Tag: stimulus

Categories
Economics

[1826] Of the stock market offers minimum risk?

In his speech unveiling a RM7 billion economic stimulus in the Parliament, the Finance Minister Najib Razak touched on the earlier injection of RM5 billion into ValueCap (translated):

In stimulating the capital market, I announced an additional RM5 billion fund for ValueCap for the purpose of purchasing equities of companies which are priced lowly due to uncertainty in the global equity market but yet exhibit strong fundamentals. The fund will be secured through a loan from the government-guaranteed Employees’ Provident Funds (EPF). Therefore, the loan not only guarantees higher returns vis-a-vis deposit rate offered by banks but it also poses the least risk to the EPF.[1]

Firstly, in the current climate it is hard to believe that the secondary equity market is able to provide better returns in the short run compared to even the dull fixed deposit account. In the long run, maybe but with the stated goal of stimulating the local capital market, surely the investment horizon is short.

Secondly, the equity market is not the least risky options available. In fact, it is probably one of the riskiest there are out there due to its inherent uncertainty. It is hard to imagine why the stock market with erratic prices would be less risky than a fixed deposit which offers stable income stream. Furthermore, if the EPF is interested in investing the least risky field with local context, it should consider investing in risk-free government bonds.

The second point on riskiness as said by the Finance Minister could either be an outright lie or a very, very ill-advised statement.

In any case, the intention behind the injection is suspect, especially, as reported by The Malaysian Insider, ValueCap is due to repay its RM5 billion loan to its three shareholders, Khazanah, the EPF and PNB.[2] Information at hand at the moment suggests that the RM5 billion would be used to pay back those lenders; it appears that the EPF would be the one financing the repayment.

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[1] — Untuk merangsang aktiviti pasaran modal, saya telah mengumumkan penambahan dana Valuecap sebanyak 5 bilion ringgit untuk pembelian ekuiti syarikat-syarikat yang mempunyai asas yang kukuh tetapi nilai pasaran mereka kini terjejas berikutan kesan pergolakan pasaran ekuiti global. Dana tambahan ini akan diperolehi melalui pinjaman daripada Kumpulan Wang Simpanan Pekerja (KWSP) yang dijamin oleh Kerajaan. Oleh itu, pinjaman ini bukan sahaja menjamin pulangan yang lebih tinggi daripada kadar deposit institusi perbankan, tetapi juga merupakan pelaburan yang mempunyai risiko yang paling minimum kepada KWSP. [Economic package unveiled (Updated with full text). The Star. November 4 2008]

[2] — KUALA LUMPUR, Nov 3 — State investment company Valuecap Sdn Bhd owes its three shareholders RM5.1 billion, which is due to be repaid in February 2009.

This debt, in the form of interest-bearing unsecured bonds, raises questions over plans for the Employees Provident Fund to lend RM5 billion to Valuecap to invest in the stock market.

In March 2003, Valuecap borrowed RM5.1 billion from shareholders Khazanah, Kumpulan Wang Amanah Pencen and Permodalan Nasional Bhd to invest in the stock market. At the time, world stock markets were bracing for a looming war in Iraq which followed on the September 2001 attacks on the US.

Valuecap’s bonds were due to be repaid in February 2006, but the company was given another three years to this coming February. At the end of 2006, the three shareholders each held RM1.7 billion in these bonds, according to documents obtained by The Malaysian Insider. [Question marks over Valuecap debt . The Malaysian Insider. November 3 2008]

Categories
Economics

[1812] Of 2008 fiscal stimulus 2.0 may prevent a lemons market

Yet another fiscal stimulus is proposed and this time, Bernanke backs it.

Oct. 20 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke endorsed additional fiscal stimulus, saying the credit crunch is “hitting home” as Americans find it harder to get loans, threatening a prolonged economic slump.

Lawmakers “should consider including measures to help improve access to credit by consumers, homebuyers, businesses and other borrowers,” Bernanke said in testimony to the House Budget Committee. “Such actions might be particularly effective at promoting economic growth and job creation,” he said, calling consideration of a stimulus “appropriate.” [Bernanke Backs More Stimulus, Citing ‘Weak’ Outlook. Scott Lanman. Bloomberg. October 21 2008]

Earlier in the year, a fiscal stimulus in form of a one-time tax break was executed. The rationale behind the first stimulus was unconvincing and true enough, it did not work as the proposers had hoped for.[1]

There is however hope for the second stimulus to succeed, unlike the first which fell victim to the game of expectation from the outset.

Access to credit in the real economy is the crux of the current crisis. Acts to improve access will go a long way in making the stimulus matters.

While I opposed the first stimulus, I may be supportive of the second effort, especially if the plan seeks to untighten credits. It is becoming clear to me that the banks’ reluctance to lend money may be a form of market failure, similar to the idea of lemons in the used cars market where there is a lack of trust as well as a form of negative externality. Banks simply do not know who to trust and hence, hoard money at the expense of the economy.

In the used car market, market failure occurs when buyers simply do not know which used cars are bad (lemons) and which are good. Prices for good used cars are higher than lemons for the obvious reason. With information asymmetry faced by buyers and sellers enjoying complete information, sellers have the incentive to sell the lemons at the prices of good cars, thus gaining handsome profits. Buyers, realizing this, simply refuse to participate in the market to avoid from being cheated and losses. Hence, market failure as transactions do not occur.[1a]

This however is not to say that the whole crisis is caused by the market. The US government has blood on its hand. Government interference in the market has caused a cascading effect throughout the US economy, leading to a government-induced market failure.

As a green libertarian conscious of the fact that market can fail and government does have a role in combating market failure, I think I can support the second, more properly tailored fiscal stimulus.

I do wonder however how could a fiscal policy improves credit access? Could the government lends directly to the market? Would the government become a guarantor to various borrowers?

But hey, since the US government already owns some banks, why not just order those banks to lower down their rates… (sarcasm) What better way to untighten credit in the market than that?[3]

On a separate note, Mark Sunshine at the Economix writes that a tax-rebate might work because the US economy might have entered into a liquidity trap in which the economy becomes unresponsive to monetary policies.[2] While I do think fiscal stimulus might work, the effectiveness of one-time tax rebate is suspect for the same reason the first stimulus failed. A fiscal stimulus based on government spending might work better than a one-time tax cut.

Whoa. What am I talking about? Heresy!

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[1] — Momentum for fresh measures built after an earlier stimulus package failed to prevent a jump in the unemployment rate to a six-year high and the longest slump in retail sales since at least 1992. [U.S. Moves Toward Stimulus as Bernanke, Bush Shift. Ryan J. Donmoyer. Scott Lanman. Bloomberg. October 21 2008]

[1a] — See The Market for Lemons on Wikipedia for more information on the subject.

[2] — Momentum for fresh measures built after an earlier stimulus package failed to prevent a jump in the unemployment rate to a six-year high and the longest slump in retail sales since at least 1992. [Will Paulson’s Two Plans Unplug the ‘Liquidity Trap’?. Mark Sunshine. Economix. October 4 2008]

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[3]p/s — Apparently, there is a rumor about that flying around…

Categories
Economics

[1810] Of more government intervention

What?

KUALA LUMPUR: The government will invest an additional RM5 billion into Valuecap Sdn Bhd to double the latter’s funds to RM10 billion, Deputy Prime Minister Datuk Seri Najib Razak said today.

[…]

Established in 2002, Valuecap is a fund management company created to invest specifically in the Malaysia equities market. Jointly owned by Khazanah Nasional Bhd, Permodalan Nasional Bhd and Kumpulan Wang Persaraan Diperbadankan (or better known as KWAP), Valuecap’s key mandate is to undertake investments in equities listed on Bursa Malaysia on a portfolio basis. [Govt to pump extra RM5b into Valuecap. Surin Murugiah. The Edge Daily. October 20 2008]

Why?

KUALA LUMPUR, Oct 20 (Bernama) — The government will provide RM5 billion in additional funds to double the size of Valuecap Sdn Bhd to RM10 billion and to invest in undervalued stocks and protect investments in government-owned companies, Deputy Prime Minister Datuk Seri Najib Tun Razak said Monday. [Government Provides RM5 Billion In Additional Funds To Invest In Undervalued Stocks. Bernama. October 20 2008]

I am sure even honest Keynesians would raise their eyebrows upon reading this.

Categories
Economics

[1519] Of fiscal stimulus meets Ricardo

As calls for fiscal stimulus to jumpstart the US economy turn into roars, the White House presented a one-time tax break as a plan.[1] The plan however failed to convince the market that there is light at the end of the tunnel. Stock exchanges in the US continue to slide down while dragging along other exchanges across the world. Why is that so?

Others have pointed out Friedman’s permanent income hypothesis; temporary change in income does not affect spending. For me on the other hand, David Ricardo comes to mind yet again.

The issue with a temporary tax cut is that it is temporary. The tax cut adds up to the US budget deficit and a knowledgeable rational taxpayer would realize that somebody has to fund that deficit. Thus, the expectation that a tax cut today means an equivalent tax hike in the future. That expectation translate into a scenario which people will save the extra disposable income to pay future hike while consumption stays the same as if there were no change in tax level at all. This is more or less a Ricardian conclusion.

The problem with such reasoning is that individuals may actually appreciate extra cash in their hand in time during times of strained cash flow. The Ricardian conclusion fails to consider temporal discount that people apply to future cash flow. Yet, how many people actually operate their perception of future income in present value?

Regardless, at the moment at least, reality on the ground seems to indicate that one-time tax break might not work, just like in previous cases.[2]

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[1] — WASHINGTON (Reuters) – Treasury Secretary Henry Paulson said on Friday that the government was considering a $140 billion to $150 billion stimulus package, and swift action was needed to safeguard the economy from a downturn.

[…]

He declined to give specifics on the stimulus package under discussion, but said a significant part would be in the form of tax relief for consumers. [Paulson says mulling $140-150 billion stimulus plan. Reuters. January 18 2008][↩]

[2] — In 2001 — despite the thoroughness and general acceptance of these studies — Congress and the White House once again chose a one-shot tax rebate to deal with an economic slowdown in 2001.

To his credit, Treasury Secretary Paul O’Neill cautioned against the rebate. “I was here when we tried that in 1975, and it just didn’t work,” he said. “If we want to change consumption patterns, we need to make permanent changes in peoples’ tax burdens.” But President George W. Bush overruled his Treasury secretary and approved the rebate idea. Checks of $300 to $600 per taxpayer were sent out in the late summer. Contemporaneous polls by Gallup, Bloomberg and the University of Michigan all found that the vast bulk of consumers expected to save the money or use it to pay bills. Subsequent studies confirmed these forecasts.

In short, there is virtually no empirical evidence that tax rebates are an effective response to economic slowdowns. The increased personal saving doesn’t help the economy because the federal budget deficit, which can be thought of as negative saving, offsets all of it in the aggregate. The main benefit of a tax rebate would seem to be political — giving politicians a way of appearing to be doing something about the nation’s economic problems that is superficially plausible. [Feel-Good Economics. Bruce Bartlett. WSJ. January 19 2008][↩]