differences in the price levels.
3. Angie Ng talks about normalising the costs of borrowing and investing in property. But she makes the odd statement that, “Normalising the interest rates by allowing it to be decided by actual market forces of demand and supply is certainly more healthy.”  Sorry to break this to you Ms Ng, but whether BNM sets the OPR at 0% or 10%, interest rates are market determined. All the OPR does is set a 50bp band to the overnight rate, everything else is determined by the demand and supply of money. Of course with the OPR target, BNM has its hand on the scales so to speak in terms of the money supply, but demand is entirely free to vary. There’s also in the article the meme that low nominal rates disadvantage deposit savers, which is not necessarily true – it’s real rates that matter, and those generally rise during a downturn unless the central bank cuts the nominal rate. Had to point that out, sorry.
4. Jagdev Singh Sidhu rounds up opinions from various research houses on the strength of the economy given the great numbers we’ve seen the past couple of months. The consensus is that the recovery is credible, but we should see better evidence on its sustainability in the second half of the year. It was pointed out by a few analysts that exports and industrial production are off their peaks of 2008. Way to go guys! But if you consider 2008 as a bubble year (which I do), then the recovery is over – we’re now back to the growth phase, and growth sustainability is a much harder question to answer. Again everyone seems hooked on analysing growth statistics (even if they note the base effect), and most are not bothering about the actual levels. And no one noted that poor capital goods imports are a direct result of the excess capacity that already existed before the recession started. Don’t look for high capital goods imports this year, it just ain’t coming. Nor will the lack of it say anything at all about manufacturers’ plans, intentions or prospects.

There Is Too A Point In Dropping Interest Rates

In today's business editorial in The Star, P. Gunasegaram clearly doesn't understand monetary policy:

"If Bank Negara decides to lower interest rates next week, as many people expect, there is little that it is likely to achieve but it will further erode returns to savers already, very low at around 2%...And the lower interest rates will weaken the already weak ringgit in the short term as those holding ringgit will get lower returns and, therefore, might opt to move into other currencies...Will there be any benefit from such a rate reduction? Not likely. Recent evidence is that interest rate reductions do not do anymore to stimulate the economy beyond a certain point. An example is Japan where interest rates have been around zero for many years with little effect on the economy."

The first point of misunderstanding is that what matters is the real interest rate, not the nominal interest rate. Japan's ZIRP didn't work not because nominal interest rates were low, but because first under conditions of deflation the real interest rate (nominal interest rates less inflation) was still positive. The zero interest rate bound puts a limit on the reduction of the nominal rate, but does not put a limit on the real interest rate. Monetary policy can still be net contractionary under those conditions.

Second, Japan's policy transmission mechanism (i.e. credit creation through the banking system) during the "lost decade" was broken. With zombie banks supporting zombie companies, monetary expansion gets trapped within the banking system, and did not support economic expansion.

Neither point is yet valid for Malaysia. With annual inflation dropping fast and potentially going negative by July, the real interest rate would be rising in the absence of a nominal interest rate cut. Given the current drop in output, higher positive real interest rates are an extremely bad idea. Just to underscore this point, here's average bank lending rates less annual CPI (log annual changes; 2005=100):



Secondly, Malaysia's banking sector is structurally sound, as (ironically) pointed out in this article in the same newspaper. Capital ratios are more than adequate, and non-performing loan ratios are flirting with all time lows. Monetary expansion and lower cost of funds will thus have a positive impact on borrowing and lending.

The second point of misunderstanding is real return to savers. With annual gross national savings well in excess of 30%, I don't think we need to encourage more savings - quite the opposite. With velocity of money already low and falling, reducing velocity further is another bad idea, and just reinforces the downturn in the economy.

The third point about the currency again confuses nominal and real rates, and misses the crucial "flight to safety" narrative of the USD over the last six months. It's true that interest parity conditions would imply, ceterus paribus, that maintaining nominal rates and thus allowing real interest rates to rise would maintain and/or strengthen the value of the MYR.

This is especially true since ceterus paribus doesn't apply - BNM is behind the curve in loosening monetary policy not only against advanced economies, but also regionally i.e. relative interest rates for MYR assets have been rising. On the other hand, demand for USD has been unnaturally high in recent months, as US financials pull back overseas investments as well as from Euro-dollar asset liability mismatches. This trend will reverse as US financial system leverage unwinds.

The billion-dollar question is - with trade suffering and the threat of imported inflation practically non-existent, does a higher MYR make economic sense?

I haven't fully worked out MYR trade/exchange-rate elasticities (something for a future blog post), but a quick regression estimate suggests a 1% rise in the USDMYR rate results in a 0.39% drop in exports and 0.24% drop in imports, both statistically significant. That is, MYR currency appreciation results in a contraction in total trade, which isn't exactly what we need right now.

One point I do agree with is that banks aren't passing on the full marginal cuts in the OPR to borrowers, as I pointed out here. That's something BNM has to work on.

Technical Note:
Source for average lending rates, CPI and external trade from BNM's Monthly Statistical Bulletin. Forex data from Pacific Exchange Rate Service.

Department of "Huh"?

Apologies to Brad DeLong for the title, but this op-ed in the Star had me scratching my head:

Control speculative trading in commodities
Making a Point - By Jagdev Singh Sidhu


Quote:

"The price of crude oil has been kept from falling through a combination of planned supply cuts by oil-producing cartel Opec to meet an anticipated reduction in demand in 2009, and the hope of demand increasing as the global economy recovers...The argument is that too low a price will mean trouble for the energy markets as higher costs have already seeped into the business. Refining costs have gone up and so too have exploration and drilling costs over the past few years as oil companies venture off the deeper waters and harder-to-access places in search of the commodity."

This is an argument that the current highish oil price is being supported by a restriction in supply as well as a higher cost structure - an argument based on fundamentals.

This is then followed by:

"Plans to limit excessive speculative trading in commodities by hedge funds must be carried through and enforced. The world doesn’t need higher priced commodities raising inflation, hitting the public’s wallets and slowing any recovery in the economy."

This suggests that speculators are driving up the price of oil - an argument based on market manipulation. So which is it? Given the current deleveraging and risk aversion going on, does anybody have the stomach for "speculating" at all?