Thursday, May 3, 2012

Firm dollar ineffective against real inflation

Apr 25, 2012
Letter from Teo Hoon Seng

WITH headline inflation up again, the Monetary Authority of Singapore (MAS) is expected, again, to use foreign exchange policy to combat it. At some point, one has to wonder how effective, if at all, this has been.

To cite some daily examples, the papaya I used to buy at S$1 now averages S$2; a small pack of vegetables that used to retail at 60 cents at FairPrice is now 69 cents; a brand of peanut butter that cost S$7.70 six months ago is now S$10.15.

The list goes on. And these do not include items repackaged in smaller quantities but sold at the same or slightly higher prices.

The MAS should consider using the good, old-fashioned interest rate tool.

Not only would this bring some relief to long-suffering pensioners, who receive next to nothing for their savings, it should go some way towards cooling our property market, where prices have been exacerbated by our monetary policy.

If inflow of hot money is a concern, there are ways to pre-empt it, such as prohibiting the parking of such funds in an interest-bearing account.

[A little knowledge is a dangerous thing. Yes, one way to combat inflation is to raise interest rates... if the problem is over demand. If demand is overheating your economy, then you raise interest rates to slow down spending, and at the same time encourage savings. The high interest rates also help to ensure that your savings do not lose value while sitting in the bank.

But, here is the problem.

There are 1.2 billion people in China who has just started to get a little rich. They are eating better food, eating more food, using more modern gadgets, needing more electricity, travelling abroad on holidays, buying more cars and more consumer goods. All these means more raw materials are being sold to China, and all those goods needs to be transported to China, so fuel prices goes up, transport costs goes up, and your 60 cents veggies now cost 70cents. China eats more peanuts. Your peanut butter costs more because the prices of raw peanuts have gone up and the cost of transporting the final product to you have gone up.

How will raising interest rates help?

Even if we raise interest rates and somehow people decide that it makes more sense to save the money, cut back on spending, and don't buy as much (which is what higher interest rates are supposed to do), it'll just mean that what you don't buy will just go to China or somewhere else where it is wanted.

And higher interest rates means higher cost of borrowing, which means higher investment costs, which will curb investment in new machines or factories or shops and that in turn will curb business and the economy might slow down or even shrink. And with high interest rates, the projection is that the economy should shrink. So raising interest rates now is just silly.]

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