My Economic Perspective

My Economic Perspective
by AW
23 June 2008

After doing a lot of reading, here's my perspective on the current economic situation (I'm no financial expert, but would like to share my knowledge and experience with all friends/colleagues. Do also give me your opinions):

Most parts of the world (China/India not included) will be experiencing a period of STAGFLATION (meaning inflation and recession co-existing).

Before I talk about the current economic situation, let me share a few pointers.

During a typical economic boom/bust cycle: INTEREST RATE is raised by the government to curb a TYPICAL INFLATION (My definition of TYPICAL INFLATION is the rise of consumer prices due to economic boom). In a period of strong economic boom, share markets will rise, business revenues/profits will increase, which will then be followed by more bank borrowing for business expansions and property purchases. Hence inflation will rise, and interest rates will be raised by the government to discourage excessive borrowing and to curb overheating of the economy. Interest rates are also raised when more and more borrowings cause a reduction in money supply (in other words, money as a commodity becomes more expensive).

However, during a non-typical era, a sudden hike in interest rates is done to strengthen the currency. Which is why during the 1997-98 financial crisis, our then DPM Anwar Ibrahim raised interest rates to extraordinary levels to discourage the excessive dumping of the Ringgit. Also, when speculators start dumping the Ringgit, money supply becomes less, hence money becomes more expensive (And then, Mahathir did the unexpected... but that's another story for another day). Do bear in mind that interest rates were also gradually raised prior to the crisis to curb overheating of the Malaysian economy.

Back to present day.

We are however, NOT in a period of a TYPICAL inflation. We're in a period of inflation caused by HIGH COMMODITY PRICES, which in turn are caused by these 4 factors:
- high commodity demands from China/India,
- rising world population leading to rising consumption of commodities
- supply shortages from peaking of natural resources
- speculators moving their money from the declining US currency, housing and stock markets to Commodity Futures markets.

Except for China/India, most countries are experiencing a looming recession coupled with inflation (STAGFLATION).

In Malaysia, I expect the following to happen:

1) House Prices
- New launches will be less due to lower demand. However, new launches will see price increases of 10 to 30% due to high raw material and energy prices.
- Secondary sub-sale markets (second-hand houses) will initially not experience price increases. From the inefficient market theory, second-hand house prices will react slower to the high commodity prices. Furthermore, a looming recession will slow down demands. However, for houses in good/prime locations, the prices will later rise in tandem with new launches. For those loaded with cash, this is a good opportunity to take advantage of the said inefficient market, to buy undervalued houses at prime locations. I repeat, prime locations.
- CAUTION: If you're taking bank loans, beware of rising interest rates!!!

2) Interest Rates
- With a looming recession, initially the goverment will be reluctant to increase interest rates as the inflation is not caused by overheating of the economy (as explained earlier) but by high commodity prices (external factors).
- Secondly, raising the interest rates will cause our Ringgit to strengthen against the US Dollar. This will harm our export market as the US is still one of the biggest importers of Malaysian products.
- But I believe the current low interest rates will not last forever. We should see interest rates in China/India be raised further to curb their economy from overheating; which will then be followed by the US and later by the Malaysian government.
- Hence, interest rate in Malaysia is expected to be raised in the long term, but only gradually. Don't expect interest rates to shoot up like during the 1997-98 crisis (reasons for that already explained earlier), unless of course we get another round of currency attacks, which is highly unlikely.

CONCLUSION
- So for those who are looking to buy houses, buy undervalued SECOND-HAND houses at prime locations.
- To insulate against expected rises of interest rates, go for a low-premium fixed interest rate loan (eg AIA's prevalent fixed interest rate loan is at 5.8%). Although AIA's rate is 1% higher than the lowest variable rate offered by OCBC, PBB and EON (BLR - 2% = 4.75%), I expect BLR to gradually increase in the long term.
- For those who have lots of cash but are not willing to invest in properties, I suggest you keep your money in low-risk NON-EQUITY funds that can appreciate 5-8% p.a. (I mentioned NON-EQUITY because the share market is expected to decline due to shrinking corporate profits caused by high raw material and energy costs). If in the long term, if you just keep your cash in savings/FD, you'd be unable to hedge your money against inflation. Unless of course you are a high-risk investor who intends to use your cash to buy over stocks/companies that crash.

There is a catch to what I mentioned above. In a worst case scenario, if the world economy experience a total financial and economic collapse, then we will have an era similar to the 1930s depression, where figuratively, everyone dies.

So buckle up your belts because we're headed for, at the very least a recoverable "flood", or at the very worst, a feared "tsunami".

AW
23 June 2008

An After-thought
I believe this decade is cursed. 9/11 attacks, terrorism, wars, global warming, draughts, floods, haze, bush fires, tsunamis, hurricanes, earthquakes, SARS, bird-flu, energy crisis, food crisis, dollar crisis, commodities depletion, over-population, etc. you name it.

As Billy Joel once sang: We Didn't Start The Fire, But It Was Always Burning Since The World's BeenTurning...