Saturday, January 1, 2011

Not For The Faint Hearted

True to form, Prime Minister Lee Hsien Loong's new year message skims over the thunderstorms in the horizon. He mentions the "challenges" of the influx of foreigners, keeping homes affordable, and coping with cost of living. "We have the means to tackle these problems," he claims. But with Goh Keng Swee gone, who's going to tackle the "impossible trinity" - a far worse problem than the Father, Son and holy Goh triumvirate.

There are more foreign funds coming into Singapore than MAS can handle, to the tune of 90% of GDP. Something's gotta give, according to a source in DBS. In October 2010, US$17 billion was spent buying up Singdollars, the strengthening of which has to be bad news for the struggling exporters. US$8.2 billion was used for spot market intervention, US$8.6 billion for forward markets. Why forward? So that the delayed time-bomb won't show up in the books now, only later, probably after the elections.

The trilemma refers to the inherent incompatibility in the three macroeconomic aims: (1) free capital flow, (2) fixed exchange rates, and (3) monetary autonomy. China chose (2) and (3), pegging its currency to the US$. Australia has a free float to support (1) and (3), which makes it vulnerable to exchange rate volatility. Singapore opted for a managed float, the exchange rate based on a secret list of 20 currencies. This basket can be distilled to 60% US$, 25% Yen, and 15% Euros. Since the S$ has appreciated nearly 3%, you would expect the interest rate to drop, for balanced fund flow. Trade-Weighted interbank offer rate (TWibor) is currently 0.4%, which means Sibor has to be in the region of -2.6%. But negative interest rate will be suicidal for the politicians, and people will prefer to withdraw cash from the banks to put behind their pillows, or in an empty Milo tin. The price of a managed float and free capital flow will haunt the domestic money supply with a vengeance.

Professor Lim Chin of NUS Business School wrote that "Singapore has the capacity to mitigate the effects of flows," echoing the bravado of Finance Minister Tharman Shanmugaratnam. He may or may not have taken into account the quantitative easing measures of the US. Thailand in 1997 (the baht was then similarly fixed to a basket of currencies with the US dollar having by far the largest weight) also butted its head against the "impossible trinity" trilemma, with disastrous results, when capital inflows rose from US$29 billion in 1990 (34% of GDP) to US$108.7 billion in 1996 (59% of GDP). Now you understand why the DBS guy is running around, yapping like Chicken Little, "The sky is falling! The sky is falling!"


  1. Not a problem for the Managers of the State.

    It's really a question of whether the people can tahan(bear with it) anymore.

  2. I am a bit confused here. If there is Quantitative Easing, the market will be flooded with US$. Why would Singapore need to sell off US$ and buy back S$ to maintain the strength of S$?

    It should be the other way round. As Singapore tries to maintain the managed float, it would need to buy more US$ selling off S$ to maintain the exchange rate. But it seems that MAS needs to maintain the strength of S$ so that imported inflation doesn't flare up.

    If MAS tries to maintain S$ strength, it would have to increase interest rate, instead of reducing it. The fact that in spite of very low interest rate, yet S$ keeps appreciating against the US$, it means that there are just too much US$ in the market, so much so that MAS is in fact trying to beat off over-appreciation of S$ against US$ by buying US$ and selling S$.

    Else, if left to free market forces, S$ would have increased at a very rapid rate!

  3. Tharman boasted that he can fend off the flood of funds from the quantitative easing by investing abroad, so why the huge size of the the market intervention? It goes to shows why the impossible trinity is so hard to crack.

  4. I agree with anonymous. The Sing$ will appreciate further not the reverse.

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