US Federal Reserve Impacts on Cambodia

Khmer Times, Dean Hethington / CBR No Comments Share:

PHNOM PENH: March 14, 2014 (Khmer Times) – Why should people in Cambodia care what the US Federal Reserve (Fed) does?
 
For two reasons, the first is its actions have a big impact on financial conditions around the world, the amount of dollars in circulation, equity markets, export markets and economic perceptions. The second is the dollar is one of Cambodia’s two currencies in circulation, and the Federal Reserve is in charge of the dollar. In a sense, it shares responsibility with the National Bank of Cambodia (NBC), Cambodia’s central bank.
The US Federal Reserve is not part of the US federal government but is basically a private bank and a public institution whose shareholders are the 12 regional reserve banks in major US cities.
 
In turn, investors in these are the nationally-chartered commercial member banks, who can elect regional Fed boards and collect a 6% return. The US Treasury receives all other profits from the Fed system
 
The Fed’s ‘dual mandate’ is stable prices and maximum employment. It is also tasked with maintaining moderate long-term interest rates, the stability of the US financial system, and it supports provision of depository services.
 
It conducts national monetary policy, supervises and regulates bank holding companies, which include the big money center US banks, Citibank, JP Morgan Chase, Bank of America and etc., and foreign bank activities in the US.
 
There is also a research arm which publishes the influential ‘Beige Book’ on current economic conditions. Finally, it’s the lender of last resort to US banks.
 
A bank’s reserve requirements vary with the amount of loans they approve. If large demand deposits are created (through loan activities), banks may require more reserves. Let’s say a bank approves a big development loan.
 
It needs more reserves. It can borrow more funds from other banks with excess reserves. The rate at which they borrow from one another is set by negotiation between them, or market forces. The Fed can influence this with its target price and by its open market operations.
 
If it sells securities, usually US Treasury notes and bonds, money is paid into the Fed and comes out of circulation. The supply of money drops. If they buy securities, money enters circulation, and there’s more of it available to support reserves.
 
Usually, talk of the Fed raising or lowering interest rates refers to the FOMC’s target rate, but the actual rate, the effective rate, is set by market forces. It’s not to be confused with the prime rate, which is the interest a bank charges on loans to its most credit worthy customers and is 2 or 3 percent higher than the cost of money to the bank, or the federal funds rate.
Because of the enormous scale of these purchases, this has been dubbed ‘quantitative easing’ as it increases dramatically the quantity of money in circulation. The main purpose is to lower long-term interest rates and keep the cost of money down in all sectors and its availability high to encourage lending and investment.
 
It’s worked in the sense that bond yields on US treasuries, for instance, are very low, below the target rate of inflation. This means the effective interest paid for these bonds has fallen. These bonds have a fixed face value, if the price for them rises, the effective gain or interest, the ‘yield’, falls in proportion.
 
Only with massive quantitative easing of its own and stimulus under the aegis of current Prime Minister Shinto Abe, ‘Abenomics’, increasing the money supply, causing a rise in inflation and encouraging a drop in the value of the yen, promoting exports, does the Japanese economy seem to be growing again.
 
Too much inflation is also a problem as the real value of money falls dangerously. A fixed wage earner, for instance, has decreasing purchasing power. The Fed’s target inflation rate is about 2%.
 
It also makes sense that a vastly increased money supply and lower interest rates tends to cause inflation, much more money chasing the same amount of goods and services, while it supports markets, investments and economic activity, especially equity markets (stock markets). 
 
Money tends to go out of the bond market as yields are low and into equities and other investments. It can create a ‘wealth effect’ where investors watch the paper value of their holdings increase and feel richer and a little more confident.
 
How does this affect Asia, particularly Cambodia?
 
Research by most analysts has shown there has been a negligible influx of actual dollars into emerging Asia even with four rounds of QE.
 
It’s not so much about the amount of new dollars in circulation here but their low cost. Borrowing in dollars has been very cheap.
 
A lot depends on the risk appetite of institutional investors, who perhaps felt immediately insecure about the withdrawal of liquidity supporting equities and the possible effects on economic activity regionally. Add to this anxiety about Chinese growth.
 
While Cambodia is insulated somewhat because of its dollar economy, the ‘wealth effect’ locally had maybe not quite taken off, and investor confidence could have still been much more robust.
 
Cambodia as a dollar economy can be carried ahead on this current for a while longer, whereas it’s the risk of present and impending inflationary pressure that may very well be the rocks against which a fragile economy may wreck a promising future.
 
However, for inflow of the US Dollar, there has to be political, social and security stability and confidence in the country overall for institutional and multinational companies to take the calculated risk of putting their investment dollar in Cambodia. (By Dean Hethington)

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