THREE BIG LIES ABOUT THE NATIONAL RESERVES THAT YOU SHOULD KNOW ABOUT

"The national reserves must not be disclosed. If this is made public, the SGD can be subject to attacks by currency speculators" is the mantra of the Singapore government. Enough of this nonsense.

Speculative attacks happen during a currency crisis. A currency crisis is a consequence of chronic balance of payments deficits (it's also called a balance of payments crisis). This is how it goes. Due to trade imbalances ie a chronic deficit, the domestic currency of the country is weakened. Its central bank either refuses or is unable to allow the exchange rate to fall. To maintain the rate, the central bank has to keep buying its domestic currency. It continues the buying policy till it runs out of foreign reserves. This leads to a financial crisis as the value of foreign debt rises in relation to the weakened domestic currency. Foreign currency liquidity freezes because no one's going to sell the foreign currency to you if the exchange rate is forcibly maintained at unrealistic levels. Eventually the central bank capitulates because no one can go against the market in the long run. It is forced to devalue the domestic currency to bring it back to equilibrium. This type of scenario happens when the market anticipates that domestic policies will not be adjusted sufficiently to devalue the domestic currency. So they attack the currency by selling (shorting it) at the unrealistic high rate controlled by the central bank. Sooner or later when the government is forced to devalue, speculators buy back the currency at lower rates and make a killing.

From the above scenario, you should already know of 2 things:

(1). First BIG LIE. Currency crisis happens when the exchange rate does not respond to market conditions. There is sufficient empirical evidence that such scenarios happen in cases of a pegged currency, ie the rate is fixed to some other currencies. In the case of Singapore, MAS manages on the basis of a floating rate, using an official band to control daily volatility only. Should chronic trade deficits force the rate down, MAS will loosen the band to allow the SGD to devalue. So the above illustrated currency crisis scenario won't happen in Singapore.

(2). Second BIG LIE. If the SGD is weakened and the MAS wants to cushion the devaluation, it is forced to intervene in the market to buy up as much of the domestic currency as possible. To do this, MAS makes use of its foreign reserves. Thus, the more forex reserves it holds, the stronger the MAS is to support the SGD. So here's the rub. Like all central banks in the world, the holdings of forex reserves of the MAS are all in the open for the world to see. It is currently about SGD427 billion. There is nothing secretive about it, and it has nothing to do with national reserves.

Currency speculators aren't watching your reserves. There are watching the market. If the market sees the currency as over-valued, they know sooner or later the central bank has to devalue. Just like a poker player, if he sees he has a winning hand, he continues raising the stakes. 

The Third BIG LIE is the increase in asset portfolio of the sovereign wealth funds. The numbers are impressive, but they don't explain how the growth happened. In 2022 Temasek portfolio value grew by S$22b to S$403b, GIC grew by S$280b. Asset growth can come in a number of ways:

Internal growth (earnings ploughed back into the business): This is well and good and a pat on the shoulders.
Currency translation : Not good. It suggests lack of hedging strategies which could have gone one way or the other way. I mentioned in a previous blog the MAS, as a central bank, has to take on market risks which was why they got hit with a S$8.7b revaluation loss in 2022. Unlike MAS, GIC and Temasek can make hedging strategies to minimise translation risks.
Valuation : Good picks or bad picks,  investing expertise or pure luck, we can't criticise from hindsight. CIO has to make a call. But generally, the last 2 decades have been good to investors who ride along with the massive liquidity pumped out by central banks all over which pushed markets to record heights. But what we should be concerned is the vast amount of holdings in unquoted equities, in both Temasek and GIC. The valuation is anybody's guess.
Capital injection : Any idiot could have increased portfolio value with fresh funds. This is not an insult but an aphorism.
Leverage (funded by more loans): This is not bad per se, but it means increased risks. Debts for operational purposes are fine. Temasek has often spoken of taking advantage of cheap funds to leverage and it is creeping into the realm of private equity fund management business. Are they investing savings, or running a private equity business? We would prefer hard-nosed risk-averse managers, not Wall Street cowboys.

Note that GIC and Temasek make annual contributions to the government of NIR (net income return) based on 50% of a computed 20-year annualised rate on their 'Net Relevant Assets', in basic terms, assets less debts. This means that in a given year, the NIRC (net income return contribution) has no relation to the actual profit or loss. In 2022, the NIRC was S$21.6b but it's not known how much came from GIC and how much from Temasek. We know MAS was unable to contribute due to its S$7.1b losses.

Read : An increase in the government's assets is not an increase in national reserves which is assets net of national debt, and Singapore has one of the highest national debt in the world.

Where did Temasek's S$22b asset growth come from? :

- Was it from its operations? Temasek's net profits in 2022 was S$10.6b. After deducting it's share of the NIRC (how much ???), it did not generate much to increase the asset portfolio.
- Did it come from currency translation? It's porfolio geographical distribution showed Singapore 27%, US 21%, but the currency distribution showed SGD 49%, USD 34%, HKD 7%. This shows there were currency hedges. USD appreciated 1% and HKD gained 0.3% over SGD. That means translation gains were not significant. Although CNY gained 3.7% over SGD and Temasek had substantial Chinese assets, these are in American Depository Receipts, which are basically USD assets.
- Did asset growth come from debts? Temasek had been taking on debt since 2014, rising from S$9b to S$90b as at 31 Mar 2022. In 2022 debt increased by S$8.5b.
- Did it come from capital injection? There was no fresh capital injection, in fact equity decreased by S$4.6b in 2022.

So where did the increase in S$22b in asset value come from? It came from a mix of operating gains (???), translation gains (???), and debt (S$8.5b) -- shared more or less equally.

Where did GIC's S$280b asset growth come from?:

- Did it come from profits? Who the heck knows. Checking out GIC performance is like looking into a black hole. We can only speculate. I'm betting my right arm GIC profits for 2022 wasn't anything to crow about for the simple reason that if it were so, the state media would have celebrated the current year ROI instead of hiding behind a 20 year annualised rate and about returns beating inflation rate.
- Did it come from currency translation? We are looking at a black hole. But this much I can say. In terms of currencies, GIC has 2 sources of funds. One is from forex reserves from MAS. It is likely that these funds would be invested in the relevant countries so there is no asset-liability mismatch, no translation losses. Two is about S$1 trillion of SGD debt + land sales + budget surpluses which are subject to translation risks if invested overseas without a hedging strategy.
- Did it come from valuation? Again, no way to tell. But note that GIC had 37% portfolio in bonds and cash. The bonds should be bleeding heavy losses in the current rising interest rate scenario and was a significant dampener on profits.
- Did it come from injection of fresh funds? Aha, this, I have plenty to talk about.

GIC gained a fabulous S$280b in portfolio value in 2022. PAP uno numero fan Singapore resident Polish blogger Critical Spectator could not help but to write with glee. His Facebook  echo chamber of fawning supporters and opposition haters asked with unabashed sarcasm where are the critics now?  Sadly lacking is the independent brain power to stop and ask where did the increase come from.

Well, a substantial part of the increase came from fresh funds injected :
- S$108b from net increase in securities issued (issuance less redemptions)
- S$75b new RMGS issued (for MAS forex reserves transferred to GIC)
- S$13b from sales of land.

So S$196b fresh funds were provided to GIC to invest., of which S$183b was from government debt. And what did I say about capital injection? Any idiot can increase asset portfolio - it's not an insult but an aphorism.

The more important question to ask is where did the increase of the balance of S$84b (S$280b-S$196b) of GIC's asset increase come from? I have no idea and nobody's talking.

Don't we all know a narrative can be spin in several ways. GIC and Temasek squirmed in word salad instead of telling it as it is. GIC lectured about high falutin 'Rolling 20 Year Annualised Rate Of Return' that cannot be measured against anything. They will not plain speak about current year ROI. Temasek talked about their participation in Singapore Airlines' mandatory convertible bonds issue "enabling the airline to strengthen its balance sheet and to position it for the resumption of global travel" and Sembcorp Marine's rights issues "which strengthened its balance sheet and liquidity position, accelerating its strategic pivot to high-growth renewable and clean energy segments" when the whole world knows Santa Claus was bailing out two troubled companies.

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INCREASE OF S$170B IN GOVERNMENT ASSETS IS NOT AN INCREASE IN RESERVES

Many Singaporeans have made consistent calls for the government to increase social spending. The prominent ones in social media I see are people like Leong Mun Wai (Progress Singapore Party), Kenneth Jeyaratnam (Reform Party), Jamus Lim (Workers' Party), Chris Kuan (retired banker) etc. The  argument is premised on the belief the large pool of reserves can support increased social spending without undermining the country's financial strength.. The ethical view is no minimum wage, suppressed wage levels due to a relaxed regulation on foreign labour, and fast rising cost of living, have thrown many local families into survival mode, a situation largely unreported in the absence of an official poverty line. The burgeoning infuriation is fed by a public perception of generous government spending on foreigners in areas like educational subsidies, as well as financial grants and schemes that benefit foreign-own companies. One would be inclined to want to know the balance sheet of Singapore Enterprise and see how their billions of dollars of enterprise grants to foreign-owned companies trickle down to Singaporeans.

The discussion invariably swirl around the two sovereign wealth funds. Non-transparency have led to the proclivity to speculate and an unhealthy tendency to imagine missing funds, distrust earnings figures, and irregular massive executive payouts. The size of the reserves is as big as the fish that got away last weekend.

Jeyaratnam is insistent the reserves are as massive as S$3 trillion. He has done some computation, but I really do not comprehend his figures. Leong has often mentioned a figure of S$1.5 trillion, and I finally understand where he got his numbers from. I will explain.

Everybody talks of national reserves but never clarify what one stands on. Definitions are important. Reserves meant many different things, throwing up wild differences in numbers. There are untapped resources such as natural resources of a country -- oil reserves, fishing grounds, forests, arable lands, etc. or brain power -- educated population. There are infras that are economic enablers - transportation networks, ports, bridges, airports, etc.

There is the well known story of the government claiming it was almost impossible to list the assets for President Ong Teng Cheong. This was civil servants taking the view reserves is the sum of all assets in every government office in the land, which is really impractical to list for Ong.

Then again, 'reserves' in accounting lingo, is an item on the liability side of a balance sheet. It represents a quantum of assets that cannot be distributed. The assets are for some non-specific use (general reserve) or some specific use (building fund, debt repayment, etc). The assets are co-mingled except for sinking funds where the assets are specifically set-aside.

There is the accounting view national reserves is simply the sum of all the net assets (assets less liabilities) in all the government offices (Ministries, Fifth Schedule companies,statutory boards, and all companies owned by them). This is the same definition as provided by MOF. It is also in the Constitution section 142 (4) which defines 'relevant assets'. It is to this definition that we must attach ourselves, where the accounting and legal terms align.

Clearly, the need for definition is compelling. The reserves we are looking for are assets, and not liabilities. In the context of the clamour to use reserves for increased social spending, the assets must represent earnings, not liabilities. Let's take the Tan Ah Kow example. He owns a TV set bought with his bonus, and a car bought with a loan from his good father-in-law. Tan can sell the TV and use the proceeds without being out of cash. But should he dispose the car and spend the proceeds, Tan will be out of cash to meet the obligation on the loan.

In the context of our search for the reserves, it should only be the TV sets that are available for us to spend. It seems to me Leong and Jeyaratnam both referred to total assets of GIC and Temasek as the reserves, possibly including the reserves of MAS. The exclusion of statutory boards, ministries and all owned subsidiary companies, are understandable as data is hard to come by. As for MAS, there seems some ambivalence. Were they referring to the forex reserves or the equity of MAS? The inclusion of forex reserves of MAS as part of national reserves is unquestionably incorrect. Both Leong and Jeyaratnam are taking Tan's TV sets and cars as national reserves. Their figures must then be inherently over-stated.

Recently the Accountant-General released the financial statements of the government of Singapore. Total assets as at 31 Mar 2022 was S$1.57 trillion.

Leong posited the total assets is 'proxy' for national reserves. I take it he meant it is an approximation for the national reserves. So now I understand where his often-touted S$1.5 trillion reserves figure is coming from. But is this correct?

Leong sees an increase of S$170 billion in reserves over 2021, enough money to go around, no need for GST increase, no social spending in drips and drabs but on a more sustainable scale, why worry about the S$7.4b loss by MAS. I think he is mistaken on the accounting.

Government accounting is on a 'cash', not 'accrual' basis. The government balance sheet shows only 'Cash' and 'Investments' on the assets side, and a list of 'Funds' on the liabilities side. All receipts by the government are deposited into their account with MAS. 'Cash' is debited and 'Consolidated Fund' is credited. All spendings are reported under a relevant 'Funds' head. The 'Consolidated Fund' is like a conduit through which all funds are routed to other 'Funds' (there are exceptions). When budgets are determined, for example S$x are for CDC Vouchers, 'Consol Fund' will be debited and 'CDC Voucher Fund' credited. When CDC vouchers are sent out, 'CDC Voucher Fund' is debited and 'Cash' credited. These 'Funds' accounts are spending heads and act similarly as specific 'reserves accounts'. They specify that the determined amount of assets must be reserved for the purpose of the spending programmes for which the Funds were set up. Operating expenditures like salaries and overheads, are debited in the 'Consol Fund'.

Read : The best explanation for the S$7.4B loss by MAS. Not a text book explainer, nor copy-cat version of official or mainstream media tid-bits.

Only the 'Securities Fund' is treated differently. Its funds do not course through the 'Consol Fund'. When the government issues securities, the proceeds are deposited with MAS. 'Cash' is debited and 'Securities Fund' is credited. Securities are government debts. Singapore government does not practice deficit budgeting. It does not borrow to spend, which is prohibited by law. It issues the following securities :
- SSGS (non-market security) meant for CPF Board to invest its national retirement funds.
- Other government securities (marketable SGS, SSB, Treasury Bills) meant for SGD yield curve discovery, for investors, and a mechanism for repo and reverse-repo money market transactions for MAS to fund short term liquidity, mostly overnight.
- RMGS (non-market security) meant to facilitate MAS to transfer excess forex reserves to GIC.

Proceeds from all these securities cannot be spent by the government. These funds are transferred to GIC (sometimes some portion to Temasek) to invest. Credit 'Cash'; debit 'Investments'.

Apart from proceeds of securities, the government also has revenue from land sales which they cannot spend. Land sales proceeds are also transferred to GIC/Temasek. Credit 'Cash', debit 'Investments'.

Budget surplus of the prior year is also transferred to GIC/Temasek. Credit 'Cash'; debit 'Consol Fund'. There was a budget deficit of S$51b in 2021 due to spending on financial aid packages for the pandemic. Thus there was no budget surplus to transfer in 2022.

The government has massive operating revenue from income taxes, fees, fines, rent, duties, etc. All these are deposited with MAS. Debit 'Cash', credit 'Consol Fund'. These may not be spent immediately, so the government invests them. Debit 'Investments'; credit 'Cash'.

Now back to Leong's S$170 billion increase in assets. In the first place, it is incorrect to hold the view the assets figure in the Statement of Assets and Liabilities as approximation for the national reserves. There is absolutely no relationship. But where did the S$170 b increase in 2022 came from?
- S$108b from net increase in securities issued (issuance less redemptions)
- S$75b new RMGS issued (for MAS forex reserves transferred to GIC)
- S$13b from sales of land.

Of the above transfers, only S$13b from land sales are the Tan Ah Kow TV sets, the rest are the cars. There is no S$170b to spend unless Leong was suggesting we sell all the cars as well and be out of cash to meet securities redemption. What did the government actually spend from the national reserves in 2022? The NIRC (net investment return contribution) from GIC/Temasek was S$20.4b which was taken into the budget.

I believe there is no S$1.5 trillion or S$3 trillion of Tan Ak Kow TV sets, ie unencumbered assets, in the reserves. The reality is way much lower. I would be extremely glad to be wrong and for either Jeyaratnam or Leong to be proven correct. They both take the gross assets figure and I wonder if they realise there is a S$981 billion debt that funded those assets. We need to know how many Tan Ah Kow TV sets there are to be able to have a real conversation on how we can alleviate financial sufferings of Singaporeans more meaningfully. Unfortunately, the government is shy with numbers here. Tan Ah Kow cars in the reserves are only of value if they provide returns over their capital costs.

IN DEFENCE OF MAS S$7.4B LOSSES - ALL CENTRAL BANKS HAVE NOWHERE TO RUN

The MAS announced a loss of S$7.4b for the y/e 3 Mar 2022. To many, it is shocking in the magnitude and the fact no one can really recall the MAS ever making losses in prior years. Whilst it's shocking to many, industry watchers were expecting this.

MAS Managing Director Ravi Menon did meet the press to present an ivory tower explainer. Symptomatic of a government used to go roughshod over the mass, the government made no attempt to explain to the ordinary man on the ground. With all sorts of bad news going on and massive losses of crypto failures, the stunning S$7.4b loss of the pre-eminent institution dismayed many. It cast a pall of gloom over the glittering city of achievements, like parents whose child is used to top performer suddenly failed a math test.

On social media, IBs are dead silent. Other disgruntled folks reacted in ignorance with calls for investigation, head chopping, and always the digression to hidden losses of national reserves in GIC and Temasek, etc.

Not surprisingly, the PAP cheer leader in social media, Singapore resident Polish blogger 'Critical Spectator', is tight-lipped. But most surprisingly, it was left to Leong Mun Wai, a non-constituency member of parliament from the opposition, to try to allay fear in his Face Book post "The MAS loss is no big deal". Leong is broadly correct in his post but there is a bit part that I disagree. I like to build on what Leong posted, and explain where I disagree. 

The biggest hit on the profit & loss for the year was from revaluation of foreign assets. The figure is hidden in the operating income line "Income/(Loss) from Foreign Operations [after transfers to/from provisions]" which registered a net negative S$4.7b. In the press conference, Menon mentioned the revaluation loss was S$8.7b. I find it disgusting that such a significant figure but the pally external auditors never considered it diligent to at least disclose in the Note To Accounts.

As with most central banks, the assets of MAS are primarily foreign, in the form of deposits with other central banks, and short term government securities. These are the official foreign reserves of the country. For financial reports, the assets are revalued resulting in a gain or loss. The foreign reserves are in various currencies, and as exchange rates move in different directions, there will be gains in some, and losses in others. For MAS, the net result was a revaluation loss of S$8.7b.

Currency	Rate 31 Mar 2021	Rate 31 Mar 2022	(+)/(-)	%
GBP	1.854000	1.787486	(+)	3.6
EUR	1.577400	1.500300	(+)	4.9
Yen	82.34281	89.8464	(+)	9.1
MYR	3.083000	3.103300	(+)	0.7
USD	1.345000	1.357856	(-)	1.0
CNY	4.871800	4.690100	(-)	3.7
HKD	5.781000	5.761240	(-)	0.4
IDR	10,830	10,567	(-)	2.4

Where SGD has appreciated against a currency, such as GBP, EUR, Yen and MYR, there will be revaluation losses because the assets in these currencies translated into SGD, now have a lower value. The reverse happens in the case, for example, of USD, CNY, HKD and IDR in which SGD depreciated against, there will be translation gains.

Leong wrote :" Of course, with perfect hindsight, the MAS trading team should have bought more US dollars, but that is too much to ask. But given more time, the MAS trading team should be able to make changes to its portfolio to mininise future exchange translation losses".

First, there is no trading team. MAS does not do forex trading. They make market intervention only as part of their open market operation to manage the exchange rate. And they do so by relaying buy/sell instructions to certain accredited banks so their presence is not seen in the market. Secondly, it's not about managing a portfolio. The quantum of the mix of currencies in the reserves is calibrated from the need to support the currencies in which Singapore deals with in both trade and financial transactions. For example, the more we deal in CNY, the more that currency will be in the reserves.

Leong wrote to calm fears "As has been demonstrated in the past, MAS normally generates an annual profit every year - 2022 is exceptional."

MAS maintains a huge foreign reserve. In terms of reserves to GDP ratio, it is one of the highest in the world. In aggregate terms, it is also massive, currently about SGD420 billion. With such a massive figure, a slight change in exchange rate will have significant impact on the revaluation P&L. The questions are then, why have such a large reserve, and why never suffered losses in the past, why only now?

Read: Is Singapore guilty of currency manipulation, buying up foreign currencies and building huge reserves to keep SGD under-valued?

Foreign reserves are needed so that MAS can provide the liquidity if there is a credit squeeze in respect of a particular currency. If there is no liquidity, then companies and the government may be forced to default on their obligations. Just like Russia recently was forced to default on some USD loan repayment not because they are bankrupt but that USD liquidity was denied to them.

How much is needed then? World Bank recommends 5-6 months of import needs, MAS thinks 65%-75% of GDP. MAS had 105% of reserves to GDP, one of the highest in the world. After transferring SGD75b to the sovereign wealth fund GIC, it is now about 95%, still very high by world standards.

But why build such high reserves? Well, persistent trade surplus all these years meant a huge inflow of currencies and MAS had to mop up the liquidity to prevent the SGD rate to break through the official band that currencies are allowed to float. So MAS kept buying foreign currencies to keep SGD rate down, ie under-valued, which makes our exports cheaper. Periodically, MAS has to tighten the SGD by letting it strengthen a bit at a tine. This is called a peg crawl. The SGD rate kept crawling up over the years, against most currencies. The appreciation had been gentle over the years as inflation was within control. So the revaluaton impact on P&L was not significant. In 2022, inflationary pressures caused MAS to tighten SGD 4 times within the financial year. The headwinds of global inflation is very strong in the current economic environment. We see high appreciation of SGD against some major currencies, resulting in massive revaluation losses.

Many fail to understand the reserves has a carry cost because a big portion of the foreign currencies are purchased with debt. This is in the form of MAS bills and FRAs issued to sterilise the SGD printed to acquire the foreign currencies. As at 31 Mar 2022 this debt was SGD230 billion. The cost of this debt is high but again, this is hidden in the financial statements. A statement commentary indicated the Total Expenditure of SGD2.8 billion was due largely to interest on this debt. If we assume an interest rate of 1% p.a., the carry cost of the reserves work out to SGD2.3 billion. 

The reserves are not magic profits that Critical Spectator and his crowd thinks. I debated a few times in Critical Spectator's obsequious echo chamber of opposition haters who subscribe to the idea the reserves are profits. If you ever debate there, you need to have an attitude of Illegitimi non carborundum.

There is a way for central banks to provide foreign currency liquidity. That is to make swap arrangements with other central banks. MAS has several of these arrangements in place. This diminishes the necessity for a standing high reserve and associated carry cost, as well as risk of revaluation losses. However, in a systemic credit crunch, the swap facility may not be availed. In the case of MAS, with or without swap arrangements, it continues mopping up foreign currencies with its managed float policy.

Leong wrote : "An exchange translation loss is a paper loss ........... The paper loss may disappear in future if the foreign currency appreciates against the Singapore dollar."

The term "paper loss" trivialises the seriousness of the matter. What it implies is that yes there was a loss, but there was no resources expended. Well actually, SGD has already been spent to acquire the currency asset. The revaluation loss is to recognise the loss now rather than to wait for the time when the asset is consumed. So feel the pain, it is for real.

Leong is technically right that when the foreign currency appreciates against SGD in the future, the losses may be wiped out. In the short term, on a day-to-day basis, exchange rate volatility indeed means the revaluation numbers fluctuate up and down. But the long term trends could be one directional. For example, will we see SGD/MYR rate back to 1:1 or the SGD/Yen to 1:300? My guess is we probably have to kiss most of the SGD8.7b loss for good.

Leong wrote : " Even if that does not happen (the currency appreciating against SGD), the return from the foreign currency assets will eventually cover the exchange losses. ............ As the MAS is expected to continue to make investment income and gains, these will usually cover the translation loss over the next few years."

Yes, Leong is right. This year, there was an investment income of SGD4b to cushion the SGD8.7b revaluation loss. So supposing next year there is no change in valuation, which means no revaluation losses/gains, and investment income remains unchanged, there will be a positive SGD4b in "Net Income from Foreign Operations". The 2022 loss can be recovered in a couple of years. But don't forget things are not so rosy. There is a carry cost as explained above.

In defence of MAS, you need to understand this. Every company that has to deal with foreign currencies has to manage the exchange and interest rate risks. They do so by some form or hedging or making sure they do not have a currency asset-liability mis-match. MAS is not a for-profit entity. Its job is to manage the monetary policy of the country. As such, it has to maintain reserves and take on the market risk and the carry cost. MAS has to do national service and bear the brunt. Ditto all other central banks in the world.

The real reason why we should not worry about this loss is the financial strength of MAS. It's General Reserves of SGD22.5b was more than enough to absorb the net loss of SGD7.4b. The capital is intact and equity is still strong at SGD41b.

The one thing I'm happy to see is the MAS observed Inter'l Financial Reporting Standards and took revaluation losses in stride. There is no monkeying around like the Federal Reserves which has, as at Q1 of this year, a marked-to-market loss of USD430 billion not recognised in the P&L. Their capital has been wiped out several times over.

.Read : How the Federal Reserves use creative accounting to hide massive revaluation losses that has completely wiped out their capital

Central banks' monetary actions expose them to market risks. All western country central banks went down the same path of 2 decades of Quantitative Easing, printing money to pour liquidity into their markets, and near zero interest rates. This was engineered to revive the economy after 2008 financial crisis. They all now need to raise interest rates to fight global inflation. All will suffer colossal losses when they mark-to-market their bloated balance sheet that is full of securities. If the SGD8.7b revaluation loss of MAS is a shocker, you ain't seen nothing yet.

BONGBONG MARCOS' SONA HAS ECONOMIC NUMBERS THAT IS AN INDICTMENT OF DUTERTE

Congratulations to the newly-elected Philippines president Bong Bong Marcos (BBM) who will present his first State Of  Nation Address on July 25. Will his ascendancy bring back the pomposity and ostentatious show in his father's days when SONA brought out the politicians and guests to challenge the Hollywood Academy Award nights. Or will it be subdued and serious given the pandemic and the headwinds of inflation and food shortages. In times of difficulties, such as current days, the leader must give the people a sense of hope. We await his speech that should basically assess the situation of the nation, and his wisdom of how his admin will advance the country.

In assessing the economics landscape, the data surely will be an indictment of President Rodrigo Duterte. Will BBM bravely review in public the data with his Vice President Sarah by his side, who is non-other than the daughter of Duterte.

1. Current Account:

The Current Accounts of the country shows the country's trade relationship with the rest of the world. Without going into the details, this records the movement of trade in goods and services, interest on loans, private transfers. A net credit is normally called a trade surplus, a net debit a trade deficit. A trade surplus means there is a net inflow of funds into the country, a net deficit means an outflow of funds.

BBM's father, President Ferdinand Marcos, had left Philippines a legacy of trade deficits since 1986 which Presidents Cory Aquino, Fidel Ramos and Joseph Estrada could not overcome. Credit to Gloria Arroyo, an economist, who managed to swing the country back to a trade surplus. Pnoy Aquino maintained the surplus levels. Under Duterte, Philippines slipped back into a trade deficit mode. Duterte gifted BBM a trade deficit of almost US$3 billion.

2. The exchange rate:

The exchange rate appreciation or depreciation is a double-edged sword. A depreciation is good for the folks receiving remittances from overseas which convert to more pesos, importers pay more for their overseas purchase, but Philippines exports becomes cheaper and more competitive. If the peso appreciates, the remittances coming home convert to lesser cash, imports become cheaper and exports more expensive. What Bangko Sentral seeks to maintain, is price stability. Nobody wants volatility in the rates.

Trade deficit means a net outflow of funds. As more Pesos are sold for foreign currencies to pay for more imports, the consequence is downward pressure on the exchange rate. Pnoy Aquino started with the rate at about USD1 : PHP46,000 The rate appreciated by about 10% and slipped back to 46.0. Duterte's admin saw the pesos depreciate by about 21.8% to 1:51,000.

As can be seen in the 2 charts above, the exchange rate moves in sync with the current account status. This makes sense as the net cash inflows and outflows impact the rate. Duterte's trade deficits weakened the peso, imported inflation and strained external debt servicing.

3. External Debt:

A Balance of Payments records a country's cross border monetary relationship with the rest of the world. Very briefly, it is split into 2 parts. The first part is the Current Account, shown above. The second part is called the Capital Account which records inflows and outflows on capital and financial transactions, such as borrowings/lendings, FDI. A deficit or surplus in the Current Account with be balanced off by a reverse sum in the Capital Account, thus the Balance of Payments will technically be zero. A simple example - if a country has a deficit Current Account, it ends up with a foreign loan to pay for the cash outflows. The Current Account has an outflow because of net imports, balanced off by cash inflow from loan that appears in the Capital Account.

All the Current Account deficits of Duterte means there were net outflow of funds. Where are the funds coming from? From external loans of course. The chart above shows Aquino kept the external debt flat but Duterte built up the foreign currency debts. Duterte gifted BBM additional PHP1.5 trillion of foreign debt.

Duterte's fiscal policies also increased domestic debt by Php 4 trillion. Overall, Durterte exploded national debt by 100% to Php 12 trillion. With the world going into an interest rate war, it is the huge external debt that will challenge BBM.

4. Interest Rates:

Exchange rate regimes manage price levels (inflation) by intervening in the FX market to manage rates. A trade surplus has upward pressure on the rates, so the central bank mops up the foreign currencies to force rates down. On the other hand in a trade deficit the central bank buys domestic currencies to force the rates up. This central bank action is easily reflected in their balance sheet.

Philippines follows the US way using interest rates and QE/QT (quantitative easing/quantitative tightening) as the tools for monetary management. The effects of changes on interest rates is not easily seen in the balance sheet. However, QE/QT are reflected in the balance sheet.

The chart above shows Philippines have a similar extended downward trend on interest rates like almost all countries. Aquino admin managed to hold interest rates steady for 6 years. This at a time when exchange rate was stronger. In Duterte's admin, the trade deficit of 2018 caused peso to depreciate, which is inflationary, and Bangko Sentral reacted by increasing interest rates about 200 basis points which in turn caused peso to appreciate again.

BBM takes over a sustained trade deficit which will depreciate the peso further unless the new president is able to improve the trade figures. A depreciating peso is inflationary. This time round, the situation is exacerbated by the acts of trading partners which are exchange rate regimes, like Singapore and China. These countries with trade surpluses will tighten monetary controls, allowing their exchange rates to appreciate to fight inflation. In other words, peso interest rates need to work double hard. Bangko Sentro has already increased interest rates recently. It is poised to go much higher. Trying to improve trade figures by raising interest and exchange rates is a tough order. You can't increase production cost and higher export prices and yet remain competitive.

5. Philippines foreign reserves:

One key metric that throws some light on the resilience of Philippines and its banking system is the level of its official foreign reserves. We can see this in Bangko Sentral's balance sheet which also shows what funded the reserves.

Every country needs to maintain a certain level of foreign reserves to withstand a credit crunch. The World Bank recommends a level to sustain 5-6 months of imports.

The Aquino admin added about US$1 billion to the country's reserves. Philippines reserves have been on the rise. Where did the money come from to purchase the foreign currencies? By debt (reverse repos and special term deposits - meant to reduce market liquidity) and some currency note printing.

Under Duterte, his appointee CEO of Bangko Sentral, Benjamin Diokno, further increased reserves by about USD1.3 billion, bringing the total to about USD5.5 billion.  Diokno's reserve purchases were funded by massive currency note printing and government deposits. Where are the huge government deposits coming from - increased domestic debt as shown in the national debt chart. Currency assets carry a valuation risks. Diokno's reserves now carry a huge unrealised revaluation loss due to apppreciation of peso. As at Mar 2022, this unrealised loss stands at USD588 million.

6. Reserves to GDP ratio :

Diokno likes to boast of the country's financial resilience with building up of the foreign reserves. But aggregates do not tell the full picture. The reserves of USD5.5B may be a very big sum, but it runs out very quickly during a credit crunch. When that happens, companies and the government go into default because the banking system cannot provide the foreign currencies for them to service their external debts. Are Diokno's reserves adequate? As economies grow, the level of foreign reserves must grow too. A better guage of reserve adequacy is to look at the Reserves to GDP ratio.

Estrada raided the reserves which plunged to its lowest level ever about 12% of GDP. Arroyo did well to bring it up to 20% level, whilst Aquino was quite consistent at the 20% level. Here comes Duterte and the reserves dropped to equal Estrada's lowest at 12%. For comparison, Switzerland has the highest ratio in the world at 115%. Singapore was at 105% before it moved some reserves to its sovereign wealth fund recently which brought the figure down to 91%.

A low level of foreign reserves heightens risks to a credit crunch just like what happened to Thailand, Malaysia and Indonesia in the 1997 Asian financial crisis. A central bank's inability to provide foreign currency liquidity in a credit crunch subjects the country's banking system to great risks.

Read: The debacle of USD or Yuan as world reserve currency. Why the Triffin Dilemma dictates the inevitable failure of any national currency used as world reserve. Why Yuan is unlikely to succeed its reserve ambition.

Summary :

Basically, the state of the nation is shaky. Trade deficits mean a depreciating peso which means importing inflation. Diokno has started moving interest rate up to protect the peso. But higher interest cost is no good for business. The inflation in Philippines is not driven by high liquidity or a demand side pressure. It is due to supply side loss of production resources. It is a situation that raising interest rates cannot address.

In all fairness, the central bank do not take all the blame. Although its monetary function is independent of the Executive, it had to work in cooperation with fiscal policies. Duterte is responsible for all the negative metrics mentioned. The trade deficit and huge external debt is a consequence of his infra 'Build Build Build' policy. There is a time lapse before hardcore infras can translate into more market efficiency and contribute to economy. The problem is the infras do not seem to be visible. Will BBM suffer the consequences or reap the benefits of his predecessor's infras programmes?

The downfall of Ferdinand Marcos in 1986 was hugely due to the country's debt position that could not take the shock of Paul Volcker's massive Fed rates applied on the USD which peaked at 21% p.a.. In our present times, a global interest rate war looms - the days of near-zero interest rates are over. There is fear Fed Chair Jerome Powell may be forced to use a Volcker style high extreme rates approach to tame their 9.1% inflation. History may repeat itself in Philippines. The son now takes over a massive foreign debt and faces a threatening interest rate shock.

If BBM's first act portends what's to come, it's time to buckle up for a rough ride. He acts on the clarion call of Diokno to kick start a digital financial infra with a new USD300m loan. One would have thought the priority is food production in view of the supply chain problems in the world and seriously take heed of the World Bank's warning of an impending human catastrophe food crisis .

I wish the new president and my beloved Philippines well. Despite my personal misgivings of the family name, I feel we should respect the vote and let BBM the opportunity to work for the people as best he could. There is only one area that I really hope he will never go. And that unfortunately, seems to be one of his favourite calls. I am referring to the revival of the failed and decaying Bataan Nuclear Power Plant. He seems adamant on fulfilling his father's legacy. Although I live 2,350 km away, I recall the 1991 Mount Pinatubo eruption blocked out the sun and wind blown volcanic dust reached our shores. The plant is rusting away, it's only 57 km from Pinatubo and along Philippines earthquake fault lines.

THE DEBACLE OF USD OR YUAN AS WORLD RESERVE CURRENCY

Renmenbi as a world reserve currency depends on the willingness of both the private and public sectors to use it in international transactions as well as the CCP's desire to take on this role. The push factor away from the dominant role of USD has been due to the burgeoning US national debt and massive money printing by the Fed since 2007. The coup de grace is the Biden admin weaponising the dollar for foreign policy objectives apparent in the Russo-Ukraine conflict. It is a new paradigm that has increased political risk to a country's reserve holdings. This has taken on some urgency with the bi-polarisation going on in the world. Whilst there has been clamour for a new world reserve currency for decades, the USD's position has hardly been realistically challenged for 2 main reasons. (1) is something known as network externality. (2) is the lack of a real alternative currency.

Network externality is the phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products. In simple English, the more the merrier. Many begrudge the USD, but since many use it as reserve currency, the push factor is weak. A good illustration is what happened with the 'Nixon shock' in 1973. The world monetary system then was based on USD backed by gold at US$35/troy oz, and all other currencies pegged to USD. US promised gold convertibility. Over time, there was not enough US gold reserves to support the creation of massive USD necessary for rebuilding the world after WWII. US reneged on gold convertibility and Bretton Woods agreement collapsed. Countries distrusted the US, yet the world continued to use USD as the reserve currency even though it had become 100% fiat, backed by nothing. The reason was because there was network externality

The second reason, lack of alternative, is really an extension of the first reason. Everyone's using the USD, no one is gong to use the Mongolian togrog, for example.

What is a reserve currency? It is simply a foreign liquid asset that a country's central bank holds, (often in cash deposits or other government securities) as a reserve. In the event of a credit squeeze and the country runs out of that currency, the central bank can provide the liquidity for their economic activities. The reserves of course, can only support liquidity for only a few months. It follows that countries will maintain reserves in the currencies their economies deal with. To this extent, several major currencies currently are world reserve currencies such as USD, EUR, Yen, GBP, AUD, CHF, CAD and CNY. In 2020, US was uno numero with 59% of world reserves in USD, EUR 2nd at 24%, CNY a distant 5th at a tiny 2.8%.

The Renmenbi is quite widely used in neighbouring countries of China, and the Belt and Road Initiative countries, even accepted for retail transactions. Countries that do international trade with China perhaps use some Renmenbi. But between countries of other trade blocks, like Americas-Europe, ME-Americas, EU-Asia Pacific, North-South countries, etc, all these have nothing to do with Renmenbi. The highest traded pairs of currencies in 2020 were EUR-USD (28%), USD-Yen (13%), GBP-USD (13%), USD-AUD (6%). The CNY was not even within the top 28 list. To claim that CNY will be the world reserve currency in the foreseeable future is a little far-fetched at this juncture. At best, in the distant future, Renmenbi could expand its reserve currency role to 17% based on its 2019 GDP of US$15b to world GDP of US$88b. That would be fair speculation.

It is fashionable nowadays to pile it up against the USD. Before we criticise the USD, and more importantly before we wish upon the Chinese to internationalise the CNY, we need to understand the fate that lies in store for any world reserve currency. The eventual collapse of the USD was foreseen by John Maynard Keynes who understood that no national currency can play the role of world reserve currency. He had proposed a one world central bank currency he called 'bancor'. In 1959 a Dutch economist Robert Triffin, had famously explained Bretten Woods, an international agreement which used USD as reserve currency, would collapse, and it did in 1971. His theory became known as the Triffin Dilemma. The Triffin Dilemma explains USD, as world reserve currency, is trapped in a death spiral that has taken 50 years to manifest.

What is Triffin Dilemma all about? Any country whose currency is used as the world reserve currency is conflicted in its domestic monetary policies and world economic well being. What is good for the country may not be good for the world, and vice versa. For the bigger good of the whole world, that country sometimes has to subjugate its own monetary sovereignty. With USD as the world reserve currency, the US has to provide liquidity not just for its domestic economy, but for the whole world. In 2019 the US GDP was US$24T and world GDP was US$88T. We are talking humongous numbers. That means US has to ensure outflow of its own currency to the world.

In my 2 earlier blogs "Are Singapore and China guilty of currency manipulation?' (Here and here) I showed that when a country has a Current Account Deficit in its Balance of Payments, ie a trade deficit, it has to sell more of its currency for foreign currencies to pay for net imports, thus their exchange rate goes down as there is a net cash outflow. The US is an exception. Because the USD is world reserve currency and most goods and services are priced in USD, the trade deficit does not lower the value of USD. Nevertheless, just like all countries having a trade deficit, the US experiences outflow of funds when it has a trade deficit. In order to provide cash outflows, US must continue to spend the currency into existence like crazy. Thus it pursues aggressive deficit budgets. It has to raise capital fast to spend into the world economy. Thus it borrows like crazy via Treasury bonds. As a borrower, the US would want their cost of funds to be as low as possible. And because USD is world reserve currency, there is huge demand for it which drives its value (exchange rate) up and interest rates low. For the countries that build up their USD reserves, they need to park it in very liquid dollar assets. There is nothing better than US Treasury bonds, where asset values keep appreciating. And so the game goes on and on and on for decades.

So the US maintains Current Account deficit in order to generate outflows of currency into the world economy. This resulted in budget deficit and huge debts and loss of confidence in the USD. To gain confidence in the currency, the US must work towards a trade surplus. Herein lies the Triffin Dilemma - the US cannot have a deficit and a surplus in its Current Account at the same time.

Here's why the US, and any country whose currency is used as world reserve country, will be entrapped in a spiral of death. The outcome for the high value USD (because it is in demand as reserves) is US businesses relocate to countries with cheaper operating costs. Jobs cannot not be protected and production gets hollowed out. This predictable outcome has already happened. With loss of jobs and production capacity, this leads to the inabilty to service the huge debts necessary to spend budget deficits that provide USD liquidity outflows to the world. Again, this has happened with the US sitting on US$37T national debt. Which then leads to money printing. And again, this has happened which the US has done spectacularly since 2007. Federal Reserves QE were massive printing exercises which leads to serious inflation and devaluation. Massive inflation for US is inevitable. But for various reasons, its self-inflicted inflation had been delayed for many years. For years there had been asset inflation (housing, bond, equity, crypto markets), but the real economy had been spared. Up to now. Reality has finally caught up with this current global inflation which is going to ignite the innate inflationary pressures that has been in their economy for 2 decades.

Read: How a Federal Reserves Bank cheats with creative accounting. See the massive build up of balance sheet via money printing

The views of the Chinese and progressives all over the world, fed-up with the mess the Americans have got us into, and dead wary of the weaponisation of the USD in foreign policies by the West, feel strongly a change is coming. By virtue of China's dominant economy which will soon overtake the US, the CNY should replace the dollar as world reserve currency.

CCP's concern was first raised in 2008 in the aftermath of the global financial crisis. PBOC governor at the time, Zhou Xiaochuan called for establishing an international reserve currency “disconnected from economic conditions and sovereign interests of any single country.” Since the world has taken no interest in this direction, China has taken to internationalising the CNY. The more the world uses CNY, the lesser the risks for China in international trade. The objective is basically self-preservation. With the massive money printing by all western central banks after 2007, China's massive foreign reserves are eaten away by devaluation of these currencies.

China has made various moves to promote the CNY internationalisation policy, such as the Dimsum bonds (allowing CNY-denominated bonds offshore), establish Renmenbi hubs in various financial capitals where offshore CNY deposits are allowed, appointing CNY clearing banks in some capitals, implementing the CIPS (Cross-border Interbank Payment System) as an alternate to SWIFT payment system, promoting the use of CNY in economic blocks such as BRICS and Belt & Road Initiative countries, use CNY in oil purchase programmes, currency swap arrangements with a few countries under the Chiang Mei Initiative in 2000, etc.

The CNY is coming from an extremely low base. There is no significant volume in CNY pair in forex trades. One would have thought with its dominance in world trade, the use of the Remenbi would have taken on a much higher role. The hill to climb here is the 'network externality' mentioned above. The Ukraine war has given the CNY some impetus, but it's still a very very long way to go.

The biggest stumbling block is China's reluctance to free up Capital Account controls. It has relaxed in many aspects, having ticked off many items in the checklist of IMF's requirements for an open capital account. But many instances of capital flows still require official permission. It is the old Communist control mentality the CCP cannot shake off. This remains the major roadblock to the internationalisation of CNY. One simply cannot have a world reserve currency that is subject to capital controls. China needs to completely liberalise capital flows, but they won't. Basically China wants to have their cake and eat it too.

Those who feel CNY will replace USD as the world reserve currency are misplaced if their persuasion lies solely on the basis of China's dominant GDP. They feel China has the same, and if not, more clout than the US when Chinese GDP is world number one as it is destined. The world economy is oiled by USD liquidity. But many fail to understand this USD liquidity is not primarily provided by the US.  The reality is the USD liquidity is provided by the massive amount of offshore USD deposits. This started way back in London and then in various European capitals where USD deposits were allowed. These offshore USD funds became known as the Eurodollar. Today offshore dollar is in many other capitals. Those in Asian capitals are loosely called Asiandollars. Singapore as an important money market centre, has huge amounts of USD deposits that used to be called the Asian Currency Unit (ACU). The importance of these offshore USD is liquidity is located close to where it it required. How big this pool of offshore USD is, nobody really knows. Since they are offshore, it is un-regulated by US, so data is scarce. Some years back JP Morgan made an estimate that 90% of financing transactions outside of US were funded by the Eurodollar. That's astounding and underlines the importance of offshore funds for a world reserve currency.

The size of China's GDP alone cannot warrant CNY to provide liquidity to the world. An offshore Renmenbi market goes hand-in-hand with CNY internationalisation. An equivalent EuroYuan is required, which takes decades to develop. But it is impossible to see the CCP acquiescence to foreign interest having some sovereign control over offshore CNY. This just won't happen.

By the way, Eurodollars allow some protection to depositors who fear US Federal threat. A Russian oligarch with USD deposits at DBS Singapore has no worries about the US government confiscating his wealth. It is outside the jurisdiction of the US.

China has no benchmark interest rate like the Fed rate or some discount rate dictated by market forces. It has a trading mentality that uses foreign exchange rate as monetary tool to manage price stability. Its interest rate is an officialdom prerogative. A market-driven interest rate is what breathes life into an open market economy for participants to know how to price and hedge themselves.

Not only is capital movement not fully liberated, China's domestic capital market is immature. Its financial institution still works under the umbrella of the "infant industry argument", a classic theory in international trade that new industries require protection from international competitors until they become mature, stable, and are able to be competitive. It simply lacks the varied instruments for countries that acquire massive CNY reserves to invest. We hear recently of Saudi Arabia pricing their oil sales to China in CNY. Where are the Saudis going to park their massive CNY? Internationalising the CNY is not just a matter of invoicing transactions, but China must provide the reserve currency as a store of value. The mechanisms are sorely lacking. Reforms from Beijing are slow in coming and often times conflicting. The road ahead is long.

Last but not least, can anyone envisage China to transition from a trade surplus to a trade deficit economy? If it does not, how will it generate the cash outflows to provide liquidity to the world?

Those criticising the mess the USD is in should appreciate as a world reserve currency, it was set up to collapse. The USD did national service for the world. Yes Americans lived off the fat of the world for decades. Their era of high cosumerism is over as those massive debts and printed money is coming back to roost in a block-buster inflation that I suspect will be a prolonged one. Those urging for CNY to replace USD must know firstly, it is getting a child to run before he can walk, and should the CNY replace USD as world reserve currency, the same fate of failure as predicted by Triffin Dilemma surely awaits the Chinese. As Keynes pointed out, no national currency can play the role of world reserve currency. It needs to be an exogenous creature, outside of world banking system. Thus he proposed 'bancor', an independent currency owned-by no country. Perhaps there can evolve some form of crypto-like algorithmn, or a One World Government currency, controlled by Claus Schwab? How voluntary and independent can that currency be?

ARE SINGAPORE & CHINA GUILTY OF CURRENCY MANIPULATION? (PART II)

In Part I (see here) I shared how a persistent Current Account surplus in the Balance of Payment invariably forces the domestic currency to appreciate. In such a situation, if the country is not a pure free float regime, its central bank will intervene in the forex market to buy up the foreign currencies and sell local currecy in their market. The result is a huge increase in the official foreign reserve balance in the books of the central bank and a weakened local currency. A policy to control and undervalue its domestic currency makes the country more competitive as their exports are cheaper. This causes a structural imbalance in world economy and infuriates disadvantaged countries that leads to trade negotiations and tariff wars. Is it possible to camouflage the build up of foreign reserves? In Part I, I showed how creative accounting made foreign reserves disappear from the books of MAS. In this Part II, let's take a look at China.

A timeline will make the picture clearer:

1978 -- Deng Xiao Peng opened up China
1994 -- China pegged the CNY at 8.28 to USD. The peg remained for next 10 years.
2001 -- China allowed to join World trade Organisation
2005 -- China allowed CNY to appreciate by 2.1 to appease pressure of trading partners.
2005 -- China switched to managed float regime. CNY appreciated by 21% next 3 years.
2008 -- World financial crisis caused an export slump. China put a brake on CNY appreciation with the rate at 6.83
2010 -- CNY allowed to appreciate again.
2013 -- PBOC declared purchase of reserves no longer necessary
2019 -- In August, China lowered the baseline to CNY7 = USD1 after huge tariff imposed by US.

The flat vertical or horizontal patterns in the rate chart above indicate controlled rate movements.  In 2013, Chinese central bank, People's Bank of China (PBOC) declared the accumulation of foreign reserves was no longer necessary. This signals non-intervention and a switch to a lesser controlled free float regime. The post-2013 sea-saw tooth pattern indicates indeed a more open market scenario.

The current account balance provides the background to central bank action on exchange rates.

China's entry to WTO in 2001 emancipated the country in international commerce. Napoleon's 'sleeping dragon' was awakened and its exports went into overdrive. Its current account surplus took on massive numbers to hit US$400b by 2008. Exports plummeted in the 2008 world financial crisis and the pandemic when trade surpluses decreased just as dramatically. The economy is so huge and export driven that any blips on world trade tend to hit their current account dramatically. As the economy recovers from the pandemic, the surplus is building again.

Once again, just as for MAS, the current account surplus and forex intervention to manage rates by China can be seen in the balance sheet of Chinese central bank.

After trade liberalisation in 2001, with trade surpluses building up, PBOC had to accumulate foreign currencies to keep the CNY pegged to the USD at 8:1. The under-valued CNY caused huge trade imbalances in the world. Other countries were robbed of opportunities, so China allowed the CNY to appreciate by 2.1% in 2005. That had little effect as China's trade surpluses continued to build up. PBOC then switched policy to a managed float to try a soft landing for the rates. CNY appreciated very quickly and PBOC had no choice but to continue accumulating foreign reserves to slow the CNY appreciation. By 2013 with China trying to move away from export-driven growth to domestic economy, and trade surplus figures dropping by about US$300b, and CNY appreciated to 6.0000 levels to USD, PBOC declared it was no longer necessary to accumulate foreign currencies.

All these are reflected in the balance sheet of PBOC which show foreign reserves building up all the way to 2015 in line with trade surplus growth. Though PBOC declared in 2013 that it was no longer to accumulate foreign currencies, trade surplus was building again and in the interim period 2013 to 2015, it was still buying up foreign currencies. From 2015 trade surpluses noose dived again, and PBOC sold foreign currencies to support the CNY which had depreciated. The balance sheet shows PBOC holdings of reserves dropped during 2015-2017.

During the period 2015-2017 PBOC shed some USD250b of Treasury Bills. Reading this against the back drop described above, it is apparent China's disposal of US Treasury Bills is nothing but part of normal central bank monetary open market actions to support the CNY. The populist notion that China was trying to get rid of US Treasury Bills to depose USD as world reserve currency is a fallacy.

Then something strange happened in 2017. Trade surpluses began building up again by US$250b to the level of US310b today. The CNY rate showed volatility of usual sea-saw pattern of currency movements in open markets. But from 2017 till today, the foreign reserves with PBOC has remained flat.

The huge current account surplus accumulated from 2017 till today means a massive net inflow of foreign currencies. No one was borrowing that huge amount of money from China and PBOC foreign reserves did not increase. If those funds entered the country, who is holding them? It has to go somewhere.

For years, China's commercial banks hold a consistent amount of foreign assets. From 2015 as PBOC weens itself of trillions of CNY worth of foreign reserves, Chinese commercial banks began building up their holdings of foreign assets. Is that a coincidence? Of course not. Chinese banks could not have acted without the central bank's instructions.

It is very apparent, China now allows foreign currencies to be deposited in local commercial banks to take the heat off criticism of PBOC accumulation of foreign reserves to suppress rates.  This is similar with Singapore central bank shedding reserves off its balance sheet by transferring some holdings to the sovereign wealth fund.

One final chart to look at is China's forex reserves to GDP ratio.

China has the second highest public foreign debt in the world of US$13T, behind the US which has US$30.7T. Yet compared to Singapore's huge reserves to GDP ratio which topped more than 105% recently, China's ratio is currently only about 8% now. It has never exceeded 21%.

At the moment China has about USD3T in foreign reserves. This seems like a massive amount of money but the economy is so large if a financial shock happens, the reserves can run out very fast. China has no worries about reserves for import contingencies because of its huge trade surpluses. At this level of reserves, it is susceptible to a credit crunch. This is especially so because almost all commercial banks are owned by the government. Thus China's reserves are considered low and a credit crunch carries a high risk of a collapse of the banking system.

From 1994 when CNY was pegged to USD at 8.2800, right up to 2015 when it seems PBOC allowed the currency free float, the Renmenbi appreciated about 27% against the dollar. Compare this to the Yen during Japan's meteoric economic rise from 1970 to 1991, in similar 21 years run the Yen appreciated 61%.

In the earlier years between 2001 to 2013 when the economy was export driven, China was reluctant to re-align the USD peg which will cause CNY to appreciate and loose export competitiveness. It probably became more receptive of CNY appreciation as it moved towards a domestic driven economy. In 2019 in response to President Trumps massive tariff, China allowed it's baseline peg to drop to 7.000. The rates since 2019 are free floating within 7.0000-6.2000 band. Trade surplus is building up again, but PBOC forex reserves are flat. It seems foreign assets are parked at commercial banks instead. However, the growth of foreign assets are not at a level that suggest PBOC is depressing the rate.

The answer to whether China is manipulating the CNY is not so clear cut as far as post-2015 is concerned.  Allowing the commercial banks to hold foreign currency deposits looks like a new development of Asian Currency Units in China. How this will play out quantitatively and the consequences is not yet clear.

I guess the bottom line is this. Many countries also peg their currency to some major currency and the economic consequences are the same - reserves build up with trade surpluses. But when an economy is as large as China, this causes major trade imbalances and needs to be addressed. When a country tweaks its exchange rate, whether it is to manage domestic inflation or to gain export competitiveness, the difference is a very thin line. Perhaps it boils down to whether it is done openly, or covertly via creative accounting. Then again, all advanced western countries use the interest rates as their monetary tool. By adjusting their interest rates to control inflation, it has similar effects as managing their exchange rates. What is the ethical difference? 

 

ARE SINGAPORE & CHINA GUILTY OF CURRENCY MANIPULATON? (PART I)

Several countries, including China and Singapore, have consistently been on the US watchlist for manipulating their currencies. This has been a bone of contention with disputes erupting every now and then. Both China and Singapore are 'managed float' regimes that require the central banks to intervene in the foreign exchange market to keep the rates within a certain band. Whether such intervention is currency manipulation rests on intention which is a thin line that is hard to prove or defend. When it is policy driven to keep rates low and thereby exports more competitive, trading partners are understandably displeased. Are China and Singapore guilty of currency manipulation? There are some quantitative tell-tale signs and you can be the judge.

The Balance of Payments (BOP) is a sort of double-entry presentation of a country's monetary relationship with the rest of the world over a stated time period. It records the inflows and outflows of funds of a country. A BOP is divided into 2 parts, a Current Account and a Capital Account. The Current Account records trade in goods and services, interest on loans, private transfers. If a country has more inflows on a net basis, it has a surplus Current Account. More net outflows means it has a deficit Current Account. The Capital account records inflows and outflows on capital and financial transactions, which includes borrowings/lendings, FDI. etc. The Capital Account should balance off the Current Account and the BOP nets to zero. One simple example to make this clear -- if a country imports more than it exports, it has a deficit Current Account. It pays for this with a loan which is recorded as an inflow in the Capital Account, thus the BOP = zero.

In reality, the BOP do not balance off with precision. If the Current Account and Capital Account does not match off, the difference is found in the books of the Central bank. It is represented in the movement in the forex reserves. Thus within the Capital Account is included a sub-account called the Reserve Account to record the net inflows and outflows of reserves. In other words, the central bank's market intervention mops up the difference in inflows and outflows of funds.

To round up the BOP, note that there is always a discrepancy figure. This is due to inaccuracies in the data collection.

The countries with surplus Current Accounts almost always tend to have pressures to appreciate their currencies. These countries are doing well, exporting more than importing. Thus there are more demand by trading partners to buy their currencies to pay for the goods and services. With high demand, their exchange rates go up. In a pure floating rate regime, market supply and demand forces will re-align exchange rates to a new equilibrium.

Let's take a look at the Current Accounts of China and Singapore :
Both China and Singapore have been running Current Account surpluses for decades. Have the CNY and SGD appreciated to the level the market suggests? According to trading partners, especially the US (because they have an agency that monitors such economic numbers) both the currencies are under-valued. The question arises whether China and Singapore are manipulating the home currencies.

Here's a peek at the balance sheet of the MAS
MAS foreign exchange holdings have increased relentlessly over the years. Singapore is a managed floating rate regime. It manages daily volatility within a band. When the rate is hitting the upper threshold, MAS intervenes in the forex market to buy foreign currencies and sell SGD thus forcing the rate down. If the rate falls to the lower threshold, MAS does the reverse in buying SGD to support the domestic currency. Singapore's persistent Current Account surplus resulted in upward pressure on the rates. To keep the rate down, MAS has to enter the market often to buy up foreign currencies. MAS balance sheet shows the upward trajectory of forex reserves consistent with the Current Account surplus chart.

How does MAS fund the forex purchases? We turn to the liabilities side of the balance sheet. First of course, is it's equity (Paid up capital and reserves). Secondly, by printing money. Thirdly is the use of government's deposit.

When MAS purchases foreign currencies, it can pay for it by simply crediting the counterparty bank's reserve account. This is referred to as 'printing' money out of nowhere. The downside is inflation due to increased money supply. So to combat inflationary outcomes, MAS forex intervention by money printing is always on a sterilised basis. This means it then issues MAS Bills to soak back the liquidity from the market. The chart shows MAS bill mechanism was only introduced in 2011 which snowballed to a massive S$161b by 31 Mar 2021.

The use of Government deposit is ingenious. You get to understand this here because no where has this ever been written about. MAS is banker to the government. Now the government deposits its revenue which are needed to meet expenditure. But there is something uniquely Singapore. The government collects vast sums of S$ which by law, it cannot spend. These are proceeds from land sales and debt in the form of government securities (for the national pension fund CPF and issues for yield curve discovery). These funds are deposited into its account with MAS pending transfer to the sovereign wealth fund GIC, for investing. MAS makes use of these funds to pay for foreign currencies it purchases in its market intervention. The foreign currencies purchased are transferred to GIC from time to time. It seems to be the only modus operandi for market intervention before 2011. This means 2 things. (1) The domestic savings (proceeds of government securities) and investments (land sales) are recycled back into the economy by MAS. (2) By eventually transferring the foreign currencies to GIC, the evidence is wiped off the books of MAS. It stands to reason the forex reserves are actually much higher, rendered opaque by the transfers to GIC.

However, the high level of forex reserves alone does not indicate the accumulation was for the purpose of suppressing the exchange rate. Every country maintains a certain level of official forex reserves that will cover several months of their import needs. IMF recommends 5-6 months of reserves. Thus as import needs grow, the level of forex reserves grows. Another way to look at it is the ratio of forex reserves to the GDP. If GDP grows, forex reserves has to be increased. Singapore GDP grew from US$96b in 2000 to more than US$400b today. A higher level of forex reserves is required. The MAS has indicated a forex level of about 65% to 75% of GDP is a safe level.

The chart above shows Singapore maintains a very high reserves to GDP ratio It is one of the highest in the world. A persistent ratio far in excess of requirements indicates market intervention to suppress upward pressure on rates.

Central bank data on its market intervention may also provide a clue. If the intervention is predominantly one way, ie buying foreign currencies, it indicates manipulation. This could perhaps be the reason why MAS has never reported this data until April 2020, probably an appeasement uder pressure by external demands for transparency. This report shows the market intervention was predominantly one way:

- 1 Jul 2019 to 31 Dec 2019 - net purchase of foreign currency of US$29.9 billion.
- 1 Jan 2020 to 30 Jun 2020 - net purchase of foreign currency of US$44.4 billion
- 1 Jul 2020 to 31 Dec 2020 - net purchase of foreign currency of US$52.1 billion
- 1 Jan 2021 to 30 Jun 2021 - net purchase of foreign currency of US$22.4 billion
- 1 Jul 2021 to 31 Dec 2021 - net purchase of foreign currency of US$  6.6 billion

The new legislation MAS Amendment ACT, allows an easier mechanism for the central bank to transfer official reserves to GIC by simply subscribing for a new foreign currency-denominated non-market government security RMGS (Reserves Management Govt Security). Some US$55b in the first half of this year has been transferred to the government in exchange for RMGS. By this creative accounting, forex reserves in MAS balance sheet immediately decreased. It dropped from S$579b in Feb 2022 to S$504b by Jun 2022. This is reflected in the reserves to GDP ratio chart showing a significant dip on the right. Is this designed to mislead by showing a lower level of foreign reserves in the balance sheet?

Trading partners are displeased when a country with a booming economy manipulates to prevent its currency to appreciate, thus keeping their exports cheap. Is Singapore guilty of unfair trade practice to maintain export competitiveness? Such unfair practice often ends up with trading partners sitting down for a trade negotiation, and at worst, a tariff war may ensue.

In addition to irate trading partners, there are other consequence for the suppression of exchange rates. Imagine MAS pressing down the lid of a pot of boiling water. At some point, MAS has to lift the lid or risk an explosion from the built-up pressure. By suppressing the rates, MAS is undervaluing the SGD. This means we are paying more for imports, in other words, we are importing foreign inflation. Thus the policy of suppressing rates is inequitable. It benefits the business class with export competitiveness but subjects residents to higher local prices. Just like the pressure building in the boiling pot, there will be a point when inflationary pressure will force MAS to take the lid off and allow the rates to rise and SGD to appreciate.

(Part II focuses on China. Check out here).