Blame the Economists?


November 7, 2018

Blame the Economists?

by
economists

Ever since the 2008 financial crash and subsequent recession, economists have been pilloried for failing to foresee the crisis, and for not convincing policymakers of what needed to be done to address it. But the upheavals of the past decade were more a product of historical contingency than technocratic failure.

 

BERKELEY – Now that we are witnessing what looks like the historic decline of the West, it is worth asking what role economists might have played in the disasters of the past decade.

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From the end of World War II until 2007, Western political leaders at least acted as if they were interested in achieving full employment, price stability, an acceptably fair distribution of income and wealth, and an open international order in which all countries would benefit from trade and finance. True, these goals were always in tension, such that we sometimes put growth incentives before income equality, and openness before the interests of specific workers or industries. Nevertheless, the general thrust of policymaking was toward all four objectives.

Then came 2008, when everything changed. The goal of full employment dropped off Western leaders’ radar, even though there was neither a threat of inflation nor additional benefits to be gained from increased openness. Likewise, the goal of creating an international order that serves everyone was summarily abandoned. Both objectives were sacrificed in the interest of restoring the fortunes of the super-rich, perhaps with a distant hope that the wealth would “trickle down” someday.

At the macro level, the story of the post-2008 decade is almost always understood as a failure of economic analysis and communication. We economists supposedly failed to convey to politicians and bureaucrats what needed to be done, because we hadn’t analyzed the situation fully and properly in real time.

Some economists, like Carmen M. Reinhart and Kenneth Rogoff of Harvard University, saw the dangers of the financial crisis, but greatly exaggerated the risks of public spending to boost employment in its aftermath. Others, like me, understood that expansionary monetary policies would not be enough; but, because we had looked at global imbalances the wrong way, we missed the principal source of risk – US financial mis-regulation.

Still others, like then-US Federal Reserve Chairman Ben Bernanke, understood the importance of keeping interest rates low, but overestimated the effectiveness of additional monetary-policy tools such as quantitative easing. The moral of the story is that if only we economists had spoken up sooner, been more convincing on the issues where we were right, and recognized where we were wrong, the situation today would be considerably better.

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The fact that Obama failed to take aggressive action, despite having recognized the need for it beforehand, is a testament to Tooze’s central argument. Professional economists could not convince those in power of what needed to be done, because those in power were operating in a context of political breakdown and lost American credibility. With policy making having been subjected to the malign influence of a rising plutocracy, economists calling for “bold persistent experimentation” were swimming against the tide – even though well-founded economic theories justified precisely that course of action.—

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The Columbia University historian Adam Tooze has little use for this narrative. In his new history of the post-2007 era, Crashed: How a Decade of Financial Crises Changed the World, he shows that the economic history of the past ten years has been driven more by deep historical currents than by technocrats’ errors of analysis and communication.

Specifically, in the years before the crisis, financial deregulation and tax cuts for the rich had been driving government deficits and debt ever higher, while further increasing inequality. Making matters worse, George W. Bush’s administration decided to wage an ill-advised war against Iraq, effectively squandering America’s credibility to lead the North Atlantic through the crisis years.

It was also during this time that the Republican Party began to suffer a nervous breakdown. As if Bush’s lack of qualifications and former Vice President Dick Cheney’s war-mongering weren’t bad enough, the party doubled down on its cynicism. In 2008, Republicans rallied behind the late Senator John McCain’s running mate, Sarah Palin, a folksy demagogue who was even less suited for office than Bush or Cheney; and in 2010, the party was essentially hijacked by the populist Tea Party.

After the 2008 crash and the so-called Great Recession, years of tepid growth laid the groundwork for a political upheaval in 2016. While Republicans embraced a brutish, race-baiting reality-TV star, many Democrats swooned for a self-declared socialist senator with scarcely any legislative achievements to his name. “This denouement,” Tooze writes, “might have seemed a little cartoonish,” as if life was imitating the art of the HBO series “Veep.”

Of course, we have yet to mention a key figure. Between the financial crisis of 2008 and the political crisis of 2016 came the presidency of Barack Obama. In 2004, when he was still a rising star in the Senate, Obama had warned that failing to build a “purple America” that supports the working and middle classes would lead to nativism and political breakdown.

Yet, after the crash, the Obama administration had little stomach for the medicine that former President Franklin D. Roosevelt had prescribed to address problems of such magnitude. “The country needs…bold persistent experimentation,” Roosevelt said in 1932, at the height of the Great Depression. “It is common sense to take a method and try it; if it fails, admit it frankly and try another. But above all, try something.”

The fact that Obama failed to take aggressive action, despite having recognized the need for it beforehand, is a testament to Tooze’s central argument. Professional economists could not convince those in power of what needed to be done, because those in power were operating in a context of political breakdown and lost American credibility. With policymaking having been subjected to the malign influence of a rising plutocracy, economists calling for “bold persistent experimentation” were swimming against the tide – even though well-founded economic theories justified precisely that course of action.

Still, I do not find Tooze’s arguments to be as strong as he thinks they are. We economists and our theories did make a big difference. With the exception of Greece, advanced economies experienced nothing like a rerun of the Great Depression, which was a very real possibility at the height of the crisis. Had we been smarter, more articulate, and less divided and distracted by red herrings, we might have made a bigger difference. But that doesn’t mean we made no difference at all.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

Safeguarding A Rules-based Trading System against America First Trade Economics


October 16, 2018

Safeguarding A Rules-based Trading System against America First Trade Economics

by Dr. Mari Pangestu, Universitas Indonesia

http://www.eastasiaforum.org

 

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“Without concerted effort and a coalition of willing leadership, including from the EU and East Asia, the future of the rules-based trading system will remain under threat.”–Dr. Mari Elka Pangestu

Despite expectations that the US Federal Reserve would raise interest rates, capital flows to the United States have led to the appreciation of the US dollar against most major currencies.

The hardest hit countries are Argentina and Turkey, which are experiencing fiscal issues complicated by their political situations. Brazil, South Africa and the emerging countries in Asia have also been affected — albeit at a lower rate of depreciation of their currencies in the 10 to 12 per cent range. Even Australia and China have experienced depreciation of around 8 per cent and 5 per cent respectively.

The level of depreciation experienced by different economies reflects how investors perceive their different fundamental macroeconomic conditions, especially the level of their current account and fiscal deficits and policy outlooks.

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The rising US dollar raises questions about the capacity of emerging economies to service their dollar-denominated debts and the vulnerabilities this could expose in their financial systems. Even if the current economic conditions point to a low potential for contagion from Argentina and Turkey, IMF Managing Director Christine Lagarde recently warned that ‘these things could change rapidly’. The uncertainty that already exists is a clear and present danger.

The uncertainty in the world economy has been increasing since Brexit and the election of President Trump in 2016, and in 2017 as the United States left the Trans-Pacific Partnership and announced many threats to impose trade restrictions. This uncertainty has heightened since January 2018 when US President Donald Trump made good on his threats to remedy bilateral trade deficits — what he sees as ‘unfair trade’ practices against the United States — by imposing tariffs on imported solar panels and washing machines, followed by aluminium and steel.

Since March, the greatest uncertainty has been from the brewing tit for tat trade conflict between the United States and China, which started with the imposition of 25 per cent tariffs on US$50 billion worth of China’s exports to the United States. China retaliated with the same sized tariffs on the same amount of trade from the United States. Trump then escalated the trade war further in September with the announcement of 10 per cent tariffs on US$200 billion worth of China’s exports to the United States.

The US–China trade conflict and the uncertainty surrounding it is expected to have knock on effects on global trade and investment flows. The impact of the reduction in China’s exports to the United States on China’s growth will reduce China’s imports, which in turn will impact the many countries that China has become a major trading partner for.

This means that China and other countries facing US trade restrictions will look for new markets for their goods. The situation has already led some countries to impose restrictions or initiate trade remedy investigations, for instance on steel. This uncertainty has and will continue to influence trade and investment, as businesses evaluate how the increased restrictions will affect their supply chains.

It is too early to tell how large the disruption will be, as it is not easy to dismantle supply chains. But the costs down the line could be great as businesses re-evaluate their trade and investment decisions to insulate themselves from tariffs rather than to maximise their competitiveness.

The most concerning aspect of all this is that, after 75 years of being its greatest advocate, the United States is now the biggest threat to the future of the rules-based trading system that has provided predictability and fairness in the way the world engages in trade. There is no clear light at the end of the tunnel.

The key question is: what is Trump’s intention? Is it to change the rules of the game to benefit the United States and address China’s ‘non-market-oriented policies’ or is it just anti-trade and America First? Assuming it is the former, there are at least three important responses needed.

First is safeguarding the stability of the World Trade Organization (WTO) as the overarching framework to provide predictability, fairness and stability. To this end, it is vital that the WTO dispute settlement mechanism continues to operate. The test case is the Chinese and EU case against US steel and aluminium tariffs and getting past the blocking of panel judge nominations by the United States.

Ensuring that the United States does not use blunt unilateral instruments to address its concerns also means that reforms to the WTO rule book are needed. More must be done to address concerns around intellectual property rights, investment, the environment, labour, competition policy, subsidies, tax, digital data and the treatment of developing countries.

Second, the process of opening-up must continue, with or without the United States. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership is a good start. And it is of the utmost importance that the Regional Comprehensive Economic Partnership negotiations are concluded in November this year. These are all important processes to signal the continued commitment of East Asia to expanding markets and fostering flows of trade and investment.

Third, and what most will agree is the most important process, is unilateral reforms. Given increased global uncertainty and limited policy space for fiscal stimulus, structural reforms are a must for East Asian countries, especially China. These range from trade and investment reforms, as well as reforms related to competition policy, intellectual property, the role of state-owned enterprises and sustainability. As in the past, unilateral reforms are more successfully undertaken when there is peer pressure and benchmarking from international commitments.

Without concerted effort and a coalition of willing leadership, including from the EU and East Asia, the future of the rules-based trading system will remain under threat.

Dr. Mari Pangestu is former Indonesian trade minister and Professor at the University of Indonesia.

This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Asian crisis, ready or not’.

The de-dollarization in China


April 10, 2018

The de-dollarization in China

 

The US dollar is so important in today’s economy for three main reasons: the huge amount of petrodollars; the use of the dollar as the world’s reserve currency and the decision taken by US President Nixon in 1971 to end the dollar convertibility into gold.

The US currency is still a large part of the Special Drawing Rights (SDR), the IMF’s “paper money”. A share ranging between 41% and 46% depending on the periods.

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Petrodollars emerged when Henry Kissinger dealt with King Fahd of Saudi Arabia, after “Black September” in Jordan.

The agreement was simple. Saudi Arabia had to accept only dollars as payments for the oil it sold, but was forced to invest that huge amount of US currency only in the US financial channels while, in return, the United States placed Saudi Arabia and the other OPEC neighbouring countries under its own military protection.

Hence the turning of the dollar into a world currency, considering the importance and extent of the oil market. Not to mention that this large amount of dollars circulating in the world definitely marginalized gold and later convinced the FED that the demand for dollars in the world was huge and unstoppable.

An unlimited amount of liquidity that kept various US industrial sectors alive but, above all, guaranteed huge financial markets such as the derivatives – markets based on the structural surplus of US liquidity.

After the Soviet Union’s collapse, the United States always thought about world’s hegemony and, above all, imagined to oppose the already active Eurasian union between China, Iran and Russia – the worst nightmare for US decision-makers – both at military and financial levels.

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As early as those years, following Brzezinsky’s policy line, the US analysts warned against the unification of Eurasia – to be absolutely prevented – and against the subsequent reunification of Eurasia with the Eurasian peninsula, to be avoided even with a war.

At that time, the three aforementioned States still conducted their business in dollars: China wanted to keep on becoming the “world factory”; Russia had run out of steam and was near breaking point; Iran had to inevitably adapt to the rest of Sunni OPEC.

With Putin’s rise to power, Russia’s de-dollarization began immediately. The share of dollar reserves declined year after year, while Putin proposed new oil contracts. Since last year, for example, dollars cannot be used in ports.

In the case of Iran, the sanction regime – in particular – has favoured the discovery of means other than the dollar for international settlements. The operations and signs of the de-dollarization continued.

The war in Iraq against Saddam Hussein was also a fight against the Rais who wanted to start selling his oil barrels in euros, while the war in Afghanistan was viewed by China as part of the ongoing overall encirclement of its territory.

Hence the importance of the Belt and Road Initiative. Also the war in Afghanistan was an attempt to stop the Eurasian project of economic and commercial (as well as political) union between Russia, Iran and China.

As further sanction, the United States has removed Iran from the SWIFT network, the well-known world interbank transfer system, which is also a private company.

Iran, however, has immediately joined the Chinese CIPS, a recent network, similar to SWIFT, with which it is already fully connected.

Basically China’s idea is to create an international currency based on the IMF’s Special Drawing Rights and freely expendable on world markets, in lieu of the US dollar, so as to avoid “the dangerous fluctuations stemming from the US currency and the uncertainties on its real value “- just to quote the Governor of the Chinese central bank, Zhou Xiao Chuan, who will soon be replaced by Yi Gang.

In the meantime, Russia and China are acquiring significant amounts of gold. In recent years China has bought gold to the tune of at least 1842.6 tons, but the international index could be distorted, as many transactions on the Shanghai Gold Exchange are Over the Counter (OTC) and hence are not reported.

Again according to official data, so far Russia is supposed to have reached 1857.7 tons. Both countries have so far bought 10% of the gold available in the world.

Meanwhile, Saudi Arabia has already accepted payments in yuan for the oil sold to China, which is its largest customer. This is a turning point. If Saudi Arabia gives in, sooner or later all OPEC countries will follow suit.

In many cases, India and Russia have already traded with Iran by accepting oil in exchange for primary goods and commodities.

China has also opened a credit line with Iran amounting to as many as 10 billion euros, with a view to getting around sanctions. It is also assumed that North Korea uses cryptocurrencies to buy oil from China.

As devastated as its economy is, Venezuela no longer sells its oil in dollars – and it is worth recalling it can boast the largest world reserves known to date.

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Furthermore, China will buy gas and oil from Russia in yuan, with Russia being able to convert yuan into gold directly on the Shanghai International Energy Exchange.

Keynes’ “tribal residue” takes its revenge. So far the agreements for trade in their respective currencies were signed between China and Kazakhstan (on December 14, 2014),between China and South Africa (on April 10, 2015) and between Russia and India (on May 26, 2015) while, at the end of November 2015, the Russian central bank included the yuan into the list of currencies that can be accepted as reserves.

On November 3, 2016 an agreement was signed between Turkey and Russia for the exchange of their currencies and in October 2017 a similar agreement was reached between Turkey and Iran.

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For financial institutions, the de-dollarization continued with the establishment of the BRICS Fund worth 100 billion dollars (on July 16, 2014) and with the establishment – on January 16, 2016 – of the Asian Infrastructure Investment Bank (AIIB), made up of 57 member countries, including Italy, which automatically caused the US anger.

In May 2015 the Russian-Chinese Investment Bank was created, followed in July 2015 by the opening of the new bank for the development of BRICS, based in Shanghai. In November 2015, however, Iran approved the establishment of a bank together with Russia.

It is worth underlining that in April 2015 the Russian national credit card system was opened, dealing also with small currency transfers.

It is also worth recalling the Duma law on de-offshorization of November 18, 2014, i.e. the legislation obliging the Russian companies resident abroad to pay taxes directly to the Russian Treasury.

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The above mentioned Chinese CIPS started operating in October 2015, while in March 2017 Russia implemented a system similar to SWIFT (interacting with the Chinese one).

The issue is complex because with fracking, the United States has become the first oil producer – hence there is less need to keep the huge amount of petrodollars. This happens while a natural oil and gas shale deposit has just been discovered, off the coast of Bahrain, with reserves of 80 billion oil barrels and 4 trillion cubic meters of gas.

The United States does no longer buy oil and gas because it does not need them, but China is increasingly the best global buyer.

Apart from the stability of gas and oil prices, which should be guaranteed in the coming years, China and its allies should be ever more able to select between the supply and, certainly, between the countries which accept the non-oil bilateral exchange with China and payments in yuan or gold.

Still today, the US GDP accounts for 22% of world’s GDP, while 80% of international payments are made in dollars.

Hence the United States receives goods from abroad always at comparatively very low prices, while the massive demand for dollars from the rest of the world allows to refinance the US public debt at very low costs. This is the economic and political core of the issue.

In fact, the Russian government held a specific meeting on de-dollarization in spring 2014.

This is another fact to be highlighted. It is a political operation that appears to be a financial one, often in contrast with the “volatility” of current markets, but its core is strategic and geopolitical.

In theory, the de-dollarization regards three specific issues: payments, the real economy issue and ultimately the financial issue, namely the financial contracts denominated in dollars.

In the first case, China will tend to eliminate every transaction denominated in US dollars by third countries and to remove settlement mechanisms involving the dollar and operating in its neighbouring areas.

In the second case, the dollar transactions will be – and are already – largely prohibited for individuals.

In the third case, the share of foreign contracts denominated in yuan is now equal to 40% and strong acceleration will be recorded in 2018.

The oil futures denominated in yuan are now booming. The first attempt was made in 1993, when China opened its stock exchanges in Beijing and Shanghai.

China itself closed operations two years later, due to market instability and to the yuan weakness. Two other things have changed since then: in 2016 the yuan was admitted as a currency making up the IMF Special Drawing Rights and in 2017 China overtook the United States as the world’s largest oil importer.

Hence, thanks to the oil futures denominated in yuan, China is reducing its dependence on the dollar and, in the meantime, it is supporting its oil imports, as well as promoting the use of the yuan globally and expanding its presence in the world. Russia has done the same.

Therefore the United States is about to be ousted as world’s currency due to its continuous series of wars and military failures (former President Cossiga always told me: “The United States is always on the warpath and up in arms, but then it is not able to get out of it”) and, like everyone else, it shall pay for its public debt, which is huge and will be ever more its problem, not ours.

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Here it is worth recalling what the US Treasury Secretary, John Connally, said to his European counterparts during a meeting in 1971: “The dollar is our currency, but your problem”.

Obviously, in relation to all these issues which also concern primarily the euro, the European Union is silent and sleepy.

IMF Article IV Consultations with Malaysia


March 11, 2018

IMF Article IV Consultations with Malaysia

The Economic News is not bad for Malaysia.  But the politics is something we as Malaysians must worry about. The regime in power is playing with race and religion to keep Malay votes and retain power. As a result, Malaysia is today a divided nation. Corruption is also at an all time high. Understandably the IMF scrupulously avoids commenting on  the state of politics –Din Merican

A New Landmark  under construction in Kuala Lumpur

The IMF Executive Board has recently concluded the Annual Article IV consultations with Malaysia. The Fund has issued a number of documents relating to the consultations. These highly nuanced documents are in a sense a report card on the performance of the Malaysian economy. They also highlight areas in which policy reforms are recommended. In the current round, there were a few issues on which there was no convergence of views.

Author/Editor:

International Monetary Fund. Asia and Pacific Dept

Publication Date: March 7, 2018

Electronic Access:

Free Full Text. Use the free Adobe Acrobat Reader to view this PDF file

The full report and related documents can be downloaded from the above site.  Additional documents are listed below:

IMF MEDIA STATEMENT

MF Executive Board Concludes 2018 Article IV Consultation with Malaysia

March 7, 2018

On February 9, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1] with Malaysia.

 The Malaysian economy has shown resilience in recent years despite external shocks and has continued to perform well. Progress was made toward achieving high income status and improving inclusion. Median household income has risen further and the already-low national poverty ratio declined. Real GDP growth has surprised on the upside in 2017, and is estimated at 5.8 percent for the year, driven by domestic demand and robust exports. While headline consumer price inflation went up to 3.8 percent in 2017 due to higher oil prices, core inflation and credit growth are contained. On the external side, the current account surplus is estimated to increase to 2.8 percent of GDP, helped by strong exports.

Growth is projected to start to decelerate from its 2017 peak, remaining above potential at 5.3 percent in 2018, and converging to its potential rate of close to 5 percent in the medium term. In 2018, headline inflation is expected to moderate to 3.2 percent, as the response of core inflation to a positive output gap is partly offset by lower contribution from oil prices. The current account surplus is expected to soften to 2.4 percent of GDP in 2018, as export growth normalizes.

Risks to the growth outlook are balanced. On the external side, downside risks include a global retreat from cross-border integration, structurally weak growth in advanced economies, and a significant China slowdown, while a speedy approval and implementation of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and possibly lingering strong global demand for electronics are upside risks. Domestically, the confidence effects related to the cyclical upturn could be stronger than anticipated, while exposures in the real estate sector pose a downside risk.

Executive Board Assessment[2]

Executive Directors commended the authorities for the strong and resilient performance of the Malaysian economy, underpinned by accommodative monetary policy and gradual fiscal consolidation. While growth will likely remain above potential in 2018, inflationary pressures appear contained, and risks to the outlook are balanced. Going forward, Directors emphasized the importance of supporting economic growth while maintaining stability, as well as raising productivity through structural reform.

Directors agreed with the planned pace of fiscal consolidation in 2018, noting that it will help build buffers while maintaining financial market confidence. Going forward, they supported a gradual consolidation path consistent with the authorities’ fiscal anchor, which would help build additional fiscal space. Directors advised that fiscal consolidation should prioritize higher revenue, to facilitate the adoption of fiscal measures to support external rebalancing. They encouraged further progress on the fiscal structural agenda, including efforts to strengthen fiscal transparency and risk management.

Directors supported the January increase in the monetary policy rate, and agreed that the current policy stance is appropriately biased toward less accommodation while remaining supportive of demand. Noting that Bank Negara Malaysia’s monetary policy framework has served the country well, Directors recommended that monetary policy and exchange rate flexibility remain the first line of defense against shocks.

Directors welcomed improvements in the depth and liquidity of onshore financial markets during 2017 following the Financial Markets Committee (FMC) measures that liberalized and increased the flexibility of onshore hedging instruments, as well as a general rebound of capital inflows to emerging markets. They supported the consultative and inclusive approach adopted by the FMC in developing these measures, and encouraged the authorities to build on these successes to address any further gaps in financial market development. Some Directors urged the authorities to phase out—in a manner that preserves financial stability—the measures assessed by staff as capital flow management measures. A few other Directors, however, were of the view that there should be a greater openness to other approaches to promoting the authorities’ development objectives. Directors urged the authorities to continue a constructive dialogue with staff on these issues.

Directors agreed that financial sector risks appear contained, with sound bank profitability and liquidity, and low nonperforming loans. Nonetheless, they noted that vulnerabilities in household mortgages and the property development sector require vigilance, and recommended taking any necessary steps to mitigate risks. They encouraged the development of a rental real estate market. Directors welcomed the authorities’ commitment to take further actions to address deficiencies in Malaysia’s AML/CFT framework.

Directors commended the authorities’ emphasis on raising productivity and investment and encouraged further labor market reforms. Priority should be given to measures that encourage female labor force participation, improve the quality of education, reduce skills mismatches, and bolster public infrastructure and the regulatory framework to further encourage private investment.

How is the economy doing?

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Malaysia’s economy is showing resilience and is performing strongly. Growth is running above potential, driven by strong global demand for electronics and improved terms of trade for commodities, such as oil and gas. On the domestic front, Malaysia’s strong employment is boosting private consumption, and investment is also helping to drive growth.

 

Martin Khor looks back at the East Asian Financial Crisis 1997


July 5, 2017

Martin Khor looks back at the East Asian Financial Crisis 1997

http://www.thestar.com.my

It is useful to reflect on whether lessons have been learnt and if the countries are vulnerable to new crises.

IT’S been 20 years since the Asian financial crisis struck in July 1997. Since then, there has been an even bigger global financial crisis, starting in 2008. Will there be another crisis?

The Asian crisis began when speculators brought down the Thai baht. Within months, the currencies of Indonesia, South Korea and Malaysia were also affected. The East Asian Miracle turned into an Asian Financial Nightmare.

https://upload.wikimedia.org/wikipedia/commons/1/14/Suharto_resigns.jpg

Despite the affected countries receiving only praise before the crisis, weaknesses had built up, including current account deficits, low foreign reserves and high external debt.

In particular, the countries had recently liberalised their financial system in line with international advice. This enabled local private companies to freely borrow from abroad, mainly in US dollars. Companies and banks in Korea, Indonesia and Thailand had in each country rapidly accumulated over a hundred billion dollars of external loans. This was the Achilles heel that led their countries to crisis.

These weaknesses made the countries ripe for speculators to bet against their currencies. When the governments used up their reserves in a vain attempt to stem the currency fall, three of the countries ran out of foreign exchange.

They went to the International Monetary Fund (IMF) for bailout loans that carried draconian conditions that worsened their economic situation. Malaysia was fortunate. It did not seek IMF loans. The foreign reserves had become dangerously low but were just about adequate. If the ringgit had fallen a bit further, the danger line would have been breached.

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Prime Minister Dr. Mahathir Mohamed and Finance Minister Daim Zainuddin introduced selective capital controls and pegged the Ringgit at RM3.80 to USD1.00.

 

After a year of self-imposed austerity measures, Malaysia dramatically switched course and introduced a set of unorthodox policies.These included pegging the ringgit to the dollar, selective capital controls to prevent short-term funds from exiting, lowering interest rates, increasing government spending and rescuing failing companies and banks.

This was the opposite of orthodoxy and the IMF policies (The Washington Consensus). The global establishment predicted the sure collapse of the Malaysian economy. But surprisingly, the economy recovered even faster and with fewer losses than the other countries. Today, the Malaysian measures are often cited as a successful anti-crisis strategy.

The IMF itself has changed a little. It now includes some capital controls as part of legitimate policy measures.

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The Asian countries, vowing never to go to the IMF again, built up strong current account surpluses and foreign reserves to protect against bad years and keep off speculators. The economies recovered, but never back to the spectacular 7% to 10% pre-crisis growth rates.

Then in 2008, the global financial crisis erupted with the United States as its epicentre. The tip of the iceberg was the collapse of Lehman Brothers and the massive loans given out to non-credit-worthy house-buyers.

The underlying cause was the deregulation of US finance and the freedom with which financial institutions could devise all kinds of manipulative schemes and “financial products” to draw in unsuspecting customers. They made billions of dollars but the house of cards came tumbling down.

To fight the crisis, the US, under President Barack Obama, embarked first on expanding government spending and then on financial policies of near-zero interest rates and “quantitative easing”, with the Federal Reserve pumping trillions of dollars into the US banks.

It was hoped the cheap credit would get consumers and businesses to spend and lift the economy. But instead, a significant portion of the trillions went via investors into speculative activities, including abroad to emerging economies.

Europe, on the verge of recession, followed the US with near zero interest rates and large quantitative easing, with limited results.

The US-Europe financial crisis affected Asian countries in a limited way through declines in export growth and commodity prices. The large foreign reserves built up after the Asian crisis, plus the current account surplus situation, acted as buffers against external debt problems and kept speculators at bay.

Just as important, hundreds of billions of funds from the US and Europe poured into Asia yearly in search of higher yields. These massive capital inflows helped to boost Asian countries’ growth, but could cause their own problems.

First, they led to asset bubbles or rapid price increases of houses and the stock markets, and the bubbles may burst when they are over-ripe.

Second, many of the portfolio investors are short-term funds looking for quick profit, and they can be expected to leave when conditions change.

Third, the countries receiving capital inflows become vulnerable to financial volatility and economic instability.

If and when investors pull some or a lot of their money out, there may be price declines, inadequate replenishment of bonds, and a fall in the levels of currency and foreign reserves.

A few countries may face a new financial crisis. A new vulnerability in many emerging economies is the rapid build-up of external debt in the form of bonds denominated in the local currency.

The Asian crisis two decades ago taught that over-borrowing in foreign currency can create difficulties in debt repayment should the local currency level fall.

To avoid this, many countries sold bonds denominated in the local currency to foreign investors. However, if the bonds held by foreigners are large in value, the country will still be vulnerable to the effects of a withdrawal.

As an example, almost half of Malaysian government securities, denominated in ringgit, are held by foreigners.

Though the country does not face the risk of having to pay more in ringgit if there is a fall in the local currency, it may have other difficulties if foreigners withdraw their bonds.

What is the state of the world economy, what are the chances of a new financial crisis, and how would the Asian countries like Malaysia fare? These are big and relevant questions to ponder 20 years after the start of the Asian crisis and nine years after the global crisis.

 

Martin Khor (director@southcentre.org) is executive director of the South Centre. The views expressed here are entirely his own.
Read more at http://www.thestar.com.my/opinion/columnists/global-trends/2017/07/03/the-asian-financial-crisis-20-years-later-it-is-useful-to-reflect-on-whether-lessons-have-been-lear/#EEkW3MiZXu87cFZM.99

The Yuan joins the SDR


December 6, 2015

The Yuan joins the SDR

Maiden voyage

http://www.economist.com/news/business-and-finance/21679341-its-new-status-might-make-weaker-yuan-chinese-renminbi-joins-imfs

Reserve-currency status might make for a weaker yuan

PASSING through the Suez Canal became easier earlier this year, thanks to an expansion completed in August. Now it is about to become a little bit more complicated. Transit fees for the canal are denominated in Special Drawing Rights, a basket of currencies used by the International Monetary Fund (IMF) as its unit of account. This week the IMF decided to include the yuan in the basket from next year, joining the dollar, the euro, the pound and the yen.

If lots of things were priced in SDRs, the IMF’s decision would have forced companies around the world to buy yuan-denominated assets as soon as possible, to hedge their exposure. That would have prompted China’s currency to strengthen dramatically. But few goods or services are priced in SDRs. Instead, admission to the currency club is significant mainly for its symbolism: the IMF is lending its imprimatur to the yuan as a reserve currency—a safe, liquid asset in which governments can park their wealth. Indeed, far from setting off a groundswell of demand for the yuan, the IMF’s decision may pave the way for its depreciation.

The reason is that the People’s Bank of China (PBOC) will now find itself under more pressure to manage the yuan as central banks in most rich economies do their currencies—by letting market forces determine their value. In bringing the yuan into the SDR, the IMF had to determine that it is “freely usable”. Before coming to this decision, the IMF asked China to make changes to its currency regime.

Most importantly, China has now tied the yuan’s exchange rate at the start of daily trading to the previous day’s close; in the past the starting quote was in effect set at the whim of the PBOC, often creating a big gap with the value at which it last traded. It was the elimination of this gap that lay behind the yuan’s 2% devaluation in August, a move that rattled global markets. Though the yuan is still far from being a free-floating currency—the central bank has intervened since August to prop it up—the cost of such intervention is now higher. The PBOC must spend real money during the trading day to guide the yuan to its desired level.

Inclusion in the SDR will only deepen the expectations that China will let market forces decide the yuan’s exchange rate. The point of the SDR is to weave disparate currencies together into a single, diversified unit; some have suggested, for example, that commodities be quoted in SDRs to reduce the volatility of pricing them in dollars. But if China maintains its de facto peg to the dollar, the result of adding the yuan to the SDR will be to boost the dollar’s weight in the basket, defeating the point.

What would happen if China really did give the market the last word on the yuan? For some time it has been under downward pressure. The simplest yardstick is the decline in China’s foreign-exchange reserves, from a peak of nearly $4 trillion last year to just over $3.5 trillion now—a reflection, in part, of the PBOC’s selling of dollars to support the yuan. Were it not for tighter capital controls since the summer, outflows might have been even bigger.

And the yuan does look overvalued. Despite China’s slowing economy, its continued link to the surging dollar has put it near an all-time high in trade-weighted terms, up by more than 13% in the past 18 months (see chart). With the Federal Reserve gearing up to start raising interest rates at the same time as China is loosening its monetary policy, the yuan looks likely to come under more downward pressure, at least against the dollar.

It would be foolhardy to predict that China will suddenly give the market free rein. That would go against its deep-seated preference for gradual reform. But while basking in the glow of its SDR status, China must also be aware of the responsibility to minimise intervention that comes with it. A weaker yuan may well be the result.