Tuesday, June 23, 2009

Engineering A Strengthening Of The Ringgit

Warning: Too long for my liking. But now that it's done, I'll just let it through.

I concluded my last post as follows:

"Half the problems of the nation can be solved by the simple act of engineering a slow but steady strengthening of the ringgit in the next 5-7 years - as part of the strategy to bring about an improving in productivity gains and a rise in the real income and wages of the people."

There are two possible ways of reading this statement:

1. That the central bank push up the ringgit and let the economy adjust accordingly. This is not an unrealistic approach. Afterall, the whole economy is interlinked with itself and the rest of the world.

2. Let the ringgit find its own path. This is an idealistic way of looking at things. This could be a culmination of the balance on goods and services, or the flows of short-term capital (as well as long-term capital) depending on the market view of the economy and the stock market.

Taking the economy as an integrated whole, therefore, there is a correlation between a stronger currency and productivity growth and real incomes and real wages.

Let me elaborate, using scenario (1).

Consider that the central bank positions the ringgit at RM3.00 to the USD.

Can the central bank just do that? Of course, it can. The central bank can support the currency at any rate that it wishes. Look at how long we did it at RM3.80!

Is it a stupid thing to do?

It depends on who you are.

If you are a strong headed PM with a finance portfolio, and if you are fighting foreigners in the name of the national interest, then you are a hero to fix the exchange rate. You can even pull all the stops just to get it done. Chop off the head. Chop off the hands. Chop off the legs. (Remember the Last King of Scotland.)

And let the whole economy adjusts....

And the Malaysian economy has been adjusting since.

How did the economy adjust?

1. The game stops for the stock market. No foreign portfolio investor will touch the Malaysian stock market, save for some brave souls from down south who figure they can do a hit and run. The KLCI is not reported by the whole press any more. It is off the radar screen.

In the meantime, we are waiting for Godot. We sit and wait and get ourselves all excited over nothing. The market treads sideways, simply because the corporate sector is dead - well, more of it being dominated by a handful of monopolies.

2. The current account in the BOP blossomed. Suddenly, from a massive deficit, we have a massive surplus. What happened? We have stopped importing machinery and investment goods. We get the surplus from commodities, electronics (this can be argued to be exaggerated), and services (more specifically, tourism, where measurement is disputable).

We have a scenario where the entire economy stopped investing and entered into an era of mass consumption. Banks with plenty of cash (or, in the jargon, excessive liquidity) find that they have interest to pay on deposits. So, they are going to create a self-sustaining virtuous circle. Because of the wholesale rescue of the economy from bankruptcy by the prevention of the workings of the financial markets, real estate values were preserved, more or less. The short-lived new central bank governor ordered an increase in the money supply by 5% per annum. Banks lent out of the basis of the surplus of the asset market value over debt. The surplus was massive. Bank loans to real estate boomed. That started the phase of the escalation of real estate prices. In this manner, the great surplus on the current account got translated into higher prices.

Is it an equilibrium?

You bet it is. With an exchange rate that was suppressed, the net foreign assets of the banking system was over-blown, which allowed them to lend and lend - not to businesses, but households.

I must confess. There is truth in the observation that, after 7 lonely years of suppressed currency, the economy has been brought closed to equilirium following the sustained escalation of domestic prices.

3. Higher Imported Prices. So when commodity prices in the global markets hit their peak just prior to the Beijing Olympics, what did we do?

We allowed full pass-through of the imported prices.

The general prices in Malaysia jumped a hefty 40%. (Who was that smart guy who argued for full pass-through?)

What happened to the economy? From my ground investigations, every other ordinary businessmen and hawkers suffered at 40% drop in business.

I presumed they meant in volume terms. And that was the start of the current economic downturn, unhelped by the bust in the US financial markets.

4. Bailing out of talents. Because of the poor business volume, local salaries and wages do not rise. Employer says to employees: "You are lucky to have a job. Oh, by the way, let's take a 40% pay cut across the board so that I do not have to sack anyone." Against the backdrop of 40% increase even in hawker food, then is a drop in real incomes and real wages.

Those who have good skills will try to look for a better jobs. Of course, you are not going to find them in Malaysia. You are going to get out of here. We are losing our talents, and hence a loss of our productivity gains. (Well, maybe the loss will result of loss of motivation and probably lack of ideas.)

5. So, as the economy grinds to a screeching halt, what did the monetary authorities do? Zero deposit rates. So cash should also flow out of the local currency and the local economy. With the people with also go capital, natural if there is emigration.

6. We respond with the liberalisation of the services sector. What does this mean? Liberalisation means we are letting foreigners open up shop in the local economy. There should be some happiness among bankers and financiers since these foreign financial institutions will pinch them by paying them 20% higher. This may not be good enough to cover for the consumer inflation but better than nothing. The same goes for other parts of the services sector. Other services: law, transport, computer, health, tourism. Yes, there could be increases in the salaries and wages of these sectors, although those unemployed will be grateful for a job regardless of pay.

7. If the services industry is going to expand as a result of the liberalisation, there could be an absorption of the unemployed but experienced workers (particularly, those who had escaped into the stockbroking business during the good old days) and probably spotted increases in salaries but I do not expect much. (Qualify: Top managers always feel they command top pays, so I won't say no to the likelihood of salaries being raised for these people. I shall wait for the NPL to rise in their last firms and look at their faces.)

This will create more jobs for white collar workers (Malaysian graduates), rather than more jobs for construction workers (foreign workers).

8. So, by taking all things into consideration, where do we think the ringgit should go?

I am not too sure about the impact of the higher salaries in the services sector on the exchange rate. (I learned that one theory says that, technically, if the services sector is big enough, the ringgit can be stronger to be at par with service prices in other countries, assuming the currencies are in equilibrium in the first place.)

Let me now try to think.

I think the salaries will have to go very much higher if we were to be able to retain the very good workers in the services sector in Malaysia, if we have a weak ringgit. If not, then we may have to let the ringgit strengthen in order that the hike in local salaries to get top-notch workers in the services sector be not too excessive - we need them to create an efficient and competitive services sector.

If the ringgit is weak, then the differential between the top-notch workers (at international prices) with the ordinary workers (at local prices) will be so huge that there will be bound to be jealousy in the work place.

Are we already in this situation in the work place? I think we are. Foreign consultants with their foreign fees which are probably 10x to 20x more than what a local professional will earn doing the same job, but probably with different experience and exposure.

This is because of systemic inefficiency and lack of competence giving rise to a weak ringgit and which together produce a vicious circle of secular economic decline.

9. I can also think of the zero deposit rate as a reflection of the current economic problem at home. Productivity growth is so low at home, and ideas so bankrupt, that even if you throw free money at the corporate sector, you ain't going get any improvement in the economy. Traders and carpetbaggers simply do not invest.

At zero deposit rates, I think we are asking for trouble.

There is this mistaken view that the 30% to 40% "gross national savings rate" is a big number.

This savings rate includes the EPF that most people have to save for the retirement. (Thank you, government for consistently eroding the real purchasing power of our future savings through sustained inflation and sustained weakness in our currency.) If we are to consider the household sector as a whole, the savings rate was only 1% (2004), according to the National Income.

The gross savings rate of our government was 24%. But by far the largest was the corporate sector (80%), largely financial sector (83%) and non-financial sector (80%).

So, I don't think we should kid ourselves. The truth of the matter is that the corporate sector was a net lending in Malaysia, while the government and households are net borrowers.

Why should the government and household sectors be asked to support the economy, specifically, the corporate sector which is sitting pretty - especially, the big, strong, friendly ones.

Where are the corporate investments?

10. Do I think the RM2.70 to the USD for the ringgit is mythical? No! It is a clear number. I dream of RM1.80 to SGD and RM4.50 to the pound sterling - like the alignment of planets.

11. Engineering the strengthening of the ringgit? Conclusion.

I think in terms of direction. In central banking parlance, it is called the exchange rate "stance" if you like. You take a position. It becomes a signal to the world.

Once the signal is clear, the world knows what to do.

For central bankers who want a quiet life, the best thing is to say nothing. To give no clue to the market, so that the market cannot speculate against it. Fine! That's another stance.

If nothing is happening, the market just ignores the ringgit. There is no engagement.

How do you think the ringgit can stay "so stable for so long"? We are being ignored.

The little transactions in the local forex market, for trade purposes, is not a really free market. It is a provincial market in some forgotten town.

Is Malaysia ready to engage the world and play the global economic and financial market game professionally, without thrashing the game board when we lose?


vinnan said...

Since the UMNO clowns kicked out Singapore the ringgit have been heading south against the SGD save for a brief period when the ringgit was actually higher than the SGD. If I am not mistaken the Finance Minister then was Tun Tan Siew Sin. UMNO can do all it like to try and control the ringgit but their racist mindset will always drive Malaysian wealth into Singapore. It has never occurred to UMNO that the retention of wealth in a contry is premised upon a fair and stable government. I have lost count of the number of times UMNO have threatened the non-Malays with violence and actually caried out the threats on top of calling the non-Malays pendatangs. In both acts neither is there fairness nor stability. Massive amounts of MYR have been brought to Singapore and even today with the currency controls in place it is not difficult to smuggle large amounts of MYR to Singapore and exchange it for various currencies. The prerequisite for a strong currency is a stable and fair political climate. So long as UMNO think it can threaten the non-Malays and grab power such as the case in Perak money will keep flowing out of the country.

hishamh said...

Oh my, what a magnificent rant! How much time did you spend on this?

I can't possibly do justice in reply at the moment - give me a day or two!

etheorist said...


I am sorry that you find it a rant.

hishamh said...

I'm poking fun at you, lol, no offense intended.

walla said...

A brilliant piece; regret i had stopped at harcharan singh khera so many years ago. ;P

hope more people pay close attention to what're written here; they're all gems, almost philosophical in insight.

etheorist said...


Otherwise known as confidence.


Can always count on you. Gems...or beads of blood.


Forgiven. Now you are forcing me to write short.

hishamh said...

I've been stuck for time to give full attention to some of the points raised in this post, so commentary will have to do.

By the numbers:

1. It's rather obvious from the BOP data and volumes on the KLSE that the level of the MYR is less of a concern to investors than capital controls.

2a. Imports of capital goods are always volatile and tend to overshoot changes in economic activity. While there was a drop in 1998-99 (-30% from 1997), capital goods imports recovered by 2000 and are now exactly double the level of 1998, implying a CAGR of 7%.

2b. Housing prices crashed in 1998-99 to the tune of 12%+. Despite all those mortgages, price increases are barely above the rate of inflation - unless you live in Perak. Overall demand has been soaked up by the huge overhang of inventory from the investment bubble of the 1990s.

2c. The net foreign asset position of the banking system is a paltry 4% of total liabilities.

3. No argument here, but since the runup in commodity prices was global, there's very little forex impact except for a bias towards commodity producing countries.

4. Based on 3, since the impact on real incomes was global, hard to see going anywhere else making a difference. In fact it should be harder, since labour demand was and is falling globally.

5. Again, with global interest rates falling, real interest rate differentials are more or less the same - capital flows will be directed more by perceived risk premiums than changes in nominal rates.

6, 7, & 8. Actually Balassa-Samuelson suggests the opposite. It is the tradable sector where wages will equalize internationally, not the non-tradable sector. Obviously, there's no hard dividing line, especially as labour becomes (however imperfectly) more mobile internationally.

Another point is that to me, when talking about services, what I think of is blue-collar jobs, not white-collar. It's a lot easier for white-collar workers to migrate than it is for blue-collar workers, which implies greater competition in the high-skill areas (consultants, software programmers, etc).

9. Corporate investment appears to be mainly heading overseas - Cambodia, Vietnam, China among others. A second factor appears to be that both government and the corporate sector have rapidly paid off external debt. The net impact is a huge improvement in the country's international investment position. For the first time since independence, Malaysia has turned into a net lender and investor internationally.

10. I do not see any particular nominal level of the exchange rate meaningful. If RM2.70 to the USD is consistent with the internal and external balance of Malaysia, vis-a-vis the internal and external balance of the United States, then that's wonderful! But still meaningless in terms of real incomes. Since the outlook for the USD is negative in relation to emerging market currencies, we'll probably get there faster than you think - but again there's no implication that there is something special or specific about that level of the exchange rate that makes it useful as a policy target. It could equally be RM2.00 or RM4.00.

11. Forex transaction volumes are now enormous, even before the current crisis. As per point 1, trade on the forex market was a function of the peg and capital controls, not the level of the currency. On an absolute level, volumes in the 6 main currencies (USD, EUR, SGD, JPY, STG, and CHF) first exceeded RM1 trillion in 2007, and were at RM1.7 trillion in 2008. As a ratio to total trade volume, it went from a low of 27% in 2003 to 143% in 2008.