The spectre of inflation in America and how it may affect Singapore
Martin Feldstein, one of Obama’s chief economic advisors warns of the risks of inflation in America given the unprecedented actions by the Fed Reserve to sharply increase money supply:
But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now.
The money supply consists largely of government-insured bank deposits that households and businesses are holding because of a concern about the liquidity and safety of other forms of investment. But this could change when conditions improve, turning these money balances into sources of inflation.
The Fed is also creating a massive increase in liquidity by its policy of supplying credit directly to private borrowers. Although these credit transactions do not add to the measured fiscal deficit, the unprecedented Fed purchases of more than $1,000bn of private securities have led to the enormous $700bn increase in the excess reserves of the commercial banks. The banks now hold these as interest-bearing deposits at the Fed. But when the economy begins to recover, these reserves can be converted into new loans and faster money growth.
The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.
The concern of Singaporeans is of course how rising inflation in the US would impact the value of the Singapore dollar. As expected, MAS devalued the Singapore dollar earlier this month, citing it’s secret policy of the currency band. Well, it’s always been known that a strong Singapore dollar hurts exports, what’s more with China on the rise, effectively giving export-dependent Singapore a run for its money. But the key point to note is that though the contents of the basket of currencies MAS weighs the Singapore dollar against the international currency standards is kept secret, it isn’t too hard to guess that the bulk of it is probably US dollars. If and when the US dollar starts to weaken as inflation rises as Feldstein warned it might above, Singapore could end up importing inflation from the US when MAS devalues the dollar in response to US dollar depreciation.
What’s bad about this is that Singapore’s consumers may be caught in a whammy when the US dollar depreciates. MAS devalues the Sing dollar in response, but China follows suit only modestly. This has the effect of raising prices here at home since most of our goods are imported from China. Indeed, China’s earlier call this month for a new internatioal reserve currency may be a step towards reducing the rising industrial giant’s dependence on the US. I’m sure most Singaporeans don’t need to be reminded that they’ve had enough of record inflation along with three straight quarters of economic contraction in 2008.