June 15, 1999
THE DANGER OF DRAINING ASIA'S POOL OF FUNDING
The word recovery is on the lips of a lot of Asia experts these days. But if Asia's economic policy makers are to witness a long-term recovery, they will first need to reverse the interventionist policies that have distorted the real cost of capital in the region and depleted the wealth of Asian consumers and investors. Contrary to popular thinking, it was the overly loose monetary policies of Asia's central banks that led to the current crisis.
The damaging effects of these policies are nowhere more evident than in Japan, where the results of unbridled monetary expansion have come home to roost. Current economic wisdom holds that there is too much savings in Japan. This keeps consumer spending weak, the thinking goes, thereby perpetuating the economic slump. To combat this dire state of affairs, the Japanese government has done nearly everything in its power to stimulate demand--from bringing down interest rates to nearly zero, to handing out spending vouchers.
While Japan's first quarter GDP figures for 1999 grew an impressive 1.9 percent, bank lending remains at an all-time low. Despite the bank of Japan's efforts to flood the money market with funds, lending by Japanese banks plunged 5.4 percent in May--the sharpest drop ever recorded. That the BoJ's super-loose monetary policies have so far been ineffective is not the result of negative investor sentiment, but is indicative of a much deeper malaise: the shrinking pool of funding.
Essentially, the "pool of funding" is the quantity of goods available in an economy to support future production. The size of this pool determines whether or not more sophisticated means of production can be introduced. For instance, if it requires one year of work to produce machinery that will increase a company's productivity, but the company has only enough money saved to sustain it for one month, then the machinery will not be acquired--and the company will not be able to boost its productivity. In other words, the size of the pool of funding sets a brake on the implementation of more productive--but longer --stages of production.
Trouble erupts whenever the banking system makes it appear that the pool of funding is larger than it actually is, encouraging producers to invest in higher stages of production than are warranted by the real funds available. When this happens, the pool of funding begins to shrink.
One of the major factors that causes the pool of funding to shrink is a prolonged loose monetary policy. Such a policy actually undermines wealth production while encouraging its consumption and thereby the depletion of the pool of funding. When a central bank expands the money stock, it does not enlarge the pool of funding--on the contrary, it gives rise to the consumption of goods that is not preceded by production. This does not lead to more, but rather less means of sustenance for the production structure.
For a while, the central banks can get away with this, as the loose monetary policies give the impression that they are boosting economic activity. However, once the pool of funding begins to shrink, monetary policy becomes ineffective. That various counter-cyclical policies have failed to lift the Japanese economy is indicative that the real pool of funding there is shrinking or stagnating. So much so that even a personal savings rate of 25 percent is not enough to replenish it.
In fact, central bank policies throughout crisis-stricken Asia have been squandering savings at a much faster pace than people are saving. In Japan, the rate of growth of M2 money stood at over 9 percent, on average, between 1980 and 1990--i.e. for a period of 10 years. This monetary pumping was accompanied by a fall in the discount rate from 9 percent in 1980 to near zero in 1998. Likewise, in Thailand, the M2 money supply had been expanding at a rate of 30 percent by 1990, while in Indonesia M2 grew by 50 percent during that year.
In South Korea the rate of growth of M2 stood persistently above the 20 percent mark throughout 1990. In Malaysia during that period M3 was expanding in excess of 30 percent. Furthermore, in August 1993, the Indonesian inter-bank call rate was lowered to 5.68 percent from 27 percent in March 1991. In December 1993, the Thai three-month inter-bank call rate was lowered to 6.75 percent from 11.5 percent in June 1992.
This massive monetary pumping generated an illusory prosperity in terms of various popular economic indicators. For instance during the second half of 1994 year-on-year Indonesian industrial production grew by 20 percent. South Korean production jumped by February 1995 to 19 percent year-on-year, while Thailand's industrial output climbed to a rate of growth of over 13 percent during that period. In Malaysia by May 1994 the yearly rate of growth of industrial output exceeded the 20 percent mark.
What is deceptive about these seemingly healthy indicators is that they represented a massive misdirection of savings, and hence, a depletion of real wealth. Asia's impressive pre-crisis GDP figures were not backed up by an equally impressive pool of funding, and could not continue without correction.
When the correction came, in the summer of 1997, indicators such as stock prices began to move toward more realistic levels, in line with the state of the real wealth of the various economies. The fall in consumer outlays in response to the fall in the stock market, did not make things worse, as most economists believe.
On the contrary, it halted the consumption of capital and began to lay the foundation for rebuilding the pool of funding. To engage in monetary pumping in order to boost consumption and stock prices only defeats this corrective mechanism. It conceals the true state of wealth in the economy, encouraging excessive consumption and a decline in the sources of funding.
Instead of continuing with policies that actively promote the consumption of wealth, the central banks should be more concerned with laying thefoundations for growth. What is needed for real economic growth is an expanding pool of funding. Until the economic leadership in Asia recognizes this, and puts a stop to misguided efforts to "reflate" its way to recovery, the situation can only get worse.
Copyright (c) 1999, Dow Jones & Company, Inc.
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