Time

Sunday, August 16, 2009

Swings in liquidity flows set to continue

IN THE face of the continuing economic slowdown affecting developed economies such as the United States and Japan, the soaring financial markets around the globe present a big puzzle.

Stock prices across the region have hit 12-month highs, clawing back the losses sustained in the fallout from the collapse of US investment bank Lehman Brothers. The property market has turned sizzling hot as well.

Yet, this financial mini-boom sits oddly, with tell-tale signs of the recession that still ravages Asian economies.

Last week, disk-drive maker Seagate said it is axing 2,000 workers from its Ang Mo Kio plant as it relocates some of its operations to other countries.

But try telling house-hunters that Singapore is still mired in recession. They were more worried about a further surge in prices as they rushed head-long into the Optima condo project next to Tanah Merah MRT station, snapping up all its 297 units within three days last week.

Some suburban condo projects such as the Centro Residences in Ang Mo Kio have also been commanding prices of more than $1,100 per sq ft - a price which is usually associated with the prime Orchard Road area.

But the exuberance is not confined to Singapore. Other Asian financial centres such as Hong Kong, Seoul and Shanghai are experiencing similar surges in asset prices - both in terms of stock and real estate.

Much has been written in the Western media about the rising jobless rates in the US, despite last Friday's report of a slight fall in numbers, and in Europe. The theory is that this is dampening consumers' demand there as they tighten their belts to save more and become more frugal in their spending habits.

Since Asian countries rely on exports for their growth, the argument goes that unless the US and Europe start to grow again, Asian economies are unlikely to experience a turnaround as well.

But this fails to explain the surge in stock prices, suggesting, at face value, the emergence of a robust V-shaped recovery for the region as it puts the global financial crisis firmly behind it.

The usual line of explanation from analysts is that Asian economies, led by China, have successfully de-coupled from the West.

A growing appetite for more of everything - from commodities to financial services - from China would take up the slack caused by falling demand in the West, so the argument goes.

Then there is the theory that as the financial markets emerge from the biggest credit crunch in decades, the higher prices simply reflect a return to normal, after being beaten down to bargain-basement levels at the start of the year.

Still, the most plausible explanation for the recent surge in asset prices is the sloshing around of 'excess money' created by central banks in their zest to unclog the global financial system and arrest any further economic decline.

Since March, the US central bank has been on a programme to buy US$300 billion (S$430 billion) worth of US government bonds and US$1.25 billion of mortgage-backed debts.

Last week, the Bank of England upped the ante by announcing it would be buying a further £50 billion (S$122 billion) in gilts, or British government bonds, after exhausting its original budgeted purchase of £125 billion.

While the original intention of the two central banks was to bring down borrowing costs and ramp up spending in their respective battered economies, it hardly comes as a surprise that some of this money is finding its way to Asia, where it is fuelling a stock market boom.

The problem is exacerbated by the ability of traders at investment banks to get access to cheap US dollar funding, as the Fed has slashed interest rates to almost zero to fight deflationary pressure caused by the fall in consumer spending.

With the greenback weakening against Asian currencies, traders also stand to make a bundle from foreign exchange gains as well, with their huge positions in regional equities.

This has produced a situation similar to that seen 10 years ago when speculators borrowed heavily in Japanese yen to make huge bets in emerging markets after Tokyo cut its interest rates to zero to fight economic stagnation.

The picture becomes still murkier when you consider the flood of money pouring out of China from the liquidity generated by the lending made by Chinese banks to jump-start the economy.

As Morgan Stanley recently noted, Hong Kong equities - and, by extension, those in the rest of the region - could be 'squeezed up' by mainland players and global investors all making a beeline for them at the same time.

So what can investors in small, open economies such as Singapore do as the collision of vast streams of liquidity cause wild swings in asset prices?

It is not surprising to find some ordinary investors throwing caution to the wind by snapping up newly launched condos or by diving deep into the stock market, even though the outlook for most businesses may still look murky.

But with global demand still weak, unemployment rising and MNCs still experiencing over-capacity in production, the likelihood is that consumer price inflation might stay low for now.

This may, in turn, mean that major central banks like the Fed and the Bank of England will not raise interest rates any time soon, or reverse course in their efforts at printing money.

For the stock market, there will be no respite from the dramatic price swings that have bedevilled equities since the US sub-prime mortgage crisis erupted two years ago.

After rising almost non-stop for three weeks, the benchmark Straits Times Index fell four days in a row last week.

Traders will have no choice but to learn to ride the wild swings produced by the ebb and flow of money as it washes through the region. Vast fortunes will be made - and lost - before the global economy begins to regain its poise.

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