Monday, April 17, 2017

Inflationary Forces

I think we have to be clear how we think of inflationary forces in this country.

We know that GST would cause a one-off increase in the price level with the introduction of the 6% on 1 April 2015.

We know that the piling up of sin taxes on alcoholic drinks and cigarettes would also only cause a one-off price increase - each time the sin taxes are raised.

We know that even the drastic depreciation of the ringgit of 20% against the US dollar would also be a one-off effect on the price level.

The academic argument on inflation is that a one-off increase in the price level is not considered inflation because inflation is the continuous increase in the price level from one period of time to the next.

On this score, the GST is free of guilt because the 6% is only one-off from the base of zero GST. At all subsequent times, the GST remains at 6% and hence the price for the same product will remain unchanged at the heightened level. Unless of course the GST is raised above 6%, then another round of one-off price increase occurs.

In the case of the sin taxes, these have in the past few years been heavily victimised because the policy makers want to raise tax revenue in the guise of self-righteousness.

The sharp depreciation of the ringgit of course is again another one-off ever since the depreciation started at about the same time as the imposition of the GST. There was gradual depreciation on a sustained basis until it hit the current level which the general public feels that the situation is completely out of control. This was when the coffee shops started raising prices by 20% to 30%. We can consider this also as another one-off impact.

In terms of analytical rigour, if we were to separate out each of these factors, the conclusion is that none of these by them is a major cause of inflation.

But the obvious answer is that there is the cumulative effect of all these little impacts. A single mosquito bite doesn't quite bother, but a hundred bites would anyone insane.

All these analytic rigour is good for the student who is trying to understand the basic mechanics of inflation. Mind you, the ability to distinguish between a one-off price increase as not inflation and the sustained increase in prices is an important one to learn in class.

After having understood the lesson, in the real world, the challenge is how to think about policies which will affect the price stability of the nation. This after all is the mandate of the central bank, a responsibility entrusted to it by the government. The world has invented the central bank in order to control the minister of finance from spending recklessly for political/populist reasons. The central bank's main tool is tight control of the money supply.

In this country, the central bank has no control over the money supply. We do not have foreign exchange control because we embrace free trade and the free flow of capital. Quantitative easing by the US Fed encouraged money to flow into the stock market here raising stock prices which subsequently fell upon profit taking. The currency rose and fell as a result of the collective inflow and outflow. We lose foreign reserves through our stock market.

The last time the central bank tried to sterilise the domestic money supply from the capital flows resulted in incompetent forex dealers at the central bank losing the pants for the nation.

The increased capital inflows and the increased monetary base encouraged banks to lend out money to the general public to punt shares, speculate on real estate and generally going on a spending spree with their numerous credit cards. The bank executives got big bonuses for creating debt recklessly.

Chief among the borrowers is the government who has learned the joy of spending to solve all political and economic problems, including an incompetent civil service which does nothing but line their pockets with giving out concessions, perks and pensions at the top of their respective scale. Nothing productive came out in the economy except huge public sector debt, raised through bonds which need to be redeemed eventually. Which they did and caused the sharp currency depreciation as foreign bondholders sold out and leave.

They left because the central bank was afraid of the impact of selling forward on the currency and foreign bondholders were left with nowhere to hedge their currency risks on their miserly discount rate on the bonds.

The attempt to control the public sector debt and the political need to spend on mega projects compelled the government "to make very difficult decision" by imposing the GST on the economy. This is a major single act of the transfer of funds from the people to the government which at once make the government rich and the people poor. There is no doubt about this - inflationary or not.

When the ordinary people talk about "inflation" they are really talking about the fall in their standard of living - times are bad, taxes go up, prices go up, margin level down, business poor, hard to earn a living.

The imposition of the GST seems to be a vindictive act to kill off the informal sector which has been the lifeline for many of the poorer sections of society which has been ostracised because they are not of true blue blood of the soil. The GST will force this group further underground, no doubt with the godsend from cyberspace.

The sin taxes and all the other taxes which the government now seems to be trigger happy in imposing will slowly but surely and persistently ensure an underlying bubbling of the inflationary forces in this nation.

The one obvious thing - to the eyes of a trained practicing economist - is this: when is the major adjustment going to take place in real estate. Real estate prices have gone off beyond the reach of the ordinary people. Either wages have to go up or prices have to come down - in order for the market to equilibrate. For the moment, the market is waiting for the equilibrating forces to come from overseas thanks to the cheapened currency.

The thing about inflation (or rather, a one-off major increase in prices) and depreciation of the curreny is that they really do decrease the standard of living of the ordinary people by increasing the costs of living and the only way that they can cope is to reduce their consumption. We are now very discerning in the things we spend money on - and only on the essentials which may also be verging on the inferior quality.

I am looking at you - the banks with your huge debt portfolio all skewed towards real estate and personal finance. You cannot lend much more because your customers have lost their credit-worthiness. Now you are only dealing with big tycoons - does that mean money laundering?

Looking ahead, the world is now entering an upcycle on interest rates - meaning that there is only one way for the interest rate to go - which up.

This is a big nervous decision for the US Fed because they have been so used to solving problems by printing money (QE) for the last three decades that for them to end that trend will just reverse everything that happened. That's why Yellen is walking on a tightrope. To fight inflation, interest rates must go up.

The good times are over. Youngsters who have had a good life putting stocks and flipping real estate may have to learn to do real jobs. The other fantasy world is cyberspace which is real in itself being of the digital economy age but probably only a handful will succeed. The rest will just have to put their noses to the grind, work at a job and wishing and hoping that properties will become affordable so that they can start their new families and get on with life.

Yes, economic theories and models are great. They help us to think clearly. But policy is an entirely different ball game altogether - a combination of every model that you can hold in your head at any one time.


walla said...

And by 2030, half the banking sector will be retrenched to make way for full automation; already some 15,000 have been pastured in the last three years.

One can already see the trend:

depopulation of the services sector when it has been touted as the next growth engine;

increasing dependence on foreign labor when value-adding is the local blue ocean sought;

national wealth engine dependent on construction of properties less and less can afford even by mortgages;

low productivity across the board in the employment sectors when developed status is the primary target;

all industries being out-competed by other countries more sober with better work ethics and education when transformation is the big word;

Furthermore, to these factors add all the toxic financial waste, accumulated non-dischargeable debts, embedded and politically-organized siphoning syndicate, and a globally bad name of corruption, kleptocracy and theocratic insanity.

The ringgit will thus remain weak. Since we can't do import substitution in a free-trade world, things will therefore cost more but people can afford less so that the standard of living will fall to the threadbare but prices will still go up.

With all that happening when there is no social net for those who will be growing older and becoming less productive year after year (

It should be a crime to have people who are incompetent and prejudiced to continue making policies which have driven this country down to this stage.

walla said...

and....the sakaification of Malaysia: