This year marks the 40th anniversary of GIC. In celebration of this milestone, Made of Bold commemorates the founding leaders’ vision of forming an entity dedicated to managing Singapore’s reserves. These bold stories have laid the foundations of GIC’s values and purpose in securing Singapore’s financial future.
These bold stories are from the publication Bold Vision: The Untold Story of Singapore’s Reserves and Its Sovereign Wealth Fund.
A Singular Man
As the economic architect of modern Singapore, Dr Goh Keng Swee wrote many budget speeches and policies. But unbeknownst to many, he was largely responsible for the first chapter of the nation’s bold reserves management story.
After separation, Singapore was keen on establishing a Common Currency arrangement with Malaysia. However, the status of a piece of land at Robinson Road in Singapore became the focal point for dispute, leading the island nation to stand its ground and inevitably resulting in a currency split.
Donning A Straitjacket
Amidst challenging social, political and economic uncertainties, a young nation stood against conventional wisdom and established a currency board system. This decision built confidence in the Singapore dollar in the early days of nation-building.
The Sterling Raj
Singapore was at the mercy of sterling’s fate – it was obliged to hold its reserves in sterling but a devaluation of the pound would mean substantial foreign exchange losses for the small nation. The Sterling episode saw a heated exchange of letters between then-British Chancellor of the Exchequer Roy Jenkins and Dr Goh Keng Swee.
Dr Goh Keng Swee and his team circumvented a US-led embargo to buy gold with an ingenious and clandestine idea of using two halves of a torn dollar bill to verify the identity of the officials involved.
A Productive Interregnum
When MAS was formed in 1971, it started off with a blank canvas – an unheard-of mix of a quasi-central bank and a currency board. The institution was not just permitted to, but tasked to invest for returns and profit, which was a pioneering approach to investing reserves for returns at the time.
Genesis of an Idea
GIC was conceived in just 7 months – from a mere idea in Dr Goh’s mind to the day he issued the press statement to announce the establishment of a new investment company.
Today, GIC may be recognized as one of the top sovereign wealth funds in the world, but its story has a very humble beginning – the company’s first Managing Director began his tenure with only a desk. There was not even a chair, until he found one in an unused room.
The Monetary Authority of Singapore (MAS) began operations on 1 January 1971. Except for the note issue, which remained the province of the Board of Commissioners of Currency, MAS assumed all other central bank functions, including the management of the country’s reserves. Thus began another stage in the history of reserves management in Singapore – a stage that coincided with the 1970s, one of the most tumultuous periods for financial markets in the 20th century.
It was Dr Goh who masterminded the formation of MAS. The International Monetary Fund (IMF) provided technical advice and, at the request of the Singapore Government, produced the initial draft legislation and framework. But Dr Goh took an active role in shaping the legislation, recalls Elizabeth Sam, a finance ministry official then. “He actually went into the details”. He would “discuss what (the IMF’s proposals) meant, what he didn’t like or what we should put in or not”.
However, by the time the legislation was ratified by parliament in December 1970, Dr Goh had moved from finance to defence. Hon Sui Sen, a mandarin par excellence who had played key roles in Singapore’s economic development from 1960 and a man of deep integrity with a profound sense of commitment to his fellow human beings, replaced Dr Goh at finance, and became the first chairman of MAS.
In 1967, in the lead-up to the currency split with Malaysia, Dr Goh had resisted the idea of a central bank replacing the currency board. Two years later, he championed the establishment of an institution that was in effect a central bank. Did his position change, and if so, why?
Dr Goh himself saw no contradiction between his positions in 1967 and 1970. In 1967, the urgent need to establish confidence in the new currency demanded retention of the currency board system. But even then, Dr Goh was conscious that the currency board would not meet all of Singapore’s needs; the currency board only catered to note issue. But a sophisticated financial system would also require the direction and coordination of the banking sector, capital markets and the exchange rate. And by 1971, Singapore needed such a central coordinating financial authority. However, in creating MAS, Dr Goh shaped the product of his vision to possess two unique features that distinguished it from the typical central bank.
First, he insisted that the institution be called a monetary authority and not a central bank. The choice of nomenclature was deliberate, intended to highlight the fact that the institution was not a full-fledged central bank as it would not have the power to issue currency, which still resided with the currency board. In other words, Singapore would have an unheard-of mix of a quasi-central bank and a currency board, a feature that intrigued monetary experts. As the 1971 IMF mission to Singapore noted:
“The combination of a monetary authority together with an autonomous currency board is an interesting innovation which marks a departure from the conventional wisdom of central banking in the emergent countries”.
Second, in an even more controversial departure from conventional practice, Dr Goh insisted on the minister for finance chairing MAS. This was equivalent to having the US Secretary of the Treasury double up as Federal Reserve Chairman or Britain’s chancellor of the exchequer head the Bank of England. Naturally, the IMF advised against such an arrangement. It would place the central bank at the mercy of a profligate government if one should arise, it warned; instead, the central bank should be helmed by someone with the independence to counter or check feckless fiscal policy.
Dr Goh took a pragmatic view of the relationship between governments and central banks. The fact was, at that time, the practice of appointing nominally independent central bank chiefs did not guarantee the independence of central banks. There were numerous examples of central banks, in both developing as well as developed countries, bending to pressure from governments to pursue expansionary, and ultimately, inflationary policies.
Indeed, even as MAS was in its inaugural year of operations, events in Washington DC were illustrating how a wily US President could sway the Federal Reserve, a putative bastion of central bank independence, to pursue an expansionary monetary policy to boost his re-election prospects. The President was Richard Nixon and the Federal Reserve’s Chairman then was Arthur Burns.
Nixon’s then secret taping system has preserved for posterity a record of his conversations with Burns in the period leading up to the US Presidential Elections in 1972. The evidence from the tapes “clearly reveals that President Nixon pressured Burns, both directly and indirectly… to engage in expansionary monetary policies prior to the 1972 election”. The tapes record how Burns initially resisted Nixon’s calls for accommodative monetary policy but eventually gave in when Nixon “craftily engineered credible threats to Burns’ power and to the Fed’s independence”.
In the short run, Nixon benefited from the monetary stimulus injected into the US economy, romping home to a landslide re-election victory against George McGovern in November 1972. In the long run, he did not. By 1973, inflation was at 8.8 per cent, double the 1972 rate. Burns slammed on the brakes then, and the result was an unemployment rate of 9.1 per cent by the end of the year. Many historians believe that Nixon lost public support rapidly in 1974 not only because of Watergate, but also because of the deteriorating economy.
It was only in the 1990s that central bank independence in Europe and the US was given stronger legislative teeth. In 1970, as Dr Goh saw it, the setting in which MAS would operate required a different approach. A tradition had developed in Singapore of prudent fiscal policy, resulting in the government posting regular fiscal surpluses. MAS was unlikely to be called on to finance budget deficits. In any event, the currency board system effectively prevented the government from resorting to deficit financing. In the circumstances, having the finance minister responsible for both fiscal and monetary policy would ensure a high degree of coordination.
The MAS Act provided for a board of seven directors. Apart from the finance minister, its other members included the permanent secretary of the finance ministry serving as deputy chairman, the accountant-general and four others appointed by the President. Of the four, one would be the chief executive of the organization, the managing director.
In 2003, the Act was amended to allow for any minister, not necessarily the finance minister, to be chairman of MAS. The principle that Dr Goh had insisted on, that MAS be overseen by a minister, has remained to this day. Indeed, apart from its chairman, other ministers have also served on the MAS Board. The ministerial presence has lent the institution a stronger voice in policy-making than it otherwise would have had. And contrary to the fear that political control of the central bank would lead to sub-optimal monetary policy, Singapore has maintained an enviable record of low inflation, low unemployment and high economic growth for many decades.
The first managing director of MAS was Michael Wong Pak Shong, who was at the Oversea- Chinese Banking Corporation (OCBC) when he was handpicked by Dr Goh to head the new organization. He helmed MAS for 10 years, guiding the organization through its formative years. It was a demanding job but one that he looked upon “as the most exciting in my whole career”.
MAS could not have begun its existence at a more stressful time for foreign exchange markets. Barely months after MAS was established, the international monetary system of fixed exchange rates was shaken to its foundation. The US dollar had come under attack because of perceptions that the Nixon Administration was continuing with an expansionary fiscal policy even as the US trade deficit was widening. There were heavy speculative inflows into European currencies, particularly the Deutsche mark and the Swiss franc. The West German central bank, the Bundesbank, after absorbing more than US$2 billion within two days, suspended further purchases of US dollars on 5 May 1971 and allowed the mark to float – thus becoming the first member country to unilaterally leave the Bretton Woods system. Other European countries like Belgium, the Netherlands, Austria and Switzerland soon followed suit. Speculation then turned to a possible revaluation of the yen.
Under the Bretton Woods system, Washington was obliged to convert US dollars to gold at the fixed price of US$35 per ounce. With major central banks deluged with US dollars, there was fear of a run on the US government’s gold stocks. Switzerland redeemed US$50 million of paper for gold in July, and France redeemed more than US$191 million. There obviously would not be enough gold in Fort Knox if all the world’s central banks began redeeming their US dollars in earnest. Consequently, Nixon announced on the evening of 15 August, a Sunday, that the gold window would be closed. With one stroke, the “Nixon shock”, as the media dubbed the series of steps Nixon announced that evening, effectively ended the fixed exchange rate system. As the MAS annual report put it: “Monetary developments (in 1971) culminated in a crisis undermining the fabric of the international monetary order which had served the world for more than a quarter of a century”.
The “Nixon shock” was to have long-lasting consequences. Except for intermittent periods of calm, markets would generally be in a state of disarray for the rest of the decade. In December 1971, the major economies cobbled together the Smithsonian Agreement in an attempt to restore fixed exchange rates. The exchange rates of most currencies were revalued against the US dollar, with wider trading margins around the new parities. But the agreement did not last.
The root cause was a lack of international policy coordination and Washington’s unwillingness to continue shouldering the burden of upholding the Bretton Woods system. The US shifted to a policy of “benign neglect” of its currency. As the then-US Treasury Secretary told his foreign counterparts laconically, “The US dollar is our currency, but your problem”.
In June 1971, sterling fell victim to a fresh wave of speculative attacks and was forced off its Smithsonian parity. Worse was to come. In March 1973, there was a crisis of confidence in the US dollar, “regarded as the most disruptive to have occurred in over two decades”, and markets were closed for two weeks. When they reopened, all the major currencies were floated against the US dollar. The attempt to revive Bretton Woods was finally abandoned, and the world shifted to a regime of floating exchange rates.
As Dr Goh wryly observed some years later, it was a telling commentary on the times that the shift to floating exchange rates “was not devised by a committee of financial experts the way the Bretton Woods system was constructed. In fact, whenever experts had met, usually in secret sessions during weekends, they were unable to reconcile their differences. Floating rates grew out of a situation that was increasingly unmanageable and when experts had run out of options”.
The international economy was racked by problems in the 1970s. Global inflation rose to double-digit levels. The Organization of the Petroleum Exporting Countries (OPEC) quadrupled the price of oil in 1973, in part because US dollar weakness had caused commodity exporting countries that invoiced their exports in US dollars to incur large currency translation losses. This led to a further spike in inflation, followed by a global recession from 1974-75. There was a second oil price shock in 1979 and inflation climbed. A new term, “stagflation”, was coined to describe the plight the industrialised countries found themselves in. The price of gold increased by about 18-fold, from US$48 per oz in August 1971 to US$850 per oz in January 1980.
Throughout this period, even as MAS was wrestling with the repercussions from the unprecedented turbulence in the international financial system, it had to develop its capabilities in the arcane field of central banking. Neither Wong nor his staff had “much central banking experience and (they) had to find (their) way and learn”, as Wong himself confessed later. But they were quick learners, securing notable achievements in several areas: developing Singapore as an international financial centre, putting in place credible banking supervision and licensing standards, ensuring the stability of the Singapore dollar, and managing the reserves.
The MAS department managing the reserves was initially called the Investments and Exchange Control – for it was in effect an amalgamation of two finance ministry units, the Department of Exchange Control and the Department of Overseas Investments (DOI). Exchange Control was a legacy of the Sterling Area and its system of exchange controls. It withered over time as MAS progressively liberalised exchange controls. The DOI, on the other hand, became the nucleus of a reserves management capability that in time expanded in scope and sophistication.
The staff transferred from DOI to the new unit, eventually named the International Department, bringing with them the culture and ethos that Dr Goh had instilled in them. Hence, MAS “approached reserves management without the baggage” of preconceived notions that reserves management should be a staid, largely passive operation, remembered Wong. Instead, the style and approach that Dr Goh had set at DOI was accepted as the model. As a result, MAS, unlike other central banks, was not just permitted but tasked, to invest for returns. It was “pretty radical” in its investment approach right from the start, recalled Sam.
The reserves were the product of the hard work and thrift of Singaporeans. Managing the reserves should thus be considered an important function in its own right, not a sideshow. There was no need for the institution to be defensive or apologetic about applying the profit motive to reserves management. Accordingly, MAS officials put aside conventional notions of how reserves should be invested, and were open to investment practices even if they were outside the traditional scope of central banks.
Implementing the currency diversification policy, though, required tenacity and ingenuity. A case in point was sterling. Just after MAS began operations, the Sterling Agreement was extended in 1971 for another two years. The Agreement required Singapore to adhere to a Minimum Sterling Proportion (MSP). This meant it would not be able to reduce its sterling holding below the stipulated threshold. Hon and Wong repeatedly pressed the British for more generous guarantees to cover the sterling held by Singapore. Eventually, Britain agreed to reduce Singapore’s MSP to 36 per cent of the stipulated base.
Soon after, Wong and Sam detected a “special situation”, a quirk in the gilts market that could be exploited to Singapore’s advantage. This was the availability of long-dated British Government Securities and Consols that had been issued during World War II to help London finance the war effort and the subsequent reconstruction. These securities could be bought at a large discount to their par value because interest rates had risen significantly since their issuance. Normal accounting convention however allowed the Consols to be valued in the books at their nominal value, which would be actualised if they were redeemed. MAS made large purchases of these Consols, which raised Singapore’s nominal sterling exposure, but with a much lower outlay in sterling.
British Treasury officers were annoyed when they learnt of these transactions. The Bank of England was asked to query Singapore’s method of valuing the Consols. In his reply, Singapore’s then accountant-general, Chua Kim Yeow, explained the accounting conventions his department used to value government assets: Gilt-edged securities and other government bonds were valued at their nominal value as they could be held to maturity; equities were valued at cost or market price, whichever was lower; all other official reserves were valued at book cost.
Chua’s reply conveyed two messages. The first, a straightforward response to the British, was that there had been no gimmickry in how the Consols had been valued. The accounting conventions adopted conformed to international practice. The second message, implied rather than explicit, was however of greater interest because of what it signified about the approach taken to value government assets. This was that the valuations were derived from prudent principles, not based on optimistic assumptions to inflate asset values.
The MAS investment team displayed a similar agility in buying gold. Up to the closing of the gold window in August 1971, MAS was constantly alert to opportunities to redeem its US dollars for gold. Pioneers of the MAS gold team recalled a dramatic occasion when they placed US dollars for gold with the New York Federal Reserve the day before Nixon closed the gold window. When Nixon announced his “shock”, the MAS team was on tenterhooks as to whether their order would be honoured. It was. MAS was a net buyer of gold through the 1970s.
By the end of the decade, the cabinet began to pay increasing attention to how MAS was managing the reserves. Despite the uncertainties in the international economy, the Singapore economy had grown consistently through the 1970s, averaging a growth rate of about nine per cent per annum. Government revenue grew healthily and Singapore accumulated annual fiscal surpluses amounting to three to four per cent of GDP. This, coupled with a high savings rate in the private sector and capital inflows, meant hefty balance of payments surpluses and the substantial accumulation of reserves. The cabinet was concerned whether MAS could do more to secure better returns from the reserves under its management.
MAS encountered two fundamental quandaries in managing the reserves. One was the extent to which central banking could co-exist with investment management. Or to put the question differently, the extent to which a central bank can breed and nurture within itself a fully fledged investment management arm.
Central banking and investment management both operate in financial markets using similar tools, instruments and analytical methods. But each approaches its task with different, sometimes conflicting, goals, attitudes towards risks, performance measurement systems and reward schemes. Central banking and investment are in effect two cultures that are best kept separate so as to allow each to flourish, a thesis that now finds expression in the decision of many central banks to hive off their investment management functions to a separate legal entity, the Sovereign Wealth Fund (SWF).
One practical problem that arises from locating central banking and investment management within the same entity is compensation. Central bankers and fund managers are paid differently. Salary scales suitable for central bankers would not attract the high-flyers required in investment management. On the other hand, paying the central bank’s investment managers higher salaries than their colleagues in other central banking areas would have had divisive consequences.
As a central bank, MAS had to develop capabilities covering the full spectrum of central banking functions, of which reserves management was just one. It understandably never saw itself as a dedicated investment management company and hence did not build up the expertise to invest in all the asset classes that global portfolio managers would normally invest in. MAS’ expertise in reserves management was in currency management and the short end of the fixed income markets. Thus, although MAS was a pioneer among central banks in investing in equities, it did not develop a team of specialists in the equity markets. Equity investments were done by officers with fixed income responsibilities as well.
The situation was similar in real estate. MAS did make one investment in real estate – the 1973 purchase of Granite House, a commercial property in London. The purchase was marked by controversy as it occurred just before a sharp fall in London property prices and in the value of sterling. The Public Accounts Committee convened a series of hearings to question the Finance Ministry and MAS officials on the purchase. The broader issue was not so much the timing of the purchase but that MAS had not developed an expertise in property. Perhaps because of its bad experience with Granite House, MAS did not make another real estate investment.
There is one example of a central bank hosting successfully a robust investment management unit, that is, Norges Bank, Norway’s central bank. Enfolded within it is Norges Bank Investment Management (NBIM), which manages the Government Pension Fund Global (normally referred to as the Norwegian Oil Fund) and most of Norges Bank’s foreign exchange reserves. Since its formation in 1998, NBIM has gained a reputation as one of the most progressive public sector investment management units in the world. It is now classified as an SWF.
One should note, however, NBIM’s unique organizational features. Though it is a unit within the central bank, strict Chinese Walls regulate the exchange of information between it and the rest of the central bank. It has its own policies on recruitment, talent development, budgeting and compensation.
The second constraint MAS faced in managing reserves lay in balancing its reserves management mandate with that of managing the Singapore dollar exchange rate.
Herein lay the nub of the issue: MAS manages the Singapore dollar to prevent it from being whipsawed or gyrating like a yo-yo because of the speculative actions of currency traders. Like any central bank, MAS seeks to smooth wide fluctuations in the exchange rate by intervening in the currency markets, selling Singapore dollars if the currency is deemed to have appreciated too much or buying Singapore dollars if the currency has been beaten down too much. This is why central banks need a “war chest” of reserves that are liquid enough so they can be activated quickly to defend the currency.
But maintaining such a war chest or float has an opportunity cost. Liquid assets, typically short-term treasury bills, generate low returns. Hence, the dilemma MAS faced. The volatile markets it had experienced since its formation counselled a “safety first” policy of maintaining a large pool of liquid assets, but such a preference would serve to depress the returns on the reserves it managed.
In 1980, Dr Goh, at the behest of Prime Minister Lee Kuan Yew, initiated a review of MAS. The review would lead to the formation of GIC and its taking over the task of managing the reserves from MAS. It is easy to sensationalise the developments surrounding the change. In reality, there was a great deal of continuity between what MAS had accomplished and the growth of GIC.
To begin with, GIC benefited from MAS’ expertise in currency management, as currency movements are important to an international investor. Also, the international department in MAS continued to manage the fixed income portion of GIC’s portfolio for several years. Later, the MAS team moved over to GIC to become the nucleus of its fixed income department. Finally, apart from fixed income, GIC would also depend on MAS’ expertise in a number of areas such as economic analysis and various corporate functions.
In short, the MAS years were an interregnum in the story of Singapore’s reserves management – an especially productive interregnum.