03 JANUARY 2014
Fed Drops Bombshell In Unexpected Tapering Act
By Dr Chan Yan Chong
This article is written over the last two days of 2013, during which the Straits Times Index ended the year 0.4 percent lower than its year-end level last year, faring even worse than Hong Kong. The Hang Seng Index closed last weekend 2.6 percent higher than end-2012, a modest performance which is better than nothing. Dow Jones Industrial Average was unassailable, closing the year 25.7 percent higher than the end of last year. Hong Kong stocks struggled to find their momentum as they are obviously weighed down by the performance of Chinese A-shares. The Shanghai Composite Index is currently 7.6 percent lower than last year-end. Singapore is also affected by Chinese A-shares, as well as the performance of its neighbours like Indonesia, Thailand and Malaysia.
At one point this year, the Singapore stock market was tracking the rally in the US stock market closely to hit a high of 3,464 points, just 11 percent off its historical high of 3,906 points set in 2007. However, when the US started sending out intentions of tapering in May 2013, funds started flowing out of Southeast Asia and other emerging countries at an alarming pace, triggering a slide in the stock and foreign exchange markets which led to the Singapore stock market actually losing out to Hong Kong stock market. Indeed, investors should not brush off the problems faced by emerging countries in Southeast Asia. After all, the 1997 Asian Financial Crisis was triggered from Southeast Asia. Back then, the baht was brutally attacked by international speculators; many were unaware of the impending ripples of devastation and sat on the sideline watching the currency attack unfurl, gloating over their fortunate escape.
Today, Hong Kong is backed by a cash-rich China that is sitting on trillions of US dollars in reserves. For this reason, I believe the currency speculators will not try their luck on either the Hong Kong dollar or renminbi so readily. Despite Singapore’s robust foreign reserves, as the US has officially started tapering, the economy of the entire region will face tremendous pressure if the Southeast Asian countries are adversely affected. Once a new wave of financial turmoil hits, all these hard-earned reserves would be eroded away very quickly. China may inject a lot of money through foreign investments into those Southeast Asian countries under attack in order to strengthen its influence in Southeast Asia region. Such investments could either be in US dollars or renminbi. In the case of an influx of renminbi through direct foreign investment, the total amount of offshore renminbi globally will increase, which would also boost the status of Singapore as the offshore renminbi clearing centre of Southeast Asia.
By the end of the US Federal Reserve (Fed) meeting on 18 December 2013, the decision to start tapering was finally announced. From January 2014, the Fed would cut back on buying bonds by US$10 billion a month, which represents a reduction from the original US$85 billion to US$75 billion. Global media and the finance industry did not seem to pay attention to this meeting prior to the Fed’s announcement. This goes to show that the global financial community was not expecting Fed to withdraw from the market at this meeting.
After its meeting in May 2013, the Fed announced that it will start tapering at an appropriate time. That bomb shell triggered a shock wave through the global financial market. Almost instantly, stock markets all over the world crashed. Some of the newly industrialised countries not only saw their stock markets crash, their currency exchange rates also plummeted. Asian countries feature prominently among emerging industrial countries, so the mini financial crisis that was set off caused many to worry if it was a replay of the 1997 Asian financial crisis. Leaders of many newly industrialised countries, as well as developed European countries, have publicly expressed their concerns and asked the US government to improve on the transparency of its tapering roadmap and decision making criteria, so that they could put in place mechanisms to safeguard their economies.
Over the past four to five years, the Fed has been printing money freely, and that has caused a significant increase in hot money all over the world. These hot money have help to prop up the stock market and currency exchange rates in many countries. Once the US starts turning off its money supply, hot money growth will stop, and there may even be a flow-back into the US. This is going to hurt the financial system of newly industrialised countries, as in the case of the mini Asian Financial Crisis that occurred in the third quarter of this year.
Seven months have transpired from the time the Fed signalled its intention in May 2013 to its recent official announcement to taper. This time frame is quite long, causing some to declare that the tapering warning in May 2013 was just the Fed “crying wolf”. However, the “wolf” did come eventually. Yet, the US stock market rose significantly to set a new historical high, which caught many people by surprise. Optimists would believe that tapering means the US economy is recovered sufficiently to warrant the taper. Others think that the reason Wall Street rallied strongly after the Fed announcement is because in his tapering announcement, Fed Chairman Ben Bernanke also assured that future tapering will be gentle. The Fed’s gentle cut back on buying government bonds is expected to be completed in a year’s time, while the current super low interest rates will remain for a while longer than expected. Financial institutions around the world are currently predicting an interest rate hike at the end of 2015.
My view is that this time, the tapering announcement does not mean that the US economy has recovered and is thus reducing its quantitative easing conditionally. Rather, it is because the Fed Chairman Ben Bernanke is retiring, and it was his last time chairing the Fed interest rates meeting. QE1, which began in March 2009, was his brainchild, so he is likely to have the moral and historical responsibility to scale back QE3 at least once during his tenure. By tapering while in office, he will be able to keep things under control as Fed Chairman in case something goes wrong in the financial market while tapering. In other words, I do not think the US currently has the condition to scale back QE3. In order to keep the market from becoming too anxious or pessimistic about tapering, he also announced that the next rate hike will be later than expected and the pace of tapering will be gentle. The fact is, he will be retiring early next year. Will he still be able to wield any influence when he is no longer chairman?
It was Bernanke who invented the ingenious strategy of quantitative easing and saved global investment banks from the brink of bankruptcy. Today, these investment banks are making big money again, and the US government has not banned the development and introduction of derivatives, even though highly sophisticated derivatives were the cause of the financial crisis of 2009. It did, however, double its effort to supervise such products.
Publish date: 03/01/14