In Part I of this series, I provided an economic philosophy for the prediction of financial crises or bubbles where I point out that it is incredibly problematic to try and predict them. We can see risks but predicting a financial crisis is something very different. There is an old joke that says God invented economists to make astrologers respectable. The point being that it is important to have an enormous amount of humility when prophesying about what is to come.
I believe words matter in writing as they state our intended meaning. Jesse Colombo when writing about Singapore did not write that Singapore real estate is overvalued; he did not write that credit has expanded rapidly in recent history; he did not write that Singapore is a major investor in the region holding potentially overvalued assets. Jesse Colombo asked whether Singapore is going to suffer from an Icelandic style meltdown. Therefore, the question before us is whether Singapore will suffer a financial crisis similar to Iceland. To answer this question, it is important that we have small understanding of the Icelandic financial crisis.
Prior to the 2008 global financial crisis, Iceland banks and investment firms began to accept deposits and borrow from foreigners to subsequently purchase foreign denominated assets. When money markets seized up in 2008 and short term credit became unavailable to even the most credit worthy firms, Icelandic banks became unable to roll over their borrowings or repay foreign creditors. To provide some perspective, Iceland’s external debts were nearly 7.5 times GDP and total banking assets were 11.1 times GDP. External debt amounted to 160,000 Euros per citizen of Iceland. Due to the collapse of the three major banks, the stock market declined more than 90%. The declining currency cause a surge in inflation above 12% for two years straight and interest rates topped out at 18%. The government budget went from essentially balanced to a deficit of 9% of GDP and the unemployment rate more than quadrupled. The point here is that this was not a small economic correction but one of the most sudden and largest, in relative terms, financial crises in human history. Therefore, what are the risks that Singapore will suffer from a similarly large and wrenching financial crisis?
Before, I begin to answer that question, I want to emphasize three things. First, I recognize many of the same risks cited by Mr. Colombo. The risks due to home value prices and the rapid expansion of credit to cite just a few are legitimate concerns, though I believe that these risks are enormously overstated. However, the question is not whether these risks are elevated but whether Singapore will suffer an Icelandic style financial crisis. Second, given that the analysis in question was filled with lots of well cited data, I will not revisit each point and will also assume everyone has already read the piece in question. Instead, I will show what I believe I more important facts to consider. Third, I will not address many related questions that could and should be asked here about policy responses or whether these things are good or bad for Singapore. I will only focus on whether these factors will lead to an Icelandic style financial crisis.
1.Singaporean external debts are elevated but not excessive. One of the most common threads between financial crises are significantly elevated levels of external debt and increasingly short term debt. Now as I noted philosophically previously, just because those two factors exist does not mean a financial crisis is imminent. Singapore currently has an external debt to GDP ratio of 4.1 well below the Icelandic number of 7.5. What is just as important is the composition of that external debt is its composition. Most of that is in banking deposits. As Singapore has become an offshore banking center and many corporations and wealthy have moved to Singapore, they have similarly brought financial assets. The large majority of external debt is in the form of banking currency and deposits. Iceland was never a banking center providing a large range of financial services to a region or wealthy population. With 1 in 10 Singaporean residents having more than $1 million USD in liquid assets to invest, it is little surprise that this number is at this level. Given that small countries will both trade and invest more outside of their own country, the risk here might be considered slightly elevated but not excessive or extreme.
2.Singapore real estate prices and debt appear to have a somewhat elevated but not excessive risk. Though there are numerous data and methodological issues associated with obtaining good estimates of the relationship between income and housing prices, Singapore real estate prices and related debt markets do not appear to be excessively stressed. For instance, the population of Singapore demonstrates relatively high inequality and available wealth. These two factors generally push real estate prices higher raising the overall home price to income ratio. Taking a simple, unweighted average of resale prices for apartments in Singapore from official data, the average price is $521,861 (I used this simple calculation as an approximation as better data to make a more precise estimate is not available). Given an average per capita GDP of $66,521 SGD according to the IMF in 2013, this implies a home price to income ratio of 7.85. Again, this is elevated and puts stress on families and business but again this is not excessive and seems not to imply an Icelandic style meltdown. Though the coming surge of home being built by developers may soften prices or push asset prices down, that is very different than causing a precipitous drop that ignites a painful financial crisis.
3.The uniquely Singaporean characteristics. Though I am normally reticent to describe a situation as different, I do believe there are some uniquely Singaporean characteristics that are overlooked. Let me give you a couple of examples. First, though there is a very large public debt, it is owed to the citizens of Singapore via the Central Provident Fund holdings and controlled primarily by the Singaporean government. While that does not make the debt and accompanying interest payments any less real, it does eliminate the possibility that investors will dump government bonds. Second, the Monetary Authority of Singapore has large foreign exchange reserves and could defend all but the largest of financial crises against currency runs or bank recapitalization needs. Furthermore, give the managed exchange rate, it is not inconceivable that should a significant risk of financial crisis arise, that MAS would simply impose currency controls keeping bank deposits in Singapore. Third, one of the risk of being a small country is the push to invest and trade abroad. Countries like the United States and China have very small external economic activity numbers, Singapore especially as a true financial center has to engage with the outside world raising many of these numbers.
4.A few specific rebuttals.
A. The chart on the second page of the piece which says that Singapore has high household debt relative to GDP fails to control for wealth and is consequently essentially meaningless when compared to other countries given the level of financial asset wealth in Singapore compared to other countries.
B. The chart on the second page of the piece which says that Singapore is experiencing an “epic” housing bubble is again blatantly misleading. While recent increases have been above the long run trend, the long term trend is nothing out of the ordinary and as shown by a simple estimation of the home price to income ratio, is elevated by not remotely close to “epic” or anything triggering a major financial crisis. The long run price increase, given that 1998 is equal to 100 in the figure, produces a long term price increase of 5% annually.
C. The numbers cited on page 2 for the home price to income ratio cannot be reconciled with third party data. For instance, according to the methodologyused by the website he cites, the average price in Singapore would need to be approximately $2.25 million SGD! Now even if you are skeptical of official Singaporean statistics on apartment resale value or my simple calculation above, I doubt anyone would believe that the average home price in Singapore is $2.25 million SGD. If you take the much more restrictive household median income using official statistics, this would still yield an average housing price of nearly $1.6 million SGD! Additionally, somehow the city center and the outside the city center home price to income ratio for Singapore are both higher than the ratio for the entire country. Given that Singapore is a city state, this seems mathematically impossible.
D. On page 4 of his piece where he complains that assets under management in Singapore surged by 9% annually between 2007 and 2012 and 22% in 2012, he should keep in mind that given returns on capital and any new inflows, that is about right. Important to put this all in perspective.
I do want say very clearly that I share many of Mr. Colombo’s concerns about the expansion of credit, low interest rates, and rapidly rising real estate prices. However, and this is very important, he so drastically overstates them to the point that valid concerns about potential financial risks become lost in a haze of hyperbole and hype.
As anyone who has read anything I have written about Singapore knows, I am no defender of the current economic policy in Singapore or the enormous irregularities in public institutions. There are some distinctly valid and reasonable concerns about economic and financial risks in Singapore. However, there is no reason to believe that these risks will result in an Icelandic style financial crisis.
Note 1: Wikipedia has a good summary of the Icelandic financial crisis.
Note 3: The external debt statistics were taken from the IMF and World Bank Quarterly External Debt Statistics database. You can find that database with data for Singapore as well as other economies here.