Thursday, October 30, 2008

Expanding the Aggregate Demand Curve

In the past 18 years since 1990, ever since the success of opening up the economy to foreign direct investments hit infrastructure bottlenecks, the Malaysian economy has been undertaking mega projects to expand the infrastructure capacity of the local economy - that is, expanding its aggregate supply curve.

This expansion of the aggregate supply curve had proved so lucrative to the policy makers that even as a solution to the problem created by it in 1997-98, the solution remained additional expenditure on infrastructure. This "counter-cyclical fiscal stimulus" has proven itself so easy to propose and implement that many politicians and poorly-schooled economists may be tempted to imagine themselves to be brilliant economists.

Infrastructure projects are probably one of the easiest projects to implement (so long as one has the money) because there is no accountability to their economic or commercial viability.

So, since 1990, Malaysia's aggregate supply curve has been pushed further and further out to the right.

The idea of building more infrastructure facilities is to expand the productive capacity of the local economy so that there is more room for private-sector business investments to increase and in the process generate growth in the economy.

If private investments are unchanged and the aggregate demand curve stays the same, the sustained expansion of the aggregate supply curve means that operators of infrastructure facilities will lose money due to insufficient demand - and the only way to ensure profitability is to raise the prices high enough, and this is easy to do for monopolies. (Note Khazanah's strategy to turn around GLCs, as an example.)

In the meantime, having expanded the supply side, Malaysia undertook no extra effort to expand the aggregate damand for infrastructure. When the Japanese and others looked to China after the 1997-98 crisis, the local operating environment hardened further for domestic direct investment. The clamour for lucrative government contracts (on the supply side) led inadvertently to a government machinery that has become hostile to homegrown investments.

Easy money policy therefore led not to an increase in local direct investments in factories and plants for exports or businesses of entrepreneurs, but to an increase in the collateral assets for banks - namely, real estate and even financial assets. With this came the consumption boom - of cars and credit cards - which thought great for the local retail trade but is no good for the secondary sector of the economy - the real economy of producing things they can be sold to the world.

Malaysia needs to expand its aggregate demand curve, by encouraging direct investments, not only from foreigners but also from Malaysians themselves. Opportunnities must be created for investors to take risk and keep the fruit of their efforts rather than have rules and regulations that strangle confidence and the animal spirits and the long-term faith in the economy. To invest is to keep faith with the country.

The monetary policy is easy enough - interest rates are low enough and banks are very keen to lend. The fiscal policy has become so elongated that we may have to raise debt to finance it. But there is a need for policy and the government process and machinery to take an enlightened view of the workings of reality.

The current global financial meltdown shows that wealth as most people perceived it is a figment of their own personal imagination, while the richness lies in the openness of society out there - of the money that is yet to be made. Assets are nothing but relics of dead people that the living merely sit on.

The expansion of the aggregate demand curve by consumption is a drive in the wrond direction as the current financial meltdown also shows. There is a need to invest by putting resources to productive use, productive in the sense that we are continually extracting more and more out of the available resources for the benefit of society, rather than to feed the greed of individuals or the fancy of a group.

Let Malaysians BE ALLOWED TO invest in Malaysia and stake a claim in the future of their own homeland - rather than be over-run by billionaires and foreigners!

Tuesday, October 28, 2008

How To Repair the Malaysian Economy

When the dust settles, what would we see?

An OECD paralysed, with a financial system staying barely afloat.

China may use the opportunity to refocus growth from foreign-owned export industries to local-owned domestic-oriented firms especially in major inland cities. There will be oppportunities for investors outside China to produce quality inputs for Chinese industries.

What will happen in the Malaysia economy? What must be done to repair the Malaysian economy?

The traditional Malaysian society and economy that we all have grown up in have been drastically changed - some would say destroyed.

We are no more Malays, Chinese, Indians and native Sarawakians and Sabahans.

Malaysia is now a mixture of billionaires, foreign workers, a whole bunch of speculators in shares and real estate, and consultants to government departments and GLCs.

We are all in for the quick gain. As opportunities for windfall gains evaporates as the oil money run out, we are all assassinating politicians for being empty handed.

First, beef up internal security to prepare for a spate of recession-induced crimes in the street.

Second, repartriate low-wage foreign workers. They are the ones that keep wages low and inhibit the use of technology in the economy - including construction.

Third, focus on investments - for exports to China. Malaysians should try to hire local professionals of all races. It is far better than attracting foreign investors to hire local professionals of all races.

Fourth, Malaysians should close ranks to work on putting together the fragmented economy (and the fragmented institutions). The divisive politics has destroyed the economy, and we do not need any 80-year olds to paddle us old-fashioned ideologies. For goodness' sake, we are in a globalised world - and what race are we talking about or are we really talking about power, monopoly, disgraceful wealth and opulence on the backs of those who toil.

Fifth, create a Third Force - the Liberals who care for the creation and spreading of economic opportunities throughout the whole society regardless of race or religion. We should take all key issues in Malaysia including the NEP-type and work out effective and transparent ways of balancing out wealth distribution, instead of the very crude old-fashioned quotas and licenses. There should be price-incentives to induce productivity gains and market-based wealth creation.

Sixth, sit down and do some proper political and economic analyses and publish them in peer-reviewed journals, even if of local origin. We have too much of foreign models using local data, and not enough original local thinking taking into account local conditions.

Seventh, we should take the Minister of Finance portfolio away from the PM and the DPM and give it back to the Minister of Finance. The PM should concentrate on national harmony and the DPM on internal security. The Minister of Finance on government spending and finance. The Central Bank on fighting inflation and financial speculation. Let the private sector a free hand to undertake investment. Remove politics from investment decisions.

Eighth, we have enough infrastructure to last another generation. We have expanded the aggregate supply curve. Let us work to use the infrastructure efficiently. Move the aggregate demand curve.

Ninth, reinstate the role of professionals in the economy. Remove politically-oreinted managers from public places.

Tenth, reinstate the role of markets in the economy with price movements doing the resource allocation. Let the people work, sweat, earn and keep.

Recession: Simple Analysis

Many people think that prices are symmetrical in their impact - when prices go up, people buy less; when prices fall, people buy more. So, if we raise prices and then lower them back to the same levels as before, things will be back to where they were before.

No quite right!

Say, when prices are doubled and people's nominal incomes are unchanged, they can only buy half the quantity of the things they used to buy.

When this happens, businesses will have only halve the usual sales and warehouses full of unsold goods. They may try to lower the prices but they will be making losses. Instead, they retrench staff to produce half the usual volume, if they were to simply write off their unsold goods.

By retrenching, they are creating the signs of a recession - the recession has already set when prices were raised.

If prices were then reduced to the same old level, people will buy what they used to buy - which is the amount they earned - but without the income lost by those who were unemployed.

After the fuel and food price hike, there should be no doubt that the recession is already set for the world.

Reinstate the Gold Standard

Keynes came in after the 1903s Depression to argue with the simple market economists in the Treasury that letting the market find its bottom would not help because many people were hungry and had no money to create the demand needed by the market. This is, in essence, the General Theory or GT.

Keynes also reinstated the gold standard and created the IMF to help maintain the gold standard by providing the necessary liquidity to stabilise currencies.

The failure of the US financial system - what it looks like to be the world financial system as practiced by the West and imitated by the East - is the destruction of the gold standard in 1973 when Nixon removed the US dollar from it - which led Greenspan to abuse it with its unbridled expansion in the name of free market and global innovation.

But the free marketeers had failed to define market rules under which everyone should operate. Banks are left to innovate to their hearts' content. The referees were sleeping.

The solution to the global financial system is to go back to the gold standard, regulate money supply, control inflation - so that the real economy and people who really work can proceed to go about with their ordinary lives - working and consuming and waiting to die.

Central Banks Have Failed!

Risk managment tries to minimise the risk associated with a given situation, structure or paradigm.

Uncertainty is associated with the changing of situation, structure or paradigm.

Risk management is a cope-out that marginalises the need to deal with uncertainty.

A bank works on the assumption that it is as good as its collateral value - which is largely mortgages or mortgage-backed papers. The collateral value increases with bank lending, which means that there is no limit to loan expansion - until the borrowers are exhausted and couldn't pay.

In risk management, you work to ensure that the collateral really does exist, and that its current value is indeed what the market says.

When the situation changes as a result of the exhaustion by banks of their customers, the whole bank lending system collapses - and out of it comes uncertainty - as to what the next model will be.

There is no uncertainty where the banking system is going - down!

There is uncertainty as to what to replace the banking system - that is, what banking policy - and nobody has a clue - because nobody is thinking about it.

While individual banks undertake risk management, it is responsibility of the central bank to manage systemic risks.

Central banks around the world have failed.

Monday, October 27, 2008

Flat With the Nose Dipped

Chinks in the Malaysian economic armour?

We have had nearly thirty "good" years since 1980 spending the "oil" money and pretending to the great. The real chink is that the "oil" money is gone, and populist policy of subsidising food and fuel is being removed - in the midst of probably one of the greatest economic turmoils of the century. So much for timing. This implicates the whole generation of politicians who went along with the merry-go-round.

Financially, we took the hit in the 1997-1998 financial crisis, from which we have not recovered. Indeed, danger looms still in the financial industry which has been quite happy to lend to consumers to buy stocks, cars and houses and a good time. But I think that the downside is limited, given that the industry has been recapitalised. I do not mean that the financial industry will not take a hit again - it is likely to, but not to the magnitude as in 1997-98 or what we see in the US and the rest of the developed world which has been relying on financial services for a living.

Malaysia will also feel a similar effect from the credit crunch. The way the local stock market is mimicking the world markets being that the local economy has no real fundamentals on its own. It has similarly been floating on inflated real estate and the general "consumer'led" recovery of old. With the scare, property prices will deflate to its real value - which could be easily halved in some areas - and this will also remove the excuse for banks to lend without thinking.

Even if interest rates are not raised or credit rules tightened, banks may not be inclined to lend.

Without loan growth, the economy will easily be flat with the tip of its nose down - before it nosedives.

The real chink is in its loss of momentum - from an irrelevant economic structure.

The relevant structure is to refocus the economy on competing in the world market - not the generation of billionaires through mega projects.

Tuesday, October 21, 2008

Rescue, Excuse

You who are so new to the job, how come you are so quickly ill-advised about what to do with the economy?!

I hope you have thrown away the same fellows who had advised the Prime Minister previously to raise fuel prices by 41% and got our prices to double across the board - just because you do not want foreigners to enjoy the fuel subsidy. Look at the mess! Great idea, bad timing!

I really hope it is not the same fellows who had just advised you on using a RM5 billion loan from EPF to support shares in the market. You reckoned that the prices of shares that this investment company is going to buy will rise so much that when you sell them again you can make enough to repay EPF the RM5 billion plus interest. If so, you are rising and falling according to your own will, and not the will of the market!

I think the government should stop fiddling with the stock market. It is the easiest route to hell and you are leading the whole economy onto that fiery path.

Remember this: No easy money, no easy money! You fellas got to do some real work, rather than showing us tricks with smoke and mirrors! Worst, if you do not realise that this is happening.

Real work means translating learning into ideas so that the welfare of the ordinary people could be improved - not helping your rich friends not to become poor when they are burnt in the market.

Put a bit of competition into the tenders so that the margins can be reduced, and the work gets done properly.

Better still, let the markets be free so that good people can have the chance to do proper work to contribute to the economy.

We should let the economy sag a bit first to weed out the waste, and not be too keen to rescue, rescue. It's excuse, excuse!

Monday, October 20, 2008

Credit Cards and Sub-Prime

Nothing to worry over credit card over-spending.

The bad loans are already factored into the interest rate - that's why you pay 10-12% pa on credit card as opposed to 5-6% pa on normal loans.

Credit cards are small loans, and it is cheaper to write them off than litigate for recovery.

I have not seen credit card debts doing much damage to banking institutions - although individuals are known to get into trouble.

But it is always a sign when banks are keen to give out credit cards that the end is nigh for the economy - they are really going for the sub-prime customers.

Sunday, October 19, 2008

In For the Long Haul

We could be going for the long haul.

The current US financial crisis could simply mean the end of the US economic dominance in the world.

The Japanese meltdown lasted nearly two decades and still counting.

For turn around, the world awaits China - and India and Russia.

Export-oriented China firms may fail in the next 2-3 years. New domestically-oriented firms need to rise. They may wait to suss out the situation to build new factories and seek bargains of old factories. This may take 2-3 years. For the result to show, if any, we may have to wait 3-5 years.

In the meantime, China has to rethink its economic policy.

We could be in for the long haul.

Wednesday, October 15, 2008

Flying Blind

Banks and financial insitutions in the US and Europe and even Japan are badly affected by overlending and loan non-performance resulting in the inability of banks to repay deposits in full and the loss of paper wealth in financial markets.

This could potentially undermine public confidence in the banking and financial system. When confidence is lost, everybody wants to keep hard cash under their beds. This threatens the economic system. So, the policymakers argued that the banking and financial system should be saved.

Saving the banking and financial system does not mean that everything is OK.

In the first place, the banking and financial system collapses because of the sharply deteriorating economic system. So the rescue package only tries to stop the financial collapse.

With no additional investment, the economic system should continue to deteriorate at the same rate as before. Hence, the fear of a global economic recession.

Bear in mind that US and Europe are in trouble because of a major structural change in the global economy - the rise of China. It is this inability to compete with China that the US under Greenspan sought to pour liquidity into the economy in order to shore it up. Exactly like Japan in 1985 - and Japan has since not recovered. Do not be surprised if the US economic deterioration should last for some time, say 15 years.

Whether the world will fall into a recession depends on China's ability to restructure from an export-oriented policy to domestic consumption.

This turnaround in economic policy requires a different set of working parameters:

(a) Instead of cheap labour, now better-pay packages are required so that consumption is sufficient to yield positive returns to investments; and

(b) The old export-oriented companies may go bust or go abroad, while a new set of industries producing for the domestic market has to arise. And these do not necessarily mean robustness in the stock market nor real estate.

We must be careful that we do not listen only to speculators for answers to real economic problems.

The narrow focus of policy on financial market as a performance indicator is one of the causes of the current global financial mess.

In the case of Malaysia,

(a) Yes, the local banking system should not be unsettled by the global financial crisis. Most banks are not allowed by the central bank to be overexposed to global markets. This is because the central bank has all the foreign exposure. If there should be concern, it should be over the central bank.

(b) Well, the local economy has continued to suffer from the 1997-98 financial crisis. Only that government spending had helped shore up the economy, with help from an easy money policy. The attempt to bring about productive change to the economic structure through regional development has not been well received - by people who are addicted to easy money from mega projects. There is a limit to how much one can keep the economy afloat by printing money, if the economy remain unproductive.

(c) The only way to live in a time of uncertainty is to reduce the uncertainty through better and more information feedback. Worse if information is being withheld from the public. Information is needed to anticipate change and prepare for it rather than be caught by surprises. At the moment, we are all flying blind.

Wednesday, October 8, 2008

Removing Excess Liquidity

Excessive liquidity is removed by the collapse of banks.

So what is this big hoohah about bankrupt financial institutions and the attempt by the government to save them?

When there is too much money in the economy, this money got pushed into assets which do not have any conceivable return. This is fine if the assets are bought with cash or past savings. But, if the assets are bought with borrowed money, then it creates a potential problem for loan repayment. It is just a matter of time that the loan repayment problem will appear in the form of non-performing loans in the books of banks.

The only way that banks can hide the problem of NPL is to keep the ratio of NPL to total loans down. As NPL rises, total loans must rise faster. That is banks are forced to gear up and escalate their lending. Banks keep lending until there are no more borrowers to lend to. Then, the NPL ratio surges.

If the gearing of banks has been increased by the reselling of mortages, then the other financial institutions buying the mortgage papers are at risk, no matter how big the potential rate of return may be. One fine day, the mortgage papers will be worth nothing when borrowers cannot repay their mortgages.

The rise in NPL means that banks must use more of their capital to cover their NPL. This cannot happen because the banks are fully geared. Since they have to throw all their capital into the NPL hole, there is no more extra cash for them to lend to new customers. If this happens to one bank, the other banks can help. If this happens to most of the banks, then there is a shortage of liquidity in the system. There is a seizure in the credit line in the whole financial system.

The natural thing to happen is for the banks to go bankrupt - which could mean 10 cents to each dollar of deposit can be repaid. Ordinary depositors pay for the sins of the banks and the borrowers.

So the central banks have to come in to rescue the banks. The mortgages are fine, because they are real estate; if the price of real estate has collapse because of the credit crunch, it is just a matter of time (18 years in Japan and still counting) for the real estate to recover. The central banks can come in to buy these mortgages and keep them. With those mortgages, the central banks can inject more capital into the banks.

But financial institutions which have bought the mortgage papers (not the mortgages) have only useless pieces of paper left. These mortgage papers are sometimes called mortgage-backed bonds, and bonds generally have a limited life, say, one year, three years, five years. These bonds become worthless because the banks issuing these mortgage bonds have gone bust. These are financial institutions that are caught with their pants down. They simply collapse, having exhausted all the reserves they have built up over the years, some, over 100 years. For these financial institutions, they will still have other assets which they can sell to other financial institutions.

It is therefore important in a monetary economy to control the money supply tightly to ensure that there is sufficient liquidity to finance businessess and other real economic activities. It is highly irresponsible for the central bank to keep printing money and maintaining a high pace of expansion of the money supply in the hope of keeping a dying economy alive. This is like pushing a string - the real economy will continue to die while tycoons are created in the financial and real estate sectors. When the uneducated rich begins to laugh at the educated poor, you know the world is upside down and ready for punishment for the greedy.

It is the responsibility of the central bank to keep a disciplined growth in the money supply so that ordinary people do not suffer - by putting their hard-earned savings as bank deposits at risk, by making them poor by engineering the escalation of property prices which put house ownership out of their reach, and generally allowing an insidous creeping up of prices in general. Inflation means ordinary people must tighten their belts so that the rich can consume more.

Tuesday, October 7, 2008

Financial Markets & The Real Economy

[Just returned from a long break.]

It is very easy to be caught up by the ups and downs of the financial markets. Financial markets are nothing more than the trading of useless papers. The reason why many people are caught up by the financial markets is that it is so easy to make money there, as well as losing it - as many would have discovered by now.

The financial markets float up and down depending on liquidity and sentiment. At the moment, both have dried up.

Now, the real world is where people go to school to be educated, to make goods and services which improve the welfare of people. This is the real world where people do sweat, and develop a daily routine which is passed down from generation to generation long enough for that routine to be accepted as culture.

It is now the accepted doctrine that the market economy is the most efficient, in that a greater variety of goods and services can be produced, distributed and enjoyed by more people. At the end of the day, the market economy exchanges the goods and services provided by diligent people.

It is also accepted, in the market economy doctrine, that the rarest of the commodities or items of restricted supply, holds the best value over time because of relative scarcity.

The US Federal Reserve has forgotten this restricted supply rule and has flooded the US and the world with so much US dollars that the way to make money is the inflation of assets - where the paper money shows its increasing worthlessness. For the banks to survive, they just have to lend more and more - to perpetuate the lie - until no more borrowers can be found.

It is time to refocus on the real economy, while the financial markets choke in their own vomit.