Thursday, February 26, 2009

Too cheap can be bad

The return of cheap prices: Accidental reprieve or intentional rethink?


THE fall of the consumer price index in Singapore, reported by this newspaper on Tuesday, follows global trends and is unremarkable in some respects.

The Today report, “The return of cheap and good”, also cited an article I wrote in August last year, “The end of cheap and good”, and suggests that the results are now reversed.

While my commentary was written before Lehman Brothers collapsed and triggered the current crisis, the analysis that Singapore has returned to being cheap and good mis-reads trends both now and for the medium-term future.

First, why are prices falling? It’s not because of fundamental increases in supply.

It’s primarily because global demand disappeared, which, in turn, was caused by the credit crunch and uncertainty about what lies ahead.

American consumers shiver. Asian producers dampen production and drop demand for commodities and other inputs. Speculators who punted on rising commodity prices, like US$200 barrel oil, close off their positions, especially if they are leveraged. This leads to prices falling further and more sharply.

Given this, what happens if and when things stabilise and growth restarts in Asia and elsewhere?

We should anticipate that fundamentals will return to push prices back up. Right now, this may seem a big “if”. But if we believe that growth and demand in Asia and elsewhere will resume, the medium-term projection must be that prices will again go up.

Perhaps the rate of that rise may be tempered. Maybe chastened speculators will no longer believe in US$200 oil. But it seems unlikely the current low prices will continue in perpetuity.

Secondly, is Singapore returning to being cheap? Some adjustments are anticipated but prices tend to be sticky downwards. This is especially when there is a lack of competition and sellers can afford to hold.

Look at property. Prices have softened. But most market segments remain above where they were before prices took off from 2005. People who bought say the Sail at below $1,000 per square foot are still ahead on paper.

Moreover, prices alone do not determine what is “cheap”. It also depends what you can afford to spend. Even at lower prices, we ask ourselves if we can afford to buy if we have lost our job or fear that is impending?

We also have to consider other countries are getting cheaper too. Indeed, some currencies have fallen much further against the US dollar than has Singapore’s. As such, we may remain relatively more expensive compared to such countries.

Thirdly, the current lower prices are the consequence of the global slump and not a deliberate policy of the Singapore Government. This is an accidental reprieve, not an intentional rethink.

In my original commentary, “The end of cheap and good”, I suggested that the problem was policymakers no longer thought Singapore should aim to be cheap and good. This could be seen in their vision of a Singapore built around luxury condos and world class casinos.

Driven by that, they were acting pro-cyclically when prices were rising, rather than dampening that rise. Thus prices rose higher even faster.

Has that vision changed? It doesn’t seem so. Indeed, with prices having climbed so far and so fast, the Government must now act against the cycle to ensure they do not come crashing down too fast and hurt the economy. That’s the logic of stimulus packages.

Deflation is not the same as avoiding inflation. The cheap price of a desperate closing down sale is not the same as the product that is affordable because the cost inputs such as labour and land were kept low.

We are not returning to cheap and good. We should now be concerned that too cheap can be bad.

Simon Tay is Schwartz Fellow with the Asia Society in New York and Chairman of the Singapore Institute of International Affairs.