The circus has come to town

Look out, the circus has come to town … and the clowns have come marching in.

First, we have the prime minister who promised that the fuel price will not change for the year. Next, we have the minister of domestic trade and consumers affairs who said the fuel price will not increase before August. Then we have the minister of international trade and industry who announced that one of the measures to ease the burden of transportation cost is to have larger trucks on the road.

The Bank Negara governor must be vying for the ‘iron will’ title when she was steadfast in not budging from the 3.5% interest rate, despite all indicators showing rising inflation and superb growth of 7.1% during the first quarter Gross Domestic Product (GDP).

She had earlier announced that the inflation rate for April 2008 was 2.7%, and for 2008 it will be 3%. This should give bragging rights to our government for being one of the best managed economies in the world.

However in another report on 28 May, Dr Zeti announced that broad money (M3) expanded by RM 51.6 billion or at an annual rate of 12.1% at the end of quarter one (Q1). If the growth of money for Q1 is 12.1% and the growth for GDP is 7.1%, the difference of 5% should be translated into inflation. That extra 5% of money in circulation is causing havoc in consumer prices.

Yet, when it was announced in April that the inflation rate for 2007 is 2%, no economist in the country lifted an eyebrow. No politician from both sides challenge the statistic. That was despite the Statistics Department reporting – Food and Non-Alcoholic Beverages prices increasing by 47.1%, Transport prices increasing by 18.3%, Housing and Utilities prices increasing by 13 .9%.

These three components which matter most to lower middle income and the poor, recorded double digit inflation, and should have immediately set of alarms.

During the past few months the price of rice has increased from RM22.30 per 10kg to RM34.50. Milk powder from RM37.00 per 2kg to RM42.00. Tea powder from RM6.50 per 500gm to RM9.50. Butter from RM5.40 to RM9.00. Jam from RM5.40 to RM8.80. Shahrir Samad should take note that it’s not ‘a joke’.

Dr Zeti has led like a pied piper playing to the tune of economic calm. Economists and politicians seem mesmerised to her tune that we can weather off the economic turbulence ahead. Meanwhile the people are encouraged to spend. Carefree use of credit cards. Banks are in competition to offer instant approved loans, some with zero interest for 6 months.

Some economists supported the lifting of fuel price subsidy, arguing that price subsidy will distort the economy and misallocate resources. While this is a valid economic argument, it should also be applied to broad economic spheres.

Space tourist

Encouraging the use of less fuel efficient Proton cars and discouraging more fuel efficient foreign brands of similar cylinder models is a distortion. Promoting the use of genetically modified organisms (GMO) and genetically engineered seeds is a distortion of our agricultural economy.

Spending RM 60 million on Tamiflu vaccines, which have shelf life of 5 years, for the avian flu which later proven to be hyped, is also a distortion. Sending a space tourist when we can ill afford is a distortion.

Implementing all the 5 Economic Corridors when we barely have the financial and human resources is a distortion. Each one has its merits and demerits and we can argue until the cows come home.

But the mother of all economic distortions, which so far economists have kept silent on, is the widening disparities between interest rates and inflation rates. When money is loaned out below inflation rate, the borrower tends to use it for speculation.

Money is spent on the stock market, as we saw the KLSE rise to 1500 points before the general elections, to encourage more spending and purchasing. If the spending is on goods and services from current economic output, then it is good and helps add up the GDP. But with cheap loans at below inflation rates the money quickly go towards speculative spending for quick profits, like second hand properties, stocks and shares.

This will inflate the economy and very soon bubbles build up. Encouraged by the artificial demand, business people will venture into more risky projects and speculative capital. All these lead to financial distortions and spin the wheel of inflation faster. When the tide turns, buoyed with rising interest rates, it will be financial ruin for many. Perhaps the tide has not turn, because the floodgate is kept locked, at least for now.

With the recent hike of fuel prices, inflation in food price, consumer goods and transportation is inevitable. The basket of goods for the average household income will shift. Weightage will be more towards food, transport, housing and utilities, which are currently given weightage by the Statistics Department at 68.7%.

Despite such high weightage, inflation recorded for 2007 at only 2%. Previously that basket of goods may have contained a cell phone, a branded t-shirt, even a golf club, or restaurant dining.

From now on, the majority of 27.4 million Malaysians whose financial status has been relegated downwards, will just make do with the basket containing mainly food, transport and housing. When the inflation tide forces the gate open, it will record double digit reading. Certainly not 5% as the piper tune wants us to believe.

Leading the clowns is George W. Bush who last month said the price of rice commodity increased was due to more Indians now consuming it, causing shortages. Indians in the sub-continent should hold down their anger because clowns crack jokes on themselves. The reasons for today’s soaring oil price, soaring food price, soaring gold and commodities prices can all be traced back to the USA.

The years 1944, 1971, 1973, 1995, 2001, and 2007 have much significance in altering the course of world economic history. In 1944, just before the war ended, the Bretton Woods agreement established that the world monetary system, based on the gold standard. All countries were to peg their currencies to the dollar.

The monetary system was dependent on and controlled by the United States. The printing of US dollars went full swing and even enabled the US to finance two wars – Korea and Vietnam, and several Apollo missions.

President Nixon

Very soon the world was floating with dollars and world inflation soared. There was just too much dollar notes than the gold in the United States to back them up at the fixed exchange of $35 per ounce.

On 15 August 1971, after the British and French governments demanded their excess dollars to be exchanged into gold, President Nixon closed the gold window.

In 1973, the currencies of the world floated, and have continued to float until today.

It was also in 1973 that the OPEC oil embargo shocked the world. OPEC demanded higher oil prices for the fast depreciating inflated dollars. It took the arm twisting diplomacy of Henry Kissinger to coerce the OPEC countries to finally trade oil in US dollars, thereby reinstating the dollars to supremacy and world reserve currency status.

This implies that all the oil traded in the world market in dollars, also belong to Uncle Sam. And Uncle Sam could go on printing dollars and selling Treasury Notes for the rest of the world. So long as the petrodollars remain overseas and do not return to US soil to cause inflationary havoc, America remains a land of plenty, supported by the kindness of the people of the world.

In 1995, post WTO, and after China officially entered the World Trade Organization, the globalised market brought new economic paradigms.

The rest of the world saved and produced. Americans consumed.

Besides the need for dollars to trade in oil, the whole world now also needed dollars to trade in other commodities in the expanded world market. Uncle Sam just continued to print, print, print the dollars. Americans would spend, spend, spend to glory. USA could finance wars in Bosnia, Iraq and Afghanistan, and sent several Discovery missions. As a result of too much money being created, the technology boom at the end of the century led to a bubble.

After September 2001, Allan Greenspan started a loose monetary policy and a series of reducing interest rate that continued until 2005, even after Ben Bernanke took over as the Fed Chairman.

Money supply skyrocketed. Easy credit led the US economy to property and stock market boom. When it was imminent that the boom has become bubbles, Bernanke started to raise interest rate in 2006. Rising interest rate threatened the subprime mortgate industry and foreclosure signals started to appear, chasing down interest rate again in 2007.

It was too late. The unwinding of the subprime mortgage industry snowballed and by July 2007, two hedge fund subsidiaries of the largest investment bank, Bear Stearns, had to close shop.

This is the turning point for the US financial system, perhaps the world. The chain of events that quickly follow was rather alarming and chaotic. All the major banks in US – JP Morgan Chase, Citibank, Bank of America, Wachovia, were in deep liquidity trouble. European banks like Barclay and UBS were also affected.

Bear Stearns

Runs were on at Northern Rock and Societe Generale. Insurance companies that covered the investment banks like Bear Stearns, Merrill Lynch, Morgan Stanley, were also affected. Had it not been for the foreign Sovereign Wealth Funds and the Federal Reserve that injected in hundreds of billion dollars into rescue packages, all these banks and their hedge funds would have been run down flat.

The fact is, all the major banks in US and some in Europe are insolvent.

So far it has been the unwinding of the subprime fiasco. It will soon lead to foreclosure of commercial properties when more and more bankruptcies are filed. Sitting under a huge pile of derivative contracts, estimated to be more than 170 trillion dollars, held by US banks, is a bomb waiting to implode.

When it does, not if, it will be worldwide financial doom. No country will be spared.

Meanwhile inflation and bubbles are created through easy credit. It spread into properties and stocks. It then spread into commodities and gold. And finally spread into food. The spending spree of the last decade in US has turned into a nightmare. The ghost of the tonnes of dollars that the US exports to the rest of the world will someday return to haunt.

Watched closely by the rest of the world, who wondered if the runaway inflation will ever reach their shores.

Our Dr Zeti’s confidence in saying, “In the medium term, slower economic growth will have a moderating effect on inflation”, seems to go down well with our docile economic community.

Unless Henry Paulson, the US Treasury Secretary, is successful in persuading China, Japan, Korea and the Arab countries to hold on to their dollar reserves and US Treasury Notes, these countries will dispose of them quickly before they lose more value.

It is ridiculous to hold on to the T-Notes for 10 years at yield lower than the inflation rate and fast depreciating dollar value.

The writings of coming era of both inflation and deflation are on the wall and very soon it will be scrambles to safety. It will be too late for Dr Zeti to realise that her confidence is misplaced. She is taking an unwarranted gamble by her inaction.

What can be done?

Stop creating more money and easy credit. Money growth should match GDP. Excess money means inflation and loss of purchasing power, which is an ‘invisible tax’ and will hit the poor most.

Interest rate can be increased slowly with 25 basis points interval, to eventually reach 5%. This will send a signal against speculative spending and prevent further distortion of financial resources.

Alternatively we can also appreciate the ringgit. This can curb to some extent on imported inflation.

Stop all nonsensical easy loans offered by banks and credit card companies. Encourage savings now, to get ready the umbrella before the storm.

Introduce the gold dinar into our monetary system. This is the permanent hedge against inflation. It may not be easy, but work towards that system.

Reduce the dollars reserve. Expand the basket of foreign reserve into gold.

Stop all divisive racial politics. All Malaysian must be united and be prepared to face the financial turmoil coming our way in about a year.

Finally with regards to the recent hike in fuel price, we should all understand that there are no easy answers. Proponents of the hike have a valid argument on distortion, especially in the long run.

The opponents are also valid in their argument that more inflation, adding to the food price inflation will compound more sufferings among the people. Plus the public transport system is still left wanting. Without a corresponding rise in wages, the sudden rise of 40% fuel price will send shock waves to our economy.

At best, the hike may not even help the government save money for fiscal projects because the fury of worldwide hyperinflation and the depreciation of US dollars value in reserve. At worst, it will bring widespread sufferings and even trigger off a recession. Under the circumstances, the hike is ill advised.

Let us all get real and not turn Malaysia into a circus.

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DR WONG ANG PENG is president of the Society of Natural Health Malaysia, and director, Dr Rath Health Foundation for Southeast Asia. His first degree is in economics with post-graduate studies in natural medicine.