Singapore Entrepreneur - Hot Money, Easy Money?

We have all seen a phenomenal growth in 2010, especially in the East Asia region. Stock market rallied, jobs created, cash registers kept ringing, and countries' GDPs in healthy numbers. It was all a stark contrast comparing with previous years of 2008 and 2009. The recovery was literally a sharp V-shape.

Most of us who have held on our jobs, operating a business, or even invested in the equity market, would have been rewarded by good bonuses, profits or capital gains in 2010. Those who had invested in properties during the downturn would be handsomely rewarded from a rise in property prices.

From a gloom and doom year in 2009 to a stellar year in 2010, who had made all these possible? Are we still going to continue enjoying such healthy growths?

In this article, I am going to describe the phenomenon and analyse the possible scenarios unfolding.


The Great Recession

I am sure you are aware of the 2 big engines of the world economy; the US and China. The US, for all mother nature's sake, was the main cause of the Great Recession of the century. It started in with a thing called Sub-Prime credit crisis. (For more understanding, you can read my previous blogs in the link.) When Mr Barrack Obama just came on board as the US 44th and first black president in Jan 2009, lucky or not, he inherited his country's and the world's largest problem. Within months, he managed to push through a legistration of a US$1.7 Trillion stimulus package to help the faltering US economy. This amount helped bail out some of the world's biggest banks from the brink of collapse. These banks went through major restructuring and cut down their exposures in toxic assets in the US and turned their heads to Asia. European banks, also largely affected by the American crisis, followed suit.

China as the darling of Asia, has been enjoying relentless growth of double-digit GDP for years. Money started pouring from the US into China, seen as the next hope to help the world out of the great mess. The rest of Asia, seen as emerging economies, enjoyed the overflow from investments in China. So in the whole year of 2010, the Asia region was enjoying an influx of 'hot money' from the US and Europe. The US stimulus package spending (called quantitative easing 1 or QE1) officially ended in March 2010.


So did the QE1 help US and the world?

QE1 spending helped the US economy from collapsing further by saving the banks. It contributed significantly Asia's unprecedented growth. However, it is still far from effective in bringing US back to its pre-crisis level. Unemployment figures, albeit decreasing, are still hovering at record high levels. Home prices are still stagnating.


Quantitaive Easing 2 (QE2)

The FED decided to inject another $600 Billion to further stimulate its economy. The amount will be spent from 2nd quarter of 2011. It will be used to purchase Treasury issued bonds from banks like Goldman Sachs and JP Morgan. These money will be used by the banks to loan out or seek further investments for returns. Such money would be expected to again spill into the Asia region as most investors are still hedging on its phenomenal growth.


Where on earth does US get so much money from?

US, being the largest economy in the world does not mean that it has a mountain of savings in its bank. It is like a large business centre which has a big capability in earning money. But all the money invested in its business are borrowed from the world. It issues Treasury bonds, like IOU, to foreign countries like China, who lends it a lot of money in return for interest. This is one way how US raises money to spend. Alternatively, it can simply print money out of mere paper. This is in the case of QE2, where $600 Billion are printed money. The effect of this, is a devaluation of the US currency. The government, however, does not see it as a problem because devaluation of the US dollars would invite higher exports of its products.


How would the QE2 unfold?

The US, for several years, has been complaining about China's stance in artificially devaluating its reminbi. China has, however, repeatedly denied this and is not succumbing to pressure from the US to appreciate its currency. For a long time, China has an unfair advantage of being the world's largest factory where most businesses from the US are outsourcing their production, tapping on its low labour cost. US has no qualms in going ahead with printing $600 Billion out of thin air to save its economy. This has a double effect of devaluing its dollar, thus making US businesses think twice about purchasing China goods with their weaker dollar. China may embark a tit-for-tat action by further supressing its yuan to maintain its currency value against the US dollar. Other major economies, fearing for their higher cost of goods with the weaker dollar may follow suit by printing more of their own currency. This is already evident in Brazil when its government started buying up all US dollars with its Real. When there was not enough, it started printing more of its own notes. If this continues, a major currency war would emerge. The world would be flooded with increasingly worthless currencies and inflation would rocket. Prices of precious metal like gold would also shoot through the roof when people scramble to find safer reserves. Governments around the world would start imposing high interest rates to curb inflation. When this day happens, a major economy apocalypse would have arrived. This time, much worse than the recent global recession.

But before we see the D day, let us see how the $600 Billion would affect us, people from Asia. Again, hot money would start pouring from the US. We may see further gains in the stock markets and other assets. But do remember that Asia has seen a sharp growth in 2010. Investors may start to see limited upside for Asia's growth in 2011. As hot money has entered into the Asia so easily, it may also exit easily to find better investments outside Asia.

Let us look at the charts below and analyse the behaviour of the equity markets in recent months. The first chart is the Dow Jones Industrial Average (DJIA), second is the Hang Seng Index (HSI) and the third is the Straits Times Index (STI). Each blue eclipse highlights the trading period between Oct 2010 and Jan 2011. The DJIA shows a clear uptrend, while the HSI and STI show sideway trend. In recent trading days, HSI and STI have also been lacklustre in performance despite DJIA seeing several days of rally. These patterns may be exhibiting some early signs of what I have mentioned; hot money exiting Asia and going back to the US. DJIA performance has lagged behind Asia's indexes by more than 20% in 2010 and it may be a catch-up time now. Moreover, this year's hot topic in Asia is about rising inflation, which may put off many investors.

So going forward, while we continue to enjoy the economic growth in 2011, let's not be complacent and always keep a watchout for any sudden market change. Happy investing!