Background:
Critical Spectator published 1st article that claimed Singapore grew richer by S$235b during the pandemic. I disagree and blogged about it. The Online Citizen covered it. CS responded with a 2nd post with entrenched views.
This blog is my reply to the 2nd post of CS.
The initial claim was reserves grew as seen from Temasek's increase in portfolio value by S$75b and Official Foreign Reserves up by S$160b. I refuted this in that portfolio value increase is not the yardstick to determine gains in wealth and the OFR is not a national reserve. In our exchanges I had tried to explain the mechanics of foreign reserves in the MAS. In turn I was advised not to have a narrow-minded approach from the banking angle but to appreciate that MAS works within a wider impact of trade and capital flows.
In the 2nd post CS expanded on his explanation with an economic overview. The gist of his narrative is under good governance, Singapore is a good place for business. Capital flows to countries that are well managed. This flow of capital creates demand for S$ which causes upward pressure on exchange rates. High rates hurt exports so MAS intervenes to buy foreign currencies. That is how MAS accumulated so much OFR. MAS pays for the foreign currencies by printing money. Too much money supply causes inflation, so MAS sterilises it by issuing securities, thus absorbing the liquidity. As long as economy is good and foreign capital flows inwards, MAS will keep increasing wealth buying up the currencies for free.
There are too many holes in the narrative. I was reluctant to write this blog because there is too much to cover. Finally I decided to belabour in the interest of sharing knowledge and demystifying all this trade and capital flows stuff. First, I need to lay out some background understanding of the intricacies of currency flows. I put it as basic as I can and in a way to facilitate explaining my arguments with points raised by CS.
The articles:
In economics data, one needs to interpret country and national in context. They are not the same. CS used the terms interchangeably. 'National' refers to the state, government, public, we the citizens of Singapore. National reserves belong to Singaporeans collectively. Country, on the other hand, includes every entity resident in Singapore. Thus not the entire wealth of the country belongs to Singapore citizens. Singapore billionaires like the Kweks, the Ngs, the Ongs etc, their private wealth are not ours. Singapore-based foreigners and foreign-owned companies, MNCs like Google, Yahoo, Microsoft, etc, their wealth booked here in Singapore do not belong to Singaporeans. CS and I had several exchanges and I had explained this difference. I note CS has now mentioned this distinction in the 2nd post.
2. National reserves :
National reserves, by definition, is the sum total of all unencumbered assets of the government. Imagine the balance sheets of all ministries, statutory boards and Fifth Schedule companies are consolidated, it will look something like this -
The national reserves are represented by the net assets, which is total assets less all other liabilities. This is the same as Equity. The change from one year over another in Equity is the increase or decrease to our national reserves. In the absence of data, we cannot determine the national reserves, nor the changes each year.
3. Intra-country investments (or International Investment Position) :
Entities resident in Singapore invest in other countries, and foreign entities in turn invest in our country. Every country maintains 2 quarterly reports called the NIIP and OFR statements. Imagine we have a huge balance sheet of intra-country investments, it will look something like this -
3.1. The NIIP (net international investment position)
The NIIP is the equivalence of Equity in a corporate balance sheet. The NIIP is the difference between what Singapore invested in the world, and what other countries invested in our country. A positive figure means Singapore is a net creditor country. Singapore-based entities own more foreign assets than foreign entities own assets in Singapore. An increase in NIIP indicates the country has increased the net investments outside.
Points to note:
3.1.1. The NIIP is a 'country' data that includes all entities of Singapore residency status. Somewhere in the NIIP are net assets of our government. In the context of national resources, we can say that only a portion of the NIIP belongs to the citizenry.
3.1.2. An increase in NIIP alone does not necessarily mean an increase in national reserves
3.1.3. An increase in NIIP creates an increase in demand for foreign currencies which are required for purchase of those foreign assets.
3.2. The OFR (official foreign reserves)
The OFR comprises mainly of liquid foreign currency assets (bank deposits, securities) and smaller sums in gold, Special Drawing Rights, IMF reserves. Just like a company must hold some of its capital in bank balances to meet liquidity needs, a country also needs to hold currency assets to meet currency liquidity needs. The OFR is a country total. An overwhelming percentage of the OFR is held by the MAS in its 'Net Foreign Exchange Reserves'. Other resident entities hold a small percentage of it.
An increase in OFR simply means more of those asset class was acquired. It does not mean there was a profit. There were hefty increases in 2020 April (S$27.3b) and June (S$10.5b). This simply means some resident entities bought this currency asset, and obviously paid for it. It does not represent any increase in wealth.
Points to note:
3.2.1. OTR is country data. It includes all Singapore-based entities.
3.2.2. An increase in OTR does not reflect increase in national reserves.
4. MAS Foreign Exchange Reserve :
MAS is tasked with maintaining S$ rate stability. To do this it must have adequate liquidity foreign currencies. Thus it maintains a pool of very liquid foreign assets commonly called the forex reserves.
In MAS books, all the OFR liquid currency asset types appear under Foreign Financial Assets, Gold has a separate line. Note that OFR figure is slightly bigger than MAS forex reserves. This is because OFR is country data, includes MAS and other resident entities.
Where does MAS get the funds to invest in those assets? It's reflected on the liabilities side. From capital, undistributed profits (Gen reserve fund), notes and coins issued, reserve deposits of banks, debt (MAS bills/notes), deposits of the government, and reverse repos (under 'other liab line). An increases in assets always has a corresponding increase in liabilities. Basic accounting.
For example, regarding the increases in the OFR 2020 April (S$27.3b) and June (S$10.5b) in (3.2). This was explained in MAS annual report : "A foreign exchange transaction was carried out between MAS and the Government in connection with fiscal expenditures. This involved a direct exchange of the Government's foreign currency holdings for S$, which resulted in an increase in the OFR and a corresponding increase in Government deposits with MAS." My guess is, govt sold some foreign assets to fund the pandemic aid package. MAS bought those currencies and sold S$ to govt. Thus in MAS books assets (forex reserves) and liabilities (Govt deposit a/c) increased accordingly.
Points to note:
4.1. MAS forex reserves is not part of national reserve.
4.2. The forex reserves is slightly less than the OFR.
4.3. Ignoring valuation gains, an increase in forex reserves does not mean increase in profits.
5. The demand for S$:
The demand for S$ reflects in the Debt market, FX market, and Money Market (MM)
5.1. S$ Debt market :
When economy heats up, demand for S$ increases. On the debt market, commercial banks extend S$ loans via fractional banking which has a multiplier effect and increases the supply of money.
MAS does not lend commercial loans. It only lends to banks in its duty as lender of last resort. This takes the form of very short term lending, overnight or 48 hours and in the form of short term facilities or repos. When MAS lends, it prints digital currencies. It merely credits the borrowing bank's reserve account, and debits loans account. Being short term, these S$ created is extinguished when the short term lending is repaid. There is no threat to liquidity.
Point to note:
5.1.1. Liquidity for S$ is provided by fractional banking. It is market driven. More credit increases money supply, but this is extinguished when loans are repaid. Thus money supply expands or contracts with the economy. MAS does not interfere.
5.2. FX market :
What drives the FX markets -- trade, investment, hedging, money transfers, speculators. A huge portion of the trades are from speculation. In a Int'l Forum on Globalisation in 1997, Prof Bernard Lietaer said as high as 97.5% of FX trades were speculative. Iowa State University mentioned 90% in 2019. I mentioned this to CS but he pooh poohed the idea speculative trades had so much impact.
Singapore is an int'l financial centre and has a significant volume of FX trades. The USD/SGD is also a significant currency pair. MAS does not participate in commercial transactions in the FX market.
Points to note:
5.2.1. Singapore is a free market. There are no controls on capital moving in and out.
5.2.2. FX market is predominantly speculative. Commercial-backed deals counted less.
5.3. How MAS manages S$ exchange rate:
A word on the Unholy Trinity of Capital mobility, Exchange Rate or Interest Rate. Central banks can only chose 2 to control, no one can do all 3 at the same time. Of course Singapore is a free market. A key point to understand is Singapore monetary policy is based on controlling the domestic exchange rate. Being mutually exclusive, MAS takes the view interest rates, and thus money supply, are endogenous. This means MAS surrenders control over interest rates and money supply to market forces.
MAS monitors the spot rate to stay close within a band computed on undisclosed trade-weighted basis. It intervenes only when the S$ rate moves outside the band. When rate is under pressure (too much selling), MAS buys S$ and sells foreign currencies. When rates are rising (too much buying) MAS buys foreign currency and pays S$. Either side of the intervention presents problems.
To be able to buy back S$, MAS must keep a foreign reserve (a pool of foreign currencies or foreign liquid assets). The size of the foreign reserve must not only be sufficient for normal needs, but able to prevent speculators from shorting the S$.
MAS buys and sells S$ with banks. Banks pay by having their reserve a/c debited and receive by their a/c credited. The effect in MAS books :
When banks' account balances go up, it pushes S$ into the market. When the balances go down, it sucks S$ out of the market. In other words, MAS intervention in forex market impacts the liquidity or money supply, which in turn, will impact domestic interest rates.
Since MAS monetary policy dictates no interference in the money supply and interest rates, there is a need to reverse the liquidity impact in the market arising from the intervention action. This is done in a way known as sterilisation. It requires a simultaneous open market operation and a forex deal.
An open market operation is when MAS sells or buys govt securities to manage liquidity. When it buys back their securities, Bills & notes go down, Banks balances go up. Money supply is increased. When it issues and sells securities, Bills & notes go up, Bank balances go down. Money supply is decreased.
When MAS intervenes in FX market and buys USD, sells SGD, money supply increases. MAS sterilise it by selling securities which decreases money supply. On the other hand, when the FX intervention is sell USD, buy SGD, money supply decreases. This is sterilised by buying securities which increases money supply.
Sterilisation cancels out the impact on domestic liquidity caused by forex intervention. But there is a cost depending on the interest rate differential between the 2 currencies. The forex reserve may be invested in foreign securities that earns an interest. MAS pays interest on the securities sold.
Points to note:
5.3.1. MAS controls only the exchange rate. Does not control interest rates and money supply.
5.3.2. Forex reserves is for stabilising exchange rate.
5.3.3. MAS only intervenes to stabilise the S$ rates.
5.3.4. Forex intervention is sterilised. But sterilisation has a cost.
5.3.5. An increase in foreign exchange reserves has a corresponding increase on the liabilities side. It is not an increase in wealth.
5.4. Money market
MAS does not control the liquidity in the market because Singapore is an exchange rate control regime. Unlike most other central banks like the Fed which controls interest rates, thus they control liquidity by Quantitative Easing or Tightening and the Fed rates.
MAS is only concerned with the liquidity for the day to meet bank reserve requirements and interbank settlements. Each morning it decides the requirements and provides the liquidity via lending facilities, repos, reverse repos and MAS bills.
6. Liquidity during financial crisis :
During a financial crisis, liquidity in the market dries up due to increased risk. MAS has to step in to provide liquidity both for S$ and foreign currencies, primarily USD. During such times, monetary policies are temporarily ignored.
6.1. S$ liquidity in a crisis
During Covid19 pandemic, the Temporary Bridging Loan and SME Working Capital Loan programmes were put up to assist SMEs. MAS does not extend loans. It creates a facility for banks to draw on at very low interest rates. When banks draw down on the facility to loan to their customers, MAS debit the Facility a/c and credit banks' reserve accounts. As at 31 Mar 2021 this facility balance stood at S$10.4b.
By crediting banks' a/c, MAS increased money supply. But hey, there's a financial crisis going on. However, these funds are temporary. When the loans are repaid, the liquidity will be extinguished and money supply returns to equilibrium.
Central banks' ability to print money easily has led to uncontrolled spending, resulting in too much money flowing in many parts of the world. Central banks' balance sheets are exploding as they take on assets. MAS, being an exchange rate regime, does not print money. This discipline has served the country well. The 2019 money printing for the pandemic aid package marks the very first time MAS has taken this route. So technically, money is for free. The government has no need to dip into the reserves. MAS can print unlimited amounts of S$ for everyone to tie over the pandemic. The damage is in the exchange rate and runaway inflation and the house of freebies will come tumbling down. Restraint is a virtue.
6.2. Foreign currency liquidity in a crisis
In times of financial crisis, such as the Asian Financial Crisis in 1997, foreign currency supply dries up due to higher risks. During such times, businesses continue to require foreign currencies. Loans need to be serviced, projects need cashflows, mortgage payments continues, currency contracts that mature needs settlement, etc.
The forex reserves of MAS are not meant to provide liquidity to the foreign currency. It is beyond even the likes of MAS. But what MAS can, and has done, is to provide the means for banks to access foreign currencies. This is done by central bank swap arrangements. MAS has such swap arrangements with important trading partners such as US, Japan, China, etc.
How does this work? An FX swap has 2 contracts, one spot and a reverse deal in the forward. Example, MAS has a USD/SGD swap arrangement with the Fed. During a crisis MAS draws down on this arrangement. On the spot leg, MAS buys USD and sells SGD. On the forward leg MAS sells USD and buys SGD.
For the spot deal, Fed credits or puts currency into the MAS account with them. In the books of MAS, Forex reserve goes up, and Feds deposit at MAS goes up. So now MAS has USD to provide liquidity to the money market. It looks like MAS has printed SGD to buy the USD. Similarly the Fed has printed USD for MAS.
When the forward leg matures, the entries are reversed.
These type of swap arrangements are huge wholesale transactions, so a massive sum of SGD is printed. But it has no impact on SGD money supply. The genius of this swap is that the SGD in the Fed's deposit account at MAS is just a matter of bookkeeping. The Fed has no need for the SGD and do not touch it. Thus the SGD is not released into the economy and has zero impact on money supply. Fed earns a few basis points for the facility.
Point to note:
6.2.1. MAS has no role in liquidity of foreign currencies under normal circumstances.
6,2,2. In financial crisis, MAS draws on swap arrangements to provide foreign currency liquidity to local needs without impacting the SGD money supply.
ADDRESSING POINTS RAISED IN 2ND ARTICLE OF CS
(A). CS : "...... - has Singapore really gotten richer by over S$200 billion during the pandemic??? Yes. In fact, the entire country (private and public sector combined) has gotten wealthier by around S$350 billion."
In our discussion, I highlighted NIIP is country data which includes Singapore based foreign entities. I note CS has now included this for mention.
CS was referring to the S$350b in NIIP. This increase simply shows on a net basis, during the period, Singapore resident entities invested more in foreign assets than foreign entities invested in Singapore assets. It does not mean more wealth was created. Simple example to make this crystal clear. Suppose a Singapore based entity borrowed S$350b in the domestic market and bought a huge piece of land in US. His US asset of S$350b will be added to the other assets line in the intra-company 'balance sheet' (see 3 above). His loan is domestic and so does not appear in the imaginary balance sheet. Result -- the NIIP increased by S$350b. Where is the gain in wealth?
(B). CS: "... the portfolio managed by Temasek increased in value by S$75 billion, GIC is sure to put in very good figures too AND the Official Foreign Reserves have grown by S$160 billion. ...... Singapore is easily over S$200 billion better off than before...."
Temasek portfolio increased by S$75b does not mean wealth increased by that sum. How does one know if expenses had increased tremendously, for example, CEO compensation. How would you know whether fresh capital was injected? To review increase in the book value of a company, look at the change in equity. (see 2 above).
The increase in OFR of S$160b is derived from Dec 2019 to Jun 2021. It has nothing to do with wealth increases. OFR is simply an asset category in the illustrated intra-country investment 'balance sheet'. (see 3 above). It simply says Singapore-based entities holdings in liquid foreign currency assets increased by so much. It does'nt tell you how much those entities borrowed to own those assets.
(C) CS: "Money tends to flow to countries which are more trustworthy, safer and have a lot of value to offer. This phenomenon is typically amplified by economic crises, when funds actually leave weaker economies and moves to safe havens like Switzerland or... Singapore. With an influx of foreign money there's a growing demand for local currency - here the Singapore Dollar."
Some capital flows to Singapore are driven by instability in investors' home country. These are merely foreign currency deposits transferred to a Singapore bank. They are deposited in the Asian Currency Unit. No change in currency, no pressure on S$.
Singapore is a big source for money market funds. Much of the foreign currency flows into Singapore actually gets placed overseas.
In (A) above, the increase of S$350b in the NIIP means during the year Singapore invested more overseas than foreigners invested in Singapore. Means a huge outflow of capital, not inflow. It contradicts the narrative of CS.
(D) CS : "With lots of money coming in, MAS intervened last year, accumulating foreign currencies to the tune of US$100 billion. The unfortunate side effect to that is that there's a lot more SGD in the market (MAS buys USD et al for SGD) - and that would be affecting liquidity of the domestic banking system. Ca. $160 billion SGD sloshing around is not something MAS wants either. ? So, what it does (like all central banks) is it issues its own bills that local banks invest in, absorbing the excess currency from the market, taking it on as a liability onto its own balance sheet. This is called "sterilization" - which is basically a policy of counteracting unwanted side effects of other decisions.? In the end, then, MAS has acquired S$160 billion worth of foreign assetsb, while absorbing excess Singapore Dollars through issuance of its domestic bills."
He seems to say some much foreign currency comes in, MAS has to mop it up. Actually MAS does not bother how much comes in. It only intervenes when the exchange rate moves either way outside the controlled band. When it intervenes it does not mean the quantum has to be matched. If USD1b comes in, but an intervention of just USD100m brought the rates back to equilibrium, then that's all it takes. It's about taking care of the exchange rate, not how much foreign currencies flowing in.
No argument with this sterilisation thingy to neutralise the SGD liquidity from purchase of USD, although he did'nt explain how. (see how it's explained 5.3 above). But he said MAS acquired S$160b of foreign assets and the excess liquidity SGD absorbed through issuance of bills. To be bitchy, the S$160 is derived from the OFR data which includes other resident entities. The MAS figure should be smaller. Sterilisation is neutralising excess liquidity by debt (MAS borrows S$ back from the market) which he fails to see. In our exchanges he indicated " Ultimately, Singapore is getting something for nothing (or for little) due to high demand for SGD." What sterilisation means is the increase of the S$160b foreign currency is funded by debt, the investors of the MAS bills. Thus sterilisation has a cost that CS ignores.
(E) CS: "MAS didn't *have to* intervene if it didn't want to - it could just let the market set however high exchange rates it wants."
MAS monetary policy is based on controlling the exchange rate. It has to intervene whenever the rate moves outside the controlled band.
(F) CS : "You see, foreign reserves are really just accumulated excess demand for domestic currency".
Does it mean there is a limit to how much S$ can be sold and the excess if bought up by MAS? Singapore is a free economy. There is no restriction on capital mobility. The foreign reserves is an accumulation of foreign currencies purchased by MAS when they intervene in the market to stabilise the exchange rate.
(G) CS : "..... as MAS occasionally transfers large sums of money to GIC for management (like it did in 2019, when it moved S$45 billion there)."
Somewhere in our exchanges, both Chris Kuan and I mentioned that an addition on the asset side must have an addition on the liabilities side. This is elementary, Watson. So the foreign reserves are funded by liabilities. It's all co-mingled and can't be itemised. Certainly some part of Capital and the General Reserve Fund, that is, Equity went into paying for the currencies. CS pooh poohed the idea that Equity builds the reserve fund. Of course not to the full extent, but certainly is partly there. Now this point of his makes it excellent to explain what I meant.
The forex reserves are invested in liquid assets which offer very low returns. MAS reviews the adequacy of the reserve funds. If it gets beyond their requirement, MAS can get it out of liquid assets to seek better yields. But MAS job is monetary policy management, not fund management. So MAS transfers this to GIC to invest.
CS told me I need to get out of the banking (accounting?) mindset and look at the macro trade environment to understand the way things work. But it is in the trenches that one sees things clearly. This is one good example.
How did MAS move S$45b of forex reserves out? Assets go down, liabilities should go down. But which account? Well MAS returned this excess reserves to the state, so it debited the Government's deposit with MAS. It was a huge sum that depleted the government's coffer. How are civil servants going to get paid. The government's budget spending are paid out of funds from this a/c.
Well, MAS returned some Equity back to the government. Net profit for 2019 was S$23.1b, of which the usual 17% was transferred to Consolidated Funds of the govt, The balance S$19.2 billion and another S$16.0 billion from the General Reserve Fund were returned to the govt by credit to their account. The net result is the govt coffers got reduced by only S$9.8m. These transactions were passed in 2020.
There is no sleigh of hands. As MAS reduces its assets, somebody has to pay for it. Reducing the assets means selling it. Somebody buys and pays for it. Transferring the excess forex reserves means selling to the govt, arms length accounting. The same happened in 1981 when excess forex reserves were transferred to kickstart GIC. This diluted MAS Equity the same way as 2020.
(H) CS : "So, does accumulation of foreign currency reserves make the country richer? Yes, but not in a way you might think. Since the money cannot be spent - because it's there to protect the currency - you just can't use it how you please. That said, a lot of it can still be profitably invested, on par with all other reserves at the government's disposal."
Forex reserves accumulated from market intervention are sterilised by MAS bills. These forex reserves are funded by debt, depositors money, and equity. An increase in forex reserves do not make us richer. More assets, more liabilities, is all.
(I) CS : "This figure <NIIP> has grown for Singapore during the last year by a whopping S$350 billion, to very nearly S$1.4 trillion ..... Why aren't domestic liabilities counted in this? ....."
Precisely, he ignored liabilities. It's like we see a guy living in a posh bungalow, but we never know he is many months in arrears on his installments.
(J) CS : This is a comment in our exchanges - "And no, during crisis foreign currency liquidity does'nt 'shut down' - the money simply flocks to whereif feels safest. Singapore is one of those locations."
Should we then assume the meaning credit drying up is not liquidity shutting down? Thailand, Malaysia and Indonesia know better. They took on too much foreign currency debts and the local currency came under attack. Foreign currency liquidity dried up during the crisis. These 3 countries certainly are not junk credit risks by any means. And no, foreign currencies did'nt flock to Singapore during that crisis.
Conclusion :
The claim was the increase of S$160b in the OFR is gains in foreign reserves by MAS. As explained, the purchase of foreign currencies by MAS when it intervenes in the market, are all sterilised and thus funded by debt in the form of MAS bills & notes. Singapore did'nt grow richer from this.
The claim that Singapore grew richer by S$75b due to increase in Temasek's portfolio is also wrong. Increase in wealth is seen in the profits of Temasek or increase in net worth. Profits in 2021 was S$56.5b. Of course, this is a massive profit, even though 83% of it came from mark-to-market gains of sub-20% holdings.
So now in 2nd post, the idea of NIIP increasing by S$350b is brought in to suggest that the whole country gained by a huge amount. Again this is wrong because domestic liabilities of resident entities are not known. At least, CS recognises now this is country data, not national. There are about 37,400 international companies in Singapore, and 1 million foreigners resident here, taking these out of the equation, I wonder how much of the S$350b left is for Singaporeans. Out of these, take out those that belong to local companies and private individuals, how much is left for the state, or nation, or the public , aka you and I?
Finally, with all these capital inflows and MAS managing to keep rate and price stability, is'nt that great? Capital inflows are like the monsoon rains, it has to go somewhere. Or a flood, and in this case, a bubble, forms. Substantial part of this capital inflows are re-deployed overseas. Remember, Singapore is a significant international money market centre and a source of funds. This is also reflected in the increase in the NIIP. But there is without doubt substantial capital inflows stay in the domestic market. Were does it go. Your HDB apartments for one. It's hitting a S$ million.
Caveat: I'm not an economist. The only economic lessons I had was in high school where I missed out 1/3 of the term due to health reasons.
If you like this type of articles, just submit your email on the right and you will be notified of new postings. I have a blog coming up next on national reserves. I think it is of current interest to many.
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