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Second letter to Malaysian PM


1st letter to PM during 1997 Asian Financial Crisis

The Letter written on 13th June 1998


Dear Datuk Seri Dr. Mahathir,

After reading the business section of the NST dates 6th, 11th and 13th June 1998, I am writing a follow up letter, to my letter dated 5th June 1998, in an attempt to explain in a little more detail what Malaysia could do to help itself. I am not an economist and do not claim to be one or an expert in such a field.

I noticed that there was some debate over bank interest rates. Should they be higher or should they be lower? Which is more important, correcting the outflow of capital or reviving the economy and making sure of lowering retrenchments and job losses and lessening the number of companies that do go under? What is an economy?

Historically, I believe that some economist have proposed increasing interest rates when the stock markets come down (during a slow down). This may be due to the out flow of capital within their economies. In the modern context I do not think it will stop the out flow of capital. In Malaysia's or Asia's context does this matter now? The devaluation that has occurred has resulted in a loss of value more than what the bank interest rates increases could have compensated for. For example, if we had bought an imported item X before the devaluation at a price of USD$1/- or RM2.75/-it's price would now be RM4.0/-. That is an increase of 45%. Would any bank offer an interest rate of 45% per annum? If the banks had a savings rate of 12%, it would take at least 3 years of savings to recover this value. A bank interest rate of 10% would need about four years. When the general public notice that they can earn as much as 45% within a few months on their Ringgit they will definitely convert their Ringgit to USD. I had observed long queues at money-changers at various shopping malls where this had occurred. The effect will reverse when the Ringgit climbs again or when people run out of Ringgit. Businesses will not run out of Ringgit when there is no demand for their goods, as they do not need to pay for raw materials and do not need workers, who need to be paid, and there will be no other bills to be paid.

High interest rates stifle business. I'll ask you a question which I had wrestled with and cost me many sleepless nights. How does one price a product, especially if it is a hi-tech one and never seen before? How does one place a market value to a product? What price will guarantee sales and profits? I believe I have solved this problem.

Generally most businesses add a profit margin of 25% or lower, to their cost, in pricing a product. Herein lies the reason as to why cost cutting works. This margin of 25% may not be applicable in the hi-tech arena but will ease the pricing headaches in the manufacturing sector.

When bank interest rates are high, they eat up this profit margin. When sales volumes are low, as in an economic slow down, low-volume-related-costs eat up into this profit margin. When demand is very low, manufactures sell off old stocks or non-moving stocks, to recover capital for more profitable ventures or as additional cost cutting measures. This results in lower prices and lower profits.

High lending rates of 12 % make this profit margin 13% instead of 25%. Hence there is insufficient profitable revenue to spur growth and expansion. Profits margins below 10%-15% can never sustain a young company as there will be a host of unexpected / unscheduled expenses. These unforeseen costs were either not taken into account in the original costing or cannot be taken into account due to current market prices, in order to stay competitive. And no one takes into account the cost of loans in their respective product pricing. If profit margins are lower than bank interest rates, it would be tempting for businesses to close down non-profitable operations and put the money in the bank. This results in job losses. High cost of loans, however easily available, will not spur growth. Hence in order to spur growth, interest rates must be of the order of 6% to 8% or less. This could be done later.

I do not have a good view of what is happening to the economy as a whole, so I do not know what is best. But if you ask my opinion, as a man in the street, as one who does not know the extent of the outflow of capital, I would choose to lower interest rates.

But then what is an economy?

Over the last six years, I have had plenty of time to observe the prices of stocks listed on the KLSE. It is my belief that our inflation rate was higher (was of the order of 8%) than those published by the authorities (about 4%). I do suspect this may have led to a greater latitude in the way companies and real people projected real incomes and revenue. As a result, real savings may have been lower. We need to look at the savings per income group and savings per person (and changes in working capital of companies) with respect to the Consumer Price Index or inflationary rate to assess whether there was a drop in savings. The actual dollar value (Ringgit value) of savings is not a good figure to be used as the value of the Ringgit does not adjust according to the rate of inflation. I believe that there was insufficient capital from the retail market to buffer the severity of stock market fall, which results in us being exposed, when the local and foreign fund managers repositioned themselves. And added to this was the lowering of the value of the Ringgit with respect to the US dollar when the fund managers moved out of the market. I think that they will wait a year before returning. I believe that our export earnings was not sufficient to annul the effect of the movement of funds by fund managers. This may be due to the fact that the financial markets grew faster then the export markets. In hind sight the growth of the financial markets should have been more restrained. Furthermore the curb on loans has taken it's toll on the economy.

How do we recover the value of the Ringgit now? One possibility is to limit the supply of the Ringgit, which, I believe, is want the banks and high interest rate were attempting to do. The other approach is to create a higher demand for the Ringgit. What is it that we can supply that no one else has? We have the Sukom 98 games. Promote this heavily overseas and get the tourist flocking in. Invite the foreign press in, let them sell Malaysia. Sell Malaysia as a mystical place not just the Games - an untapped Paradise, remember all of Asia is here, the Filipinos, Bangladeshis, Indonesians, Thai's, Japanese, Koreans, Indians, Singaporean.. The foreign journalist can reach the foreign public faster than any government to government dialogue. Use the tourist to sell Malaysian products. This can be our saving grace. Any experienced salesman will tell you that 90% of the sales is done when a customer walks into the shop. While the customer is outside it is very difficult to sell him a product.

If one examines the stock market trends, my interpretation is that of an inflationary price rise over the years of around 8% per year, based upon the data I have. But real wage increases have been kept in check as they were based upon a 4% inflationary rate and by importing cheaper foreign labour. Hence real savings and purchasing power has reduced by 4% per year, every year. This I believe is the real cause of the severity of the economic slow down. But, if the Ringgit had not devalued so much, I would have expected to see some form of deflation - at least for prices of non-exported goods. Whether a deflation will occur and to what extent and for how long, I cannot say as I do not have sufficient data and have never done any analysis for deflation.

I believe that the stock market is a better, 'in-hind-sight' indicator of the rate of inflation as a corroboration exits in the price of property. Reference to 11th March 1997 NST on the Malaysian House Price Index, indicates that the price of terrace houses increased from 100% in 1990 to 174.9% in 1996, an increase of 9.6% per year. Semi Detached house prices rose from a 100% price level to 154.2%, an increase of 7.4% per year. Detached house prices increased from 100% to 196.2%, an increase of 11.8% High rise units went from 100% to 115.7%, an increase of 2.3% as of 1996. A major portion of a householders income goes to paying rental or servicing his housing loan. This is real inflation for him and hence the property price movement has to be taken into account in this inflationary rate. Personally, I think our property prices are too high and should be allowed to drop by 30% to reflect a 4% rate of inflation. Unlike manufacturing, plantation. etc, property does not generate export income.

How do we measure the growth of an economy?

Personally, I believe that the stock market indices may be just an indicator of the economy and not the economy itself, as we know it. For example, if one is in a cold air conditioned room and walk over to the thermometer it will show you the temperature of the room. Placing your finger to warm up the thermometer will cause the indicated temperature to rise, but the room itself, will still be cold. Turning down the air conditioner will allow the room to warm up again.

What is our economy? How is our wealth being generated? We have to do work in order to generate wealth and we use money to do that work. Who actually is the economy? I believe it is that person who stoops to plant a seedling of rice, that person who, in the wee hours of the morning, taps the rubber trees, that person who operates a lathe machine, that person who feeds another mouth, that person who stands behind the counter and sells you an item, that person who buys an item so that he can do some thing useful with it. These are the people who generate the economy, these are the people who bear the burdens, the rest of us live off their efforts. Look after these people and the economy will prosper.

You see, the economy is like several rivers. The water flows down a river and as a consequence supports a myriad range of activities. There may be different species of fish, prawns, insects, plant and bacterial life. Adjacent to the river, we have plants, shrubs, trees and more animals big and small. The river is their life support system, it provides water and food. If the upstream activities are poisoned, the down stream activities are affected. When one river meets another, one identity may be lost. One may be too acidic to sustain the activities of the other, or together they sustain newer species of plant and animal life. Similarly, money is just like water, and there are rivers in an economy. Identify, these rivers of money and keep the upstream activities healthy and keep the rivers clean.

Why do we have a local currency? If we look deep within ourselves you will see that we are made of millions of cells. Each cell has a cell wall for it to survive within its environment and have its own identity. This cell wall protects the cell from foreign harm and from external chemical reactions which are necessary to support the whole organism, from harming the internal chemical reactions necessary to support the cell. Hence, ideally a local currency buffers the impact of global activities so that local activities can be sustained.

Basically, the real economy comes from the effort of manufacturing, plantations, farming, trading of goods, transportation ..etc. There are physical goods produced and tangible assets attained. Movement of funds in and out of the stock markets does not produce any goods but can earn money and can affect our currency and there by affect the price of physical goods. The stock market in itself is an intangible economy and not a physical one. Why should one affect the other? What we have is actually, two separate and distinct systems operating under one currency. Major changes in one affect the other. In effect, I believe, most modern nations are undergoing a change where they now have two major economies. A tangible one and an intangible one. If we keep the two separate one should not drastically affect the other. How do we do this? One possible solution is to have a Malaysian dollar, M$, for trading on the stock market and Ringgit Malaysia, RM, (Real Money?) for the real physical economy, that is two separate currencies. The second possibility is to have shares listed on the stock market quoted in US$ and all other transactions in RM. This will help isolate the impact of foreign fund movements in and out of the country and hence not change the value of the Ringgit substantially, upwards or downwards. This will, possibly, reverse the Ringgit fluctuations against the US dollar from the current phenomena. The Ringgit will drop a little before a stock market climb due to local demand for stocks, thereby listed companies raising more capital in terms of Ringgit. And when a crash happens, the Ringgit will rise a little as local sellers convert back into Ringgit.

As identified correctly in NST articles, most of Asia appears to be influenced by Japan's economy. The US economy does influence a lot of countries but unknown to most, I suspect is the existence of a third economy that does have significant influence on the world economy.


.....
an engineer

This article on the 2nd letter to PM was reproduced here by Dr. Peter Achutha - 24 December 2017.


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