Impact of Velocity of Money for Malaysia

The quantity theory of money (QTM) asserts that aggregate prices (P) and total money supply (M) are related according to equation:

P = VM / Y

where Y is real output and V is velocity of money.  A central implication of QTM is that a given change of money growth induces an equal change in inflation rate. Milton Friedman thus claimed that “inflation is always and everywhere a monetary phenomenon”.

A crucial assumption behind this claim is that the velocity of money or its growth rate is constant and money growth has no effect on real GDP growth. For Malaysia, we could use the same equation for velocity, V=PY / M. In which case for a 5-year period, the velocity ratio of nominal GDP to quantity of money (M2) was as follows:

	2013	2014	2015	2016	2017	Jun-18
Nominal GDP (RM trillion)	1.02	1.10	1.16	1.23	1.35	1.45
M2 (RM trillion)	1.44	1.54	1.59	1.60	1.72	1.77
V = PY/M	0.71	0.71	0.73	0.77	0.78	0.82

It may be observed that the velocity of money remains rather constant with some marginal increase from 2016.

According to St Louis Federal Reserve (Yi Wen, on “The Quantity Theory of Money”, Paper No. 25) the post-war U.S. data suggests that velocity of money is far from constant. So instead of assuming the velocity of money or its growth as a constant, we can use the QTM equation (in lower case and percentage change in growth rate)

v = p + y – m

to accommodate the changes in velocity to be dictated directly by three sources: inflation, output growth and money growth. For the U.S., in the long run Friedman is probably right – changes in inflation and changes in money growth are closely related (St Louis Federal Reserve, 2006, Number 25).

In Malaysia, money growth (M2) was observed as follows:

	2013	2014	2015	2016	2017	Jun-18
Change in M2 (%)	7.94	7.53	2.88	3.05	4.82	5.71

And inflation over the same period was:

	2013	2014	2015	2016	2017	Jun-18
Change in CPI (%)	2.10	3.20	2.10	2.10	3.50	0.80

Nominal GDP growth declined from 6% in 2014 to 4.5% by June 2018, as depicted below:

	2013	2014	2015	2016	2017	Jun-18
Change in GDP (%)	4.70	6.00	5.00	4.20	5.40	4.50

What does this mean? How fast money changes hands per unit of time is the velocity of money. This is a gauge of economy’s strength or people’s willingness to spend. Since December 2017, the tempo in the Malaysian economy has dropped. Velocity of money, as expressed earlier, v=p+y-m and shown below (from 2013 up to June 2018):

	2013	2014	2015	2016	2017	Jun-18
Velocity of Money (%)	(1.14)	1.67	4.22	3.25	4.08	(0.41)

In a sense higher velocity may suggest greater vibrancy in the economy and that it is likely to expand. Over last five years, this has been upward from 2013 with a general decline thereafter (save for a rise in 2017).

Stable money growth assists in keeping inflation in check. That’s helpful to savers but does not encourage consumption or business uptick. (We are far from hyperinflation for now and that’s 50% increase per month – a’la Venezuela or Zimbabwe).

So what can we do? The Central Bank has an array of tools (interest rate, reserve changes and open market operations) but policy constraints or conundrum may veer towards “tweaking” than a radical shift. A low interest rate environment may assist in business sentiment or provide conditions for growth. But that impacts exchange rate in a rising interest rate regime of the U.S. So should we do quantitative easing (“QE”) to stimulate growth and income? But that may impact inflation.

The U.S. did its QEs for six years without inflationary pressure because the economy was already deflationary when it began. In addition, banks and financial institutions hoarded the money in order to shore up their own balance sheets and regain profitability. Banks had toxic loans and were unusually cautious. Meanwhile, the real economy remained productive and growing. M2 money supply remained fairly stable.

For Malaysia, we need stimulants of the right type – perhaps measured quantitative easing - and appropriate fiscal measures to improve the general economic tempo. And that we hope the Minister of Finance could do in Budget 2019.

References:

1. The Quantity Theory of Money, Economic Synopses, 2006 (Number 25)

2. Money Growth, Money Velocity, and Inflation (www.thismatter.com)

3. What is the correlation between money supply and GDP? By Sean Ross (www.investopedia.com)

4. How does the velocity of money affect a national economy? (www.quora.com)

5. Department of Statistics and Ministry of Finance, Malaysia

6. www.tradingeconomics.com

Is Kuala Lumpur (KL) a Major Financial Centre?

KL’s ranking as a financial centre is now 40^th (up six places) according to Global Financial Centre Index 24 in its September 2018 Report. It is however, ranked below Dubai (15^th), Abu Dhabi (26^th) and Doha (34^th).

London has been replaced by New York as the world’s most attractive financial centre as Brexit prompts banks to shift jobs out of the city. Hong Kong and Singapore are ranked after London. Hong Kong is only three points behind London. It is highly likely that an Asian centre will top the list soon. The rise in China’s centres (Shanghai or Beijing) will be limited by the tight control exerted by the ruling Communist party.

Key areas for a rise or fall are attributed to several factors. Human capital factors include: availability of skilled workforce, flexible labour market and quality business education. The business environment factors include regulation tax rates, corruption, economic freedom and how difficult or otherwise of doing business. The financial sector development factors assess volume and value of trading, cluster effect and employment and economic output. The infrastructure factors include price, availability of office space and public transport. Reputation and general area considers subjective matters like innovation, brand, cultural diversity and competitive positioning.

It looks like a tall order for KL to move up further but move up we must! Or, we end in another failed aspiration to be a financial hub. The good point is that if Dubai or Abu Dhabi could do it, surely we could do better!

Reference

Long Finance, Global Financial Centres Index, Z/Yen Partners in collaboration with the China Development Institute.

This Photo by Unknown Author is licensed under CC BY-NC-ND

Hot Deals for Monday WW44'2018

Welcome to Hot Deals for Monday, where you have opportunities to Buy or Sell!

Opportunity 1

Marketing and retail footwear looking for new investors to acquire 20% stake in company.  Consistent dividends of 5% or more for over 5 years.

Opportunity 2

Property development company with good results and dividends.  Sale of about 25% equity interest in company.

Opportunity 3

Company dealing in outdoor and gym equipment, has been in business for 15 years.  NTA around RM7.5 mil.  Profit ranging from RM0.5 mil – RM1.0 mil.  Profit guarantee is feasible.  Offering price RM5.0 mil.

Opportunity 4

Oil Palm estate over 2,000 acres in Kedah.  With potential for property development.  Asking price RM3 p.s.f.

Opportunity 5

“Edupreneurship” opportunity!  An established education provider is offering an exceptional opportunity to grow entrepreneurs in higher education field.  The potential “edupreneur” will be given the chance to manage a college by taking a minor equity position (40%) in the education group for RM2.0 mil, with an option to buy-out the company later.

If you are interested in the above opportunities or would like to offer your hot deals, please contact info@mpcap.com.my or 603 - 2283 1170 for further details!

Limitations of Financial Ratio Ranking

In previous article, we discussed about initial stocks screening method using financial ratios (Read more here).  This week, we would like to discuss more on the limitations of financial ratio ranking.

In the electronics sector, it is a common practice for companies to maintain high cash position and low debt levels.  The debt-to-equity (D/E) ratio for most electronics companies are very low or near zero.  Thus, D/E ranking may not be meaningful.

Also, financial ratios are computed using financial statements.  Different companies may have different approaches to recognize their costs.  For instance, MPI cost of sales is very high but their Selling, General & Administration (SG&A) costs are low.  As such, MPI’s gross margin is relatively low compared to its peers but its operating profit margin is on-par with its peers.

Users could either manually adjust the input data or carefully select at least two financial ratios in the same category, (example, Gross Margin & Operating Margin) to smoothen the impact of input data discrepancy.  Nevertheless, this methodology is a useful to benchmark companies in a selected sector.

Source: Ratios were calculated based on financial data from Bursa MarketPlace

Disclosure: The authors may have interest in the stocks of the companies in this article.

Five Entrepreneurship Lessons

Over the last 22 years, I have learnt at least five key points that one needs as an entrepreneur:

1.     Best in the Field

It is a branding feature, that people recognize your expertise. And project finance is our speciality. We need to be the “go to person” in the sector. It is a niche that others have difficulty establishing a name. So referrals and customers come for the expertise in your field.

2.     Nimble

For a small business, being nimble is key. Environment keeps changing. Only reactive/proactive steps are relevant.

3.     Know your Cashflow

It is necessary to review cashflows  frequently- weekly or bi-weekly. Once a year is a recipe for disaster. Have a close understanding of costs and revenue streams to survive in a competitive environment.

4.     Listen

Listen to your customer needs, employee priorities and exercise your good intuition of what’s right. Nothing will be perfect but work hard to be close to a desired benchmark/ model is helpful. Try to exceed expectations but accept that there are times that this may not be possible.

5.     Remain Tough Internally

Running a business is not easy. Neither is a corporate career. Others may look better than you- but you don’t know their struggles. Remaining tough internally helps to surf a volatile business landscape. Let people underestimate your capability. If you look at some football games, the “weak” ones surprise the great sides – because someone thought it was going to be a walkover.

Lots of people want to give advice- expand, merge, sell out or close it – only you know what ticks and that matters! So work for the immediate and have a broad framework for the longer term.

Best of luck!

USMCA: Is The New Trade Deal Better?

USMCA is not about the MCA in the U.S. – but sometimes you may think they (MCA) are better off in the U.S.!

USMCA is the renamed NAFTA and called the “U.S.-Mexico-Canada Agreement”. The deal updates the 1994 North American Free Trade Agreement.

Hadrian Mertins-Kirkwood, a researcher with the Canadian Centre for Policy Alternatives described the agreement as a “mash up between the Old NAFTA and the new TPP”. TPP is the Trans Pacific Partnership (“TPP”) Agreement amongst 12 nations which Trump withdrew from.

The key points of the USMCA include:

·       USMCA will expire in 16 years unlike NAFTA which was infinite;

·       It increases U.S. footprint in agriculture in Mexico and Canada;

·       USMCA allows Mexico and Canada to continue exporting vehicles to U.S. with a cap. Car parts that must be manufactured in North America increases from 62.5% to 75%;

·       Intellectual property regimes are strengthened with patents and copyrights now ranging from 10-20 years. Great news for big pharma!

·       Suing government (by companies) on potential future profits have been scrapped between Canada and U.S.; and

·       USMCA does not mention about climate change.

So who are the winners and losers? Analysts say big corporations stand to gain the most (in all three countries).

What next? All three countries are expected to sign before end November 2018. And if ratified, most of the provisions of the agreement are expected to go into effect in 2020.

Reference

1. NAFTA out, USMCA in: What’s in the Canada, Mexico, US trade deal? – Heather, Gies, Al Jazeera News

2. Advantages of NAFTA – The Hidden Benefits of NAFTA, Kimberly Amadeo, The Balance