“Maginot Mentality” a term that is a byword for leadership who takes comfort in the past, unable to recognize fundamental changes had taken place. On Feb 14th after its monetary policy review, the MAS announced the gradual appreciation of the S$ remained the “appropriate policy stance”. The writer wonders if policy-makers are afflicted by their own “Maginot Mentality” – overly comfortable with ultra low interest rates, unable to recognize that the ground had shifted. Given the S$ correlation to US interest rates, the MAS may well be fighting yesterday’s battles when the Federal Reserve eventually raise rates, thereby rendering MAS’s policy ineffective or even counter-productive.
MAS policy targets a gradual appreciation of the S$ Nominal Effective Exchange Rate (NEER) which represents the undisclosed trade weighted value of S$ in relation to Singapore’s main trading partners. It is meant that the NEER should be strong enough to control imported inflation, thus supporting economic growth. Until 10 years ago, targeting an appreciation of the NEER kept inflation in check. But things began to go awry from 2005 onwards.
The above chart shows the cumulative year by year increase in inflation (blue) and the cumulative appreciation of the S$ against trade weighted index as a proxy to NEER (red). You can see that inflation start to accelerate in 2007 but throughout the 10 year period, the NEER has appreciated almost in lock step with inflation. However, this should not be the case since the appreciation of the NEER is meant to curb inflation. In addition, since 2008 the 1 year deposit rate (green) flat lined close to 0.5% and the 10 year bond yield (grey) averaged 2.5%. By relying solely on NEER appreciation, MAS had produced negative real interest rates by mimicking the monetary conditions from the West despite the absence of their problems of low growth, high unemployment and potential deflation.
Why did the NEER appreciation failed to curb inflation? The answer is the FT policy which flooded the economy with foreign workers and the Profit Maximization Strategy which work hand in glove with the latter. Transport costs (Goods Vehicle and Bus COE +500%), real estate (Residential +89%, Industrial +138%) and rents (+52% last 4 years), among others, have driven inflation to an extent that any disinflationary benefit from the appreciation of the NEER has been overtaken. Negative real interest rates caused homebuyers to over-estimate affordability, developers to bid up land prices, businesses to over-expand, unproductive ones to thrive, banks lending too much and large companies to overpay for acquisitions. This created far greater demand for resources than the economy can cope. The present policies caused the Singapore economy to grow well above the rate it could naturally sustain, are inflationary and the root cause of unaffordable housing, high cost of living and poor returns on savings.
The NEER policy alone cannot curb these excesses as the link between the NEER and inflation may be irretrievably broken by present government policies. The writer suggests the MAS apply interest rate targeting to guide the economy along a sustainable growth path. In any case, the S$ will be weakened by higher US rates which would worsen inflation. This will force the MAS to raise interest rates belatedly when it should act preemptively to forestall risks.
The role of central banking had been famously described as “taking away the punch bowl just as the party gets going”, i.e. raise interest rates when growth is too strong in order to balance the risks and trade-offs in the economy. When interest rates overtake inflation, the unnatural speed of the economy will slow. Uncompetitive industries such as those on low productivity and addicted to labour inputs tend not to survive in such monetary conditions. The creative destruction improves the economy’s productivity by ridding it of excessive labor reliance and resource usage. Higher rates enforce discipline on pricing since cost of financing is no longer cheap. Citizens’ savings and CPF earn a real return and will not be sacrificed for low financing costs to the business and corporate sector.
Unfortunately, the MAS’ role is to support government policies, not to lean against economic risks and excesses by acting according to its own judgment on growth and inflation. However, monetary policy is too important to be left to politicians who by nature tend to favour one part of the electorate over another according to ideology.
It is for this reason that central banks, an indispensable check and balance in advanced countries, are free from political control. Singapore lacks such diligent niceties which stand in the way of the growth at all costs strategy. But the institutional lack of check and balance has heightened risks to economic stability due to inflation, elevated property prices, excessive bank lending, among others. An early rise in interest rates back in 2011-2012 would have lessened these risks. This is all the more ironic given the government’s “foresight” in “long term planning”.
* The writer has spend his entire career in managing balance sheet currency, interest rates and liquidity risks. As such, determining the direction of central bank monetary policy is a crucial element of his job.
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