Asia braces for the end of easy money
Higher foreign exchange reserves should help avoid a 'taper tantrum' but other risks remain
MOTONAO UESUGI, Nikkei senior staff writer
TOKYO -- Visitors to the Royal Palace Park in Phnom Penh don't need to worry if they forget to bring wads of Cambodian riel with them -- all of the owners of the nearby food and drink stalls tell their customers to pay in U.S. dollars anyway. It is the same all over the country: Bank loans, hotel visits and checkups at medical clinics are all paid in dollars. And, despite pleading from the government for banks to use the riel, there is little sign of Cambodia giving up the greenback anytime soon.
Huot Pisey Pichny, 25, owner of the Pasteur Cafe, says she lists her menu items in dollars because it is more convenient for her customers, who don't like to carry large quantities of riel with them all the time. She pays her staff in dollars, too.
Cambodia's use of the dollar accelerated in the early 1990s, when the United Nations set up a transition authority to help guide it out of civil-war rule. But the small Southeast Asian country has been awash in dollars over the last decade, when the U.S. Federal Reserve went on an unprecedented money-creating spree. The amount of dollars circulating globally totaled about $6.9 trillion at the end of October, up 240% since 2007. As a result, the currency poured into every corner of the world -- including Cambodia.
The Fed, along with other central banks around the world, have spent about $11 trillion on emergency measures to prop up the global economy since the financial crisis began in 2007. But some analysts, including Torsten Slok of Deutsche Bank, believe the world reached "peak liquidity" this year, as Western central banks began to withdraw their stimulus policies. This great unwinding should gain pace now that the Fed is seeking to "normalize" its policies by gradually raising interest rates and cutting its $4.5 trillion balance sheet.
This worries Chea Serey, director general of central banking of the National Bank of Cambodia, who hopes the Fed will think about her country as it begins soaking up the excess dollars it printed over the last decade.
"I think it is important to consider what impact it has on the emerging economies whenever they make a decision on monetary policies," Chea said. "I think they should bear in mind what could happen elsewhere and also the costs and benefit of ... their policies on other regions' economies."
Though Cambodia's relationship with the U.S. currency is rare, the Fed's tighter policies are likely to have an impact across Asia. When American rates rise, capital tends to flow out of other regions -- including Asia -- and return to the U.S. This can cause the U.S. dollar to rise, rattling regional stock and bond markets. Higher interest rates can make it harder for companies to repay debt, and fewer dollars in circulation can make it more expensive to obtain credit. Prices for assets that have been boosted by low interest rates, including property, are sometimes tested.
In Phnom Penh, land prices have doubled in recent years, but lately office vacancies have been rising -- a sign of potential trouble. But even if an economic bubble burst in Cambodia, there would not be much its central bank could do about it because the bank is only the guardian of the riel -- and dollars account for 83% of the money circulating in the country.
Daisuke Karakama, chief market economist at Mizuho Bank, said the scale of the monetary policies that are slowly being unwound makes it hard to predict the impact of normalization. But he notes that it is coming amid anxieties about the end of a long bull market in stocks, bonds and other assets in many regions.
"Considering the size of easing, it's hard to imagine [the impact] on the world's economy or asset prices," Karakama said.
The ripple effects of the Fed's decisions were demonstrated in the so-called 2013 taper tantrum, when fears of an early end to U.S. easy money spooked financial markets, including in Asia. Indonesia was among the worst affected, forcing its central bank to lift interest rates to support its falling currency. The Indian rupee plunged to an all-time low against the dollar.
Today, however, Asian economies have built up foreign exchange reserves to deal with a sudden reversal of foreign capital. For instance, South Korea has reserves of $387 billion, compared with around $250 billion before the 2008 global crisis. Still, Asian central banks know that reserves are only a temporary cushion -- if the Fed is tightening monetary policy, as it is doing, Asian central bankers will want to reduce the allure of U.S. markets by raising rates locally.
Most analysts point to the very conditions that are allowing central banks to normalize their policies -- rising economic growth around the globe -- as evidence that the effects of higher interest rates will have a muted impact.
On Nov. 30, the Bank of Korea pre-empted the Fed's interest rate hike by raising rates for the first time in more than six years -- a step that intensified pressure on central bankers elsewhere in Asia to begin tightening. Central banks that could raise interest rates next year include those of Malaysia, India and Pakistan, according to Capital Economics.
The People's Bank of China, the nation's central bank, expanded the money supply from 47 trillion yuan ($7.1 trillion) in 2008 to 165 trillion yuan as of October. Although it says it takes a "neutral" position, it has been in lockstep with the U.S. monetary easing policy until recently and is now catching up with the U.S. in monetary tightening.
This leaves Japan behind the major central banks in monetary tightening, though there have been market rumors that the Bank of Japan may be conducting "stealth tapering" -- lowering the amount of its asset purchases without making an official policy change announcement. But BOJ Gov. Haruhiko Kuroda said this month that the bank will continue its "extremely accommodative" monetary policy to achieve its 2% inflation target as soon as possible.
None of these moves toward normalization necessarily spell hard times ahead for the Asian countries that suffered during the taper tantrum, said Gareth Leather, an analyst at Capital Economics, in a research note.
"Even if monetary policy tightening in the developed world did lead to a sudden pullback in capital flows, it is unlikely that this would cause policymakers in the region to panic," said Leather. "Current account deficits in the three countries hit hardest during the 2013 taper tantrum have either narrowed significantly or returned to surplus [in the case of Thailand], with the result that they have become much less dependent on foreign financing to sustain domestic spending."
Since the taper tantrum, there have been two other major episodes that shook Asian markets. Between mid-2015 to early 2016, financial markets noticed diverging economic performances between the U.S. and China and feared a possible devaluation of the yuan against the dollar. This has triggered capital outflows not just from China, but also from other Asian markets.
Asia was hit again after the election of Donald Trump as U.S. president in November 2016, as expectations grew that Trump's promised stimulus policies would prompt the Fed to raise interest rates more quickly than previously expected, said Faraz Syed, an economist at Moody's Economy.com. Indonesia, Thailand and South Korea were among the countries affected.
"Overall, higher interest rates in the U.S. make emerging market assets less attractive, because investors can expect to get a higher return than before for holding the same low-risk U.S. assets," he said, adding that if "the U.S. becomes more protectionist [under Trump], capital outflows in Asia are likely to increase."
Since the start of the global financial crisis in 2007, the global supply of money -- that is, cash circulating in the world plus deposits -- has swollen to a size far larger than the real economy. In 2016, the money supply totaled $88 trillion, 16% higher than the world's gross domestic product, according to calculations based on World Bank statistics.
This is unusual. For half a century until the mid-2000s, money increased almost in sync with the growth of the real economy. But since 2009, it has been growing much faster than GDP, and the gap between the two has become wider every year. Amid the shrinking global economy, central banks left the money faucet wide open, pushing the world's money supply up by 76% over the decade from 2006. Funds supplied by central banks in Japan, the U.S. and the eurozone quadrupled in the same period.
This money had to go somewhere. And while central bankers may have hoped low interest rates would prompt companies to invest in new factories and higher wages, they have instead lifted asset prices of all types, from property and art to stocks, bonds and bitcoin. The market value of global stocks fell below $30 trillion in the spring of 2009 but recently expanded to a record high of about $83 trillion. According to U.S. investment research company MSCI, real estate held by investment funds and financial groups was valued at $7.44 trillion at the end of 2016, up 21% from the end of 2009.
Such high valuations have been dubbed the "bull market in everything," which Goldman Sachs International analysts warned last month is starting to look very mature. "It has seldom been the case that equities, bonds and credit have been similarly expensive at the same time, only in the Roaring '20s and the Golden '50s," the analysts wrote in a widely discussed research report.
Many corporations took advantage of low interest rates to raise money in the debt market, in some cases using the proceeds to buy back their shares instead of reinvesting in their businesses. Now some companies are returning to the bond markets before interest rates rise further, including Alibaba Group Holding, the Chinese e-commerce company. Alibaba raised $7 billion from international investors last month with a new bond issue with a maturity of up to 40 years. But the company, which is investing aggressively in brick-and-mortar retail stores, is expected to pump the proceeds back into its business.
The money glut
As the supply of money has expanded, it has ended up in some unexpected places.
Apple, which has reached a world-leading market value of nearly $880 billion on the strength of iPhone sales, recently became a world leader in something else, too: corporate bonds. This summer, its holdings of corporate bonds topped $150 billion -- more than any financial group.
To buy these bonds, the high-tech company used surplus funds -- money that a traditional company might have invested back in the business. In the year ended Sept. 30, Apple earned $63.5 billion in cash but invested $24 billion in plant and equipment and research and development, less than 40% of its earnings in cash in the same year. Excess reserves continued building up, while outstanding assets under management increased twentyfold over the past decade.
Such behavior would seem to make Apple as much an asset manager as it is a high-tech company. Companies typically spend cash they earn on buying real assets, such as machinery and equipment, and borrow money to do this if they are short of cash. They save remaining funds in deposits or securities, or use them to repay debt. Until the 1990s, they prioritized investments, and investments were usually greater than savings.
In the late 1990s, a change began to occur among Japanese companies. They started cutting back on investments, anticipating that the Japanese market would shrink due to the declining population. German companies, which made handsome profits from exports, also started saving up money. In recent years, U.S. companies began to hoard cash, too.
According to the Organization for Economic Cooperation and Development, companies based in developed countries saved about $446 billion more a year than they invested. A report released in March by the U.S. Federal Reserve Bank of Minneapolis stated that this expansion was due to increasing profits at multinational companies, which then boosted their savings. Production in countries with low wages pushed down labor costs and led to even more savings.
Some analysts cited other reasons for the spike in savings, including the advent of oligopolistic tech companies that generate vast profits, such as Apple and Alphabet, declining capital spending due to the rise of digital industries, and preparation for R&D in the future.
Companies used to borrow money from households that had deposited money in banks; now they also lend money. This has added to the money glut and helped to keep interest rates low.
Meanwhile, households are also cutting back on spending and saving more money. Particularly in Asia, people are increasing their savings in anticipation of a longer life. Savings are high even in China, a country that has enjoyed remarkable economic growth. Although abundant funds are available, it is becoming more difficult to stimulate the economy and prices because companies and households are not spending much.
While central banks were putting off the decision to scale back monetary easing, money pooled up in places like Cambodia. Historically low interest rates and a money glut are at a turning point now -- but no one can foresee how wide the ripple effect will be when the money supply shrinks.
Additional reporting by Nikkei staff writers Kosuke Takami, Masayuki Yuda and Mitsuru Obe