How do we get out of the debt trap without printing more money?

The policy options open to major economies, including China, to reduce debt, before another global crisis hits

Pedestrians crossing in Tokyo. Quantitative easing stopped a debt implosion, but its initial success enabled politicians to avoid structural reforms, The result was slower growth from declining productivity, even as companies and governments continued to borrow. In short, we are in a debt trap! 

ALL of us are worried about growing global debt as a precursor to another round of crises. After the last global financial crisis, 2007-2009, global debt rose to more than US$200 trillion or US$27,000 for each person in the world.

Since 2.8 billion or nearly 40% live on US$2 per day, there is no way that the debt can ever be repaid. The bulk of debt owed by governments, banks and companies will be repaid by creating more debt.

If we are happy to create money, we should be happy to create more debt. Right?

Wrong. The right question is not the size of the debt or liability, but where is the net asset? Individually, we can always repay the debt if we spend less than what we earn, or invested in an asset that generates sufficient income to pay the interest.

Collectively, the government can always borrow to repay, because it can always tax to repay, if not principal, at least on the interest. Countries only get into trouble when they owe foreigners and cannot raise enough foreign exchange to repay their debt.

High levels of investment – and debt – are good for China’s economy

Charles Goodhart, Emeritus Professor at London School of Economics and one of the foremost thinkers on money and banking has written a series of important articles for Morgan Stanley, analysing the current debt crisis.

Emerging markets

The reason we ended up with more debt than ever is due to three factors since 1970 – the willingness of the financial sector to lend, the increase in global savings relative to investment and the demand for safe assets. Professor Goodhart attributed the structural increase in savings to favourable demographics in the last forty years – particularly as emerging markets like China increased their savings from growth in their labour force that engaged in international trade.

The increase in savings relative to investments created a global savings glut, which meant lower real interest rates.

The willingness of emerging markets to park their excess savings in advanced countries in the form of official reserves and the banks willing to extend credit at lower interest rates created the boom in financialisation. Lower interest rates encouraged speculative activity (funded by debt) rather than investments in long-term productive projects.

When the bust occurred, the advanced central banks wanted to avoid a debt implosion and added to the bubble by lowering interest rates and flooded the markets with short-term liquidity.

The quantitative easing (QE) stopped the widening of the crisis, but its initial success enabled politicians to avoid taking tough action in structural reforms. The result was further slower growth from declining productivity, even as companies and governments continued to borrow, affordable only at near zero interest rates. In short, we are in a debt trap – more debt, little growth.

China lacks urgency about its debt problem, IMF says

Negative interest rates are causing a major problem in the global economy

 Central banks charged with reviving growth using only monetary policy are now actively using negative interest rates and desperate enough to think about helicopter money.

Negative interest rates as a policy tool was invented by small countries like Sweden and Switzerland to discourage large capital inflows that created excessive currency appreciation.

But for the eurozone and Japan to try that would actually destroy their banks’ profitability, which is why bank shares dropped after these were introduced. If banks think they will lose money, they will cut back lending to the real sector further, negating the objective of QE to stimulate growth. Banks receiving QE funds faced the double prospect of being punished for taking credit risks and also the need to increase both capital and liquidity due to the tighter bank regulations.

Helicopter money

Helicopter money is not about central bankers jumping out of helicopters to atone for their mistakes, but about central bank financing a massive increase in fiscal expenditure – truly monetary creation on a large scale. If this happens, watch out for a rise in gold prices.

Prof Goodhart has carefully analysed the three options for deleverging or getting out of the debt trap. The first is to deleverge by swapping debt for equity, being tried by China.

This is feasible when the country is a net lender and both borrowers and lenders are state-owned entities. The second option is to use inflation to reduce the real value of debt. As the recent experience showed, getting inflation even up to target was tough to achieve.

The third option is to address collateral by inducing lenders and borrowers to renegotiate their debt or make the debt permanent. This is both painful and difficult and is unlikely to be adopted unless other options are tried.

China’s banking regulator moves to contain off-balance-sheet risk

In my view, the true result of the Bank of Japan’s negative interest rates is a tax on the older generation, because they are the ones not spending.

Japan tried Keynesian fiscal spending, which failed to sustain growth but created a huge debt overhang.

The Japanese older generation and the corporate sector keeps on saving because they are worried about the future, not surprising given an aging population and sluggish demand for exports.

So if you can’t increase the inflation tax, or corporate taxation to reduce the fiscal debt, use negative interest rates to reduce the value of savings of retirees and the corporate sector. Only Japanese savers would not revolt under such inequity.

For countries that have net savings and large public assets, like China, there is a fourth option to get out of the debt trap, and that is to re-write the national balance sheet. Most foreign analysts who worry about China’s debt overhang forget that after three decades of growth, the Chinese state has also accummulated net assets (net of all liabilities) equivalent to 166% of GDP.

That can be injected as equity into the overleveraged enterprises and banks if and only if the governance and return on assets can be improved under better management.

In the short-run, a clean-up of the over-leveraged enterprise sector and local government debt, embedded in the official and shadow banking system, will help sustain long-run stable growth. How to do this technically will be explained in the next article.

By Tan Sri Andrew Sheng who writes on global affairs from an Asian perspective.

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US's Quantitative Easing (QE) ended, but not financial supremacy

By Luo Jie

The Federal Reserve has officially announced an end to the third round of its quantitative easing bond-buying program. To deal with the financial crisis and make up for the failure of the US government to adequately stimulate the economy, the Federal Reserve has generated trillions of dollars for the American economy in the past six years. It shifted its own financial burden to the rest of the world to some extent.

Europe and Japan also adopted the policy of quantitative easing, albeit with little result. But the US achieved its goal. The fundamental reason is that it is the dollar, rather than the euro or the yen, which is the world's currency for clearance and reserve. The US dominance of the world's financial system has remained quite solid.

When the US pushed forward this policy of quantitative easing, the world complained because the US was dragging down countries and institutions that hold US dollars. Now that the US government and the Federal Reserve have gained some confidence, quantitative easing was abandoned. But Washington has shown indifference to the world's reactions.

In the past six years, there has been much discussion of US decline. The situation in Iraq and Afghanistan enables people to see the limitation of US influence, but the capabilities of US systems still surpass those of other countries. These capabilities are more than enough to maintain the US as a global superpower when it is at the center of a global crisis.

Some media recently speculated that on the purchasing-power basis, China is overtaking the US and becoming the world's biggest economy. China's GDP has been supported by low-end economic activities. It has a long way to go to build up its high-end economic capabilities and build financial systems. Besides the economy, China lags behind the US in terms of national defense, soft power and diplomatic partnerships.

To put it more precisely, China cannot compare with the US. But comparing the two has been popular both within and outside China. Chasing or passing the US can hardly become a China policy. China needs to undergo a tough process to make it stronger.

Both China and the US should keep a sober mind to discuss the possibilities of big power relationship patterns in the 21st century. US financial dominance indeed makes China uneasy, while China takes the initiative to establish an Asian infrastructure investment bank, the US is highly alert and tries to exclude its allies such as Australia and South Korea.

China is clear about its gap with the US. How to narrow it is not only an issue for China, but also for both. The US will not be able to monopolize the world's development opportunities. Its material decline is real, and only when it adds flexibility to the current world order, can its interests be maximized. In the international community, when the strength of a superpower is declining, its morality will be tested.

Souce: Global Time

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Rising tides of currencies globally cause inflation, money worthless!

A PACKET of nasi lemak (rice cooked in coconut milk) with a fried egg costs around RM2 nowadays. I remember getting a similar packet (and in bigger portion) at RM1 ten years ago. It is a 100% price appreciation in ten years! My friends and I were jokingly saying that nasi lemak would be a good investment tool if it can be kept for ten years.

However, all of us know that nasi lemak is best served when it is fresh. It can never be kept for long despite its potential for value appreciation. In fact, its value will drop to zero as soon as it turns stale. And interestingly, the same situation applies to the money we hold today. Our currency can be as “perishable” as nasi lemak in this global money printing era if money is not produced for the right purpose and use in the right way and the right time.

The global economies have been embarking on expansionary monetary policies since the financial crisis broke out in 2008. Central banks around the world are printing money to support their economies and increase exports, with the United States as the primary instigator.

The Mighty Dollar

Since 2008, the Fed initiated several rounds of measure termed “Quantitative Easing”, which is literally known as an act of money printing. The Fed's balance sheet was about US$700bil (RM2.1 trillion) when the global financial crisis began; now it has more than tripled. With several countries' central banks including the European Central bank, the Bank of Japan and the Bank of England taking similar expansionary measures and encouraging lending, more than US$10 trillion (RM30.3 trillion) has been poured into the global economy since the crisis began.

While the global central banks have become addicted to open-ended easing and competed to weaken their currencies to boost economies, the impact of these measures to the global economy is not quantifiable or realised yet. However, basic economic theory tells us that when there is too much money chasing limited goods in the market, it will eventually spark inflation.

When money is created out of thin air, there is no fundamental support to the new money pumped into the economies. More money supply would only be good if the productivity is going up or in the other sense, when more products and value-added services are created. In the absence of good productivity, more and more money would not make people richer. Instead, it would only decrease the purchasing value of the printed notes.

Let's imagine a more simplified situation. For example, we used to purchase an apple for RM1. If the money supply doubled but the amount of apples available in the market remains, one apple will now costs us RM2 instead of RM1. Now, our money has halved its original value. If the central banks of the key economies keep flooding the global markets by printing more money, the scenario can only lead to the worst, i.e. hyperinflation.

This occurred in Germany after the First World War. Hyperinflation happened as the Weimar government printed banknotes in great quantities to pay for its war reparation. The value of the German banknote then fell since it was not supported in equal or greater terms by the country's production.

Flood of money

The sudden flood of money followed by a massive workers' strike, drove prices out of control. A loaf of bread which cost 250 marks in January 1923 jumped to 200 billion marks in November 1923. People collected wages with suitcases. Thieves would rather steal the suitcase instead of the money, and it was cheaper to light fire with money than with newspaper. The German currency was practically worthless during the hyperinflation period.

That scenario may seem incredible in today's context. Nevertheless, we should not downplay the severity of a global inflation should the current synchronised money printing push the economies of major countries to burst like a balloon in sequence.

When this scenario happens, people with savings and fixed income will likely be the hardest hit. To withstand the tide of inflation, the best defence is to invest in assets such as publicly traded shares, metal commodities like gold and silver and properties that can hedge against inflation.

Investing in any assets require in-depth research before embarking on one. Commodities and stock markets are liquid assets that can be bought and sold with relative ease, while properties are favoured as long-term investment.

With Malaysia's current economic and population growth, added with its still comparatively low property prices in the region, our primary and secondary market properties are good investment assets for investors to gain from the continuous capital appreciation that this industry is enjoying.

With the above as a backdrop, are property prices really going up globally?

Using the nasi lemak analogy, if we were to buy a RM100,000 medium-cost apartment 10 years ago, it would be equivalent to 100,000 packets of nasi lemak. Assuming it has doubled in price today, it would still be the equivalent of 100,000 packets of nasi lemak at RM2 today. It would seem to me that the true value of properties hasn't gone up, but that global currencies have just gotten cheaper.

FOOD FOR THOUGHT
By DATUK ALAN TONG

FIABCI Asia Pacific chairman Datuk Alan Tong has over 50 years of experience in property development.

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New global currency wars warning!

The recent money-pumping measure by the United States has been criticised by Brazil as a protectionist move which will adversely affect developing countries.

THE recent announcement by US Federal Reserve chief Ben Bernanke that the United States would be renewing its pumping of money into the banking system has been acclaimed by some parties as a move to revive its faltering economy.

But the Fed’s measure to revive “quantitative easing” is not being welcomed by all. It has instead caused anxiety in some developing countries.

Their fear is that a large part of the massive amounts of money being unleashed into the financial markets may fail to boost the US economy but will find its way as unwanted capital flows into some developing countries.

Bernanke announced that the Fed would purchase US$40bil (RM124bil) per month of mortgage-linked assets from the market, and do so continuously until the jobs situation improves.

The hope is that cheap and abundant money will encourage entrepreneurs and consumers to spend more and spark a recovery.

However, previous rounds of such quantitative easing did not do much for the US economy.

A large part of the extra funds were placed by investors not in new US production but as speculative funds in emerging markets or in the commodity markets, in search of higher returns.

In developing countries that received the funds, adverse effects included an inflation of prices of property and other assets, as well as appreciation of their currencies which made their exports less competitive.

On the other hand, the US dollar depreciated because of the increased supply of US dollars and the reduced interest rates, making US exports more competitive.

Brazil has been in the forefront of developing countries that are critical of the US money pumping. Last week, the Brazilian finance minister Guido Mantega called the US Fed measure a “protectionist” move that would re-ignite global currency wars.

Mantega told the Financial Times that the third round of quantitative easing would only have a marginal benefit in the United States as the already high liquidity in the United States is not going into production.

Instead, it is really aimed at depressing the dollar and boosting US exports.

Japan has also decided to expand its own quantitative easing programme in response to the US move, and this is evidence of tensions and a currency war, said Mantega.

In previous rounds of liquidity expansion in recent years, Brazil has been one of the developing countries adversely affected by sharp currency appreciation, which reduced its export competitiveness and facilitated import increases.

Recently, Brazil’s currency, the real, has weakened from the high of 1.52 real to the dollar to the present two real, which has improved its competitiveness.

But the new liquidity expansion in the United States may again cause a flood of funds to enter Brazil and reverse the currency trend.

In such a situation, Brazil may be forced to take measures to stop the real from appreciating, said the minister.

Previously, the country had taken capital controls to discourage inflows of foreign funds.

What has irritated Brazil even more is an accusation by the US Trade Representative Ron Kirk that Brazil has become protectionist in raising some tariffs, even though the Brazilian measures were within its rights in the WTO framework.

Brazil’s Foreign Minister Antonio Patriota last week wrote to Kirk pointing out the unfairness of a protectionist US accusing Brazil of protectionism.

“The world has witnessed massive monetary expansion and the bailout of banks and industrial companies on an unprecedented scale, implemented by the United States and other developed countries,” said Patriota.

“As a result, Brazil has had to cope with an artificial appreciation of its currency and with a flood of imported goods at artificially low prices.”

He pointed out that the United States was a major beneficiary, as it almost doubled its exports to Brazil from US$18.7bil (RM58bil) to US$34bil (RM105bil) from 2007 to 2011.

“While you refer to WTO-consistent measures adopted by Brazil, we, on our side, worry about the prospect of continued illegal subsidisation of farm products by the United States, which impact Brazil and other developing countries, including some of the poorest countries in Africa.

“The US has managed in a short period to remarkably increase its exports to Brazil and continues to reap the benefits of our expanding market. But it would be fairer if those increases took place in an environment not distorted by exchange rate misalignments and blatant Government support”.

As the quantitative easing from the United States and Japan is only going to take effect in future, it remains to be seen whether history will repeat itself – it will have minimal effect on the United States and Japanese economic recovery but will cause problems for developing countries – or whether it will be different this time.

GLOBAL TRENDS By MARTIN KHOR

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