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Bertonomics

Looking at the world through the lenses of Singapore A level Economics =D

Month

March 2016

Sharing is Caring

Why buy a car if you could simply ride on someone else’s car, much like a taxi? Why live in hotels when you travel overseas when you could save costs by living in someone else’s home? Such are the questions that mobile applications like Airbnb, Uber and Turo have posed to users as they seek to develop a business around the concept of a Sharing Economy.

The Sharing Economy or Collaborative Consumption is built under the notion that access is more important than ownership. It bridges the gap between supply and demand but instead of transactions enacted by firms previously, most who offer their services are everyday individuals who have resources that they do not maximise.

For a quick introduction to the sharing Economy watch this short video done by my graduated students.

For example, California-based Airbnb lets people rent out their spare rooms to others for extra income. Turo allows others to rent your cars when you are not using them. Uber, already seen in Singapore, allows individuals not registered as taxi drivers to play similar roles, driving people around for a fee. Such peer-to-peer rental schemes provide extra income for owners and can be less costly and more convenient for consumers.

choice
Snapshot of the Sharing Economy – Credits to PWC Consulting

The current digital technology has made it effortless to aggregate supply and demand. Smartphones and mobile applications make it easy for GPS satellites to track for the nearest room and car available for rental. Social Media and online rating systems make it easy to establish trust. Finally, the ease of internet banking allows quick and effective transactions. Such efficiency have created the “peer-to-peer economy” or the “sharing economy”.

excitement

It is no coincidence that many of these apps were made during the crisis years of 2008-2012. A sluggish economy encourages sharing as people search for alternative sources of income and aim to reduce costs. Moreover, it is also environmentally friendly as it encourages more efficient use of available resources, discouraging overconsumption. It is also no surprise that according to a study conducted by PWC consulting as shown above, those who are most excited about the sharing economy belong to the millennials. These individuals were born into the digital age and grew up with social media, thus their increasing involvement in the labour force is likely to impact the future of consumption. Increasingly, it may induce a shift from ownership to access.

Sharing economy sector and traditional rental sector projected revenue growth - Infographic

As seen from a study by PWC above, by 2025, the 5 key sharing economy sectors could generate revenues of up to a staggering $335bn. Airbnb totals more than 155 million guests annually, 22% more than Hilton Worldwide, a multinational hospitality company. Five-year old Uber already operates in 250 countries and its market capitalization as of 2015 was valued at a startling 41.2 billion, more than the market capitalization of American Airlines, Genting Singapore and United Continental. The point is that the sharing economy has massive potential, moreover the industry works under the veil of the network effect, the more users utilize such apps, the bigger its area of expansion.

Impact on Market Structures

The key impact on market structures is the reduction of barriers to entry for households with excess resources. But there is a paradox in the sharing economy. It both increases and reduces competition. For example Airbnb allows any willing person to rent out his/her room or whole home to outsiders, becoming a source of competition to existing hotels. This reduces the market dominance of big hotel chains and reduces prices to make the market closer to achieving allocative efficiency. However, the platform of Airbnb itself will becoming increasingly dominant because of the network effect and network economies of scale . Indeed Airbnb can be said to be a near international monopoly when it comes to short-term rental of private accomodation. For Uber, in Singapore, it is at least challenged by Grab, thus it may result in an oligopoly situation. Whatever the case, whenever there is innovation disrupting the relevant markets, the consumers win! So cheers! Sharing is indeed caring =).

Co-authored by Deng Quan and Gilbert

 

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Entering the Negative Zone

Imagine a bank that charges negative interest. Depositors are charged for placing their money with the bank. The thought sounds crazy. But, in recent years, faced with long periods of low inflation, various central banks have used negative interest rates for the purpose of increasing aggregate demand and inflation.

On Jan 29, the Bank of Japan(BOJ) surprised markets by adopting a negative-rate strategy, cutting its benchmark interest rate to -0.1%. It joins the European Central Bank (ECB) as one of the few central banks which have resorted to negative interest rates.

Commercial banks hold reserves that are not lent out to the bank clients. A small fraction of the total deposits is held internally by the bank or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request. However, when a central bank charges a negative interest rate for parking its reserves with them, it is penalizing and charging commercial banks for leaving their reserves with the central bank. They are thus encouraged to lend it out, increasing AD (consumption and investment), spurring demand-pull inflation.

It is an unorthodox method to counter deflation and a rather desperate attempt to hit core inflation of 2% in which the BOJ has failed to achieve the target for extended periods of time. But, the extent of its impact is likely to be minimal.

How much good will it do?

  1. Animal Spirits – Liquidity Trap

In theory, interest rates below zero should reduce borrowing costs for households and firms thus increasing loans. In practice, however, the problem is not that banks are unwilling to lend out the money, it is simply that the market lacks investors willing to borrow money from banks – i.e. it’s a credit demand problem and not a supply issue.

Since the property bubble burst in the 1990s in Japan, corporate savings have been massively rising in Japan. Some have used the term balance-sheet recession to refer to Japan’s crisis. A balance sheet recession occurs when the private sector faced by the burst of a nationwide debt-financed bubble becomes a net saver as it aims to pay off the bad debts it has accumulated during the bubble years. The money supply must be grown in tandem with the number of private debts to successfully raise investment and consumption. Unfortunately, interest rates have reached near zero levels but loans have not picked up, coining the term a liquidity trap. With confidence so low, it is unsure whether the negative rates will truly be a problem-solver for the ageing economy.

  1. Why should you keep your money with the banks if you can keep it under your mattress?

In theory, interest rates below zero should reduce borrowing costs for households and firms thus increasing loans. In practice, however, if banks charge depositors for keeping their money with the banks, cash may go under the mattress.

In layman terms, why should you keep your money with the banks if you can keep it under your mattress since both do not give you a return? In fact, placing it under your mattress is safer since you dun have to spend time actually retrieving money from ATMs and you can spend it anytime with you. In economic terms, it is often referred to as the liquidity-preference theory.

This perceivable danger has yet to surface as most commercial banks have yet to penalize depositors except Julius Baer which began to charge large depositors. But, if banks were to begin to charge for deposits, massive numbers of depositors may decide to extract their deposits, it will become a bank run and pose a systematic threat to the banking system. The BOJ and ECB knows the underlying possible of a bank run thus they should cautiously.

A few key points to note:

  1. Japan was actually experiencing negative real interest rates before the BOJ chose to break the negative barrier. Although nominal interest rates were mildly positive(0.01%), inflation was mildly positive(1%). Nominal IR – Inflation Rate = Real IR
  2. Markets are affected by expectations. QE and negative interest rates are meant to be an unorthodox ‘secret’ weapon that the central bank can use as a ‘last resort’ monetary policy. However, the BOJ has been enacting such monetary easing since the 1990s after the property bubble. By now, market expectations have calibrated themselves to such monetary easing. Its effectiveness will dampened over time as investors become accustomed to the use of QE. Analogically speaking, a ‘secret’ weapon is not so powerful if you keep using it and your enemy starts to anticipate it.

 

Stumbling Dragons

A few months ago, the Chinese financial sector experienced numerous setbacks as it experienced unprecedented depreciation of its currency and a tumbling stock market.

The Shanghai Composite Index, China’s main benchmark, closed 6.4% down at 2,749.79 on Jan 26 and the plunge does not seem to be stopping.That was the index’s largest one-day percentage loss since the Chinese government got rid of a “circuit breaker” mechanism on Jan. 8. The system, put into place at the beginning of the year, was blamed for sparking rather than stopping volatile trading.

Weakness in the Chinese Economy

The major fall in China’s index can be attributed fundamentally to its weakening economy. After more than 30 years of rapid economic growth, labour wages are rising. Investment rate-of-returns are rapidly falling. China’s voracious demand for commodities is slowing down as seen from the crash of nearly all commodities prices. Moreover, during the boom years, over-investment was seen in major core industries such as steel, construction and property. Although such investment pay not have an effect in supply over a short-run, over the long-run as we are experiencing right now it will generate spare capacity, further placing downward pressure on prices. This has jump started the massive selling of China’s stocks as economic growth has revised downwards.

Besides its weakening economy, the increase in interest rates in the US has sparked massive capital flight from China. Although China sets up capital controls, leakages still occur within the system resulting in hot money to flow from China to the US. Outflows jumped in December, with the estimated 2015 total reaching a record $1 trillion, more than seven times higher than the whole of 2014 based on Bloomberg Intelligence data dating back to 2006. Such leakages have resulted in an increase in the supply of Yuan in the global market which places downward pressures on the Yuan.

Graph

From its historical low of 1 USD to 6.20 RMB, the RMB has depreciated to its current level of 1 USD to 6.5777.  The PBOC(central bank of China) has made major effort to defend the Yuan to ensure currency stability. It has used its hoard of foreign reserves to buy up Yuan, increasing demand and reducing supply to prevent further depreciation. It is doing so for 3 major reasons:

  1. Capital flight results in a reduction in loanable in banks. This has a contractionary effect on the economy as the decreased supply of funds puts upward pressures on interest rates and increases the cost of borrowing. This reduces investment and consumption, reducing AD while the economy is already experiencing a structural slowdown.
  2. In Nov 2015, the IMF has decided to add the Yuan into its special drawing rights currency basket. The development is key to ensuring that the Yuan becomes internationalized, expanding its financial sector and breaking the monopoly currently held by the USD. But to do so, the Chinese government needs to maintain confidence on the Yuan and needs to show discipline in ensuring a stable exchange rate. A rapidly depreciating Yuan is not what foreign investors will like to see as a possible future global currency as it affects their expected rate-of-return.
  3. A depreciating currency reduces the value of assets in terms of foreign currency. Thus, a depreciating currency may spark further capital flight as investors shift their money out to maximize returns. It turns into a vicious cycle where capital flight triggers a depreciating currency that further encourages more hot money to escape. Although the PBOC currently has a large amount of foreign reserves at its disposal, it needs to ensure it stop gaps the panic flight before its reserves amount gets threatened.

With the $107.9 billion drop in December, Beijing’s foreign-exchange reserves have fallen every month but one since May. Tough times loom ahead for the Chinese economy as the US may potentially further raised its interest rates later in the year which may sparked further capital flight.

The road ahead

The truth is that China’s golden opportunity to reform its financial sector may have disappeared. Previously, cheap credit from around the world flowed to developing countries thus funding their development and investment. Exchange rates were relatively stable as seen from the gradual and modest appreciation of the Chinese Yuan. A stable exchange rate and ample capital made it favorable for financial reforms to take place since markets were stable and massive capital flight was unlikely.

However, much has changed. Global economic growth has decreased. China’s economy faces dire spare capacity in its key industries. Most importantly, the Federal Reserve has ended QE, raised the short-term interest rates in December 2015 and probably intends to further normalize interest rates in the days ahead. This has exasperated capital flight from developing countries, especially China.

Just as China attempts to open up its financial sector and relaxes capital controls, the global conditions will only encourage further capital flight and put further threat on its economic stability as it faces a depreciating exchange rate and a sluggish economy.

Contrary to popular belief, the better short-term solution is perhaps to increased capital controls to stabilize the Yuan and prevent further capital flight. When the market stabilizes after the series of rounds of interest rates rise by the Federal Reserve, China can then make use of the opportunity to gradually open up its financial sectors in selected areas such as Shanghai and Beijing.

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