QIC Inside Investor Relations – Volume 39 – How does inflation and the US Federal Reserve rate hike affect Taiwan's economy and stock market? View from Peter Kurz - Mr. Taiwan
(Photo: QIC)
This episode of the Inside Investors Relation is edited and republished with permission from TaiwanPlus Point
The recent sharp correction in global stock markets, driven by the U.S. Federal Reserve's interest rate hike, has resulted in heavy selling pressure in various countries' stock markets, and many investors are asking, "Will the stock market fall again? How long will inflation last? Will Taiwan's economy go into recession? Peter Kurz - Chief Strategy Officer of QIC or Mr. Taiwan, who accurately predicted the stock market correction at the end of last year, said that high inflation will be the main variable for investment in this year and next year, which will not only affect the industry supply chain, he also worries about the impact on the labor market in the long run. In addition, a rise in interest rates will certainly lead to a contraction of capital in the stock market but he also believes that Taiwan’s rate of saving is also due to come down once the country starts to reopen post the pandemic, which could also impact the stock market.
In this episode of the Inside Investor Relations, Peter will provide his view on how the current inflation and interest rate hikes will affect Taiwan's economy and stock market, as well as how he sees the stock market trend this year, via a personal interview.
Q: Peter, so glad to have you here. So my very first general question is about inflation. Everyone is talking about inflation right now. You've lived in Taiwan for more than 34 years. How serious is it right now here in Taiwan?
P: As far as the concerns about inflation, they are as dire, quite frankly as anytime I've seen here in Taiwan. Although I've lived long enough to see pretty bad inflation back in the States, back in the 80s, I don't think we're quite at that stage, but we are at risk for that. The reasons are a lot of the same background phenomenon back then are happening now. We are seeing rising oil prices, which was one of the key triggers, and oil is clearly one of the key drivers to prices across the entire economy. Whether it's from transportation to agriculture, to production of fertilizers or plastics and so forth.
Secondly, we have the backdrop of extremely high monetary growth that we also saw back in those days. So all these factors suggest that we do need to take this problem of inflation seriously. Although Taiwan, in my experience, has lesser inflationary pressures in the past because it is still a fairly open economy. We export and import quite a bit of our total GDP. That helps take off some of the price pressure. But it does mean that we are also importing a lot of energy and oil.
The goods market in Taiwan has been very stable in pricing for much of the 30 plus years that I've been here. But the property market has surged, and when you consider that, ultimately you do have to pay for your abode. You have to buy things at stores that themselves have to pay for their physical storefront as well. All this will eventually feed into prices. But in fact, it's been rather centralized.
Q: Do you think it will remain elevated?
P: This is the big question. There are reasons to think that this is triggered by short-term bottlenecks in the supply chain that will be resolved over time. And we now have the Ukraine conflict, which one hopes will not last for a long time. Even if it does at some point, there will be adjustments made that will allow for a replacement of some of the shortages that have been created by the conflict. But to some extent, there will be no way of replacing all the grain and other commodities that have been produced out of Ukraine, so there will be shortages. But again, what we're concerned about is not necessarily an elevation of prices but a continuous elevation of prices over time. That's more of a psychological issue, and it's also a matter of controlling wage growth. This is one factor that can create that ongoing increase. You raise oil prices by 10, 20, even 100% and it's a one-off event. But if there is a perception among workers that their cost of living is going to continue to rise, they're going to demand higher wages and that will only increase the prices of producing these things. That's where you get this sort of ongoing process of inflation.
Q: When we talk about inflation, we often think of interest rates. The Central Bank of Taiwan has recently raised interest rates by 25 basis points. Do you think it will be the first of many interest rate hikes this year?
P: One-off interest rate hikes are not very effective because once they're done, people just go back to their normal spending patterns. For them to be effective, there at least needs to be the perception that there will be more to come and for that perception to be built in, you have to have at least one more rate hike. And certainly Taiwan's interest rate policy is going to be influenced by U.S. interest rate policy, and the U.S. Fed has already given indications that there will be most likely many more rate hikes to come. I don't know how many. Thus the chances are we're going to see at least a few more coming out of Taiwan. Although historically Taiwan has not always followed the Fed to the same extent, they have typically followed them to the same direction.
Q: Do you think it will effectively contain inflation?
P: I think it's containable. It depends, of course, on the resolve of the central banks. And as I said, right now they are showing that resolve based on recent Fed pronouncements. In the U.S. they are talking a very tough game, so if that plays out then I think it is containable. And as I said, it's a question of whether this spills over into wage inflation which brings up another issue, though. Remember we're also coming out of a COVID epidemic and we're now also going into the Ukraine crisis here. We're going to be reading this in the history books for many decades to come. This will be a very unique period. But in any case the impact of COVID seems to have been to have, I won't say permanent, but certainly a very marked impact on the labor market. People are not going back to work the way they had beforehand. I think a lot of people realize that “I've been held up at home, I didn't spend anything and I got along OK, so maybe I don't need to earn that much or I don't want to take the risk of going out and meeting with other people given the fact that COVID still exists.” So the labor force has shrunk, and I think that's a global phenomenon as well. That's going to be pushing a little bit of upward pressure on wages as well. So this is another issue. It's, again, more of a supply issue than it is a demand issue, but it will, as I said, create a sort of feedback effect on to demand as well.
Q: I want to talk about recession fears. If we look past into the history, and we see similar patterns link to the Great Recession. Do you have this feeling these days?
P: There are a number of scenarios that could play out to run along that scenario, for sure. One fact we haven't talked about where the financial markets are because we've just come off a historic bull market in equities and debt markets. So we’ve already begun to see them unwind a bit. Will that continue? Will it gain momentum? And will there be a spillover effect on the economy from that? Certainly raising interest rates will slow the economy down. Of course that's what it intends to do, and you can control all those different factors, including the financial market, the labor market, the goods market and of course, the energy market; are all these balls that we have to keep up in the air and make sure that none of them hit the ground. It's going to be challenging. And I think that you're going to get maybe excessive inflation or a recessionary economy. One or the other because you're not going to be able to fine tune it to that degree. But all of that probably does mean that the financial markets will continue to decline. That's at least my feeling.
Q: The cause of inflation could be quite complicated. But one of it, maybe the most significant one, is the energy crisis. And right now we have the war in Ukraine. Can you draw comparisons between now and what happened in the 70s and 80s energy crisis in the Middle East? Do you think we can learn from history? Are there any implications there?
P: We can always learn from history. We may still make the same mistakes but at least we'll know why. But in any case, it was actually a very similar backdrop which was quite interesting to think about in both the respect of the monetary policy that was again the backdrop to that scenario back in 1973. We had already seen a very aggressive expansion of monetary base in the United States, largely because of the funding of the Vietnam War, and also a very aggressive domestic anti-poverty policy as well. So that was the backdrop there. And of course, that created the devaluation of the price of oil, because the money supply increased so much. And so, the oil producing countries used the war with Israel in 1973 as an excuse to embargo the United States and other Western economies, and created this massive shortage of oil. And, of course, that persisted for a while and triggered the whole inflationary trend that followed thereafter.
It extends into the 80s because the Central bank of the United States refused to raise interest rates in the face of that expansive monetary base and the rising inflation, and thus the problem just persisted. And of course, once inflation gets sort of burnt into people's perceptions as a backdrop of the economy, then it becomes self-perpetuating.
Now we're seeing again a period of very expansive monetary policy because of the not only COVID, but ever since the 2008 financial crisis as well. And once again, we have an oil-producing country invading a neighboring country just as the Arab nations invaded Israel back in 1973, and in both cases created this bottleneck in oil supplies. In the case of Russia, it's the West that was imposing the shortages by embargoing Russian oil and Russian natural gas without an ability to replace it all. And so we've created this artificial shortage in the oil market, which is surging oil prices and I don't think it's going to be resolved anytime soon. Even though the U.S. has a lot of capacity that they could shift to Europe, it'll take years for them to build the facilities to be able to export the natural gas and for European nations to be able to accept it as well. You need very special facilities to be able to do that.
Q: Against the current inflationary environment and interest rate hikes, what’s your view on the Taiwan Dollar?
P: You know, obviously many think here in Taiwan that a weak NT dollar is a good thing for our exporters to be more competitive, but this also means that the cost of imported goods will increase for the average consumer. And at the same time, my studies have suggested that the semiconductor industry, which of course has become so prominent in Taiwan, actually benefits from a stronger NT dollar not a weaker NT dollar. I believe is because they are so capital intensive. They need to be building new equipment and importing that equipment so much. Over time, having a stronger currency actually makes them more competitive.
Well, more broadly, I think any capital intensive industry will want a stronger currency to boost their ability to purchase the equipment that they need and invariably that equipment is imported and will impact their competitiveness in the longer run. Wages actually account for a relatively smaller percentage of their total cost. The depreciation of that capital equipment is a much higher percentage. There are obviously other industries certainly supporting semiconductors or that are perhaps beyond the electronics industry altogether that would be in the same category, but I think it's a question of how you want to shift the interest rate policy in order to influence the economy itself. Historically government policy has been inclined to try to keep the NT dollar weaker in order to promote exports. But we're not the same economy we were 20 years ago, 30 or 40 years ago. I would like to see a change in that mentality myself for the ability for Taiwan to upgrade its sophistication, value add and the quality of the products that it's producing. But at the same time, when you weaken the NT dollar, you're taxing your own population because all those imported consumer goods that they have been buying will become more expensive. To the extent that we want to create a more domestic demand-oriented economy, so we're not as export-oriented as we had been in the past. It requires a stronger NT dollar as well. The problem is that in these times we can't necessarily choose exactly what type of currency policy we want. If the US Fed is raising interest rates so aggressively, that means we'll have to raise rates here as well. And there'll be a price to pay for that.
Q: The housing issue, mortgages, all are tied quite tightly with the interest rate hikes. What's your view on the real estate market in Taiwan?
P: Well the real estate market in Taiwan has been a very bumpy ride over the past few decades. There have been booms and busts along the way and there have been surges in prices and then sometimes followed by increases in supply as well. A lot of it is driven by capital flows. And so you saw back in like 2008, for example, there was a very clear period where there was a very substantial flow back of capital from China back into Taiwan and that surged the property market here and created a gap between prices and average wages to an extent that it priced a lot of people out of the market. Now, that's been sort of stabilizing a bit. There was another blip in 2012 but since then the market has been sort of stabilizing. But again, this gets back to wages. It's not just about lowering housing prices but it's also about increasing wages. And these are all policies that need to be thrown into the mix. There has been a surge of building though again, in response to the higher prices, in response to policies to encourage building. And so I think we're going to see some rectification of that. But it's probably going to mean lower prices or at least very flat prices for housing in Taiwan. Which from a societal standpoint is not a bad thing. Obviously, if you're trying to make money on your home, it may be a little more discouraging. But, I would expect that, given the fact that as I said, with a lot of supply coming online prices are already pretty high to begin with. And of course, demographically Taiwan's population has not been growing. In fact, Taipei has been declining as well which is what you would expect because people are moving out to the cheaper suburbs. There's a better transportation infrastructure to allow them to do that. So I mean that's all a good thing. So I don't want to sound negative. I'm actually quite positive about the housing picture in Taiwan but I'm not that positive about housing prices in Taiwan.
Q: You talked about concerns on wages. Everyone has shared the same experience where the wage or the real wage growth has been very slow in Taiwan. And compared to the inflation hikes, what's your take on that?
Well, look, I mean, this is almost more of a political than it is an economic discussion. Because what we have seen with the wage picture in Taiwan is similar to what we saw in the United States and that is globalization. The fact is that so much production capacity has moved basically to China and then from China to Southeast Asia as well.
So in the United States GDP has actually been growing pretty well. But if you took out Street and Silicon Valley from that picture you'd probably see a very different number and a much lower number as well. And so the bulk of the number of people who are actually working have not seen substantive wage increases and that's the same issue here in Taiwan. Now that we are seeing this sort of back flow or step away from globalization we'll probably see some of those factors reverse as well. That is to say wages will begin to increase as we try to onshore more of that production here in Taiwan and elsewhere. But of course globalization also created tremendous efficiencies in the economy. So the top line GDP number was much stronger. So what you're really talking about is the wealth gap or the income gap issue. That's why it's really more of a political issue or it certainly touches on the political issue a lot more.
Q; Are you talking about tax policy to reduce the gap?
P: Well, this is yet another step as well. And certainly that is the direction that the Biden administration is moving forward and to the extent that the U.S. tax rate creates a sort of cover, if you will or a baseline for other countries to begin to adjust their tax policies then you might see tax increases elsewhere. But there is very strong evidence to suggest that income tax rates do a lot to reverse the wealth gap. And so you know what we may be seeing with the reversal of globalization and as you pointed out the changes in taxation policies around the world we might start seeing that wealth gap narrow as wages increase but also perhaps a slight slowing in the economy.
So I agree that this is a unique opportunity to attract some of that talent. But realistically I think it'll only be marginal flows because Taiwan still has a semi-controlled capital flow environment and a very highly regulated financial market here. But nonetheless I think we can still attract some professionals. But more importantly, I think the point is we need to raise wages here in Taiwan to boost domestic demand. There are a lot of companies that are trying to start up. Either a mom and pop restaurant to maybe a startup of E-commerce operations or an app-based business that want to build a business from their base in Taiwan because you can always do better setting up a business in your home economy, but find that the purchasing power of the local economy is just too low, as I've seen it happen many times. So, for that reason, I think you can create a whole new different industry segment, for example, a service sector or an e-commerce or a software sector industry developing with a higher wage driven economy.
Q: Peter, as we are approaching the end of this interview, we are wondering what's your prediction towards Taiwan's stock market this year?
P: In a word, I'm not optimistic now. I had always felt that we were getting to the end of this bull market. And I said that, as is often the case of a lot of bull market late periods, you can see a surge in prices taking place. There was a lot of momentum in prices as well. That's why I originally thought that we could in that surge reach to 20,000 (TAIEX). I really meant 19,000 something but now than we have gotten the invasion in Ukraine, and of course the other factors we've been discussing now like rising interest rates and inflation, I don't see that as possible. I also believe Taiwan’s rate of saving is also due to come down once the country starts to reopen post the pandemic, as we have seen in the US, which could also impact the stock market. In fact, I do see the market trending lower probably for several quarters to come. At least several quarters. I mean we're talking typically – and I don't have any reason to put a timeframe on it here – but typically, these market cycles tend to work out over the course of one or two year cycles.
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