Tag: inflation

Categories
Economics

[1218] Of time for a rate cut?

An article in the Business Times today states that inflationary pressure has subsided:

INFLATIONARY pressures in Malaysia, which have abated since oil prices settled, are expected to subside further this year, say economists.

The economy is unlikely to experience strong cost-push inflationary pressures like that felt by consumers last year when pump prices were hiked following a spike in global crude oil prices, they said. [Rupa Damodaran. Inflationary pressures in Malaysia seen weakening further. Business Times. May 14 2007]

This might signal a possibility of a rate cut some time soon. In fact, there are at least four factors that might make interest rate cut favorable.

One is low inflation as mentioned in the article. Having an inflation-fighting policy when inflation is weak is kind of harsh.

Two, real interest rate is nominal rate minus inflation. Falling inflation, given constant nominal rate causes real rate to go up. Higher returns, in turn, encourages saving, discourages spending or investment, ceteris paribus:

”If real returns continue to swell, we fear it would have some dampening effect on private consumption spending, a trend that may go against the move to spur private consumption,” he added. [Rupa Damodaran. Inflationary pressures in Malaysia seen weakening further. Business Times. May 14 2007]

Further, higher real returns might have caused greater demand for Malaysian bonds:

There was a strong buying interest in the local government bond market last week, especially from offshore parties, which caused yields to fall quite significantly.

[”¦]

Week-on-week, the three-year and five year benchmark MGS fell 24 bps and 25 bps respectively to close at 3.18 per cent and 3.19 per cent.

Meanwhile, the 10-year lost 26 bps to close at 3.47 per cent. [Strong buying interest in govt bonds. Business Times. May 14 2007]

A rate cut would cause real returns to go down and reverse the carrot and stick model, spurring more robust economic activities.

Three, the ringgit is at a nine-year high.

KUALA LUMPUR, May 14 (Bernama) — The ringgit closed higher against the US dollar Monday to hit a new nine-year high since 1998, supported by continued inflow of funds and strong trade surplus, dealers said. [Ringgit Ends Firmer Against US Dollar. Bernama. May 14 2007]

Appreciating ringgit hurts Malaysian export. Strong ringgit makes Malaysian goods more expensive to buyers that uses other currencies.

Four, an expected economic slowdown later this year. Anticipating a slowdown, a rate cut could spur investment and thus possibly stopping an expected slowdown dead on its track.

For recording purpose, below is a table reproduced from Business Times:

Copyrights by Business Times, Malaysia. All rights reserved. Fair use.

The Malaysian equivalent of the Federal Open Market Committee, the Monetary Policy Committee will meet on this coming May 28.

I, of course, prefer the market to set the rate instead of a central bank.

Categories
Economics

[1172] Of pressure for liberalization builds up

The International Herald Tribune, one of many, picks up a report by Associated Press:

KUALA LUMPUR, Malaysia: Foreign funds inflows are keeping Malaysia’s markets on a long rally, but the money is staying in the country because of central bank restrictions and is starting to create economic imbalances, analysts say.

The local currency, the ringgit, is not allowed to be traded offshore, which means currency transactions are limited to within Malaysia. That has created a massive pool of money. [Awash in foreign funds, Malaysia faces economic imbalances over central bank restrictions. AP via IHT. April 8 2007]

Too much many chasing too few capital is a classic, or rather, a textbook recipe for inflation, as mentioned in the same report:

The excess cash in the country is leading to inflationary pressures as there is more money than before, chasing the same amount of goods. [Awash in foreign funds, Malaysia faces economic imbalances over central bank restrictions. AP via IHT. April 8 2007]

Further in the article:

Speculation is now mounting that Bank Negara might eventually lift a curb on the offshore trading of the ringgit that was imposed in 1998 during the Asian financial crisis. [Awash in foreign funds, Malaysia faces economic imbalances over central bank restrictions. AP via IHT. April 8 2007]

It is time to dump our neomercantilist policy in favor of liberal ones.

Categories
Economics

[1141] Of eeriely familiar rhetoric in Venezuela

In Venezuela, Hugo Chávez the socialist, while going on a fool’s errand:

Mr. Chávez champions these ideas, which will take effect in January, as ways to combat inflation, which in recent weeks crept up to 20 percent, the highest in Latin America. Officials blame ”hoarders” for shortages of basic goods and price increases for food on the black market. Mr. Chávez says the renaming and redenominating the currency will instill confidence in it. [Venezuela to Give Currency New Name and Numbers, NYT, March 18 2007]

Isn’t that familiar?

Categories
Economics History & heritage

[1106] Of fighting inflation by shooting down the zeros

What would one do to fight runaway inflation?

In Venezuela, chop the zeros off:

CARACAS (Reuters) – President Hugo Chavez said he will chop three zeros off new bolivar currency bills to bolster Venezuelans’ perception of a strong currency in a bid to curb inflation, which is now highest in Latin America. [Reuters, Feb 16 2007]

If I remember my history correctly, the German Empire took similar route to combat inflation right after the First World War. Though similar, there is one major difference.

In the aftermath of War to End All Wars that did not only fail to end all wars but instead made way for a larger war, the Allied was victorious and the Central Powers was devastated: the Ottoman Empire ceased to exist, Astro-Hungary disintegrated while the German Empire was humiliated through and through. As if such victory was not enough, the Allied at the Treaty of Versailles imposed heavy war reparation against the German state. Given heavy debt burden as well as the power to print money, the German government indulged in seigniorage.

The ability to print money might be cool but be careful, if you printed too much money, you might end up poorer, as the German learned in the 1920s. The German not only learned a lesson or two about inflation — they learned it the hard way.

In 1923, one US dollar was equivalent to 4.2 trillion mark. No. I am not kidding. That is 4,200,000,000,000 mark; 4.2 x 1012 mark. Imagine, if you lived in Berlin in 1923, you would have to use scientific notation to buy a sack of flour. And converse in German to boot!

And oh shit, imagine the (nominal) cost of roses on Valentine! Inflation on top of inflation cannot be good news.

Further, the nominal interest rate stood at around 900%. For comparison purpose, as of February 2007, the Malaysian nominal interest rate is 3.5%.

The funniest thing is, since prices across the board were raising so fast on daily basis if not on hourly basis, the central bank could not print out enough money to make life a little bit simpler for the Germans. In fact, there is one famous picture that depicts how bad inflation was back in 1923:

Public domain.

On Wikipedia: “A German woman feeding a stove with currency notes, which burn longer than the amount of firewood they can buy.”

Suffice to say, I do not think a person could buy dirt with the mark in 1923.

Some time in the same year, the German government which got tired of probably raising the interest rate almost daily — while the people got tired of running from the banks to the stores just to make sure 4.2 x 1012 mark would still be 4.2 x 1012 mark an hour later — replaced the heavily inflated mark with a new mark. Those outrageous zeros were slashed. While the Venezuela is cutting three zeros, the German cut 12. The new regime brought sanity back to an insane monetary roller coaster ride.

Apart from that, the new mark was anchored to real assets, which, I do not think is true for the Venezuelan bolivar. Because of this — this is the only policy tailored to fight inflation — and the reputation of Venezuelan central banking, I believe that the problem Venezuela is facing would not end anything soon. Reputation is important in the fight against inflation. Given how populist the Venezuelan government is right now, I doubt the central bank — which I assume has no independence on monetary policies — would have the stomach to fight inflation.

Apart from that slashing of zeros, there are other efforts aimed to fight inflation. For instance, Venezuela is cutting down taxes to fight inflation:

Chavez said VAT will first be reduced on March 1 by 3 percentage points and then by a further 2 points on July 1. [Reuters, Feb 15 2007]

And to promise to introduce new taxes to replace the old taxes:

To compensate for the income loss, Chavez, a proud socialist, said the government will create new taxes, including one that could involve the private property of the rich. [Reuters, Feb 15 2007]

With the removal of VAT, prices could fall but it remains unclear what the net effect would be as, as stated in the first Reuters’ article, price could increase with the slashing of zeros. The price increase is similar to the effect of abolishing the pennies.

Moreover, the abolition of VAT encourages consumption, which could lead to demand-push inflation. I am unsure what the net tax shift would be though.

Right or wrong nevertheless, Venezuela will be an exciting economy to watch from far.