Invest in Singapore Property and impact of QE2 Quantitative Easing

Invest in Singapore Property and impact of QE2 Quantitative Easing
Article contributed by: www.PropertyBuyer.com.sg

On the 3rd Nov, 2010, the federal reserve announced a US$600 billion bond buying. Quantitative Easing is euphemism for printing more money without a corresponding increase in economic output.

Since the last time, we highlighted in 2008, “The additional funding requirements total more than US$1 trillion (US$ 1000 billion) The concern is, how are they going to raise US$1 trillion in 2009? Bill Gates is worth around US$55 billion just to provide a benchmark. If they cannot raise this cash through increased taxes, (since both presidential candidates have declared they are not raising taxes), they will have to borrow from sovereign sources such as Japan, China, South Korea, Saudi Arabia who traditionally buys US treasury bonds. But going from an average borrowing of US$200-300 billion a year to US$1 trillion? This is an additional whopping US$ 700 to US$ 800 billion. Who’s buying? Even the sovereign funds do not have that much funds considering that much of their funds are already in US treasury bonds, Euro bonds and other investments. The US government may make up the short-fall through increasing money supply temporarily. If this increase of money supply is temporary, inflationary pressures may be controllable, if not, such increase in money supply is surely inflationary. In other words, inflationary pressure tends to force interest rates hike in the USA. ” (Source: http://www.propertybuyer.com.sg/articles/compare-singapore-home-loans-/Global-Economy-Credit-Crisis-and-Interest-Rates/)

So it has come true and it comes in the form of a US$600 billion fund to buy back long term treasury securities (Bonds with long maturity).

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Why Does Federal Reserve Want To Print US$600 Billion To Buy Back Treasury Securities?

The US federal government is in budget deficit since Republican Ronald Reagan came to power. Within 8 years he has single-handedly squandered America’s wealth. US turned from a net creditor nation into a net debtor nation. Since 2004 to 2008, the US government has been running consistent budget deficits in the US$ 200 to US$ 400 billion range. All these monies need to be financed by individuals, corporations from within America and sovereign states from outside of America.

Lately in 2010, the expected US federal government deficit is likely to be US$1.171 trillion with a total of US$14.078 trillion of debt. “The total deficit for fiscal year 2009 was $1.42 trillion, a $960 billion increase from the 2008 deficit.”

(source: http://en.wikipedia.org/wiki/2010_United_States_federal_budget)

The largest holders of US debt as at Nov 2010 are: -

(source: http://www.cnbc.com/id/29880401/The_Biggest_Holders_of_US_Government_Debt?slide=16)

1. Federal Reserve and Intra-governmental holdings – US$5.345 trillion

2. Other investors and Savings bonds – US$1.266 trillion

3. China – US$868.4 billion

4. Japan – US$836.6 billion

5. Mutual Funds – US$648.6 billion

6. Pension Funds – US$643.8 billion

7. State and Local Governments – US$534.7 billion

8. United Kingdom – US$448.4 billion

9. Depository Institutions – US$273.7 billion

10. Insurance Companies – US$260.6 billion

11. Oil exporters – US$226.6 billion

12. Brazil – US$165 billion.

13. Caribbean Banking Centres – $159.1 billion

14. Hong Kong – US$137.8 billion

15. Taiwan – US$130.2 billion

Looking at foreign governments, China, Japan, UK, Oil exporter countries, Brazil, Hk and Taiwan held US$2.813 trillion in US federal debt. The Federal Reserve and various government actually hold the most of the federal government debt.

“From December 2008 to March 2010, the Fed bought $1.7 trillion of Treasury and mortgage-backed securities.” (Source: AP, http://www.msnbc.msn.com/id/39954647) that explains the high federal reserve holdings.

Looking at foreign governmental reserves (Source: http://en.wikipedia.org/wiki/List_of_countries_by_foreign_exchange_reserves): -

1. PROC (China) - 2.4543 Trillion USD Sep 2010

2. Japan - 1.050235 Trillion USD Jun 2010

3. Eurosystem - 753.642 billion Sep 2010

4. Russia - 501.1 billion Oct 2010

5. Saudi Arabia - 410.3 billion Dec 2009

6. India - 300.21 billion Nov 2010

7. Republic of Korea - 293.35 billion Oct 2010

8. Brazil - 287.206 billion Nov 2010

9. Hong kong - 266.100 billion Sep 2010

10. Switzerland - 249.556 billion Aug 2010

11. Singapore - 221.398 billion Oct 2010


With the budget shortfall of US$1.17 trillion, this is the amount that must be borrowed in 2010. So this large amount is unlikely to find supporters amongst foreign sovereign funds. So a large part of this debt needs to be absorbed internally or by foreign corporations and mutual funds.

In any one year, there would be demand on US Treasury debt, but putting out such a large amount would totally overrun all or any potential lenders or buyers of the Treasury securities. In order to fully reach this borrowing quantum, the coupons being offered will have to rise in order to meet the dwindling demand.

If the coupons being issued is the 30 years treasury bonds, then this would raise long term interest rates. And it may also hit shorter tenor treasury bonds indirectly.

So the natural way to NOT saturate this demand for US dollar treasury bonds is to not issue so many, but since the US runs a huge deficit, it has to issue treasury bills.

In this case, the US federal government issues more currency (Print more money) to the tune of US$600 billion and use this money to buy back longer tenor treasury bills. This has the effect of freeing up money into the economy.

Intention 1 – Reduce Long Term Interest Rates To Facilitate Recovery

The intentions are to reduce long term interest rates. Like we mentioned previously, the US federal government cannot set interest rates and then do nothing about it, else a black market will form. They can set target interest rates and then put the money where the mouth is so as to achieve that.

Intention 2 – Print More Money To Reduce The Currency Exchange Rate

This is to devalue the US dollar versus trading partners so that it provides a competitive edge to the US exporters. The other side of it is also to reduce the imports and reduce the trade deficit.

Intention 3 – Pump Cash Into The Market

The third intention is to pump cash into the US market. With this money being used to redeem treasury bonds, money goes into the hands of bond holders.

Could The US Government Achieve The Desired Effect?

Throughout history, countless countries and countless times have economies defaulted or devalued their currency in order to get out of trouble. Since most debt are in US dollars, devaluing the dollar devalues the debts as well. So it is no big deal when this happens if the situation is dire.

As we stressed previously, the interest rates do not just go to the rate the Federal Reserve wants it to go. Businesses need funding and are willing to bid for the funds at a rate they can afford. The only way interest rates can go down is for the Federal Reserve to flood the money market with money in excess of borrowing demands therefore reducing rates.

Federal Reserve should reduce interest rates long enough so that the US economy has a chance to recover.

However there are major risks such as inflation within the US as purchasing power drops. This could hurt US consumers hard and hurt consumption if inflation becomes serious. It could have the opposite effect of what the US federal reserve wants, instead of stimulating the economy, it ends up killing the economy.

On The Money Printing (Quantitative Easing)

On top of that, it pumps US$600 billion into the market, of which at least 60% (www.propertyBuyer.com.sg’s guesstimates by looking at the 15 largest holder of Treasury bills) are expected to stay within the US and begin to re-inflate the economy judging by the composition of bond holders. The global economy is inter-connected, leakage is expected in an open economy such as the US. Thus some portion of this money is expected to find it’s way into other countries.

We believed that the US economy should be able to hold out a few months even without this round of US$600 billion of quantitative easing even while the Bureau of Economic Analysis has been publishing report of a weakening US economy.

By some possibility, the US economy could even recover without any of this quantitative easing. So we see this as election economics. This is pump priming to make sure that unemployment reduces to an acceptable level in 2 years, ready for the next presidential election.

We have no opinion about the US presidential elections, but for the good of the world economy, we need a strong USA until some other country takes over as the engine of growth and consumption. So between war mongering Republicans and Democrats, Democrats are the lesser of the two evils.

On US Currency Devaluation (By Default)

The US dollar will naturally weaken due to this extra money supply. This extra money supply will with returned to the holders of such treasury bonds and until they are withdrawn will end up in the banking system as deposits.

The availability of such deposits will enable banks to lend out more money. As the USA practices fractional reserve (reference: http://en.wikipedia.org/wiki/Fractional-reserve_banking), by making available this US$600 billion, the broad money supply could by multiplied by up to 10 times, if it is fully leveraged. The US sets it’s fractional reserve at 10% of deposits, but for depository institutions (smaller banks or thrifts) having less than $55.2m the reserve requirement is reduced thereby leading to more leverage potentially.

“A cash reserve ratio (or CRR) is the percentage of bank reserves to deposits and notes. The cash reserve ratio is also known as the cash asset ratio or liquidity ratio. In the United States, the Board of Governors of the Federal Reserve System requires zero percent (0%) fractional reserves from depository institutions having net transactions accounts of up to $10.7 million.[3] Depository institutions having over $10.7 million, and up to $55.2 million in net transaction accounts must have fractional reserves totaling three percent (3%) of that amount.[3] Finally, depository institutions having over $55.2 million in net transaction accounts must have fractional reserves totaling ten percent (10%) of that amount.[3] However, under current policy, these numbers do not apply to time deposits from domestic corporations, or deposits from foreign corporations or governments, called “nonpersonal time deposits” and “eurocurrency liabilities,” respectively. For these account classes, the fractional reserve requirement is zero percent (0%) regardless of net account value.[3]”

(Source: http://en.wikipedia.org/wiki/Reserve_requirement)

Printing US$600 billion and pouring it into narrow money supply M1 is quite a lot and could cause the market to re-inflate definitely. But much of these money will likely end up in Broad money supply. And because of the complicated way in which currency is created using Fiat money (money issued by central banks and sovereign nations as legal tender. It is based on faith in the country’s ability to repay the note), then the effects of how much devaluation it should do to the US currency will be very hard to compute.

And most people, even very seasoned economists will be hard pressed to predict or calculate how much the US dollar should depreciate given this excess currency. Given that it is so complex, the large majority of the people may trade one way or the other given the sentiments therefore rendering the best economist speechless. Therefore, the extend of the US dollar depreciation will be largely a matter of sentiment and consumer and business confidence level of the US economy as a whole. Hence the whole currency may stay under-valued or over-valued for extended periods of time.

When the market goes down, the market always predict that it will always go down. But when the market sentiment improves, the US dollar may yet appreciate in a few years. But nobody knows.

ON JOB CREATION AND US EXPORTS BY CURRENCY DEVALUATION

The US export sector is only US$ 1.057 trillion (year 2009) out of the total economy of around US$14 trillion. By devaluing it’s currency, even if it increases it’s exports by US$300 billion (illustration), it is expected that job creation will be marginal. Dropping $300 billion into a population base of 300million is like dropping US$1000 per person. Assuming that 70% of this extra US$300 billion GDP goes into wages, the rest taxes and profits. This is just an extra US$210 billion in national income. US domestic economy is in the magnitude of US$9 trillion range, therefore it may only have limited impact. And not to forget, by dropping the currency value, it can be a zero sum game as components and raw materials that are imported and necessary for finished products will cost more too.

On Economic Leakage Of This US$600 Billion Quantitative Easing

We estimate that easily up to 30 to 40% of this money could end up in other countries. So excess US cash will not all stay within the US boundaries. But US$180 to US$240 billion money inflow is not a big deal for the world, unless it is concentrated within a few countries.

Also, with quantitative easing, the US dollar is expected to fall in value thereby mitigating the impact of inflow of such money. Unless for countries whose currencies are pegged to the US dollars. In such a scenario, it makes sense for the other countries to alter the exchange rates in view of the true and reduced value of the US dollar, but that is not the only way.

In addition to the leakage coming from the Quantitative Easing (Printing money), low interest rates environment will also export credit to the rest of the world. In view of anemic economic growth in the US, some smart money will search for higher yielding assets overseas. This leakage will form what is known as a Carry Trade in which investors acquire cheap funding in USD and immediately transfer this money into foreign assets with a higher yield. It will be extremely hard to estimate this impact as we mentioned earlier in the article, quantitative easing leads to increase in broad money supply and due to fractional reserve system, there could be a large multiplier effect by making available funds to borrowers. Such money may be the more scary force.

Such HOT money or Smart money will find it’s way into the more open economies of the world.

China has already raised the reserve ratio for it’s banks to 17.5% to 18% (Source: http://www.chinadaily.com.cn/china/2010-11/10/content_11530809.htm), so any potential extra hot money is partially buffeted.

More countries who are likely to receive such hot monies may impose some form of regulation either on the banking side or on the housing side or on the stock market side. Let us just hope that these countries do not over-react and kill the market.

Some countries may impose rules making it harder for foreign companies to own properties or for foreign individuals to buy properties.

Some of these HOT money will arrive into some countries causing some form of inflation which may force the local governments to act.

How Much Is Expected Of This US$600 Billion To Come To Singapore?

However, for Singapore’s case, the strengthening of the Singapore Dollar versus the US dollar will mitigate to some extent these money inflows.

International Financial centers around the world will usually get a bigger share of this money.

“The main forex trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. “ (Source: http://en.wikipedia.org/wiki/Foreign_exchange_market) therefore these centers could also see an influx of funds. Other major financial, trading or commodity centers may also see an influx of short term investments.

If part of these US$600 billion quantitative easing funds is withdrawn and immediately transferred to Singapore markets, then surely Forex markets liquidity will suddenly rise will be the first to get this funding followed by equities.

What Is The Likely Effect Of Singapore Property Prices?

Some funds may start to buy up commercial properties, retail malls, offices buildings and industrial centers in Singapore. Individuals and some smaller funds may engage in carry trade leading to HOT money buying up shares. However we cannot then assume that Singapore’s economy as a whole will be fine, in fact higher risks awaits in 2011 on the economic front as global consumption has not yet recovered.

Equity Has An Impact On Property Sentiments.

It is important that landed properties in Singapore is still restricted to Singaporeans and Singapore PR, a prestige class of property assets otherwise foreign funds can corner the Singapore Property market.

The existing super rich may seek to become Permanent Resident to get into the landed market in Singapore buying up good class bungalows.

The other classes of properties such as Condominiums and apartments are all subject to the usual speculative forces. Cluster landed developments may see renewed interests.

There are currently no rules against foreigners purchasing property in Singapore therefore some funds may flow towards this sector.

It is very hard to estimate what effects such funds may impact on Singapore property market, but in case there is more statistic showing asset price inflation, we guess that the regulators can reduce the leverage by reducing the lending loan to valuation percentage.

Singapore Banks also have quotas limiting the percentage of loans they are allowed to make for investment properties, therefore limiting access to credit.

Whichever way the funds go, whatever effects it may have on the Singapore properties, if you are buying a residential property to stay in, do so at your own affordability and do not try to guess too much which direction it is heading.

POSSIBLE SCENARIOS FOR SINGAPORE INVESTMENTS

If inflation can be maintained in Singaore and controlled despite US currency devaluation. The US economy recovers and starts to resume it’s role and help global consumption. We would have survived another scare. However a more multi-polar world will emerge with China taking a larger share of the world’s economy. China Yuan will also become more dominant. However China still has some way to go before it’s export driven economy can upgrade, therefore China will continue to make sure that any currency increase vis-à-vis the US dollar will be moderate so as to allow time for China’s industries to upgrade.

What is almost certain is, the world’s economy will enter a period of higher risk and volatility. Growth and bust cycles may become shorter and the likelihood of anyone losing their jobs is higher.

In the short term however, equities may see increased volatility including sharp rallies and immediate pull backs. There is a likelihood that equities will rally and if sustained, will lead to improving property sector sentiments. The average P/E of Singapore equities may increase, leading to it being more overvalued as fundamentals have yet to catch up.

If such a scenario holds true, the property prices going up is not due to fundamentals but due to increased liquidity. Therefore property buyers will be faced with even elevated risks. You can check out Property buying versus renting in our article section.

And don’t rule out the US returning to the forefront of the global economy yet.