Monetary Policy Must Be Long Range
United Daily News editorial (Taipei, Taiwan, ROC)
January 7, 2011
The Central Bank's latest monetary policy has "Three Targets." It is raising interest rates 0.125 points to "target inflation." It is expanding credit control measures to "target real estate speculation." It is substantially increasing the amount of foreign capital in NT denominated savings accounts to "target foreign currency speculation." The Central Bank may be clear about its targets. It may be direct in its methods. But the NTD has recently undergone changes. The real estate market has also been affected. It is too early to judge the effectiveness of monetary policy. From a mid to long-term perspective, monetary policy will need considerably more adjustment.
The Central Bank's "Three Targets" policy appears to cover everything. But raising NTD interest rates will attract international hot money. Targeting inflation and targeting foreign currency speculation are to some extent at odds with each other. The policy involves a dilemma. For one, it imposes a 0.125 point rate hike. For another, it raises the deposit reserve rate for foreign capital in NTD accounts to 90%. As we can see, the Central Bank still sees targeting foreign currency speculation as more important than targeting inflation. Recent reports from foreign exchange markets say that George Soros has targeted the NTD. The Central Bank has good reason to be alarmed. Especially since other Asian countries are also attempting to prevent the influx of hot money. The government should openly declare war on hot money. This is consistent with the principle of Central Bank intervention in currency markets in the event of abnormal fluctuations.
Besides, much of the upward pressure on commodity prices and real estate prices comes from excess liquidity. According to statistics, in November of last year, the M2 money supply was 30.6 trillion dollars. It was 2.3 times the gross domestic product (GDP), and came close to historic highs. This demonstrates the degree of liquidity in domestic capital. But this liquidity has two sources. One. The financial tsunami and an extremely loose monetary supply. Two. The Central Bank's long term defense of exchange rates, its foreign currency purchases, and its subsequent release of NTD into the market. Therefore it must target the accelerants -- commodity prices, the tinder -- real estate prices, and the combustibles -- liquidity. If the Central Bank targets foreign currency speculation, it should be able to reduce pressure on the exchange rate. Controlling the flow from its source will also yield short-term benefits.
But defending exchange rates to keep out hot money is merely a short-term countermeasure. Currency exchange rates must reflect long-term economic growth and trade strength. Otherwise expectations of currency appreciation mean that hot money will inevitably interfere with monetary policy. Also, the longer one delays, the higher the price one must eventually pay. Liquidity has increased in recent years. Monetary policy now sits atop a landslide dam about to give way. The real attraction is the expected appreciation of hot money, and the resulting capital gains. The NTD has appreciated less than the currencies of less developed neighbors. But it has not lagged behind economically. Paradoxically, this may encourage more attacks. Therefore Central Bank monetary policy must target short-term currency speculation. But in the mid and long term, it must reduce expectations of appreciation, and inhibit asset price speculation. It must allow the market to determine the price of the NTD. and aggressively target real estate speculation. Each of these policies is necessary.
Now consider the targeting of real estate speculation. This reduces the incentive for hot money inflows. It also reduces the risk of excessive loans in the housing market. Lest we forget, one of the causes of the financial crisis was inflated U.S. housing prices. This led to the excessive expansion of credit. When real estate prices turned around, the entire financial system experienced cash flow problems. High real estate prices have long been the prime cause of public discontent. Targeting real estate speculation may calm the public, and stabilize the political situation. But the Central Bank has targeted only certain areas, special loans as a means of credit control. The domestic money supply remains too large. Therefore its policies may not be effective as hoped. It must raise interest rates in a comprehensive manner. Increased costs will reduce the speed at which funds flow into the housing market.
Targeting real estate speculation requires raising interest rates. A tightening of monetary policy is necessary for many reasons. When assessing quality, people usually resort to comparisons, They compare their level of development and economic structure with that of similar countries. They compare consumer price increases. But from a long-term perspective, a less than two per cent rate of return of capital is unlikely to promote investment in productive capacity and may limit long-term economic growth. Funds will flock the real estate and equity markets, which yield far higher returns, creating asset bubbles. Low interest rates are even more likely to lead to financial inertia, over-reliance on public investment in debt, and neglect its self-liquidating character. Therefore, getting interest rates back on track is key to the structural adjustment of domestic economic development.
The global world economy will invariably deal us wild cards. Monetary policy involves a time lag. With monetary policy one can not look only at the current numbers. One must look far ahead. Central Bank President Peng Hui-nan began raising rates in June of last year. He displayed the panache of a star CEO. But we remind Peng that while gradually raising interest rates 0.125 points may not be harmful to the health, any beneficial effects may be diluted by the time lag. It is not an adequate solution to this year's raging inflation pressures. It may even end up stillborn thanks to political and economic variables, and cause the government's carefully laid out monetary policy to fall short.