Here We Go Round the Mulberry Bush

Our PM in Japan (excerpt):

Malaysia asking for yen credit to help with national debt, says Dr Mahathir

MALAYSIA is asking Japan for credit as part of efforts to resolve its debt problem, Prime Minister Dr Mahathir Mohamad said today.

Speaking at a joint press conference with Japanese Prime Minister Shinzo Abe, Dr Mahathir said he was told Japan was considering the request.

“I have explained the financial problem faced by Malaysia, and towards solving this financial problem, I have requested for yen credit from Japan and Mr Abe, the prime minister, will study this request,” Dr Mahathir said.

I don’t have much time, so I’ll keep this short. I’ll give TDM the benefit of the doubt here – he could be talking about refinancing some of the USD debt under 1MDB, which makes sense since the yield on that debt was way above market. However, using JPY loans to cover MYR debt makes no sense at all.

No, International Reserves are NOT Government Savings

I’m starting to read this in social media comments about Malaysia’s public debt. That the government doesn’t have reserves; no, that Malaysia has plenty of international reserves; but Singapore has more reserves than we do! etc.

This is almost wholly nonsense.

An Obsession With Surpluses

No, I’m not addressing the government deficit. Rather this is about Malaysia’s (slowly) diminishing current account surplus. I wrote about it at length last year (link), but here’s another flavour of the same argument (abstract):

Current Account Deficits:The Australian Debate
Rochelle Belkar, Lynne Cockerell and Christopher Kent

This paper documents the clear change of view, which has taken place in Australia over the past three decades or so, concerning the relevance of the current account deficit for policy. Historical experience under a fixed exchange rate regime suggested that large persistent deficits were unsustainable and could leave the economy vulnerable to sudden reversals in sentiment. These concerns persisted after the floating of the Australian dollar and financial deregulation, and it was thought that all arms of policy should help to rein in the then much larger current account deficits. However, these policies were shown to be ineffective and, by the early 1990s, the argument that current account deficits represent the optimal outcomes of decisions made by ‘consenting adults’ gained wide support. This paper presents some empirical evidence consistent with optimal smoothing in the face of temporary shocks; the persistence of the deficit is attributed to a modest degree of impatience relative to the rest of the world. Although it is now widely accepted that policy should not seek to influence the current account balance, the issue of external vulnerability remains of interest. Here, country-specific considerations are important, and it is argued that the factors that have made Australia relatively resilient to external shocks are also those that helped to attract foreign capital in the first place.

It's an old paper, but still relevant. I'll note in passing here two things:

1. The underlying argument is similar to my own – whether the current account is in surplus or deficit (and the extent of that imbalance) is primarily driven by factors in the domestic economy, not the external sector or the exchange rate;
2. Australia now has almost no FX reserves to speak of, despite being heavily exposed to trade and commodity prices, and a foreign presence in their bond market that exceeds ours. IIRC, they barely have one month cover of retained imports.

The implication is that all adjustments take place in prices instead of levels i.e. the AUD exchange rate adjusts, not their level of reserves. Despite this difference, the MYRAUD cross rate is one of the most stable I’ve ever seen outside of a pegged exchange rate. Or to put it more bluntly – despite not having accumulated “insurance” (FX reserves) against capital outflows, and thus deliberately exposing the exchange rate to greater volatility, the AUD does not appear to be any more volatile than the MYR is. There was an exception to this, running roughly from October 2008-May 2009, coinciding with the collapse of Lehman Brothers and running to the beginnings of the global recovery. But this was more the exception that proved the rule.

Notes:

Rochelle Belkar, Lynne Cockerell and Christopher Kent, "Current Account Deficits:The Australian Debate", Reserve Bank of Australia Discussion Paper 2007-02, March 2007

More Reserve Gibberish

Scenario 1:

I borrow $100 from my neighbour Adam for a month and give him an IOU. In my books, I’ll have $100 in liabilities to Adam that I have pay back in 30 days, while Adam has an asset of $100 that he can claim from me. Adam is however short of cash, and sells my IOU to Chong across the street a week later. In my books, I still owe $100 in 3 weeks time, but this time to Chong. From my point of view, it hardly matters where the money came from – I still have to pay it back based on the IOU. The important point here is that the debt outstanding remains $100. The transfer of the debt liability from Adam to Chong doesn’t constitute an increase in my borrowing.

Scenario 2:

Muthu is going on holiday and wants my help to take care of his cat. So for a week, I will have a cat around the house that I’m responsible for, at the end of which I’ll have to return it to him. During that week, my balance sheet will show that I have a “debt” of 1 cat to Muthu (it shows as an asset on his balance sheet). He’ll be very upset if I don’t have it when he returns.

Reserves and Reserve Cover

This is really tiresome (excerpt):

Malaysia's Bond Recovery Is Under Threat

Malaysia’s bonds are coming back in favor but the respite may be brief. The level of the nation’s foreign reserves is coming under scrutiny as investors brace for outflows from emerging markets.

The lowest reserve adequacy in Asia is sapping demand for the securities just as they are recovering from the longest selloff by foreign investors in eight years. Relatively high foreign ownership and an acceleration in inflation from last year are adding to risks as major central banks sound increasingly hawkish on interest rates….

…Malaysia’s reserves are sufficient to finance 6.5 months of imports, according to data compiled by Commerzbank AG using a 12-month moving average. That compares with 9.9 months for Indonesia, 10.8 for Thailand, 11.2 months for the Philippines, and 21.6 for China.

Bank Negara Malaysia’s reserves amount to just 1.1 times the amount of short-term debt on issue, Commerzbank estimates. The corresponding ratio is 2.8 for Indonesia, 3.7 for the Philippines and 4.3 for India….

Ringgit Fallacies: Imported Inflation and International Reserves

Another week, another multi-year low for the Ringgit. Since BNM appears to have stopped intervening, the Ringgit has continued to weaken against the USD, to what appears to be everyone’s consternation. There is this feeling that BNM should do something, anything, to halt the slide – cue: rumours over another Ringgit peg and capital controls.

To me, this is all a bit silly. Why should BNM lift a finger? Both economic theory and the empirical evidence is very clear – in the wake of a terms of trade shock, the real exchange rate should depreciate, even if it overshoots. NOT doing so would create a situation where the currency would be fundamentally overvalued, and we would therefore be risking another 1997-98 style crisis. Note the direction of causality here – it isn’t the weakening of the exchange rate that gave rise to the crisis, but rather the avoidance of the adjustment.

Pegging the currency under these circumstances would be spectacularly stupid. I’ll have more to say about this in my next post.

China, Gold and Reserve Currencies

In case you missed it, gold looks to be declining again (USD per troy ounce):

But let’s keep some perspective:

Government Debt and FX Reserves

From Bloomberg via The Edge (excerpt):

Malaysia raising $2 billion as worst Asia currency saps reserves

SINGAPORE/KUALA LUMPUR (Apr 14): Malaysia is tapping the U.S. dollar bond market for the first time in four years as it burns through foreign-exchange reserves defending Asia’s worst currency.

The government is poised to sell as much as $2 billion of Islamic notes this week, one month after state-owned Petroliam Nasional Bhd. issued a record $5 billion of sukuk and conventional debt in the U.S. currency. Malaysia’s foreign currency holdings fell 9.4 percent this year, the steepest first-quarter loss since the 1997 Asian financial crisis. The ringgit dropped 5.4 percent, compared with a 4.6 percent slump in the Indonesian rupiah.

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.

Commodities and Currencies

There’s quite a bit of gloom in the air these last few weeks. The plunge in oil and other commodity prices, capital pulling out of emerging markets, and currency turmoil, have people getting very worried about growth prospects next year. There doesn’t appear to be a bottom yet on oil prices, and it’s anybody’s guess where all this will end up.

In Malaysia’s case, oil price depreciation and Ringgit depreciation seems like one piling on the other – the latter is making things worse (Malaysians feel relatively poorer), on top of the drop in oil and gas revenues. But conflating the two like this is wrong. The depreciation of the currency is in fact a required and necessary result of the drop in oil prices.

Ringgit Getting You Down? Don’t Panic

The stock market is losing ground, the Ringgit is being hammered, interest rates are slowly rising, inflation is increasing, and growth is anaemic. Not a whole lot of good news lately.

Don’t Panic.

The market selldown is general; it’s happening across the region and pretty much affecting most emerging markets. Malaysia is one of many, and we’re not being singled out. Just as expansionary monetary policy in advanced economies and greater global liquidity helped support emerging markets in 2010-2011, we’re seeing a pullback as the Fed begins signalling its willingness to reverse course.

Don’t Panic.

The Optimal Level Of International Reserves

East Asia over the years have been variously accused of currency manipulation and neo-merchantilist policies. Massive reserve holdings in the region – e.g. China’s USD3.2 trillion, Japan’s USD1.3 trillion; nine of the top twenty reserve holdings are in East Asia  - can be pointed to as proof of this assertion.

A new research paper in this month’s NBER circulation disputes this view however (abstract; emphasis added):

Optimal Holdings of International Reserves: Self-Insurance against Sudden Stop
Guillermo A. Calvo, Alejandro Izquierdo, Rudy Loo-Kung

This paper addresses the issue of the optimal stock of international reserves in terms of a statistical model in which reserves affect both the probability of a Sudden Stop–as well as associated output costs–by reducing the balance-sheet effects of liability dollarization. Optimal reserves are derived under the assumption that central bankers conservatively choose reserves by balancing the expected cost of a Sudden Stop against the opportunity cost of holding reserves. Results are obtained without using calibration to match observed reserves levels, providing no a priori reason for our concept of optimal reserves to be in line with observed holdings. Remarkably, however, observed reserves on the eve of the global financial crisis were–on average–not distant from optimal reserves as derived in this model, indicating that reserve over-accumulation in Emerging Markets was not obvious. However, heterogeneity prevailed across regions: from a precautionary standpoint, Latin America was closest to model-based optimal levels, while reserves in Eastern Europe lay below optimal levels, and those in Asia lay above. Nonetheless, there are other motives for reserve accumulation: we find that differences between observed reserves and precautionary-motive optimal reserves are partly explained by the perceived presence of a lender of last resort, or characteristics such as being a large oil producer. However, to a first approximation, there is no clear evidence supporting the so-called neo-mercantilist motive for reserve accumulation.

April 2012 Monetary Conditions [Updated]

Well, I’m back from my break, recharged but thoroughly unrested

But on to last week’s monetary data release from BNM. I haven’t done one of these for a while, as (1) little substantive has changed; and (2) while I’ve been updating the data, I’ve lacked the time to publish a review in a timely manner. Old news is stale news as they say.

Nevertheless, things are heating up (metaphorically) in a monetary sense. With Europe back in the news, China showing signs of a slowdown, and US recovery losing steam, it’s back to global risk aversion again. And that means global capital outflows into US treasuries (notice that gold hasn’t budged).

We’re only seeing a few signs of this locally though, as money supply growth is pretty stable (log annual and monthly changes; seasonally adjusted):

Reserves, Deposits and Loans

Some days I feel like tearing my hair out. It seems like so many people are living in a past that just doesn’t exist anymore. It’s one thing for a layman not to grasp the intricacies of macro-economics – but its quite another for analysts and economists to make basic mistakes. And even worse if its a policy maker.

I fully understand how Hafiz Noor Shams feels.

Jeff Frankel On The Renminbi’s Prospects As A Reserve Currency

He doesn’t think the conditions are there yet (excerpt):

The Rise of the Renminbi as International Currency: Historical Precedents

…Some are now claiming that the renminbi could overtake the dollar for the number one slot in the international currency rankings within a decade (especially Subramanian 2011a, p.19; 2011b). The basis of this prediction is, first, the likelihood that the Chinese economy will surpass the US economy in size and, second, the historical precedent when the dollar overtook the pound sterling as the number one international currency during the period after World War I...

Revisiting The Dollar Hegemony: Alternative Reserve Currencies Over The Years

In yesterday’s mail from the National Bureau of Economic Research (abstract):

Reserves and Baskets
Michael D. Bordo, Harold James

We discuss three well known plans that were offered in the twentieth century to provide an artificial replacement for gold and key currencies as international reserves: Keynes’ Bancor, the SDR and the Ecu (predecessor to the euro).The latter two of these reserve substitutes were institutionalized but neither replaced the dollar as the principal medium of international reserve.

Despite the brief and dry abstract, the paper itself is a very readable and informative trip down memory lane, outlining the various attempts over the years to find a replacement for the US Dollar’s role as the primary reserve currency in the post-war international monetary system.

3Q Forex Update

What a difference a few months make. With increasing uncertainty over global growth and the threat of defaults in the Euro area, there’s been a general retreat from emerging market currencies to “safe-haven” currencies such as the Yen, the Swiss Franc and especially the USD.

No surprise then that the trade-weighted indexes have both dropped (index numbers; 2000=100):

The Triffin Dilemma Revisited

Lorenzo Bini Smaghi of the Executive Board of the ECB explains the Triffin Dilemma (excerpt):

The Triffin dilemma revisited

The intellectual heritage of Robert Triffin begins with the relevance of his “dilemma” to our days. We still have a situation in which one national currency – the US dollar – serves as the main international currency. It remains at the heart of the international monetary and financial system (or IMS). And we still have a fundamental tension between the currency demands of rapidly growing economies, the domestic policy incentives of reserve issuing/holding countries, and global economic and financial stability: in Triffin’s words, the system remains “highly dependent on individual countries’ decisions”.

Financial Crises: A Primer On Survival For Emerging Markets

Jeff Frankel of Harvard summarises the current thinking:

The 2008-09 Global Financial Crisis: Lessons for Country Vulnerability

After the currency crises of 1994-2001, and especially the East Asia crises of 1997-98, a lot of research investigated what countries could do to protect themselves against a future repeat. More importantly, policy makers in emerging markets took some serious measures. Some countries abandoned exchange rate targets and began to float. Many accumulated high levels of foreign exchange reserves. Many moved away from dollar-denominated debt, toward other kinds of capital inflow that would be less vulnerable to currency mismatch, such as domestic currency debt or Foreign Direct Investment. Some instituted Collective Action Clauses in their debt contracts to facilitate otherwise-messy restructuring of debt in the event of a severe negative shock. A few raised reserve requirements or otherwise tightened prudential banking regulations (clearly not enough, in retrospect). And so on.

2Q 2011 Forex Update

The Ringgit has continued to rise against the USD, despite some hiccoughs along the way (index numbers; 2000=100):

What’s apparent is that the pace of appreciation has slowed to something closer to the pre-crisis rate of around 0.3% per month, rather than the torrid 0.7% pace in the recovery phase.