We need to talk about the reserves

We need to talk about the reserves.

As a firm believer in democracy, I see the SDP and The Reform Party as the most credible parties for bringing a meaningful improvement to the way Singapore is ruled. This may surprise many people since these parties are obviously not the most popular, but I see there being little mileage in the sort of conciliatory or non-confrontational approach that other parties seek to take with our current leaders. Simply put, collaboration or opposition will quickly become irrelevant if the ruling party deem you a threat to their power. Once that point is reached, they will seek to destroy you. Indeed, I think we see this playing out right now in the way Dr Teo Ho Pin has been attacking WP in recent days, and I imagine some WP members will come around to my way of thinking in the short to medium term. The only way forwards is thus to fix or, if you will, reform our system of government.

Since it is RP and the SDP that I see as the most credible opposition parties, I read with some interest Kenneth Jeyaretnam and Jeremy Chen’s thoughts on how to deal with Singapore’s reserves. The reserves are an area of particular interest to me and my first meaningful blog entry was on that topic. Unfortunately I am not an economist so I do not have any fully fledged policy manifesto to share with the world. Rather, I seek to hopefully enlighten ordinary Singaporeans as to the state of the nation by arguing from what I see as first principles and hopefully common sense.

There are many questions to ask on this topic. Some of them are outlined here but there are surely many more. Let us start with a few

What is the purpose of the reserves?
How much reserves do we need to fulfil their purpose?
Do we have too little or too much reserves to fulfil their purpose?
How should the reserves be managed?

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What is the purpose of the reserves?

This is a big question. Given the amount of government secrecy around their accumulation and management, it is hard to give a concrete answer. I would however suggest that we can infer the purpose of the reserves from how they have been used in the past. First of all, let us put to one side the unlawful gifting of millions of dollars from our reserves to the World Bank, and the practically identical, shocking, but apparently not unlawful gifting of billions to the IMF. Since it must surely be the case that our government has accumulated these reserves for the sake of the nation rather than foreign NGOs, we can hopefully discount these as examples of their true purpose.

As far as I am aware there is only one occasion in the history of Singapore that the reserves have been drawn down for government spending. That was in response to the worst financial crisis in living memory, the sum drawn down was S$5 billion, and it was drawn down to fund policies to protect local workers and the economy. This appears to me at least to be a reasonably uncontroversial Keynesian approach to economic policy and the reserves can obviously serve a very useful role in this context.

How much reserves do we need to fulfil their purpose?

This question is deceptively simple. If S$5 billion was enough to ride out the last financial crisis, perhaps it is enough for the next one? Sadly not. Singapore was arguably lucky to return to strong growth so quickly after the last financial crisis and furthermore we cannot assume the next one will not be worse. Since, for better or worse, we have already accumulated vast quantities of reserves, we do have the option of maintaining them at a high level if we deem that appropriate. We must therefore make some assumptions to drive the answer to this question. What if the next recession is three times worse than the last one? What if it lasts for five years instead of one? Europe today shows us these arbitrary assumptions are not unreasonable. So if we take these numbers and apply them to the sum of S$5 billion we end up with S$75 billion. To me that seems like a reasonable start. Clearly we need some reserves, but not an unlimited sum. Perhaps even this value is too much but I think many Singaporeans would not be comfortable drawing down to a bare minimum value.

Do we have too little or too much reserves to fulfil their purpose?

Recently the Straits Times pegged the value of the reserves at S$800 billion. To give some perspective, the government’s draw down in 2009 of S$5 billion is less than one percent of this value. The exact total of our reserves is of course a secret but just from what we know of government stakes held in locally listed companies (which are worth over S$100 billion) we do appear to have a vast surplus of reserves. Of course this surplus should not be squandered, but for the government to continue accumulating such sums under extreme secrecy is not justified. From the above, I propose we maintain a government controlled quantity of reserves around S$75 billion, but the remainder poses a more complicated question. Let us be conservative and suppose it is worth S$500 billion. What do we do with this quantity of reserves that the state has no moral claim over?

What to do with our excess reserves?

Here we join the debate between Messrs Jeyaretnam and Chen. Mr Chen earmarks certain spending priorities on social welfare which is laudable, but he does not appear to address the much larger question around the hundreds of billions of dollars the government has accumulated to date. In fact, Mr Chen’s spending priorities come out as costing much less than ten billion dollars. The Singapore government reported a surplus of S$36 billion last year. Clearly the plans he has in mind can be funded many times over from existing revenue without even talking about the principle value of S$500 billion. This is a shame because he appears to miss the wood for the trees, and we do need a debate on this bigger question. To over simplify, this can probably be characterised as “keep the reserves and live off the interest”.

Mr Jeyaretnam is arguably looking at the bigger question in suggesting that the sum (which in my argument, not his, is suggested to be S$500 billion) should be distributed to citizens. This is not unreasonable either. If we accept that the government has over-accumulated the reserves then the decision tree is relatively simple. Either the government keeps it or they do not. If they do not, then who do they give the value to? Foreigners or citizens? Behold! The binary choice with only one answer. Everything else is just details.

My position is also that the government has no moral claim over this wealth. It has been needlessly accumulated from citizens in the first place. The suggestion that individuals will squander this money that would be better managed by the state is not valid for various reasons. Ho Ching’s track record does not appear to be strong enough to support this argument. Further, this reasoning sets up a false dichotomy between the state and the individual. In most developed countries a hybrid approach exists for retirement savings. Individuals do control their own private pensions, but they are only allowed limited control in the sense that their pensions must be invested with approved fund managers. If we distribute the value of the reserves in some fashion, we can follow this model to ensure they are not squandered. So distributing this wealth to the citizens seems to not be unreasonable.

How should the reserves be managed?

Mr Jeyaretnam makes the most important point here. The principle objective has to be to make the management of the wealth of the nation transparent and accountable.

First let us talk of the management of the S$75 billion which I seek to keep under government ownership. Clearly we can not rely on the IPO route to force transparency in this case, but legislation could easily serve such a purpose. If we suppose then that transparency can be imposed, accountability follows to some extent. Citizens could vote out a government that mis-managed the reserves, but I believe we should ideally seek to make management of the reserves independent from government policy, and thus the ballot box would not be the ideal path to accountability. Another idea would be to give citizens management shares in whatever vehicle holds these assets. In that way, managers could be held accountable annually through an AGM like process or similar.

Secondly, let us talk of the S$500 billion to be distributed to citizens. Here I diverge somewhat from Mr Jeyaretnam’s plan to do an IPO of Temasek & GIC. Some of the stakes taken by Temasek and GIC are frankly bizarre and we can come up with a better plan if we think through the asset allocation in more detail. Essentially we want to give this wealth to our fellow citizens in a reasonably secure form that encourages long-term wealth creation. I don’t believe that this sum needs to be actively managed. A strategy to track global equity markets and high-grade government and corporate debt does not seem unreasonable. I think this is the sort of advice an independent financial adviser would give on long-term wealth management. To summarise, we then need to rebalance the holdings of Temasek and GIC and probably merge them into one investment vehicle. One of Ho Ching (CEO of TH) and PM Lee (Chairman of GIC) are going to lose their jobs, but that is a loss we can cope with. We then do an IPO of this vehicle and give the shares to citizens in a transparent fashion.

To speak more on asset types. I have noted previously that holding the reserves in the form of controlling stakes in local companies creates perverse incentives that prevent the government from taking difficult decisions for the wellbeing of the nation. Furthermore, I propose that the government uses the reserves to fund policy driven spending to support the economy in difficult times. In that case, the reserves need to be easily convertible to cash in a recession. Under the current model, converting large stakes in locally listed companies is fraught with difficulties – if not actually impossible. Strategically important companies would undergo management turmoil at the worst possible time. Finding a buyer would be practically impossible – not least because a potential buyer would presumably know that the Singapore government needs the cash. For these reasons, the government controlled S$75 billion would have to be held in more liquid positions. Equity stakes over a few percent would be avoided and high-grade debt and cash would be in the portfolio.

To conclude

The current management of our reserves is frankly a mess. We are ideological prisoners to a government that blindly believes in accumulating wealth, to be managed by the state itself in the utmost secrecy. Given that less than 1% of the current reserves was drawn down to deal with the most severe global financial crisis in living memory, it appears that the current multiple hundreds of billions of dollars held is grossly excessive. Whilst I am open to the suggestion that we keep the reserves and “live off the interest”, I prefer to distribute the wealth back to the nation from which it was incorrectly accumulated in the first place. I propose keeping a relatively smaller sum under government control to serve a purpose I believe to be worthwhile – that being to fund government spending during difficult times. A sum of S$75 billion is chosen. This should be held in liquid instruments that can readily be converted to cash in a crisis. I suppose that there are multiple hundreds of billions of dollars beyond this value to be distributed to citizens. This is done by converting the current holdings of Temasek and GIC into more passive investments in global indices. The fund managing these instruments is listed and shares distributed to Singaporeans.

As noted previous, I am not an economist, but I hope to contribute to this debate as a reasonably well-educated lay person. What do you think?