The ‘Hot Money‘ Illusion

Last year, the Dow Jones Industrial Average hit a record high of 16,588, totally overshadowing the previous high of 14,000 in 2007 (pre-financial crisis). Does it mean that the US economy is out of the woods?

US Markets

Hardly so. As we all know, the Federal Reserves has been printing more the US$3.5 trillion of fresh money over the last 5 years to try to revive their struggling economy through their 3 tranches of Quantitative Easing (or ‘QE’ in short) programmes. Also, Federal Reserve has set its interest rates
to almost zero, allowing institutions to borrow more and cheaply, in a hope that more spending would spur the economy.

As such, there are lots of ‘hot money’ floating around, waiting to be deployed. And it is no surprise that most of this ‘hot money’ are in the hands of banks. 

For comparison, check out the Shanghai Composite Index (China) as well as our local Straits Times Index (STI).

China Markets

In China, the Shanghai Composite has fallen by about 30% since 7 years ago (before the financial crisis started). In fact you can see that the index level today is far, far away from the high in 2007. Since the crisis, the Chinese government has been rampantly implementing measures to cool down the economy and negotiate a ‘soft landing’. They have also been clamping down on shadow banking, which effectively reduced the amount of ‘hot money’ in the economy. (For a detailed explanation of ‘shadow banking’, check out Investopedia’s The Rise And Fall of The Shadow Banking System). All these measures kept the stock index low, but it is probably a temporary pain while the Chinese government is restructuring their economy to make it more robust for the future.

Singapore Markets 

In Singapore, we can see a mix of US’s liberal money policy as well as China’s ‘tough love’ strategies. As Singapore’s key interest rate — the SIBOR — is closely tracking the US Federal Reserve’s interest rates, this means that SIBOR is at almost zero. At the time of writing, it is about 0.3%. Adding in most bank’s markup of about 0.7%, total interest is only about 1% (floating rate). Therefore you can see many people buying properties because of the affordable monthly loan instalments.

Cooling Measures

Here’s where the tough love comes in. The Monetary Authority of Singapore (MAS) started realising that an economic bubble is forming when property prices are reaching record highs. They resorted to measures such as property rulings and additional stamp duties, loan curbs, more stringent loan requirements to cool the market.
Similar cooling measures are implemented in the car industry when COE premiums hit record highs. For car purchases, loans are now kept to a maximum of 5 years, with a loan limit of 50% to 60%.
These measures prevent the economy from overheating due to the ‘hot money’ syndrome and encourages financial prudence in purchases of the 2 most expensive things in Singapore - property and car.

Tapering of QE

While there is no ‘magic pill’ to solve the economic issues, especially when the US economy is still $17 trillion in debt, the light at the end of this long, dark tunnel could be the Federal Reserve’s December 2013 announcement of the ‘tapering’ of its quantitative easing policy. Fed chairman Ben Bernanke expects a tapering of $65 billion per month. The QE programme is achieved by the Fed buying back bonds from the hands of the public, exchanging cash for the purchase and hence the cash is injected into the public’s hands. What the tapering simply means is that US will cut down on the bond-buying, and hence less money would be injected into the economy. It is widely expected that by end-2014, the QE programme would cease.
Concerns are that interest rates would rise following the tapering, and inevitable end of the QE policy. Those who have bought their properties recently (at a considerably higher price over the average) and took up floating rate loans will suddenly see their monthly repayment go up.
For example, a 25-year property loan of $800,000, at 1% interest rate will require a monthly repayment of $3,015. If the interest rate rises by to 2.5%, the monthly repayment becomes $3,589, and increase of almost $570 monthly, or $6,840 yearly.
Hence the key lesson that we should keep in mind is that the current ‘hot money illusion’ is nothing but a temporary occurrence. Look at statistics and past historical data for an idea whether a purchase is made logically and wisely, rather then simply making decisions based on emotions.

The above information are not to be construed as investment advice, and are purely my opinions. You must do your own research and analysis before making investments of any kinds.