Bracing for another another "hot money" crisis

Sam Chee Kong

So what our policy makers in this part of the world is doing to protect us from all these ‘lose money’ from entering our shores? Apparently our Governor of Bank Negara Tan Sri Dr Zeti Akthar’s response to the FED’s QE2 seems to contradict with what our neighbors are trying to achieve. Instead of preventing the inflow, rather it is encouraging a greater inflow of foreign capital and declared that we have to manage the increase in volatility of the markets due to QE2.

A country’s Money Supply is basically the total of all notes and coins, loans and credit and other liquid investment. Or put it simply the total Money Supply of a country consist of the following :

a) M1 - Notes and coins and money in checking account

b) M2 - M1 + savings a/c, time deposits and market funds

c) M3 - M1 + M2 plus institutional time deposits and US $ floating abroad.

Traditionally when a country wants to increase its money supply it has to go through its Central Bank. Two of the more commonly used instruments are the SRD ratio and the Bond Market. SRD or statutory reserve deposit is the amount of deposit that normal banks need to keep with the Central Bank, normally at about 10%. If the Central Bank sees that there is a need to increase the money supply in the country then it will reduce the SRD ratio say to 9%. Banks will then need to deposit less with the Central Bank and hence have more funds to do increase their loans to customers.

The second method is the making use of the Bond Market. During an expansionary monetary policy the Central Bank will need to buy back more bonds from the market and hence this will help increase the money supply in the country. This is also known as the ‘Open Market Operations’ of the Central Bank and by buying and selling bonds in the market it can influence the liquidity in the market.

However nowadays there is another method whereby the Central Bank can increase the money supply through its ‘Printing Press’ namely Quantitative Easing or QE. QE is just another nicer way to describe‘Money Printing Out of Thin Air’ by the Central Bank. In America QE is done by the Federal Reserve Bank of America or FED. In contrary to popular belief, the FED is a private entity and it doesn’t belongs to the government. Two of its major shareholders are Citibank and JPMorgan. The FED acts as the Central Bank of America and it makes the daily decision in the running of the country’s finances.

Since the last global financial meltdown in 2008, the FED has tried various means to prop up the economy but to no avail. So, ‘Helicopter Ben Bernanke’, the chairman of the FED initiated the QE1 to the tune of $2 trillion with the main objectives of QE1 is to increase the number of new jobs to 2 million and also to boost the lending by banks so as to get the economy moving.

However after 18 months of record low interest of close to zero and trillions spend on increasing the money supply in the country, it seems that it had failed in its attempt to restart the economy. On 3/11/2010 the FED announced that it will initiate QE2 which will add $600 billion of hot money into the economy and another $300 billion to buy up some of the toxic waste in MBS (Mortgage Back Securities) from the banks.

China, Brazil, South Korea and the Euro zone are some of the countries that voice out their disapproval against QE2. They have initiated what they call ‘Capital Control’ to isolate their countries against the onslaught of ‘hot money’ from entering their country. So now, how does QE2 initiated by the FED affect other countries?

First of all by printing more money the FED is essentially devaluing the US dollar. By devaluing its dollar it hope to increase its exports because its goods will be more attractive by now. However this will eventually leads to currency war among other countries. Each and every country with embark on a competitive devaluation of its currency so as to make its exports more competitive. Japan on Sept 16 sold more than 2 trillion yen in order to drive down its currency and Bank Rossii, Russia’s Central Bank bought US$1.1 billion and 136 million euros at the same time so as to keep the rouble within the trading range.

This ‘Beggar Thy Neighbor’ policy will not work in the long run because everybody will try to out devalue each other in order to make their exports more competitive. Thus, this might look more like a Zero Sum Game. In the end if this fails, then they might resort to raising trade barriers or implement currency controls which will prohibit the flow of capital across borders and this is the main contributor of the 1930s depression.

Secondly increasing the money supply does not help solve an insolvent banking system and insolvent household/consumer that have debts up to its eyeballs, but rather will only contribute to price inflation. The definition of inflation is ‘Too Much Money chasing too few goods’ may apply because by increasing the money supply will only increase the demand for goods and thus will lead to increase in price.

As the FED seeks to blowup the global monetary system through its printing press and monetizing its debts, only precious metals like gold and silver cannot be monetized because GOLD is money. Currencies are used to be back by gold during the Breton Woods era until fiat currencies are introduced later. Fiat currencies can be printed at will out of thin air but money (gold) cannot be devalued at the whim of politicians because it is scarce resources. So at the end of the day it is only a proper strategy to ‘include physical gold as part of your investment portfolio’ because the more they print the higher the price of the yellow metal and the weaker the currencies. This will inevitably leads to less purchasing power, lower standard of living and higher asset prices.

So what our policy makers in this part of the world is doing to protect us from all these ‘lose money’ from entering our shores? Apparently our Governor of Bank Negara Tan Sri Dr Zeti Akthar’s response to the FED’s QE2 seems to contradict with what our neighbors are trying to achieve. Instead of preventing the inflow, rather it is encouraging a greater inflow of foreign capital and declared that we have to manage the increase in volatility of the markets due to QE2.

What a load of BS ! Increase in volatility in financial markets is the last thing we want to manage. Hot money is something that we cannot easily reign in, they can come and go at a flick of time. We do have short memories, as witness during the 1997-98 Asian financial crisis, the main contributor is none other than those hot money. Once they pull out in droves they are able to cripple your economy and markets. If we continue letting those loose money in, we will see much more asset inflation. Nowadays it appears there is a huge real estate bubble going on in the Klang Valley. A decent double storey terrace house can easily fetch higher than RM 500,000 and a semi-detached house are sold at no less than RM 1 million in the Klang Valley. If you don’t call this a bubble then I don’t know what it is. If there are any bailouts in future, who is going to pay for all those mess? We taxpayers will be the ones that will be footing the bill through increase taxes, reduce subsidies and etc.

Good government policy begins with the refusal to make the ordinary people pay for mistakes that are not theirs. While our policy makers are trying to do is to preserve our spending and consumption so as to inflate its way out of any contraction in the economy. It seems that our expansionary monetary policy will not solve our budget deficits and reduce our government debts and it appears that we are in a liquidity trap. Instead we should be embarking on a more conservative Contractionary Monetary and Fiscal Policy of spending less and saving more so as to Reduce our Debt/GDP ratio and reduce our Budget Deficits so that our economy is more resilient to future economic shocks.