(Printed in The Edge October 10th, 2022)
US Fed Chairman Jerome Powell recently hiked the US Fed Funds Rate by 75 basis points to between 3.00 to 3.25%, and signalled that by the end of the year, they were targeting an interest rate of 4.5%. This means that another 125 basis points of interest rate hikes are in the offing. He went on to say that their final target is to bring inflation down to 2%, from August 2022’s 8.3% year-on-year. That presages some very vigorous movements for the US Dollar (USD), and some rather bleak outlooks for other currencies that do not act to preserve the value of their currencies.
The current downswings of the Malaysian Ringgit against the USD have many worried how long it would last and how much their lives would change. Thoughts of whether they would be shoved into poverty, hunger, or hopelessness have popped up foremost in their minds.
Why would a currency like the USD have so much sway in Malaysian’s lives? Based on the European Central Bank (ECB) in 2021, the USD is the currency in roughly 40% of all trade invoices globally. Former Malaysian Prime Minister Muhyiddin was recently quoted as saying the food import bill for last year was RM63 billion. One can do the math easily and find that upward changes in USD would lead to higher costs of food in Tanah Airku. This was evidenced recently by the crisis in the price of chicken in Malaysia (sparked by the cost of its feed which is 100% imported into the country) and of broad-based food inflation. What’s worse is that, it is not a one-off event: Russia’s unwarranted aggression against Ukraine has pushed wheat and corn prices stratospherically, and oil & gas prices teeter on the brink of another atmospheric flight with the Northern Hemisphere’s winter coming up and Russian supply sanctioned. This is on top of a four-year drought in South America, big exporters of grains and feeds to the world.
With all this doom rolling in like a killer tsunami, thoughts and actions must now turn towards defending theRakyat. In our last article in The Edge we pointed out that BNM (Malaysia’s Central Bank) has done well in managing forex (foreign exchange) risks for itself, but now we must ask whether we have the experience to handle what is happening in the US economy as the consequences hit the Rakyat.
What is happening to the US economy is a major fight against stagflation. In the 1970s and 1980s, they had a major battle against it that is eerily similar to what it is today. In that episode, lasting 16 years, the US had emerged from the Vietnam War and the huge amount of wartime spending that was needed was in their economy, they were forced to abandon the Gold Standard, and the Oil Crisis happened, sending inflation zooming upwards and GDP (Gross Domestic Product) skidding downwards.
Chart 1
The data range we chose was from 1972, a year before the Oil Crisis, to 1987, when the US stock market crashed on Black Monday, changing economic fundamentals substantially. Some datapoints popped out:
- The US CPI went from 3.27% in 1972 to a high of 13.55% in 1980, before going down to below 2% a year before the 1987 crash, and
- US interest rates, using Fed Fund Rates, started at 5.33% in 1972 before going as high as 18.9% in 1980 and thereafter falling to 6.77% in 1987.
Chart 2
This entire stagflation episode took 16 years to fight. This was not a sprint but an ultra-marathon. The current one looks likely to be another long battle, too.
How did Malaysia do during this period?
Quixotically, Malaysia started the period already at high interest rate levels and kept them high throughout the period, with a peak of 12.4% in 1982. This seems to say we were fighting two different crises, one before the period and one during. Further, inflation started at 3.2% in 1972, hit a high of 17.3% in 1974, and ended at 0.3% in 1987 which indicated an overkill, as Malaysia’s GDP dropped from 7.8% in 1984 to a -1% recession in 1985, kicked along by severe drops in rubber and tin prices, two commodities forming a large bulk of Malaysia’s export earnings then.
Chart 3
As one can see in the chart above, Malaysia’s interest rates were in double digits from 1980 to 1987 (and skirting around 10% in the years before) while from 1982, the US’ trended downwards from under 10% to 6.77% in 1987.
Despite the higher interest rates’ posture by Malaysia, the Ringgit actually fell against the USD in the period of 1980 to 1987:
Chart 4
This seems to say that if another country’s economy doesn’t recover as fast or policy action meant for another purpose is lagging in ending or even implementation as the case may be, then that country’s currency (herein Ringgit) will lose value against another’s (herein USD).
However, this chart added mystery to the whole thing:
Chart 5
Basically what it says is that the US and Malaysian economies were countercyclical to each other but given what happened, counter-intuitively, Malaysia was not immune to what was happening in the US and the transmission of higher inflation through its causes did happen and Malaysia was hit as well.
Nowadays, as we had argued several times before, things have changed. Due to Malaysia pegging the Ringgit to the USD in 1998, our economy is pro-cyclical with the US’ as this chart shows:
Chart 6
Does this mean this time, Malaysia will be hit worse?