Has global finance reformed itself

I was updating my class notes with Rodrik’s ‘Inescapable Trilemma’ of global economic integration. In his original blog post from 2007, he equates ‘global economic integration’ mostly with financial globalisation or financialisation. In the process of re-visiting Dani’s original blog post, I saw this one.

The underlying premise of the blog post that we should not miss the ‘trees’ for the ‘wood’ or that all progress is incremental is well-made. It is actually a short review of a book by Ilene Grabel. The blog post is from January 2018, almost three years old.

In this period, I think, more grounds have emerged to reject the optimism.
In other words, the time lapse gives us a good ‘distance’ perspective. The period that has lapsed since Dani Rodrik’s blog post gives us an opportunity to see more clearly the binding constraint that overshadows these incremental positive developments that Dani mentions in the blog post and which the author appears to have covered.

The Federal Reserve intellectual capital invested in its monetary policy experimentation has to be written down. Only when American intellectual paradigm concedes the folly of the post-2008 policy framework will the European copycats change too. Until then, there is no redemption to the mounting economic, social and political costs of this lunacy.

From ZIRP to NIRP – it is broadly bent

Two weeks ago, at least two persons forwarded me the speech by Ben Broadbent, the Deputy Governor of the Bank of England and a member of the Monetary Policy Committee of the Bank of England. The speech was an attempt to strenuously deny any fiscal dominance of monetary policy and an attempt to reinforce the credibility of the monetary policy regime and its inflation targeting framework. In other words, there is no agenda to generate inflation.

Paint me cynical. But, if the central bank were to pursue an agenda of generating stealth inflation, it would have to deny it first. Otherwise, it is not stealthy anymore. It will be factored into the decision-making of all ‘economic agents’ and the purpose will be defeated. So, I did not find anything it that impressed me.

Then two days ago, this news-story appeared in Bloomberg. The Bank of England is going to explore how to implement negative interest rates. This was disclosed in the Minutes of the Meeting of the MPC held in September. The relevant paragraph is this (paragraph no. 52):

The Committee had discussed its policy toolkit, and the effectiveness of negative policy rates in particular, in the August Monetary Policy Report, in light of the decline in global equilibrium interest rates over a number of years. Subsequently, the MPC had been briefed on the Bank of England’s plans to explore how a negative Bank Rate could be implemented effectively, should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates. The Bank of England and the Prudential Regulation Authority will begin structured engagement on the operational considerations in 2020 Q4. [Link]

Students and scholars can focus on the ‘decline in global equilibrium interest rates’. Now, any student of economics would know that a decline in the equilibrium interest rates suggest a structural or permanent decline in potential economic growth. That can lead to a decline in the equilibrium interest rate.

If so, how does it explain unaffordable real estate prices and how does it explain the current stock market valuations? Third, how is it possible to improve the structural or permanent decline in potential growth through reductions in policy interest rates or through asset purchases since it is well-known that monetary policy tools are better suited to address short-fun fluctuations in aggregate demand? Fourth, in the attempt to do so, what other distortions are being created and what price is being paid? Fifth, are those costs worth it? Sixth, where is such a cost-benefit analysis?

In the monetary policy report published in August, the Bank of England had a box item on negative interest rates, running into nearly four pages. It focused on the limited pass-through of negative interest rates because banks may not lower interest rates on bank deposits by households. Therefore, they would be worried about their net interest income and may not lower their lending rate. Hence, the transmission of negative rates is impeded.

Apparently, a paper by the European Central Bank, first published in June 2019 and updated in June 2020 found that in countries with negative interest rates, the policy worked as long as banks had sound balance sheets and were adequately capitalised. Such banks passed on their negative interest rates to depositors. Companies which could not do away with corporate deposits lengthened their deposits and reduced their bank deposit holdings to invest in tangible and intangible assets. You can find the paper here or here.

Even if I take it at face value, I wonder if it was possible to control for other factors here. Did the firms borrow because they sensed investment opportunities or because of low rates? Further, the paper probably makes no distinction between greenfield and brownfield investments. If well-capitalised banks passed on negative rates (not impeding the transmission effect of negative rates), then the question to ask is whether well-capitalised banks would have lent in any case without having to force them to increase the quantum of loans by lowering the return they made on each loan. In the process, their loan profiles are bound to suffer and, over time, they can become less well capitalised. Further, not much time has lapsed to ascertain the true and the full extent of the costs of such policies. Let us consider some of these costs.

In America, the funded status of the 100 largest corporate defined benefit pension plans increased by $93 billion during August as measured by the Milliman 100 Pension Funding Index (PFI) over July but, year-to-date, it was down 4.7%. [Link].

For S&P 1500 companies, the funded pension status was around 83% in August 2020 compared to over 100% in December 2007. [Link]. That is the contribution of UMP, QE and ZIRP.

This is the latest I could find on public pensions and that too, only for America:

The total funding gap for the 143 largest US public pensions plans is on track to reach $1.62tn this year, significantly higher than the $1.16tn recorded in 2009 in the aftermath of the global financial crisis, according to Equable Institute, a New York-based non-profit think-tank. The weak financial condition of the US public pension systems poses severe risks for the living standards of millions of employees and retired workers. Equable estimates that returns of US public pension plans averaged -0.4 per cent over the 12 months ended June 30, well below the 7.2 per cent targeted by these schemes [Link]

If large corporations who had multiple banking relationships and who could withdraw the bank deposit to invest had access to capital markets, then why should the central bank follow this route at all? According to the authors, smaller firms are afraid to withdraw their cash deposits for fear of hurting the bank relationship. If so, then the cash deposit-channel might work in the opposite direction. They will not withdraw their cash to invest nor will they earn interest on deposits. Therefore, at the margin, their risk-taking appetite might be impaired. So, such policies might end up favouring market concentration and the dominance of big players over SME firms in Europe that have been the backbone of their economies. The ECB working paper does not seem to have taken these into consideration.

Further, the paper confirms that banks, since they did not want to pass on negative rates to household deposits, increased their fees because fees are “significantly more opaque”.

Funnily, the Bank of England had published a working paper (Staff Working Paper No. 883: ‘Does quantitative easing boost bank lending to the real economy or cause other bank asset reallocation? The case of the UK’ by Simone Giansante, Mahmoud Fatouh and Steven Ongena, August 2020) that shows that banks that received reserve injection from the central bank as part of the asset purchase programme by the central bank directed their reserves to relatively higher-yielding sovereign assets in Europe with low risk weighting rather than using the funds to undertake real lending. So, the authors conclude that the central bank might be better off considering targeted lending programmes. Back to credit allocation!

Negative interest rate is being explored to ensure that real rates are negative and become more negative. But, if inflation is structurally low and cannot be pushed up through policy measures (my view is that they cannot push the inflation rate higher), then policymakers will keep pushing nominal rates deeper into negative territory and/or pursue other disguised and open forms of monetary debasement – nominal GDP targeting, average inflation rate targeting and purchases of all assets.

None of them would address the real economy goals of output, employment and inflation that the central banks are pursuing. Expect more distortions in the economy, asset markets and more frustration for the masses.

Why detonating democracy is a pre-condition

Andrew Sullivan’s ‘Weekly Dish’ is now available in substack.com. Soon, it will become fee-based. Right now, one can subscribe to it. The latest dish is thought-provoking. It is titled, ‘We are all algorithms now’.

Some excerpts:

… the constant delegitimization of liberal democracy by left intellectuals has taken a toll almost as heavy as Trump’s. Every major corporation and cultural institution — from Google to the New York Times — now pays tribute to an extremist ideology, critical race theory, that despises liberal democracy as a mere mask for the brutal, unending oppression of non-whites….

… The sickening street violence that the far left has downplayed, and permitted to run riot in major cities could be a mere taste of what is to come — along with ever-stronger white nationalist gangs instigating or responding in kind. (Trump’s toleration of this dangerous right-extremism in the past four years is as unforgivable as the left’s excuses for murderous violence.) But the upshot is the same: we will be lucky if the country doesn’t erupt in large-scale civil violence by the end of all this.  

[My comment: Amusing for me to see the anxiety to maintain equivalence between far-left anarchy which is now endorsed by the intelligentsia and the mainstream media in America  and far-right extremism which Trump might not have condemned with alacrity but belatedly. Further, his convention speech did say that hate crimes and police excesses would be dealt with by the Justice Department and the laws of the land]

It’s all about the feels, and the irrationality, and the moment, which is why Trump is so perfectly attuned to his time. 

My comment: Again, the anxiety to make sure that Trump is part of or the cause of the problem and not just a manifestation of the trend that the country has taken.

One of the more basic motives in American life — making money — is all you now need, the documentary shows, to detonate American democracy at its foundation. 

My comment: The important point is the detonation of democracy. It is not a side-effect. Elites have deemed it necessary now to continue with making money.

Remember how vast numbers of white liberals drastically shifted their view of America — almost overnight — from a flawed but vibrant multiracial democracy to a version of apartheid South Africa because of a single video of a brutal arrest and murder. This week, I watched videos of people literally burning Harry Potter books, like latter-day Nazis, in the cause of transgender liberation. It’s safe to say, I think, that many of these people have lost their minds — just by staying online. And they not only think they’re perfectly sane; they think they’re heroes…..

…. Watching the videos, even more than reading text about them, raises the percentage of white liberals who believe the cops frequently or always use excessive force by around 20 percentage points.

This is important – on the once-called ‘mainstream media’:

In the past, we might have turned to more reliable media for context and perspective. But the journalists and reporters and editors who are supposed to perform this function are human as well. And they are perhaps the ones most trapped in the social media hellscape….

… The press could have been the antidote to the social media trap. Instead they chose to become the profitable pusher of the poison. Or worse, perhaps they still haven’t realized that this is what they have become: purist, preening propagandists for their own tribe…

… And maybe the result November 3 will be decisive enough to give us a breathing space to rebuild a rational discourse.

[My comment: This is an interesting sentence, thrown in almost as an after-thought. But, the implications are clear. It is a hint that the media and their owners have divided America to defeat Trump just as they have no compunction in detonating democracy to make money.]

He concludes on this note:

My bet on the extinction of liberal democracy in America therefore remains in place, and ahead of schedule. We may even at some point realize that it has already actually happened.

Evidence in favour of unshackling farmers

It is interesting to see the tactics. I am still trying to learn from it or still trying to understand the timing of it. When the government made the announcement in May and passed Ordinances to essentially dilute Agricultural Product Market Committees and allowing farmers to sell to whomsoever they wished, there was not much protest from other political parties. So, it was possible to imagine that this was an idea whose time had come.

As I had noted here, Subhash Garg, the former Secretary of the Department of Economic Affairs, who had turned into a government critic since his removal from the Ministry, transfer and then his subsequent retirement from civil service, had written positively about the agricultural reforms.

Harish Damodaran, a keen observer of Indian farming, wrote eloquently and optimistically. All the links are in my earlier blog post. It will be useful to know the political calculus that shifted in the last four months. Suddenly, they are also coming out of the woodwork.

One of the Ministers in the Union Cabinet resigned. The floodgates opened. As Shankkar Aiyar notes here,

the first protests emerged in Punjab triggering the resignation of Akali Dal leader Harsimrat Kaur Badal from the Union Cabinet. Soon an allusion, the scrapping of minimum support price, turned into a political declaration…. Rahul Gandhi alleged it was a corporate conspiracy. Mayawati dubbed the bills anti-farmer and pro-rich. Mamata Banerjee’s Trinamool Congress said the bills were draconian. 

As Shankkar Aiyar goes on to note,

A model APMC and contract law was shared with states as early as in 2003. In 2007 under the Congress-led UPA, model rules were released and the Congress shifted vegetables and fruits out of APMCs in 2013. Indeed, the 2019 Congress Manifesto expressly states, “Congress will repeal the Agricultural Produce Market Committees Act and make trade in agricultural produce—including exports and inter-state trade—free from all restrictions.”

The Parliamentary Standing Committee has said that APMC do not serve farmers. Cue Shankkar again:

In January 2019, the parliamentary standing committee on agriculture — including MPs from Congress and Akali Dal — observed APMCs have “become hotbed of politics, corruption and monopoly of traders and middleman” and “are not working in interest of farmers”.

Rather surprising to find a piece like this in Mint and its overall negative tone. It paints the glass half-empty. It is one thing to make a case for information flows when transactions are undertaken in the free farming market. It is not that difficult, frankly. How does government track the prices of other goods that go to make up the CPI basket? Can it not repeat them for farm products?

The article wonders if this liberalised farm trade benefited farmers. Disappointing stuff. Same newspapers will also write in favour of liberal international trade. Where is the evidence for it? But, here, there is evidence.

This is from an article in ‘BusinessLine’ on the 29th May 2020:

Despite the lockdown, this year, mango farmers in the Konkan region of Maharashtra reaped handsome gains. Breaking from the past practice of selling their produce to middlemen, they sold their produce of Alphonso mangoes to consumers, directly. That saw the farmers bag between ₹800 and ₹1,000 more for every box of three to six dozen mangoes, depending on the size of the fruit. [Link]

‘Financial Express’ notes on the 7th September:

Signs of a weakening of the Agriculture Produce Marketing Committee (APMC) networks are now evident across major farm production centres in the country, heralding an era of unfettered market access and bolstered bargaining strength for farmers….

…. In many centres, particularly in states like Maharashtra and Uttar Pradesh, the farmer community, organised as farmer producer organisations/companies (FPOs/FPCs), and the small traders/aggregators are giving the APMC markets a miss. In Maharashtra, some FPOs, which FE spoke to, narrated how a definite shifting is taking place in agriculture marketing. There is also anecdotal evidence of aggregators and food processing firms buying directly from the farmers on a scale seen never before….

The quote below from the article in ‘Financial Express’ neatly captures what the government measures have done. How can empowering farmers and giving them more options be bad for them?

… Under a new central law on inter-state trade, farmers have the freedom to sell their produce in any market within and outside the state of their residence, without being hamstrung by the APMCs. No state levies will be imposed on trade outside the APMC mandis and the farmer is supposed to receive payment within three working days after deal. According to the new law, anyone having PAN card can trade, while the Centre reserves the right to lay down any new procedures, including mandatory prior registration….

… Via another Ordinance on contract farming, farmers would get share of post-contract price surge, after they sign agreements of contract farming with private players. Also, they will have the cover of minimum guaranteed price if open market/mandi rates fall drastically

It will be useful to know who is driving the protests and for what ends and why political parties would oppose more choice to the farmers. Harish Damodaran and authors in ‘Indian Express’ provide some answers:

There are two drivers. The first is the farmers, who view the dismantling of the monopoly of APMCs as a precursor to ending the existing system of government grain procurement at assured minimum support prices (MSP)….

… The ordinance itself does not mention anything, directly or indirectly, to suggest an end or phasing out of MSP-based government procurement. But farmer leaders contend that the true intent of the latest reforms is to implement the recommendations of the Shanta Kumar-headed High Level Committee on Restructuring of Food Corporation of India (FCI)….

… (The second set of reasons is) coming from the state governments and arhatiyas (commission agents) in mandis. The arhatiyas (Punjab alone has some 28,000 of them) provide platforms outside their shops, where the produce of farmers is unloaded, cleaned, auctioned, weighed and bagged, before being loaded and moved out. They receive a 2.5% commission over and above the MSP. These payments aggregated over Rs 2,000 crore in Punjab and Haryana last year.

States also earn substantial money from the various levies on the value of produce transacted in APMCs. Punjab’s annual revenues from mandi fees and a ‘rural development’ cess — which add up to 6% on paddy and wheat, 4% on basmati, and 2% on cotton and maize — are estimated at Rs 3,500-3,600 crore. All that would obviously get hit if trades were to move away from the mandis.

The article in ‘Indian Express’ also notes the following:

Farmer leaders in Maharashtra, including Raju Shetti of Swabhimani Paksha and Anil Ghanwat of Shetkari Sanghatana, have actually welcomed the ordinances. Shetti, a two-time Lok Sabha MP, has called them “the first step towards financial freedom for farmers”.

That is the point that Shankkar Aiyar makes at the end of his column:

A product manufacturer can enter into a contract with a buyer, seek an advance, source credit using the order, access know-how, insurer output and sell his produce anywhere. The farmer deserves the same freedom — and liberation from political licence raj.

Further, further on central banks and inflation

My friend Amol Agrawal had flagged two pieces – one by William White and one by Lord Meghnad Desai. His post is here.

I have not read the original pieces yet. But, I read the extracts that Amol had drawn our attention to. My response is as follows:

Based on the excerpts cited, it is hard to see how Mr. White’s arguments are different from Lord Desai’s. Lord Desai’s arguments have been made by William White in other essays, papers and article White had written. Lord Desai’s point that “when prices started to come down, it was not due to policy. It was because after the decade’s oil shocks, capital moved away from the North Atlantic shores to Asia.” has been made by many including by yours truly.

To state it immodestly, my first long essay as a young researcher in 1996, was on the real causes of the decline in inflation and the outlook for inflation, hence.

More recently, the long piece I had written for Mint reiterates these points. It will be useful to your readers to read that piece.

Further, I had argued in my FT ‘Market Insight’ piece that inflation fell as a result of labour arbitrage and not as a result of central bank policies. 

Further, the ‘On the economy’ blog of the Federal Reserve Bank of St. Louis (Nov. 2019) wrote the following:

Still, Dvorkin and Bharadwaj noted that their analysis revealed a negative relationship between automation and routine manual employment in local labor markets, which supports the thesis that automation may be an important driver of polarization in the labor market.

So, even if globalisation is on the retreat (attempts to restore it to its pre-2008 glory is one of the important explanations behind the players arrayed against Trump), technology would keep labour uncertainty up and wage growth down. Therefore, the attempts by central banks to stir inflation through extended loose monetary policy, zero and negative rates at present and forward guidance as to their continuation until inflation rate reaches, on average, 2%, etc., will end up creating inflation elsewhere. That is what William White is focusing on.

Therefore, Lord Desai’s arguments are part of the whole piece and both of them represent two sides of the same coin.

Lastly, these issues are discussed in detail in ‘The Rise of Finance: Causes, Consequences and Fears’ that Gulzar Natarajan and I had written.

Forest fires and financial markets

Barack Obama tweets:

The fires across the West Coast are just the latest examples of the very real ways our changing climate is changing our communities. Protecting our planet is on the ballot. Vote like your life depends on it—because it does. [Link]

A great response:

I live here. Have a seat and learn something, sir. In the state of California the environmentalist lobby sets policy. Controlled burns? Bad for air. Logging to reduce forest density? Bad for the owls. Focus on replacing ancient transmission lines? Nah, we’re building wind farms. [Link]

Edward Luttwak confirms:

My son lives in the north of San Francisco. Lots of trees… lots of free word to be collected with ease for winter warming. But by local ordinance that is forbidden. That is how the wood accumulates, till it burns in forest fires. The California Department of Unintended Consequences.  [Link]

All the three above are in line with an article by James Rickards in ‘Washington Post’ on the 2nd October 2008. It was titled, ‘A mountain, overlooked: how risk models failed Wall St. and Washington’. It is available here

I mention this in my classes. The ‘Great Moderation’ was actually a manifestation of the lesson that James Rickards mentions and was forgotten by policymakers just as California’s Democrats had forgotten the importance of mini forest fires. Central bankers wanted to avoid recession at all costs. Mini recessions are like mini-forest fires to avoid wild fires and mini-avalanches set off by ski slope operators to avoid  big avalanches. The determination to avoid business cycle recessions at all costs resulted in a big one in 2008 and will result in another bigger one again.

Postscript: another interesting tweet by Edward Luttwak:

In AUS, Japan, Vn, India all agree that Trump, whatever his other faults, has been an excellent “national security President” by (finally) reacting to Chinese expansionism & technology theft. They ridicule the DEM line that Trump is subservient to Putin (Nixon embraced Mao…)  [Link

Is inflation targeting in India broken?

About a month ago, I wrote in Mint about India’s inflation targeting regime needing a review. Yesterday, Mint carried a page-long article authored by yours truly on the same topic. The title was chosen by them (‘Why RBI’s inflation regime is broken?’) and it was dramatic. It was edited from the original version and the original is available here: VAN_Inflation management_15092020.

I argue that inflation is only one manifestation of the broader issue of overheating and that India’s original ‘multiple indicators approach’ (well, at least before flexible inflation targeting was enshrined into law) worked quite well until the double-digit inflation episode occurred between 2008 and 2013.

Coincidentally, I ran into this blog post on the website of the Federal Reserve Bank of St. Louis dated 27th August 2020 which shows that why a 2% target may not fit all countries. It is meant for the developed countries, of course. For several countries, ‘Housing, water, electricity, gas and other fuels’ is the single largest component.

Then, as I was about to compile this post, I searched for an article/paper by Prof. Charles Goodhart that I remembered reading that the ‘2%’ number was plucked out of thin air. I could not locate it. I did come across the following references but none of them were download-able:

(1) ‘The political economy of inflation targeting: New Zealand and the UK’ (https://www.researchgate.net/publication/316665290_The_political_economy_of_inflation_targets_New_Zealand_and_the_UK)

(2) ‘Twenty years of modernisation: The Reserve Bank of New Zealand’

Instead, I came across an article by Neil Irwin from the New York Times in 2014 and it stated the following:

To understand that thinking, it’s worth understanding how New Zealand’s 2 percent target became so entrenched in the world economic order to begin with. The story starts in that Southern Hemisphere nation in the summer of 1989, with a kiwi farmer and banker named Don Brash.

When Mr. Brash stepped down as managing director of the New Zealand Kiwifruit Authority to lead the country’s central bank in 1988, he was taking the helm of an economy that had been through a rough two decades, with high inflation and disappointing growth.

Mr. Brash tells the story of an uncle who sold an apple orchard in 1971 and put the money into long-term government bonds to finance his retirement, only to see inflation wipe out 90 percent of his life savings by the time the bonds matured.

In the years before Mr. Brash took the helm of the central bank — the Reserve Bank of New Zealand — his predecessor had made progress in bringing down inflation and making the bank more independent from the whims of politicians. But that independence had not been codified in law.

That’s what the Reserve Bank Act of 1989 was supposed to do. It directed the finance minister and the head of the central bank to arrive at a formal target for how high inflation should be, and granted the central bank political independence to guide interest rates to achieve that inflation level. The head of the central bank could be dismissed for failure to reach the inflation goal.

For David Caygill, New Zealand’s finance minister at the time, the essential part of the law was establishing the bank’s independence from the political process. “Inflation targeting wasn’t from our point of view the main point of the act,” he said in an interview this month.

The debate over the legislation was contentious. Labor unions feared that focusing so pointedly on inflation would lead to higher unemployment. Some business interests agreed. “This is wrong in principle, undemocratic and inflexible,” the New Zealand Manufacturers’ Federation said in a statement in July 1989.

Mr. Brash wrote in his memoir that one prominent real estate developer “called publicly for me to announce my body weight, so that he could work out how much rope would be needed to hang me from a lamppost in Lambton Quay,” referring to the downtown area of Wellington, New Zealand’s capital.

Ultimately, however, the leaders of the majority party in Parliament decided to brush off the concerns. It helped the cause that one of the bill’s strongest opponents was laid up in the hospital. And Christmas was around the corner.

Once the law was enacted, though, there was the difficult question of what the inflation target should be. Zero percent? Two percent? Five percent?

Mr. Brash and Mr. Caygill got a head start on an answer from an offhand comment made during a television interview in 1988. Roger Douglas, Mr. Caygill’s predecessor as finance minister, had been seeking to dissuade New Zealanders from thinking that the central bank would be content with high inflation, and so he said in an interview that he was aiming for inflation of around zero to 1 percent.

“It was almost a chance remark,” Mr. Brash said in a recent interview. “The figure was plucked out of the air to influence the public’s expectations.”

With Mr. Douglas’s figures as a starting point, Mr. Brash and Mr. Caygill agreed that it would be best to expand the range to give them more room to manoeuvre, but only a bit. New Zealand would aim for inflation between zero and 2 percent.

Friedman’s social responsibility of business

Again, my friend Amol Agrawal had blogged about the 50th anniversary of the article by Milton Friedman on 13th September 1970. He had quoted the relevant sentences here:

..the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collective doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means.

That is why, in my book Capitalism and Freedom, I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” [Link]

Friedman’s logic was understandable. He did not want social responsibility to become an excuse for the intrusion of the state into commercial activity either directly or through intrusive regulation. But, he has not anticipated how the ethical pillars of capitalism would be so weakened as to make government intervention look not only plausible but preferable.

The question is whether staying within the rules alone suffices. Externalising internal costs is the big issue. The other issue is creating the very rules of the game themselves. In other words, gaming the rules. These are not socially responsible pursuits of shareholder wealth maximisation.

These trade-offs are not easily resolved. They will come back again and again. Answers would depend on which one appears egregiously harmful and excessive at that point in time. Right now, Friedman appears to have erred just as the conditions that prompted him to write that piece made the argument sound rather appropriate and sagacious.

Fifty years later, Friedman’s logic could again be resurrected. That is how these things play out. But, each generation makes the mistake of thinking that it has discovered or arrived at the final word on the issue.

Origins of dollar hegemony

My friend Amol Agrawal had found this article and blogged about it. How he finds the articles, speeches, papers and historical information to blog about is a trade secret. It is an interesting article but is partial and incomplete. Dollar’s convertibility to gold was a feature of Bretton Woods I.

he best paper to read in this is the late Professor Ron McKinnon’s paper, ‘Rules of the Game’: https://bit.ly/3iDqh4s

The paper came out in 1993. He turned it into a book in 1996. I had not read the book. But, I use this paper in my course on macro-economic and exchange rate concepts and historical developments. I have been teaching this course for more than a decade in different educational institutions with slightly different titles.

That financial institutions promoted the use of dollar and that circumstances (such as American regulations) contributed accidentally to the development of offshore dollar markets are well-known. But, they neither exclude nor contradict political economy explanations for dollar hegemony. Invoicing of global commodities trade in dollars could not have happened without political canvassing, lobbying, arm-twisting and more.

Indeed, the very exclusion of those considerations in this OMFIF piece is, in itself, a good political economy question to pose.

India needs a new strategy for an era of a weakening US dollar

India needs a new strategy for an era of a weakening US dollar

4 min read . Updated: 14 Sep 2020, 09:53 PM ISTV. Anantha Nageswaran

Our forex management needs revision in response to the US Fed’s new monetary policy framework

The speech by the chairperson of the US Federal Reserve on 27 August, while inaugurating the virtual monetary policy symposium held annually at Jackson Hole, marks a radical shift, or, rather, confirms one that has been taking place unofficially, if not quite stealthily, for the last 12 years.

Jerome Powell said that the Fed would target average inflation and that policy decisions would be informed by an assessment of the shortfall from an undefined maximum employment level. This means that interest rates will stay lower for much longer. This is a 180-degree turn from the policy of Paul Volcker in the 1980s that saw real US interest rates spike. That sent the US dollar soaring in the 1980s and cemented its dominance of the post-Bretton Woods world. Therefore, it is logical that this new framework would see the opposite effect on the dollar in the months and years ahead. We should be prepared for prolonged dollar weakness. This has profound implications for India’s foreign exchange (forex) reserve management and currency strategy.

The Reserve Bank of India (RBI) will need to keep buying dollars to prevent the rupee from appreciating and to avoid recognizing losses on its purchase of dollars in the last two years. It might end up being a case of the tiger chasing its tail. It might become the equivalent of retail investors averaging down.

That would erode revaluation reserves. Forex market intervention would allow domestic credit to flow to zombie assets or stock market speculation, or both. Together with non-existent returns on foreign currency assets, holding forex reserves might become an exorbitant burden rather than a sign of strength, as in the past.

To evolve a national consensus on a new forex strategy for India, RBI can do a full-scale comprehensive analysis of the following angles. It can publish a discussion paper, invite comments and then finalize a new strategy.

One: Central bank capital adequacy; because whether RBI intervenes or not, its revaluation losses will rise if the dollar goes into a free fall. In fact, with intervention, RBI will be accumulating more of a depreciating asset.

Two: Trade impact; particularly on India’s oil import bill and exports. Note that export growth is more a function of demand (i.e., income growth in target markets) than of prices, which are influenced by the exchange rate. The most recent evidence from India is the performance of Indian exports in the period between 2002 and 2008 and again in 2010 and 2011. Exports surged despite rupee strength. A global growth boom was the more critical factor for India’s export performance.

Three: India’s balance sheet situation; the International Investment Position (IIP) is just a statement of foreign currency assets and liabilities. A strong currency could be used to improve the external debt situation by paying down debt. Alternatively, the country can examine refinancing costly foreign currency loans at lower rates, or pursue a combination of the two.

Sustained strength in the Indian rupee will be an unusual experience. The last time it happened was soon after the new millennium, when the “India has arrived” story gained traction. India took on too many external liabilities for too little productive payoff. It did not end well. In fact, it is not over yet. We should not repeat those follies. Further, currency strength would run counter to Atmanirbhar Bharat, as it makes imports attractive. So, the government and RBI must act in concert.

The competitiveness of Indian manufacturing must be enhanced through other means. Subsidizing retail and agricultural consumption of electricity at the expense of industrial users must be re-examined. Land-use conversion from agriculture to non-agriculture must be eased, simplified and made less costly in terms of both time and money. Regulatory and compliance burdens must be systematically eased by a time-bound plan, with transparent monitoring and reporting to the public. States must come on board and the Centre should kick-start the process by calling a summit with chief ministers.

Despite the recent re-classification of micro, small and medium enterprises (MSMEs), the new thresholds do not go far enough in incentivizing their growth. They remain growth-unfriendly and need to be revisited. Payments to MSMEs for goods sold and services rendered must happen automatically. Both the government and private sector buyers are guilty. Goods and services tax invoices and the government’s e-procurement must be automatically linked to the Trade Receivables System. It is technically feasible, and should be mandated with severe penalties for non-compliance.

If these changes happen, then India can have the best of both worlds: a strong currency and firm economic fundamentals, with the former reflecting the latter. However, business-as-usual, with RBI resisting a rising rupee, will succeed not in weakening the currency, but hurt the economy in multiple ways.

Covid’s fallout is upending familiar behaviour patterns and policy responses. The sooner we recognize them, the stronger we’ll emerge. I am not sure if there is any other option.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views. [Link]

For those interested, pl. find below the INR-REER (BIS version):

Also, a good exposition of the underlying issues has been done by Sajjid Chinoy in BloombergQuint.